The Reserve Bank of India has been working on a phased implementation strategy for a CBDC and the pilot may be launched by the end of this year.
RBI Digital Currency- Central Bank Digital Currency (CBDC)
- CBDC is the same as currency issued by a central bank but takes a different form than paper.
- It is the sovereign currency in an electronic form and it would appear as a liability (currency in circulation) on a central bank’s balance sheet.
- The underlying technology, form, and use of a CBDC can be molded for specific requirements. CBDCs should be exchangeable at par with cash.
- The idea of “Central Bank Digital Currencies” (CBDC) is not a recent development. Some attribute the origins of CBDCs to Nobel laureate James Tobin, an American economist, who in the 1980s suggested that Federal Reserve Banks in the United States could make available to the public a widely accessible ‘medium with the convenience of deposits and the safety of currency’.
What are the Benefits of CBDC?
- Alternative to physical cash
- Instantaneous process: Transacting with CBDC would be an instantaneous process. The need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another.
- Reduces cost of currency management: India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC. Large cash usage can be replaced by CBDC. Also, the cost of printing, transporting and storing paper currency can be substantially reduced.
- Need of the hour: If the private currencies gain recognition, national currencies with limited convertibility are likely to come under some kind of threat. CBDCs thus become the need of the hour.
- Volatility: CBDCs, being the legal tender by Central Bank, will not witness any volatility as in the case of cryptocurrencies.
- Easy tracking of currency: With the introduction of CBDC in a nation, its central bank would be able to keep a track of the exact location of every unit of the currency.
- Curbing Crime: Criminal activities can be easily spotted and ended such as terror funding, money laundering, and so forth
- Scope in Trade: Foreign trade transactions could be speeded up between countries adopting a CBDC.
Why is CBDC preferred over Cryptocurrency?
- Sovereign guarantee: Cryptocurrencies pose risks to consumers. They do not have any sovereign guarantee and hence are not legal tender.
- Market volatility: Their speculative nature also makes them highly volatile. For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
- Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
- Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
- Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering. They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
- Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy. This could pose a risk to the financial stability of the country if their use becomes widespread.
- Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).
What is the difference between CBDCs and cryptocurrency?
- Cryptocurrencies, such as Bitcoin, are digital tokens created by a distributed network or blockchain using cryptographic tools. CBDC are legal tenders by Central Bank.
- While cryptocurrencies are decentralized, CBDCs are centralized
- Cryptocurrencies offer anonymity, CBDCs would allow central banks to know exactly who holds what.
- CBDCs are also not stablecoins, which are a form of cryptocurrency that is pegged to another asset, for example, Tether. A CBDC would not be pegged to any fiat currency; it would be the fiat currency. A CBDC version of a dollar would be the same as a dollar bill.
Issues involved with CBDC
- Innovation with centralization: The approach of bringing a sovereign digital currency stands in stark contrast to the idea of decentralization.
- Liability on RBI: when bank customers wish to convert their deposits into digital rupee, the RBI will have to take these liabilities from the books of banks and onto its own balance sheet.
- Inflationary risk: Central banks would indulge in issuing more digital currencies which could potentially trigger higher inflation.
- User adoption: User adoption could also pose a major setback for the smooth roll out of the CBDC in India. The main challenges would always be user adoption and security.
- Reduced savings: Many, including various central bankers, fear that people may begin withdrawing money from their bank accounts as digital currencies issued by Central banks become more popular.
- Volatility: the risk is higher and there is more price volatility and lesser acceptance as a money instrument globally, unless the trust factor and investor protection factors change.
- The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
- The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
- There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.
- RBI is creating small pivot for experimenting CBDC where financial transaction is happening through digital currency.
- CBDC has to be a gradual process, various nuances has to be taken care not only about its utilization but also about the impact it will make.
- More clarity on the concept in the days to come will be the key for CBDCs and much will depend on how the whole concept will evolve in India which is predominantly a paper currency market.
Source: Indian Express