Of all the proposals that Finance minister Nirmala Sitharaman presented in her speech as part of the Union Budget 2022-23, the announcement about the launch of digital rupee had the potential to touch the lives of almost all Indians. While there was speculation about the digital rupee for very long, its contours were not known. The finance minister, in her speech, further clarified that the digital rupee or the Central Bank Digital Currency (CBDC) will be based on latest technologies on par with the digital framework behind Bitcoin and other popular cryptocurrencies.
While Presenting Union Budget 2022, Finance Minister Nirmala Sitharaman announced that the Reserve Bank of India (RBI) would be rolling out its digital currency soon. The Central Bank Digital Currency (CBDC), RBI's digital currency is going to be introduced in 2023.
"Introduction of a central bank digital currency will give a big boost to the digital economy. Digital currency will also lead to a more efficient and cheaper currency management system," Sitharaman had said in her Budget speech.
Many people are getting confused between cryptocurrency and digital currency. So are they the same? ; What is the difference between the two? ; Do we need them? What are all the Myths & Reality surrounding to it ?
Lets us discuss them in a brief manner.
What is a Central Bank Digital Currency?
A Central Bank Digital Currency (CBDC) is a digital form of a legal tender issued by the central bank. It is equivalent to fiat cash and may be exchanged one-to-one but in a different form. A sovereign currency in electronic form will appear on the central bank's balance sheet as a liability (currency in circulation). It should be possible to exchange CBDCs for cash.
Central banks worldwide are promoting digital currencies for various reasons including to popularise usage of electronic money and thwart the emergence of private digital assets such as cryptocurrencies.
Unlike other cryptocurrencies that are DeFi or decentralised financial tokens, CBDCs will be backed by central reserves just like all other fiat currencies. The digital rupee is essentially going to be the digital representation of a rupee backed by the Reserve Bank of India (RBI).
Difference between a CBDC and Cryptocurrency
CBDC (Central Bank Digital Currency)
The electronic form of fiat money used in contactless transactions is called a digital currency.
Cryptocurrency is a store of value that is protected by encryption.
A central body oversees the digital currency (RBI for India).
Cryptocurrency is uncontrolled and decentralised.
The value of digital currencies is stable, as they are accepted worldwide.
The value of cryptocurrencies is highly volatile, and digital coins are not yet generally recognised.
Only the sender, receiver, and bank are aware of digital currency transactions.
On a decentralised ledger, cryptocurrency transactions are made public.
Strong passwords are required to protect digital wallets, banking apps, credit cards and debit cards.
Encryption protects cryptocurrencies.
Developing our own CBDC could provide the public with uses that any private Virtual Currencies can provide and to that extent might retain public preference for the Rupee. It could also protect the public from the abnormal level of volatility some of these VCs experience
What is the need for a CBDC?
While interest in CBDCs is near universal now, very few countries have reached even the pilot stage of launching their CBDCs. A 2021 BIS survey of central banks found that 86% were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects.
Why this sudden interest?
The adoption of CBDC has been justified for the following reasons:-
(i) Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency;
(ii) Jurisdictions with significant physical cash usage seeking to make issuance more efficient;
(iii) Central banks seek to meet the public's need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.
CBDCs have some clear advantages over other digital payments systems - payments using CBDCs are final and thus reduce Settlement risk in the financial system.
Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over - the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements - there would be no 'Settlement' risk.
Do we need CBDC in India?
India is leading the world in terms of digital payments innovations. Its payment systems are available 24X7, available to both retail and wholesale customers, they are largely real-time, the cost of transaction is perhaps the lowest in the world, users have an impressive menu of options for doing transactions and digital payments have grown at an impressive CAGR of 55% (over the last five years). It would be difficult to find another payment system like UPI that allows a transaction of one Rupee.
For India in particular, another benefit of RBI's CBDC is that India's high currency to GDP ratio could be reduced if cash usage is reduced by CBDC introduction. While India has made huge strides in digital payments with UPI, the significant displacement of cash is still a challenge due to the anonymity that cash offers.
A pilot survey conducted by the Reserve Bank on retail payment habits of individuals in six cities between December 2018 and January 2019, results of which were published in April, 2021 RBI Bulletin (please see charts below) indicates that cash remains the preferred mode of payment and for receiving money for regular expenses. For small value transactions (with amount up to ₹500) cash is used predominantly.
To the extent the preference for cash represents a discomfort for digital modes of payment, CBDC is unlikely to replace such cash usage. But preference for cash for its anonymity, for instance, can be redirected to acceptance of CBDC, as long as anonymity is assured.
Addressing this aspect in a non-intimidatory manner as part of the new CBDC can spur mass adoption in cash-driven micro-economies, which could in turn reduce the overall demand for physical currency. This can significantly and positively impact the huge costs of printing, transporting, storing, and distribution of physical currency, Mainstream adoption of this CBDC can be a giant step in transforming India into a digitally empowered country and attain the government's vision of achieving a cashless economy. It could be a game-changer, bringing further rapid shifts in the banking and payments ecosystem.
