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Central Bank Digital Currency (CBDC)

Central Bank Digital Currency (CBDC)

Why in news?

  • The Reserve Bank of India (RBI) is working on a phased implementation strategy for its own digital currency and is in the process of launching it in wholesale and retail segments in the near future.
  • A high-level inter-ministerial committee set up by the Finance Ministry had recommended Central Bank Digital Currency (CBDC) with changes in the legal framework including the RBI Act, which currently empowers the RBI to regulate issuance of bank notes.

Central Bank Digital Currency (CBDC)

  • It is a legal tender and liability of a nation’s central bank in the digital form.
  • It is denominated in a sovereign currency and appears on the balance sheet of a nation’s central bank.
  • CBDC is a digital currency which can be converted/exchanged at par with similarly denominated cash and traditional central bank deposits of a nation.
  • At present, central banks of various nations are currently examining the positive implications that a digital currency contributes to financial inclusion, economic growth,  technology, innovation and increased transaction efficiencies.

Benefits of CBDC

  • Alternative to physical cash
  • Instantaneous process: Transacting with CBDC would be an instantaneous process. The need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another.
  • Reduces cost of currency management: India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC. Large cash usage can be replaced by CBDC. Also, the cost of printing, transporting and storing paper currency can be substantially reduced.
  • Need of the hour: If the private currencies gain recognition, national currencies with limited convertibility are likely to come under some kind of threat. CBDCs thus become the need of the hour.
  • Volatility: CBDCs, being the legal tender by Central Bank, will not witness any volatility as in the case of cryptocurrencies.
  • Easy tracking of currency: With the introduction of CBDC in a nation, its central bank would be able to keep a track of the exact location of every unit of the currency.
  • Curbing Crime: Criminal activities can be easily spotted and ended such as terror funding, money laundering, and so forth
  • Scope in Trade:  Foreign trade transactions could be speeded up between countries adopting a CBDC.

SC Garg Committee recommendations (2019)

  • Ban anybody who mines, hold, transact or deal with cryptocurrencies in any form.
  • It recommend a jail term of one to 10 years for exchange or trading in digital currency.
  • It proposed a monetary penalty of up to three times the loss caused to the exchequer or gains made by the cryptocurrency user whichever is higher.
  • However, the panel said that the government should keep an open mind on the potential issuance of cryptocurrencies by the Reserve Bank of India.

CBDCs vs Cryptocurrency

  • Cryptocurrencies, such as Bitcoin, are digital tokens created by a distributed network or blockchain using cryptographic tools. CBDC are legal tenders by Central Bank.
  • While cryptocurrencies are decentralized, CBDCs are centralized
  • Cryptocurrencies offer anonymity, CBDCs would allow central banks to know exactly who holds what.
  • CBDCs are also not stablecoins, which are a form of cryptocurrency that is pegged to another asset, for example, Tether. A CBDC would not be pegged to any fiat currency; it would be the fiat currency. A CBDC version of a dollar would be the same as a dollar bill.

Challenges in rolling out National Digital Currency

  • Potential cybersecurity threat.
  • Lack of digital literacy of population.
  • Introduction of digital currency also creates various associated challenges in regulation, tracking investment and purchase, taxing individuals, etc.
  • Threat to Privacy: The digital currency must collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency.

Recent Developments

  • El Salvador, a small coastal country in Central America, has become the first in the world to adopt Bitcoin, as legal tender.
  • Britain is also exploring the possibility of creating a Central Bank Digital Currency (Britcoin).
  • In 2020, China started testing its official digital currency which is unofficially called “Digital Currency Electronic Payment, DC/EP”.
  • In April 2018, RBI banned banks and other regulated entities from supporting crypto transactions after digital currencies were used for frauds. In March 2020, the Supreme Court struck down the ban as unconstitutional.

Way Forward

  • The creation of a Digital Rupee will provide an opportunity for India to empower its citizens and enable them to use it freely in our ever-expanding digital economy and break free from an outdated banking system.
  • Looking into its impact on macroeconomy and liquidity, banking systems and money markets, it is imperative of policymakers to thoroughly consider the prospects of Digital Rupee in India.

 

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Mussoorie Times

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