From UPSC perspective, the following things are important :
Prelims level : CBDC, Cryptocurrency
Mains level : Digital Rupee: Prospects and challenges
The Union Finance Minister has announced the launch of the Digital Rupee — a central bank digital currency (CBDC) — 2022-23 onwards.
Who will launch the CBDC?
- The Reserve Bank of India will launch the CBDC in the upcoming financial year.
- This follows the government’s plans to launch the CBDC that will be backed by blockchain technology.
What is a CBDC?
- CBDC is a legal tender issued by a central bank in a digital form.
- It is similar to a fiat currency issued in paper and is interchangeable with any other fiat currency.
- One chief difference will be that a Digital Rupee transaction will be instantaneous as opposed to the current digital payment experience.
Features of CBDC
- High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
- Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
- Liability of central bank: It is a liability of the central bank just as physical currency is.
- Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.
What is the need for CBDC?
- Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
- High currency in circulation: India has a fairly high currency-to-GDP ratio.
- Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
- The growth of cryptocurrencies such as Bitcoin, Ethereum, etc has raised challenges to fiat currencies.
Key benefits offered
- Faster system: CBDC can definitely increase the transmission of money from central banks to commercial banks and end customers much faster than the present system.
- Financial inclusion: Specific use cases, like financial inclusion, can also be covered by CBDC that can benefit millions of citizens who need money and are currently unbanked or banked with limited banking services
- Monetary policy facilitation: The move to bring out a CBDC could significantly improve monetary policy development in India.
- Making of a regional currency: In the cross-border payments domain, India can take a lead by leveraging digital Rupee especially in countries such as Bhutan, Saudia Arabia, and Singapore where NPCI has existing arrangements.
Why is CBDC preferred over Cryptocurrency?
- Sovereign guarantee: Cryptocurrencies pose risks to consumers. They do not have any sovereign guarantee and hence are not legal tender.
- Market volatility: Their speculative nature also makes them highly volatile. For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
- Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
- Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
- Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering. They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
- Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy. This could pose a risk to the financial stability of the country if their use becomes widespread.
- Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).
- The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
- The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
- There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.