Daily News Analysis » Central Bank Digital Currency (CBDC)

Central Bank Digital Currency (CBDC)

Why in the News?

According to reports, the RBI’s digital rupee — the Central Bank Digital Currency (CBDC) may be introduced in phases in 2022-23.

Key Points:

About Central Bank Digital Currency:

  • According to the RBI, CBDC is the legal tender issued by a central bank in a digital form.

What is Legal Tender?

  • Legal Tender is any form of paymentrecognized by a government, used to pay debts or financial obligations, such as tax payments. 
    • For Example, National currencies, such as the U.S. dollar, Rupee are legal tender. 
  • In the U.S, the Treasury is authorised to create and issue dollars to the public.
  • Laws ensure nothing other than official legal tender gains enough traction to be used as money in the economy.
  • It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. 
    • Only its form is different.
  • The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
  • CBDCs enable the user to conduct both domestic and cross-border transactions which do not require a third party or a bank.
  • Central bank digital currencies would also reduce the risks of using digital currencies in their current form. 
  • The digital rupee will be the digital version of physical cash.

Benefits:

  • Reduced dependency on cash
  • Higher seigniorage due to lower transaction costs
  • Reduced settlement risk
  • More robust, efficient, trusted, regulated and legal tender-based payments
  • Promote financial inclusion
  • Boost to the digital economy

CBDCs vs. Cryptocurrencies

Cryptocurrencies

CBDCs

  • Unregulated and decentralized.
  • Regulated by Central Bank i.e. incase of India (RBI)

 

  • Use a permissionless open network
  • Use a private permissioned block chain network
  • Users that use cryptocurrency have anonymity
  • CBDCs will be attached to a person’s existing bank account, containing their personal information. 

Similarities of Cryptocurrencies and CBDCs

  • Both cryptocurrencies and CBDCs are virtual assets that exist in online infrastructure. 
  • They both reduce the need for physical cash and streamline paying for goods and services. 
  • They also use the basic concept of blockchain technology, like storing transaction data in blocks and using nodes to verify transactions.

Types of CBDCs

  • Wholesale CBDCs

      • Wholesale CBDCs are similar to holding reserves in a central bank. 
      • The central bank grants an institution an account to deposit funds or use to settle interbank transfers. 
      • Central banks can then use monetary policy tools such as reserve requirements or interest on reserve balances to influence lending and set interest rates.

  • Retail CBDCs

    • Retail CBDCs are government-backed digital currencies used by consumers and businesses. 
    • Retail CBDCs eliminate intermediary risk—the risk that private digital currency issuers might become bankrupt and lose customers’ assets.

Central Bank Digital Currencies at a Glance:

  • As of March 2022, there were nine countries and territories that had launched CBDCs.

  • The Bahamas
  • Antigua and Barbuda
  • St. Kitts and Nevis
  • Monserrat
  • Dominica
  • Saint Lucia
  • St. Vincent and the Grenadines
  • Grenada
  • Nigeria

What is Blockchain Technology?

  • Also referred to as Distributed Ledger Technology (DLT), Blockchain is a system which helps in recording information. 
  • The system is basically a digital ledger of transactions that is distributed with the entire network of computer systems and servers on the blockchain.
  • Every block in the chain contains information of transactions made and every new transaction’s information is added to each participant’s ledger. 
  • In this way, the database is managed by multiple participants and is decentralised (there is no central agency managing the system).
  • Bitcoin and other digital currencies such as Ethereum use blockchain technology to function.