Central Bank Digital Currency

Central Bank Digital Currency



Why in the News?


Speaking at the BIS Innovation Summit 2024 in Basel, Switzerland, Governor Das expressed the RBI’s intentions to conduct pilot trials involving the usage of Central Bank Digital Currency (CBDC) in commercial papers and certificates of deposits. He emphasized the transformative potential of the e-Rupee and highlighted the significant opportunities for the digitization of payments.


About the Digital Currency


A central bank digital currency (CBDC) refers to a type of digital currency issued by a nation’s central bank. It shares similarities with cryptocurrencies, but unlike them, its worth is determined and guaranteed by the central bank, aligning with the value of the country’s traditional fiat currency.


What is Fiat Currency?

  • Fiat currency denotes a government-issued form of money that lacks tangible backing such as gold or silver. It holds status as legal tender, enabling its exchange for goods and services.
  • Historically, fiat currency primarily comprised banknotes and coins, but technological advancements have enabled governments and financial entities to complement physical fiat currency with a credit-based system, facilitating digital recording of balances and transactions.


Type of Central Bank Digital Currency


There are typically three classifications of Central Bank Digital Currencies (CBDCs): retail, wholesale, and hybrid. 

  • Retail CBDCs: Retail CBDCs are tailored for use by the general public, enabling individuals to conduct everyday transactions and payments. They are accessible to the public through digital wallets, smartphone applications, or other payment platforms. Designed to function akin to physical cash, retail CBDCs offer a secure and digital method for conducting transactions.
  • Wholesale CBDCs: Wholesale CBDCs are designed for utilization among financial institutions, such as banks, and are not directly accessible to the general public. They serve to facilitate high-volume and high-value transactions, such as interbank transfers and securities settlements.
  • Hybrid CBDCs: Hybrid CBDCs amalgamate features from both retail and wholesale CBDCs. They offer greater flexibility compared to the other two categories as they can be employed by both the general public and financial institutions. Depending on the requirements of the user, hybrid CBDCs can accommodate everyday transactions as well as large-scale purchases.


Purpose of Central Bank Digital Currency


  • CBDCs could potentially reduce the expenses associated with maintaining a complex financial system, diminish cross-border transaction costs, and furnish individuals currently using alternative methods of money transfer with more economical alternatives.
  • CBDCs also present the opportunity to mitigate the risks linked with utilizing digital currencies or cryptocurrencies in their current state.
  • Reinforcing the implementation and oversight of monetary policy by central banks while also enhancing the capacity to identify and prevent illicit activities through real-time monitoring and analysis of CBDC transactions.
  • The primary aim of CBDCs is to offer businesses and individuals engaging in financial transactions with privacy, transferability, convenience, accessibility, and financial security.
  • The main objective is to reduce risks and minimize expenses associated with managing physical currency, including costs related to replacing damaged notes, transportation, insurance, and logistical operations.


Why is the RBI promoting Digital Currency?


  • Reduced Central Bank Costs: CBDCs may decrease the expenses associated with printing and circulating physical currency and diminish the reliance on intermediaries in payment processes.
  • Enhanced Security and Privacy: CBDCs ensure secure transactions and offer increased privacy, thereby mitigating the risks of fraud and identity theft.
  • Potential for Economic Growth: CBDCs facilitate faster and more efficient payments, potentially stimulating economic activity and fostering growth.
  • Facilitation of Cross-Border Transactions: CBDCs can simplify and lower the costs of international transactions, reducing the necessity for foreign exchange conversions and intermediaries.
  • Mitigation of Illicit Activities: CBDCs can potentially decrease illegal activities such as money laundering and tax evasion by meticulously recording and tracing all transactions.
  • Simplified Tax Collection: CBDCs could streamline tax collection procedures due to the comprehensive recording and tracking of transactions.
  • Increased Transaction Efficiency: CBDCs can streamline payment systems, shorten settlement times, and facilitate quicker and more convenient transactions.
  • Enhanced Financial Inclusion: CBDCs can broaden access to financial services for individuals and businesses underserved by traditional banks, thus fostering financial inclusion.
  • Improved Monetary Policy Control: CBDCs offer central banks improved tools for managing inflation, interest rates, and other macroeconomic indicators, thereby aiding in economic stabilization.



Challenges with Digital currency


  • Regulatory and Legal Considerations: Current laws and regulations may require adjustments to accommodate the distinctive features and needs of CBDCs, such as programmability and controlled anonymity.
  • Technological Infrastructure and Security: CBDCs must be equipped with robust security measures to safeguard against cyber threats, including encryption, multi-factor authentication, and secure data storage. 
  • Privacy and Anonymity Concerns: Balancing the imperative for privacy and anonymity with the necessities for anti-money laundering and counter-terrorism financing presents a delicate challenge.
  • Public Adoption and Awareness: Encouraging the public to utilize and embrace a new CBDC system, particularly when contrasted with the flexibility and familiarity of physical cash, can pose a significant obstacle. 
  • Competing with Private Banks: CBDCs may pose a potential competition to private banks for attracting deposits, potentially influencing their capacity to lend and make investments.


Way Forward


  • Suitable Regulatory Frameworks: Develop clear and adaptable legal and regulatory frameworks to govern the utilization of CBDCs and mitigate potential risks. Foster collaboration among central banks, financial institutions, and policymakers to create a conducive environment for CBDC adoption.
  • Promote Public Awareness: Educate the public on the advantages and applications of CBDCs to foster trust and encourage widespread adoption. Encourage businesses and consumers to embrace CBDCs through various promotional initiatives and campaigns.
  • Cybersecurity and Privacy: Implement robust security protocols to safeguard CBDCs from cyber threats and maintain the system’s integrity. Strike a balance between preserving privacy and anonymity while fulfilling anti-money laundering and counter-terrorism financing obligations.
  • Integrate  Emerging Technologies: Integrate CBDCs with cutting-edge technologies such as blockchain, smart contracts, and offline payment capabilities to enhance their functionality and attractiveness.


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Prelims based Question


Q1. Consider the following statements regarding Central Bank Digital Currency:

  1. Bahamas was the first economy to launch CBDC nationwide.
  2. CBDCs aim to reduce the cost of Financial transactions.

Choose the correct answer using the codes given below:

(a). 1 Only

(b). 2 Only

( c ) . Both 1 and 2

(d) . Neither 1 nor 2





Mains Based Question


Q1. What are CBDCs? How is it different from cryptocurrency? What are the key challenges and obstacles associated with the implementation and adoption of Central Bank Digital Currencies (CBDCs)?


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