Digital Currency

Why in news?
  • The Reserve Bank of India is planning to launch pilot projects to assess the feasibility of using digital currency to make wholesale and retail payments, thereby calibrating its strategy for introducing a full-scale central bank digital currency (CBDC).
  • It will have the same functionality as a fiat currency and will coexist with digital payment methods and .
  • Finance Ministry set up a high-level inter-ministerial committee that recommended the introduction of a Central Bank Digital Currency (CBDC).
  • This would require changes to the legal framework, including changing the RBI Act.
What is CBDC?
  • Central Bank Digital Currency (CBDC) represents the legal tender and liability of a nation's central bank in the form of digital currency.
  • Generally, it is denominated in a sovereign currency and appears on the central bank balance sheet.
  • A CBDC is a digital currency that can be converted/exchanged into cash or traditional central bank deposits at par.
  • The underlying technology and form can be based on specific needs of the people.
  • Many countries are examining the potential benefits that digital currencies would bring to financial inclusion, economic growth, technology, innovation, and increased transaction efficiency.
  • Some countries have already rolled out their national digital currency, such as,
  • Sweden – krona 2) Bahamas – sand dollar  3) China- e-RMB How is it different from private virtual currencies?
  • Private virtual currencies are not issued or regulated by any central authority nor do they have any intrinsic value.
  • Further they cannot be converted to sovereign currency at par.
Benefits of CBDC:
  • Interbank settlement: Interbank settlement would no longer be necessary since this liability would be handled by the central bank.
  • Efficient transactions: Currency in digital form, it can make financial transactions more efficient.
  • Reduce costs: Due to its high currency-to-GDP ratio, it can significantly reduce the printing, transporting, and storing of paper currency.
  • Trade settlements: Trade settlements will be made on a real time basis and their costs could be reduced as no intermediary will be involved.
  • Currency management: Reduce the cost of currency management and allow real-time payments without interbank settlement.
  • Tracking: the central bank could keep track of each currency unit precisely.
  • Criminal activities, such as terror funding, money laundering, and so forth, can easily be spotted and ended.
  • Other digital currencies and cryptocurrencies: It will encourage people to use the national digital currency instead of other private digital currencies and cryptocurrencies. This will avoid speculation and volatility and increase confidence of investors and consumers.
  • Reduce dependence on bank deposits: This will reduce dependence on bank deposits and consequently reduce government expenses on insuring bank deposits.  
  • Amendments to laws: Reserve Bank of India Act deals with currency in a physical form. Therefore, changes may be required by the law. The Coinage Act, Foreign Exchange Management Act (FEMA) and Information Technology Act would also need to be amended as a result.
  • Cyber security: In India, there are already many cyber security threats. With digital currency, cyber attacks could increase and threaten to steal data.
  • Digital Illiteracy: According to the Digital Empowerment Foundation report, 90% of the Indian population is digitally illiterate
  • Threat to privacy: In order for the digital currency to prove its holder's identity, it would need to collect certain details about the individual holding it.
  • Flight of money: Sudden money flight from banks under stress will be easier.
  • Cost of credit: Since bank deposits will become unpopular it will reduce the credit availability and therefore increase its cost.
  • Other challenges: There are also a number of challenges related to regulation, tracking investments and purchases, taxing individuals, etc.
  • The introduction of a national digital currency will prevent various threats associated with the private-owned cryptos and will take India one step closer to being an effective digital economy. However, the government must create necessary safeguards before the implementation process can begin. Increasing digital literacy, ensuring high standards of cyber security and advancing technological preparedness must be ensured. Legal and operational aspects such as amendments to certain Acts, scope of CBDCs (retail vs wholesale payments), underlying tech (distributed ledger vs centralized ledger), validation mechanism, distribution architecture (through RBI or Banks), degree of anonymity etc. must be carefully considered.

Posted by Jawwad Kazi on 16th Jul 2021
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