What is a Central Bank Digital Currency (CBDC)?

The Central Bank Digital Currency is a form of centralized digital currency that is issued by the country’s central bank. They are more likely similar to cryptocurrencies, besides the fact that their value is fixed by the central bank. They are considered equivalent to the country’s fiat currency.

In India, CBDC is also known as the ‘Digital Rupee’ or e₹“. It is presented by the RBI as a digital tender issued by the central bank. Now, digital rupees feature the same stability as physical cash. It builds trust, safety, and the settlement of transactions digitally.

What is the main focus of CBDC?

CBDC is mainly working to ease businesses and consumers with privacy, accessibility, convenience, and fund security. With CBDCs, the cost of maintenance is also reduced significantly. It maintains smooth transferability in complex financial systems and also diminishes cross-border transaction costs. 

CBDC’s implications eliminate the threat that is associated with digital currencies and their usage. Cryptocurrencies are known for their volatile behavior, as their value constantly fluctuates. whereas CBDCs are directed and governed by the central banks of countries, with a sense of security and ease of exchange.

What are the common types of CBDC?

In general, there are two types of major CBDCs available: wholesale and retail. Consumers and businesses prefer retail CBDCs, and financial institutions and larger enterprises choose wholesale CBDCs.

• Retail CBDCs  

Retail CBDCs are digital currencies that are governed and backed by the central government and offered to consumers and businesses. The use of these currencies eliminates the risk of intermediary fraud. Here, consumers can’t lose their assets, and no digital currency issuer might become bankrupt.

There are two types of retail CBDCs: token-based retail CBDCs and account-based retail CBDCs. Token-based retail CBDCs are accessible with both private and public keys. Due to this method, users can make anonymous transactions easily. Account-based retail CBDCs ensure digital identification to channelize accounts.

• Wholesale CBDCs 

Wholesale CBDCs hold reserves in a central bank. Here, the central bank easily grants wholesale CBDC transactions and deposits funds to settle and interexchange money. Central banks are free to set their interest rates, monetary policy tools, reserve requirements, or balances.

What are the common models of CBDC issuance?

• Direct CBDC Model

In this model, the central bank itself manages and handles CBDC. Here the whole command grants control over process, issuance, distribution, and redemption. The central bank protects the digital ledger and preserves the security and unity of CBDC. Overriding the conventional need for financial mediators,  individuals, and businesses can hold CBDC accounts directly with the central bank.

• Intermediary CBDC Model 

In this two-tier model, central banks willingly collaborate with commercial banks and other financial institutions for CBDC accessibility and distribution. Central banks can issue CBDC to intermediaries to provide CBDC services to the public. The intermediaries establish a connection between the central bank and CBDC users, account payment services, and other operations.

• Hybrid CBDC Model

The hybrid CBDC model blends both the direct and intermediary CBDC models. It ensures the direct issuance and management of CBDC to serve intermediaries in certain aspects.

Here, the central bank allows the public to directly open their CBDC accounts, like in the direct model. Moreover, it also allows intermediaries for specific services or functionalities, support, and transactions. This model aims to maintain the balance between the central bank and existing financial institutions.

What are the common forms of CBDC?

• Account-based CBDC

 An account-based CBDC approach requires the involvement of a trusted third-party verifier to verify the account holder and regulate the account balance before they start making payments.

• Token-based CBDC

Token-based CBDC verification utilizes blockchain technology to override the need for previewing balances before allowing transactions. These processes provide a more direct approach without the need for an account.

What are the significant advantages associated with CBDC?

1. Improved and Efficient Transaction

CBDC ensures efficient transactions, minimizing the waste of time. It works by streamlining the payment mechanism, diminishing settlement time, and enabling faster and more convenient transactions.

2. Amplified Financial Inclusion

 Traditional means of transactions used to take longer than required. However, CBDC provides smooth access to financial services for individuals and businesses.

3. Regulated Monetary Policies

CBDCs share effective monetary policies for managing inflation in the market, interest costs, and other macroeconomic indicators. 

4. Controlled cost for the Central Bank

 CBDCs regulate the cost of money printing and circulating in physical cash. It also reduces the need for intermediaries when making payments.

5. Increased security and privacy

 CBDCs allow secure transactions and an authentic way to make payments, eliminate the risk of fraud, and identify theft. 

6. Stimulated economic growth

For developed and developing countries, it is important to make faster payments to promote efficient economic activity and growth.

7. Cross-border transaction

 With CBDC, it’s easier and more convenient to lead international transactions. It reduces foreign conversion and intermediaries’ requirements in the middle. 

8. Restriction over illicit activities

 CBDC ensures that no money laundering or tax invasion cases can be found as the whole data is recorded and transactions are easily traceable.

9. Seamless Tax Collection

CBDC simplifies the whole equation of paying taxes as all the transactions get recorded and are easy to verify. 

10. Fusion of Emerging Technologies

 CBDC allows emerging technologies to integrate, foreseeing advanced solutions, potential new cases, and applications.

What are the possible disadvantages associated with CBDC?

1. This can lead to financial disintermediation

 CBDCs could lead to unemployment as they eliminate the need for financial intermediaries, like banks and other institutions.

2. Risk of bank runs and instability

 As CBDC demand is hyping, it can cause disability to the financial system and may lead banks to escape and run.

3. Requirement of funds for investment

 The implementation of CBDCs requires technological investments and infrastructure funding to set it up well.

4. Vulnerable to cybercrimes

Similar to other online digital systems, CBDCs are vulnerable to cyberattacks and hacking.

5. Threat to user privacy and surveillance creation

Based on the CBDC design, there is a risk involved in user privacy, and the establishment could be used for surveillance.

