Central Bank Digital Currency

10th December, 2021 Economy

Figure 3: No Copyright Infringement Intended

Context:

RBI Chairman has issued concern with respect to central bank digital currency (CBDC).

The term central bank digital currency (CBDC) refers to the virtual form of a fiat currency.
A CBDC is an electronic record or digital token of a country's official
As such, it is issued and regulated by the nation's monetary authority or central bank.
As such, they are backed by the full faith and credit of the issuing government.

An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC — to the extent large cash usage can be replaced by CBDC, the cost of printing, transporting and storing paper currency can be substantially reduced.
The need for inter-bank settlement would disappear as it would be a central bank liability handed over from one person to another.

Significance of CBDC over cryptocurrency:

overeign guarantee: Cryptocurrencies pose risks to consumers. They do not have any sovereign guarantee and hence are not legal tender.
Market volatility: Their speculative nature also makes them highly volatile. For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering. They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy. This could pose a risk to the financial stability of the country if their use becomes widespread.
Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

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.

Some key issues under RBI's examination include, the scope of CBDCs, the underlying technology, the validation mechanism and distribution architecture.
Also, legal changes would be necessary as the current provisions have been made keeping in mind currency in a physical form under the Reserve Bank of India Ac
Consequential amendments would also be required in the Coinage Act, Foreign Exchange Management Act (FEMA) and Information Technology Act.
Sudden flight of money from a bank under stress is another point of concern.

The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.