Debunking Myths & Misconceptions about CBDC
Is CBDCs is a new concept?
In the past, Central bank digital currency (in retail form) existed as early as the 1990s, when Finland introduced the Avant Card. However, central bank retail deposits were abolished so that central banks would not compete with the rest of the financial system. And the Avant Card failed because its network of users was too small. So, what is new is not CBDCs, but the fact that they can now quickly establish themselves in modern digital networks, where buyers and sellers can access them effortlessly.
Is CBDCs is a response to the popularity of Cryptocurrency?
No, there are a lot of use cases for digital currency in India. The simplest ones include giving specific subsidies like food subsidies, etc. The government can transfer the subsidy via CBDCs to the beneficiary who can then use it for that specific purpose only. So a CBDC transferred for buying ration cannot be used for paying rent. This is even better than direct cash transfer to bank accounts where you are not sure how the cash is being utilized.
Not just subsidies. CBDCs can be used to create impulses in the economy too. Suppose, the government decides to boost some part of the economy, say travel. The government can issue a travel CBDC to everyone to use only for travel. Sure, we have Leave Travel Allowance (LTA) for it right now but it comes with its own complex execution mechanisms. A digital taken that can be instantly used with IRCTC or some travel aggregator can be a game-changer.
Is one CBDCs can be used commonly by all countries?
There is no one-size-fits-all CBDC solution. Central banks can tailor their own CBDC to their specific requirements, in the same way that different countries have different banknotes.
For example, Japan must consider specific offline requirements to account for frequent earthquakes and power outages, while African Central Banks want to ensure digital payment for unbanked parts of society.
Everyone will have bank accounts at central banks!
There are various types of CBDC, from account-based to token-based concepts, and the extent to which central banks are involved in retail interactions varies. In most countries, the involvement of central banks will be minimal. Since commercial banks have existing relationships with consumers, they are the best players to distribute a CBDC; they provide existing apps that can be extended to utilize CBDC, and they have the know-how to manage Know Your Customer (KYC) processes.
CBDC is just another form of digital payment!
Existing digital payment schemes either require a subscription and/or a bank account or credit card, or they impose fees. Furthermore, not all merchants accept payment by every type of digital service provider. In contrast, a CBDC would be an official legal tender with the same functions as physical money, backed by a central bank. It would be the first truly interoperable digital means of payment, meaning any merchant or person would accept it. It serves as unit of account to value goods and services, and is a store of value that can be saved, retrieved, and exchanged at a later time.
People need an internet connection to pay with CBDC!
As a CBDC is legal tender, payment must be guaranteed at any time - even in areas without a network or internet connection or electricity - e.g., when there is a power outage. RBI & NPCI soon would enables consecutive offline payments to ensure digital payments can be made by everyone, everywhere, at any time by way of USSD for UPI and other online modes.
Every CBDC payment can be tracked!
Today, digital payments always involve disclosing personal data to a payment services provider, a merchant, or both. A CBDC should allow complete anonymity up to a certain threshold - as is the case with cash. The possibility to truly balance privacy versus transparency will be crucial to the development of CBDC as it should provide privacy to the user while still meeting the required Statutory & Legal compliances requirements of the central bank in order to prevent money laundering or tax evasion.
CBDC is always based on Blockchain technology!
Blockchain is a great technology that works very well for certain use cases. However, because a CBDC is provided by a trusted institution, blockchain is not essential to its operation. While a number of design criteria for a CBDC can be met by blockchain and distributed ledger technology (DLT), there would be difficulties to achieve such as secure consecutive offline payments, the possibility to truly balance privacy versus transparency, and also ensuring highest resilience with no single point of failure in a CBDC ecosystem.
India's Finance Minister Nirmala Sitharaman announced that the central bank will be ready to launch its blockchain-based central bank digital currency (CBDC), the digital rupee, before March 2023. However, the Reserve Bank of India's (RBI) Executive Director, T Rabi Sankar, clarified that the central bank is also open to other technologies.
For the implementation of the CBDC in India to be successful, some breakthrough initiatives on various parameters remain keys - such as planning for better digital financial literacy in rural, unbanked and underbanked populations, deployment of robust tech infrastructure, a strong legal framework, and the elimination of cultural barriers.
The successful adoption of this technology in India will also depend upon the creation of a strong regulatory framework, which will not only help govern the technology but also actively address potential barriers to adoption of CBDCs.
The digital currency infrastructure requires significant investments and its implementation will not be without initial as well as ongoing hiccups. The threat of cyber-crimes surrounding digital payments and currencies demand that cutting-edge cybersecurity measures be applied, apart from the use of technologies that ensure high standards of user experience to drive adoption. It is imperative to secure early stakeholder participation and commitment to ensure the success of this initiative.