Central Bank Digital Currency (CBDC) -The Digital Rupee

Central Bank Digital Currency (CBDC) the Digital Rupee- Relevance for UPSC

General Studies III- Economy.

In News

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.

What is Central Bank Digital Currency (CBDC)?

• CBDC is the legal tender issued by a central bank in a digital form and is the same as a fiat currency and is exchangeable one-to-one with the fiat currency.
• 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 decentralized 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.

Advantages of CBDC

• CBDC is a high-security digital instrument and can be used for payment, a unit of account, and a store of value
• Like paper currency, each unit is uniquely identifiable to prevent counterfeit.
• It is a liability of the central bank just as physical currency is.
• It is a digital payment instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.
• It is efficient than printing.
• It reduces the risk of transactions.
• It makes tax collection transparent.
• Prevents money laundering.

How will CBDC help?

• Introduction of CBDC has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, reduced settlement risk.
• Introduction of CBDC would also possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option.
• RBI had proposed amendments to the Reserve Bank of India Act, 1934, which would enable it to launch a CBDC.
• The government had been planning at the time to introduce a Bill in Parliament that would prohibit “all private cryptocurrencies in India” with “certain exceptions.”
• Government has received a proposal from Reserve Bank of India in October 2021 for amendment to the Reserve Bank of India Act, 1934 to enhance the scope of the definition of ‘bank note’ to include currency in digital form.

CBDC preferred over Cryptocurrency- The reason

• Cryptocurrencies pose risks to consumers and do not have any sovereign guarantee and hence are not legal tender.
• Their speculative nature also makes them highly volatile.
• A user loses access to their cryptocurrency if they lose their private.
• In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
• Cryptocurrencies are more vulnerable to criminal activity and money laundering as they provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
• A central bank cannot regulate the supply of cryptocurrencies in the economy which could pose a risk to the financial stability of the country if their use becomes widespread.
• Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security. For example, the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland.

Need in India

• India is a leader in digital payments, but cash remains dominant for small-value transactions which can be to a certain extent replaced by CBDC.
• India has a fairly high currency-to-GDP ratio.
• An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.