In the recent past, worldwide interest in cryptocurrency has risen. A recent survey says 86% of the central banks across the world are actively researching cryptocurrency while 60% are engaged in CBDC. Against this backdrop, the Reserve Bank of India (RBI) discussed its “phased implementation strategy” of a Central Bank Digital Currency (CBDC).

Central Bank Digital Currency (CBDC)

CBDC is a central bank issued digital currency which is backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.

The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.

What is Currency chest?
Currency in India is managed by Currency chest. Currency chest is a place where the Reserve Bank of India (RBI) stocks the money meant for banks and ATMs. These chests are usually situated on the premises of different banks but administrated by the RBI.

Why India needs a digital rupee?

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.

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).

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.

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.

Others:

It is efficient than printing notes (cost of printing, transporting, and storing paper currency)
It reduces the risk of transactions
It makes tax collection transparent
Prevents money laundering

Issues involved with CBDC

Innovation with centralization: The approach of bringing a sovereign digital currency stands in stark contrast to the idea of decentralization.
Liability on RBI: when bank customers wish to convert their deposits into digital rupee, the RBI will have to take these liabilities from the books of banks and onto its own balance sheet.
Inflationary risk: Central banks would indulge in issuing more digital currencies which could potentially trigger higher inflation.
User adoption: User adoption could also pose a major setback for the smooth roll out of the CBDC in India. The main challenges would always be user adoption and security.
Reduced savings: Many, including various central bankers, fear that people may begin withdrawing money from their bank accounts as digital currencies issued by Central banks become more popular.
Volatility: the risk is higher and there is more price volatility and lesser acceptance as a money instrument globally, unless the trust factor and investor protection factors change.

Way forward

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.

Conclusion

RBI is creating small pivot for experimenting CBDC where financial transaction is happening through digital currency.
CBDC has to be a gradual process, various nuances has to be taken care not only about its utilization but also about the impact it will make.
More clarity on the concept in the days to come will be the key for CBDCs and much will depend on how the whole concept will evolve in India which is predominantly a paper currency market.