A total of 134 countries and currency unions, representing 98% of the global GDP, are currently investigating the potential of Central Bank Digital Currencies (CBDCs).

India’s Initiative 

• The Reserve Bank of India (RBI) has been proactive, launching a pilot project for the ‘digital rupee’ in late 2022.
• Types of Digital Rupee
  • CBDC-W (Wholesale): For settling secondary market transactions.
  • CBDC-R (Retail): A digital version of fiat money, serving as a direct liability of RBI, unlike UPI, which involves commercial banks.

About Central Bank Digital Currencies (CBDCs)

• A Central Bank Digital Currency (CBDC) is a digital form of fiat money issued by a central bank.
  • It is also known as the digital fiat currency or digital base money. 
• It is distinct from cryptocurrencies and virtual currencies as it is centrally controlled. 
• It can be considered a liability of the central bank, similar to physical banknotes and coins.

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• Characteristics of Central Bank Digital Currency (CBDC)

  • Digital Counterpart to Fiat Money:
    • CBDCs function as digital equivalents to traditional fiat currencies, fulfilling the roles of payment, unit of account, and store of value, similar to paper banknotes.
  • Unique Identifiability:
    • Each unit of CBDC is uniquely identifiable, ensuring security and preventing counterfeiting.
  • Part of the Base Money Supply:
    • CBDCs are considered part of the base money supply, similar to physical currency, and represent a liability of the central bank.
  • Digital Bearer Instrument:
    • CBDCs can be stored, transferred, and transmitted across various digital payment systems and services, independent of the specific system used for transactions.

• Implications for Commercial Banks

  • Lower Commissions: Potentially lower commission fees due to the streamlined nature of digital transactions.
  • Reduced Customer Data-Selling: Less opportunity for commercial banks to sell customer data.
  • Deposit and Credit Policies: Changes in deposit accumulation and credit policies due to higher funding costs.

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Cryptocurrency vs. Central Bank Digital Currency (CBDC)

Benefits of CBDC

• Financial Inclusion: CBDC aims to expand access to digital financial services, particularly for those without bank accounts.
• Enhanced Payments: Improves the efficiency and speed of digital payments, including cross-border transactions.
• System Resilience: CBDC can operate independently of commercial banks, making the payment system more robust.
• Economic Growth: Increased financial inclusion can contribute to economic growth.
• Global Integration: CBDC can facilitate cheaper and faster international payments, benefiting India as a major remittance recipient.
• International Collaboration: Participation in global CBDC projects can foster interoperability and cooperation.

Challenges in Implementing CBDC

• Security and privacy: Safeguarding user data and preventing unauthorized access to CBDC wallets are paramount concerns. Striking a balance between privacy and security is essential to build trust among users.
• Scalability: CBDCs need to handle a large volume of transactions efficiently, especially during peak times. Ensuring the system can scale to meet increasing demand is vital for its success.
• Lack of perceived value proposition: For users to switch from existing payment methods, CBDCs need to offer clear benefits such as lower fees, faster transactions, or additional features.
• Monetary policy implications: CBDCs could affect the effectiveness of monetary policy tools. Central banks need to carefully consider how to manage these implications.
• Mitigating Cybersecurity Risks: Protecting against hackers trying to steal funds or personal data.
• Building Public Trust and Education: Gaining public trust and informing people about the benefits and security of CBDCs to overcome resistance to digital currency.

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Way Forward

• Address Privacy and Security: The RBI must tackle privacy and security concerns to encourage widespread adoption.
• Establish Regulatory Standards: Uniform standards for security, privacy, anonymity, and grievance redressal are necessary.
• Promote Interoperability: Enhancing interoperability and offering additional functionalities could incentivize users to adopt the digital rupee.
• International Cooperation: To fully leverage CBDCs for cross-border payments and remittances, India must engage in global CBDC projects once a comprehensive regulatory framework is in place.

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