Working of Central bank digital currency (CBDC)

Last Updated24/09/2021

The Reserve Bank of India is likely to soon start pilot projects to assess the viability of using digital currency to make wholesale and retail payments.
The projects shall help adjust RBI’s strategy for introducing a full-scale central bank digital currency (CBDC).
A high-level inter-ministerial committee set up by the Finance Ministry had recommended the introduction of a CBDC with changes in the legal framework including the RBI Act, which currently empowers the RBI to regulate issuance of bank notes.

It is a legal tender and liability of a nation’s central bank in the digital form.
It is denominated in a sovereign currency and appears on the balance sheet of a nation’s central bank.
CBDC is a digital currency which can be converted/exchanged at par with similarly denominated cash and traditional central bank deposits of a nation.
At present, central banks of various nations are currently examining the positive implications that a digital currency contributes to financial inclusion, economic growth, technology, innovation and increased transaction efficiencies.

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.

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.

Ban anybody who mines, hold, transact or deal with cryptocurrencies in any form.
It recommends a jail term of one to 10 years for exchange or trading in digital currency.
It proposed a monetary penalty of up to three times the loss caused to the exchequer or gains made by the cryptocurrency user whichever is higher.
However, the panel said that the government should keep an open mind on the potential issuance of cryptocurrencies by the Reserve Bank of India.

Potential cybersecurity threat.
Lack of digital literacy of population.
Introduction of digital currency also creates various associated challenges in regulation, tracking investment and purchase, taxing individuals, etc.
Threat to Privacy: The digital currency must collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency.