What is a central bank digital currency?

Digital currency may seem like a new concept, but if you use cards, netbanking or payment apps like Paytm and Google Pay, you are already part of the movement towards cashless transactions that it is designed to strengthen. CBDCs, though, are about more than just cashless transactions and could end up transforming the banking system.

The biggest nudge to governments’ digital currency push has come from the rise of cryptocurrencies like Bitcoin and Ether that have prompted speculation about the future of fiat currency – that is, currency backed by governments – as they claim to do most of the work of the modern banking system more swiftly and at a fraction of the cost.

How is CBDC different from cryptocurrency?

Although they are called ‘cryptocurrency’, Bitcoin, etc, are not currency but digital assets. They are privately issued and are not backed by any sort of authority, government or otherwise. But a fiat currency, such as the US dollar or the Indian rupee, is backed by a central bank, which guarantees its value. 

CBDCs would be the electronic version of the physical currency and not a new currency altogether. According to RBI deputy governor T Rabi Sankar, it would represent “legal tender issued by a central bank in a digital form”.

Where cryptocurrencies and CBDCs could overlap would be in the technology on which they are based, with finance minister Nirmala Sitharaman saying in her Budget 2022 speech that the RBI CBDC would use “blockchain and other technologies”.

Blockchain is a kind of distributed ledger where the record of every transaction involving the cryptocurrency is maintained by every single device on which it is stored. It does away with the need for a central authority to validate each and every transaction.

Advantages of CBDCs

At present, cash is the only money issued by the central bank that citizens use directly. Non-cash transactions are mediated by commercial banks (SBI, ICICI Bank, etc).

Commercial banks open an account on the condition that you maintain a minimum balance. This puts banking beyond the reach of poor people. However, CBDCs – because they are digital and issued by the central bank – could make banking possible for everyone.

In the years since demonetisation we have already seen the speed and other benefits of digital payments, but CBDCs could do the same for international transactions, at a lower cost. Commercial banks sometimes fail, and depositors lose a big chunk of their money despite the deposit guarantee scheme, but when your money is parked with the central bank there is no risk of default.

Disadvantages of CBDCs

CBDCs could spell the end of privacy as wherever you go – even with your phone turned off – you will leave a digital trail paying for food, fare and lodging.

State-backed digital money could also be bad news for volatile private cryptocurrencies (like Bitcoin), possibly making their values crash.

If CBDCs make it possible for the common man to bank with the central bank, people might choose to park their money with it, eliminating the risk of bank failure and losing money. That could leave commercial banks with less money to loan to industry and for other uses, increase interest rates and possibly hurt economic growth. This could also destabilise commercial banks in times of crises when depositors seeking safety might pull out their money and park it with the central bank.

9 countries already use digital currencies

Among the nine countries with active CBDCs, eight are small island nations in the Caribbean. Currently, at least 87 countries are researching or developing CBDCs, including 14 who are running pilot programmes.

In October 2021, Nigeria became the latest country to introduce a digital currency, eNaira. For now, only those with bank accounts and digital wallets can access it but the long-term plan is to allow any citizen to use e-Naira even if they don’t have a smartphone.

Among major economies, China is the closest to fully launching its digital yuan, which it had begun developing in 2014. It’s undergoing its last pilot programmes ahead of a trial during the Winter Olympics in Beijing this week, followed by a full launch shortly after.

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