Today, countries are seized with the idea of cryptocurrency as in this modem digital age, paper banknotes are gradually losing their role as a reference value in payment systems across the world. Digitisation of payments cannot be ignored by the countries and therefore, it has become pertinent for Central Banks to consider new technologies in payments in order to ensure that their money can still remain a safe payment anchor in this era.
Cryptocurrencies aspire to be a new, digital, encrypted, and decentralised form of currency. However, to be considered a currency, there has to be a unit and a defined process of issuance. A committee of International Financial Reporting Standards Foundation (IFRS) Foundation’ pointed out that cryptocurrencies cannot be treated as financial assets as cryptocurrency is neither cash nor an equity instrument.
This is the reason why many countries have refrained from officially recognising cryptocurrencies, a privately owned/created store of value in an encrypted format, as a digital currency, an electronic form of fiat money issued by the government.
What is CBDC?
A Central Bank Digital Currency is a digital token, similar to but not the same as cryptocurrency, issued by a central bank of a country. They are pegged to the value of that country’s fiat currency and enjoy government mandate as opposed to cryptocurrencies. Usually, token-based CBDC doesn’t require the two parties to have a bank account; a person can pay with CBDC much like a payment made in cash. A BIS publication highlighted three different ‘variants’ of CBDC:
Account-based, where Central Bank allows people to open an account and transfer money between account holders.
Token-based or retail-based, where each token represents ‘digital cash’ for use by the general public or non-banking entities.
Wholesale-based, where a restricted-access digital token is issued for wholesale settlements like interbank payments and even, cross-border payments.
Account-based CBDC can offer a direct substitute to traditional demand deposits in India. While there is a great potential to implement both the wholesale and retail-based channels to reduce both retail transaction costs and make existing banking institutions more effective and efficient. It can also enhance the financial independence of banks.
The RBI is currently working towards a phased implementation strategy. Some key issues under examination are-
the scope of CBDCs- whether they should be used in retail payments or also in wholesale payments;
the underlying technology- whether it should be a distributed ledger or a centralised ledger;
the validation mechanism- whether token-based or account-based,
distribution architecture- whether direct issuance by the RBI or through banks;
degree of pseudo-anonymity, etc.
India’s high currency-to-GDP ratio holds out another benefit of CBDCs that can replace large cash transactions and reduce the costs that the central bank bears for printing, transporting, and managing cash.
As per RBI’s Annual Report for 2020-21’, the printing money bill stood at a staggering
Rs 4,000 crore. CBDC currency is hard to duplicate or counterfeit and is secured by consensus mechanisms that prevent tampering. While they have all the positives of
cryptocurrencies, CBDCs are regulated and standardised as opposed to being dictated by investor sentiments, usage, and user interest. This currency offers stability and safety in a digital currency market that is known to be volatile and thus replace legal tender around the world. As paper currency makes it difficult for interest rates to go negative at the time of financial crises, interest-bearing CBDC can allow banks to cut interest rates in response to a large deflationary pressure.
While CBDC is sure to give a boost to the already strong digital infrastructure of the country, what will be exciting to witness will be the exact system that the government introduces for the adoption of the CBDC. A country like India with a large and diverse population works as a sample market for the entire world to understand the mechanism of a new product, in this case, a digital currency.