WHAT IS CENTRAL BANK DIGITAL CURRENCY(CBDC)?

Central Bank Digital Currency (CBDC)

“Total digital payments in India have increased by 216% and 10% in terms of volume and value, respectively, for the month of March 2022 when compared to March 2019”, as per RBI’s reports.

RBI envisions to bolster India’s digital economy, augment financial inclusion, and pave the way for a more efficient monetary and payment system and after the success of UPI, India is on its way to launch CBDC (Central Bank Digital Currency) as its new pilot project. As the name itself suggests, it is a digital form of the currency that we hold and not a new currency.  Let us understand this with an example, suppose person A gives Rs.100 to person B; what he is really giving is the RBI Governer’s “a promise to pay” a sum of Rs.100 to the bearer(B). It can be used to pay for any transaction in India. CBDC does the exact same thing, but digitally, which means it is the exact same currency but not in a physical form. CBDC is different from the already existing digital currency, cryptocurrency,  because CBDC operates on authorized, centralized blockchains, whereas cryptocurrencies work on permissionless blockchains.

How many categories of CBDC are there?

1.  General purpose or retail (CBDC-R)- It would be available for use by private sector, non financial and businesses. It is an electronic version of cash for all retail transactions.

2. Wholesale (CBDC-W)-  It has restricted access to selected financial institutions. As per RBI, “it is intended for the settlement of interbank transfers and other related wholesale transactions”.

How did the need for CBDC arise?

1.CBDC allows users to carry domestic as well as cross-border transactions without the assistance of a third party. During the Russia-Ukraine invasion, half of the reserves of Russia, which were around worth $600 billion, were frozen by the USA, UK and the EU. A significant chunk of India’s reserves is also held overseas. This creates an uncomfortable ground for us in the global monetary system, where if any country like China or even India does something which is not approved by the West, the financial system may collapse.

2. A very noteworthy feature that cash transactions serve is “anonymity,” that is, it doesn’t leave a trail; CBDC being a digital transaction, will obviously leave an audit trail, making it difficult to carry out illegal transactions on the network.

3. CBDC can also ensure that the subsidies/crop loans ultimately reach the end consumer and are utilized in the correct way as intended. It will simplify the implementation of the RBI’s monetary and fiscal policy.

How much security is promised under CBDC regime?

While blockchain technology preserves transparency, it hinders security.

1. The Reserve Bank of India prefers a centrally controlled, conventional database infrastructure instead of Distributed Ledger Technology(DLT). The main difference between both the infrastructures is how data is updated. In conventional technology, data stored in several nodes is controlled by one authoritative central body. Whereas in the DLT database system, the ledger is maintained jointly by several units in a decentralized manner.

2. RBI intends to develop the CBDC project as a large-scale digital platform that is able to support high rates and volumes of transactions.

3. The technology will provide the user with tamper-proof access control protocol and cryptography (the secure communication technology where only the sender and the intended receiver can access the contents of the message delivered).

4. It will have the ability to integrate with other IT platforms.

CBDC AS A FIAT CURRENCY

Unlike other cryptocurrencies, the CBDC is backed by the central government of India, much like China’s digital yuan, which protects it from being extremely volatile. CBDC is thus a legal tender, meaning it has to be accepted as payment if offered. 

HOW IS CBDC DIFFERENT FROM UPI?

When looked at from the consumer’s perspective, CBDC and UPI appear to be very similar. However, looking at it from the bank’s perspective, they are two completely different things. Let’s take an example to understand this.

Consider a consumer, A, who buys a packet of biscuits from his local vendor, B, and transfers   Rs 20 via google pay. Both A and B receive a notification simultaneously, Rs 20 is debited from A’s account, and the same is credited to B’s account. Although the entry is made immediately, the actual funds aren’t transferred between the banks at that time. Since there are multiple transactions between multiple customers of multiple banks, usually, the net funds are transferred between the banks on a daily or weekly basis.

 Now let’s consider the same example where CBDC is used in place of UPI. When A buys goods from B the actual transfer of funds takes place in real-time, and this transaction is noted in RBI’s ledger. It is exactly like paying cash but in a digital manner. The use of CBDC completely eliminates the roles of banks during the transaction.

UPI is a platform that performs electronic transactions which require the intermediation of banks. This is not the case in CBDC. The CBDC facilitates the user to withdraw digital currency and keep it in their mobile’s wallet, and upon payment, the money moves from one wallet to another without any involvement of the banks. Thus CBDC also promotes anonymity over UPI as no third party has any knowledge as to whatsoever the transaction was- apart from the RBI. This is so because of the zero involvement of the banks in the entire process.

Another key difference that can be noted between CBDC and UPI is that CBDC does not require an active internet connection to operate.