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Central Bank Digital Currency

  • 30 Nov 2021
  • 7 min read

Why in News

Recently, the Reserve Bank of India (RBI) has proposed amendments to the Reserve Bank of India Act, 1934, which would enable it to launch a Central Bank Digital Currency (CBDC), thus enhancing the scope of the definition of ‘bank note’ to include currency in digital form.

  • The move has come amid the government’s plans to introduce a Bill on cryptocurrencies in the current Parliament session that seeks to prohibit all private cryptocurrencies in India with certain exceptions.

Key Points

  • About:
    • CBDC is a digital form of Fiat Currency which can be transacted using wallets backed by blockchain and is regulated by the central bank. It is a legal tender issued by a central bank in a digital form.
      • Fiat money is a government-issued currency that is not backed by a commodity such as gold. Fiat money gives central banks greater control over the economy because they can control how much money is printed.
    • Though the concept of CBDCs was directly inspired by bitcoin, it is different from decentralised virtual currencies and crypto assets, which are not issued by the state and lack the ‘legal tender’ status.
  • Need:
    • Addressing the Malpractices:
      • The need for a sovereign digital currency arises from the anarchic design of existing cryptocurrencies, wherein their creation, as well as maintenance, are in the hands of the public.
        • By regulating digital currency, the central bank can put a check on their malpractices.
    • Addressing Volatility:
      • As the cryptocurrencies are not pegged to any asset or currency, its value is solely determined by speculation (demand and supply).
      • Due to this, there has been huge volatility in the value of cryptocurrencies like bitcoin.
    • Digital Currency Proxy War:
      • India runs the risk of being caught up in the whirlwind of a proxy digital currency war as the US and China battle it out to gain supremacy across other markets by introducing new-age financial products.
        • Today, a sovereign Digital Rupee isn’t just a matter of financial innovation but a need to push back against the inevitable proxy war which threatens our national and financial security.
    • Reducing Dependency on Dollar:
      • Digital Rupee provides an opportunity for India to establish the dominance of Digital Rupee as a superior currency for trade with its strategic partners, thereby reducing dependency on the dollar.
    • Advent of Private Currency:
      • If these private currencies gain recognition, national currencies with limited convertibility are likely to come under some kind of threat.
  • Significance:
    • It would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
    • India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC to the extent large cash usage can be replaced by (CBDC), the cost of printing, transporting and storing paper currency can be substantially reduced.
    • It will also minimize the damage to the public from the usage of private virtual currencies.
    • It will enable the user to conduct both domestic and cross border transactions which do not require a third party or a bank.
    • It has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, and reduced settlement risk.
    • It would also possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option.
  • Issues:
    • Some key issues under RBI's examination include, the scope of CBDCs, the underlying technology, the validation mechanism and distribution architecture.
    • Also, legal changes would be necessary as the current provisions have been made keeping in mind currency in a physical form under the Reserve Bank of India Act.
    • Consequential amendments would also be required in the Coinage Act, Foreign Exchange Management Act (FEMA) and Information Technology Act.
    • Sudden flight of money from a bank under stress is another point of concern.
  • Recent Developments:
    • El Salvador, a small coastal country in Central America, has become the first in the world to adopt Bitcoin, as legal tender.
    • Britain is also exploring the possibility of creating a Central Bank Digital Currency (Britcoin).
    • In 2020, China started testing its official digital currency which is unofficially called “Digital Currency Electronic Payment, DC/EP”.
    • In April 2018, RBI banned banks and other regulated entities from supporting crypto transactions after digital currencies were used for frauds. In March 2020, the Supreme Court struck down the ban as unconstitutional.

Way Forward

  • The creation of a Digital Rupee will provide an opportunity for India to empower its citizens and enable them to use it freely in our ever-expanding digital economy and break free from an outdated banking system.
  • Looking into its impact on macroeconomy and liquidity, banking systems and money markets, it is imperative of policymakers to thoroughly consider the prospects of Digital Rupee in India.

Source: IE

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