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What is Central Bank Digital Currency or CBDC in layman terms?

CBDC is Fiat currency in virtual or digital form that is issued and regulated by the Central Bank of a sovereign state. Fiat currency is generally understood as legal currency issued by government which is not backed by any commodity such as gold or silver.

In India, CBDC is proposed to be introduced by Reserve Bank of India (‘RBI’) before the end of next year. It is rumoured that India’s CBDC may be named as e-Rupee or Bharat Coin.

Is CBDC same as stable coins in concept?

One may argue that it is same as stable coins [eg Tether (USDT), USD Coin(USDC)] currently issued as a class of cryptocurrency, but one major difference is that stable coins are private currency not issued or backed by central government, but only backed by fiat currency, commodity or other cryptocurrencies.

Functioning of CBDC

Everybody will need to have a wallet or an account with the central bank bypassing local intermediary banks, with whom we currently have our bank accounts. 

CBDC and current forms of payments (cash, digital payments, etc)

In my opinion, there is one key difference between CBDC and current forms of digital payments like G-pay and UPI in India. For instance, when a person makes payments at a retail store through G-pay and UPI, there is immediate execution of front-end transaction of payment from the buyer to the retailer, but banks still bear a risk till the back-end transaction is complete. The back-end transaction is pending to be completed between both the sender’s and the receiver’s banks which happens through their accounts with the RBI and is usually believed to happen once at the end of day. 

Thus, along with the trail/traceability of money, there are intermediaries involved in the current system of digital payments. While using cash, while there is no intermediary, the transaction is anonymous and complete immediately without leaving any trail.

Under India’s CBDC, money will flow directly from the sender’s account with the RBI to the receiver’s account with the RBI without any intermediary. Thus, both the front-end and back-end transaction is immediate. However, the transaction trail is available to the government.

Degree of centralisation or government control on CBDC

With the introduction of CBDC, Central Bank is likely to have legal monopoly over creation and destruction of a nation’s currency. Being centralised in nature, there are concerns about the privacy of people. It is envisaged that it may grant totalitarian control to the government over its people and their spending. CBDC may be a programmable currency, for instance it can be programmed that some money may expire.

As an example, to boost spending during times of recession or to hold off a recession, they can grant CBDC to everyone or anyone by levying conditions that such CBDC would expire within a specified time unless it is spent by the account holder. They can even control where the money can be spent and direct the funding to a particular sector only. As an example, they can direct that money is to be spent only on grocery items in a store who also has a wallet open with the Central Bank. 

During inflation, they could potentially put a limit on the amount of gas that can be bought from a gas station when it is getting too expensive or supplies are too low. They may also restrict any person’s ability to spend out of CBDC that it owns when a person is deemed criminal or absconding by a Court.

Advantages of CBDC

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Low cost of issue – since notes and coins need not be printed, further promotes cashless economy.

Sovereign backed – CBDC are created by State/Govt, whereas crypto currencies are created by networks, hence not backed by Govt/sovereign.

While CBDC would be managed by the Central government or RBI, Cryptocurrencies are managed by a computer code with no central authority. Hence, the values of cryptocurrencies (other than stable coins) can fluctuate very widely.

Where is the World on CBDC?

Even CBDCs are prone to rat race among the world economies

China leads CBDC adoption and testing, and the Winter Olympics earlier this year provided it an international centre stage to test the capabilities of the e-CNY.

While people within the Federal Reserve are having a serious thought on impact of issuing digital dollar on monetary policy, as per a recent statement by head of US Treasury, creation of digital dollar could take years. It is an issue of pride for India that while in India we can undertake digital payments using current methods at Nil/nominal costs, same is not the case in United States. Hence, it is imperative for the authorities in US to first make the existing payment systems cheaper, faster and more accessible. However, few days back, the US lawmakers have introduced a bill named as ‘Stablecoins Transparency Act’ to being greater transparency to the stable coins market place.

Ecuador and Uruguay have had failed attempts at CBDC. European officials plan to launch digital Euro by 2025.

Sweden has made some positive headway by running a pilot CBDC project for e-Krona. However, it should be noted that the dynamics are altogether different in Sweden, where very little cash is being made use by the local population today.

Earlier this week, Iran announced to launch its own CBDC – ‘Crypto-Rial’, which will be minted and their maximum supply will also be solely decided by its Central Bank.

As per Economist, 80% of Central Banks are considering issuing CBDCs in the near future.  Bank of international settlements, which is a club of Central Bankers says that within three years a fifth of the world will live in countries that have CBDC. However, in case this is adopted by the mainstream population, this could put the traditional banks with fractional reserve banking out of work and can affect economic growth as they cannot rely on consumer deposits to finance their loans. 

Parting thoughts

From a user experience perspective, there is unlikely to be any difference between use of CBDC and existing mode of digital payments in India and hence the question of whether CBDC is really required when we have UPI in India.

It is believed that it is actually when Facebook (now known as Meta) decided to introduce its currency Libra, it gave a big jolt to the Central Banks worldwide and they started to expedite the CBDC movement. Had it been allowed to be successfully launched, Facebook would have already had within its Libra economy its existing user base of more than 2 billion people worldwide. 

CBDC is likely to give safety of money from theft, saving costs in printing notes and coins and thereby lowering overall systemic costs. However, if users can convert bank deposits into CBDCs with a simple swipe, it could result into deposits out of banking system and onto central bank’s balance sheet, thereby knocking off the intermediary bank from the chain.

One idea proposed by researchers at the Bank of England and the European Central Bank is to limit how much can be held in a CBDC.

Though the Indian government has announced to introduce CBDC in this year’s budget, it would be more pragmatic to adopt a wait and watch policy on introducing this paradigm shift in monetary policy. Primary focus should be on making the rural sections of the country tech literate and also making those areas free of power outages if it is desired to have a mainstream adoption.

Currently, RBI seems to be having FOMO on CBDC looking at the way other countries have kickstarted their CBDC project. Biggest motivation of RBI to introduce CBDC is because of threat to monetary policy and monetary sovereignty due to ever increasing impact of cryptocurrencies among the population of India. 

The three biggest problems that are foreseen with CBDCs are disintermediation of the banking system, privacy and currency substitution across borders.

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