6. Challenges with cross-border transactions

The acceptance of CBDC could cause hindrances and difficulty in the implementation of cross-border transactions and regulatory harmonization.

7. Can cause an income gap

If the distribution of CBDCs doesn’t happen equitably, it can create income inequality at large.

8. Less availability of physical cash

 CBDCs are fully functional only on digital infrastructure. They are vulnerable to power outages and other types of disruptions.

9. Challenging to implement anti-money laundering measures

CBDCs are not potent enough to track physical cash, which could lead to the rise of money laundering and terrorist acts.

10. Share command with the central bank

 The design of CBDCs shares all regulatory power with central banks, which can manipulate the economy by making decisions that go against society’s interests.

What initiative did CBDC take in India?

By the end of 2022, RBI had launched a pilot ‘e-Rupee’. It was launched to build a digital version similar to paper currency, ensuring a seamless transition to CBDC.

Starting with eight banks in the country, the RBI is approaching digital currency using the intermediary model.

In February 2023, this project was launched in five cities within closed groups based on invitations only. Under this project, RBI issues CBDCs to intermediaries for giving digital wallets to end users.

The mode of transaction would be similar to physical currency.

Here are some RBI plans that are incorporated into e-rupee:

1: It functions offline, supporting the usage of CBDC with little to no networking.

2: It programs under restricted government usage and has a defined purpose.

3: It is easy to adopt, uses both new and legacy payment systems, and operates smoothly.

4: It guarantees the right to privacy in terms of physical cash.

What kind of experience do end users get with CBDC?

• Creating an E-wallet

 The E-wallet interface conveniently allows front-end solutions by acting as a catalyst for CBDC adoption.

• Account creation

Account creation requires personal information, identity verification, and the establishment of authenticated means of accessing the wallet.

Management of accounts needs strong identity, accessibility, and the elimination of fraud and cybersecurity. 3-step verification works on KYC, user self-registration, and Aadhar-based OTP verification.

• Loading and unloading

In this process, users need to link any of the onboarded banks to load and unload CBC tokens from their bank account.

• Wallet features

Users can easily check their account’s balance and denomination of tokens using wallets. With this, users can easily track their transaction history, individual payments, and acknowledgments.

• Security

Having token management allows counterfeiting, auto-locking, and freezing of accounts. Additionally, the potential vulnerabilities and safeguards can be easily stored in value tokens.

• Sending CBDC

Users can easily make purchases at merchants by paying into CBDCs. Now users have two options in terms of sending CBDC: scanning the QR code or entering a mobile number.

• Receiving CBDC

Users can easily receive CBDCs through digital wallets. They can also accept CBDC using peer-to-peer transactions or central bank-regulated platforms.

What are the major key considerations for increasing adoption and usage?

• Policies Framework

Anonymity: CBDC expects a tiered anonymity framework using the threshold value of the transaction.

Data Privacy: CBDC requires stronger data privacy frameworks based on prioritizing data collection.

Resilience: Built a layer of risk-control fraud protection and compliance.

• Technology

Scaling up infrastructure: CBDC requires controllable decentralization, emphasizing modular architecture and an increased framework.

 Operational Efficiency: CBDC requires operational capacity by setting up rules and a distribution layer based on computing.

Which countries have launched their piloted CBDCs?

• Bahamas: Sand Dollar, launched in October 2020 
• Cambodia: Bakong, retail, launched October 2020
• Antigua and Barbuda: DCash, launched March 2021
• Grenada: DCash, launched March 2021
• Nigeria: e-Naira, launched October 2021 
• Dominica: DCash, launched in December 2021 
• Ghana (Bank of Ghana): e-Cedi
• Sweden: e-Kronam
• Central Bank of the Islamic Republic of Iran 
• Kazakhstan (National Bank of Kazakhstan): Digital Tenge
• Russia (Bank of the Russian Federation): Digital Ruble
• South Korea (Bank of Korea)
• Saudi Arabia (Saudi Central Bank) 
• Central Bank of the United Arab Emirates
• Singapore (Monetary Authority of Singapore)
• South Africa (South African Reserve Bank)
• India (Reserve Bank of India): Digital Rupee
• China (People’s Bank of China): e-CNY
• Japan (Bank of Japan): Digital Yen
• Hong Kong: e-HKD
• Thailand (Bank of Thailand) 
• Australia (Reserve Bank of Australia)
• France (Banque de France)
• Brazil (Banco Central do Brasil): Digital Real
• Uruguay (Central Bank of Uruguay): e-Peso
• Philippines (Bangko Sentral ng Pilipinas)
• Central Bank of the Republic of Turkey
• Norway (Norges Bank)
• Venezuela: Digital Bolivar
• Bahrain (Central Bank of Bahrain)
• Bhutan (Royal Monetary Authority of Bhutan)

All in all

CBDC has the potential to channel several benefits to the financial system. Though there are challenges and drop downs involved, with careful planning it could establish a successful financial system.

FAQs

What are CBDCs?

CBDC stands for Central Bank digital currency. It is also known as “e-rupee.”It is a legal tender exactly similar to paper currency approved and assigned by the central bank of the country.

Is CBDC similar to bitcoin/ cryptocurrencies?

No. CBDC is a digital form of currency, similar to bitcoins or crypto. However, it has a fixed intrinsic value that is governed and regulated by the central bank of the country. But bitcoin‘s value is volatile by nature; it keeps fluctuating.

What are the risks involved with CBDC?

CBDC is vulnerable to cyberattacks; this system can be easily breached. It also uses a centralized database system that potentially risks the privacy of users. Its impact is foreseen over traditional banking, which could lead to financial instability.

How are CBDCs different from UPI and other modes of fund transfer?

CBDCs are a form of digital currency that is assigned and governed by the central bank of the county. Whereas UPI or other fund transfer modes are the form of payment