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Central Bank Digital Currency (CBDC)

  • IASbaba
  • July 22, 2022
  • 0
Economics
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In News: The Reserve Bank of India (RBI) is in the process of implementing the Central Bank Digital Currency (CBDC) in a phased manner for wholesale and retail segments

  • The introduction of CBDC was announced in the Union Budget 2022-23, by Finance Minister and necessary amendments to the relevant section of the RBI Act, 1934 have been made with the passage of the Finance Bill 2022
  • India’s official digital currency is likely to debut by early 2023, which will mirror any of the currently available private company-operated electronic wallets.
  • The CBDC will be a sovereign-backed digital currency.

Central Bank Digital Currency (CBDC)

  • CBDCs are a digital form of a paper currency and unlike cryptocurrencies that operate in a regulatory vacuum, these are legal tender issued and backed by a central bank.
  • Budget 2022-23, the Government of India announced that its central bank will issue a digital currency as early as 2022-23.
  • The main objective is to mitigate the risks and trim costs in handling physical currency, costs of phasing out soiled notes, transportation, insurance and logistics.
  • It will also wean people away from cryptocurrencies as a means for money transfer.

Merits

A Combination of Traditional and Innovative:

  • CBDC can gradually bring a cultural shift towards virtual currency by reducing currency handling costs.

Easier Cross-Border Payments:

  • CBDC can provide an easy means to speed up a reliable sovereign backed domestic payment and settlement system partly replacing paper currency.
  • It could also be used for cross-border payments; it could eliminate the need for an expensive network of correspondent banks to settle cross-border payments.

Financial Inclusion:

  • The increased use of CBDC could be explored for many other financial activities to push the informal economy into the formal zone to ensure better tax and regulatory compliance.
  • It can also pave the way for furthering financial inclusion.

Risks

Privacy Concerns:

  • The first issue to tackle is the heightened risk to the privacy of users—given that the central bank could potentially end up handling an enormous amount of data regarding user transactions.
  • This has serious implications given that digital currencies will not offer users the level of privacy and anonymity offered by transacting in cash.

Disintermediation of Banks:

  • The shift to CBDC can impinge upon the bank’s ability to plough back funds into credit intermediation.

Other risks are:

  • Faster obsolescence of technology could pose a threat to the CBDC ecosystem calling for higher costs of upgradation.
  • Operational risks of intermediaries as the staff will have to be retrained and groomed to work in the CBDC environment.
  • Elevated cyber security risks, vulnerability testing and costs of protecting the firewalls
  • Operational burden and costs for the central bank in managing CBDC.

Way forward

  • Robust data security systems will have to be set up to prevent data breaches. Thus, it is important to employ the right technology that will back the issue of CBDCs.
  • The financial data collected on digital currency transactions will be sensitive in nature, and the government will have to carefully think through the regulatory design. This would require close interaction between the banking and data protection regulators.
  • Also, the institutional mechanisms would need to ensure that there is no overlap between different regulators and chart out a clear course of action in case there is a data breach of digital currencies.

Source: The Hindu

Previous Year Question

Q.1) With reference to ‘Bitcoins’, sometimes seen in the news which of the following statements is/are correct (2016)

  1. Bitcoins are tracked by the Central Banks of the countries.
  2. Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a Bitcoin address.
  3. Online payments can be sent without either side knowing the identity of the other.

Select the correct answer using the code given below:

  1. 1 and 2 only
  2. 2 and 3 only
  3. 3 only
  4. 1, 2 and 3

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