Central bank digital currency (CBDC)

  • September 8, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Central bank digital currency (CBDC)

Subject: economy

Why in the news?

Central bank digital currency (CBDC), to be launched this year, could become a tool for reducing time and cost for cross-border transactions, Reserve Bank Deputy Governor T Rabi Sankar.

Details:

CBDC is probably the most efficient tool for reducing time and cost for cross-border transactions by eliminating the  settlement risk.

Concept:

  • A Central Bank Digital Currency (CBDC), or national digital currency, is simply the digital form of a country’s fiat currency.
  • Instead of printing paper currency or minting coins, the central bank issues electronic tokens.
  • This token value is backed by the full faith and credit of the government.
  • CBDC is a legal tender issued by a central bank in a digital form.
  • It is similar to a fiat currency issued in paper and is interchangeable with any other fiat currency.

Merits 

  • Reduce the cost of currency management
  • May reduce inflation – as a high currency to GDP ratio is inflationary (might decline unnecessary cash holdings.
  • Digital Rupee transactions will be instantaneous as opposed to the current digital payment experience.
  • Enabling real-time payments without any inter-bank settlement thus, reducing transaction cost and time.
  • The cost of printing, transporting and storing paper currency can be substantially reduced.
  • Financial inclusion.
  • Better targeting of beneficiary of cash subsidy schemes
  • Counter the growth of private forms of digital money.
  • The state-backed digital currency can provide investor/consumer protection, the private can confidently invest in the associated infrastructure without any doubts over its regulation.
  • Less volatile than other private digital currency as regulated by the RBI
  • Better monetary policy transmission
  • The central bank would be able to keep a track of the exact location of every unit of the currency, thereby curbing money laundering, terror financing and counterfeiting.
  • Reduce dependence on dollar for international transaction

Concerns

  • Digital illiteracy
  • Lack of internet and smartphone penetration
  • Technology related exclusion from welfare schemes
  • Cyber threat
  • Collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency thus privacy concerns
  • Technological issues- underlying technology, the validation mechanism and distribution architecture.
  • Sudden flight of money from a bank under stress is another point of concern.
  • Eliminate the large infrastructure of banking and financial institutions.

CBDC vs Cryptocurrency

BasisCryptocurrency Central Bank Digital Currency
Meaning Digital token issued  by a private institution or firm.Central bank digital currencies are digital tokens, similar to cryptocurrency but issued by a central bank.
Legality Not a fiat currency as not backed by the government.A central bank digital currency is the digital form of a country’s fiat currency.
Technology Based on cryptography and blockchain technology i.e a public ledger needs every user consent for transaction.Central bank digital currencies are designed to be similar to cryptocurrencies, but they may not require blockchain technology or consensus mechanisms.
Intrinsic value No intrinsic value but used for transaction due to acceptability, scarcity and anonymity.They are pegged to the value of that country’s fiat currency.
Regulation Cryptocurrencies are unregulated and decentralized thus, involving anonymous transactions.As a centralized form of currency, they may not anonymize transactions as some cryptocurrencies do.
Effect on monetary policy Complicates monetary policy transmission for being a parallel unregulated currencyCBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.
Value Cryptocurrencies are highly volatile, with their value constantly fluctuating.CBDCs, backed by a government and controlled by a central bank, would provide households, consumers, and businesses with a stable means of exchanging digital currency.
Acceptability Their value is dictated by investor sentiments, usage, and user interest.Legal backing
Spending Double spending as software on a computer

can be used repeatedly.

Fiat currency has the property that once spent, it cannot be spent again except through forgery, be-

cause it is no more with the spender.

Note:

  • Cross border payments are transactions between a payer and a payee, who are located in separate countries. They can be combinations of payments between individuals and banks or companies.
  • Presently, cross border payments take place through channels such as SWIFT, Rupee Drawing Arrangement (RDA) and Money Transfer Service Scheme (MTSS).
Central Bank Digital Currency (CBDC) economy