Central Bank Digital Currency (CBDC)

  • IASbaba
  • August 24, 2022
  • 0
Economics
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In News: Recent report stated that Reserve Bank of India’s (RBI) digital rupee — the Central Bank Digital Currency (CBDC) — may be introduced in phases beginning with wholesale businesses in the current financial year.

  • In budget 2022-23, Finance Minister had said that the central bank would launch the CBDC in the financial year 2022-23.

What is Central Bank Digital Currency (CBDC)?

  • CBDC is the legal tender issued by a central bank in a digital form.
  • It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.
  • The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
  • Though the concept of CBDCs was directly inspired by Bitcoin, it is different from decentralised virtual currencies and crypto assets, which are not issued by the state and lack the ‘legal tender’ status.
  • CBDCs enable the user to conduct both domestic and cross-border transactions which do not require a third party or a bank.

Significance

  • It would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
  • India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC to the extent large cash usage can be replaced by (CBDC), the cost of printing, transporting and storing paper currency can be substantially reduced.
  • It will also minimize the damage to the public from the usage of private virtual currencies.
  • It will enable the user to conduct both domestic and cross border transactions which do not require a third party or a bank.
  • It has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, and reduced settlement risk.
  • It would also possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option.

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.
  • Compromise of credentials is another major issue.

Disintermediation of Banks:

  • If sufficiently large and broad-based, the shift to CBDC can impinge upon the bank’s ability to plough back funds into credit intermediation.
  • If e-cash becomes popular and the Reserve Bank of India (RBI) places no limit on the amount that can be stored in mobile wallets, weaker banks may struggle to retain low-cost deposits.

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

  • The usage should be payment-focused to improve the payment and settlement system. Then it can steer away from serving as a store of value to avoid the risks of disintermediation and its major monetary policy implications.
  • 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 RBI will have to map the technology landscape thoroughly and proceed cautiously with picking the correct technology for introducing 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: Indian Express

 

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