On 1 st November, the Reserve Bank of India launched India’s first Central Bank Digital Currency pilot project for wholesale purposes. As of now 9 banks namely State Bank of India, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank and the Indian unit of HSBC Holdings have been given the go ahead to proceed with the CBDC for settling secondary market transactions.

Each of these banks will test system with 10000 to 50000 of their customers and check the overall working for larger participation.

What are Central Bank Digital Currency or CBDC?

Inspired by the concept of Crypto-currencies and Stable coins, CBDCs are digital currencies issued by a country’s central bank.

They are a digital version of the currency of that country, essentially bank-notes issued in digital form. Although the form of CBDC is different, it is the same in substance as standard currency notes.

Why was CBDC introduced?

The stated aim of the CBDC concept is to bolster India’s digital economy, enhance inclusion in India’s financial sector and make the payment and settlement systems more efficient.

Last Diwali, 80% of transactions done were electronic or digital. Despite the increase in UPI, India’s total value of currency in circulation is Rs. 31 Lakh Crore, an increase of almost 80% since demonetization.

While digital payments have expanded in a major way, cash continues to remain an essential part of the Indian economy.

CBDC has the potential to drive digitization and financial inclusion by giving everyone access to banking services. CBDC is a secure alternative to private currencies. It is also expected to increase transparency in the banking ecosystem. You may get the benefits of crypto-currency, without the associated risks of non-recognition.

What are the types of CBDC or Central Bank Digital Currency?

 There are essentially two types of CBDC:

 a.)  Wholesale CBDCs: Similar to central bank reserves, the account is created with the central bank for the purpose of depositing funds – volumes can be controlled via reserve requirements or lending rates. They are used for institutional or bank to bank transactions.

 b.)  Retail CBDCs: Central Bank Digital Currencies which are used by consumers and businesses. Retail CBDCs eliminate intermediary risk – the possibility that digital currency issuers become bankrupt and are unable to fulfil their obligations.

Currently, the e-Rupee (Retail CBDC) is expected to be tested for retail use within a month in some locations.

How is CBDC different from traditional crypto-currency?

Crypto-currency is a decentralized medium of exchange and store of value which exists using block chain architecture. While a crypto-currency may not be regulated by a central authority, a CBDC is regulated by a country’s central bank.

Crypto-currencies may be volatile, however CBDC are simply physical currency in digital form and are hence as volatile (or non-volatile) as the country’s legal tender.

What is the status of CBDCs internationally?

China was the world’s first major economy to introduce the CBDC as a pilot project in April 2020.

However, the first nationwide CBDC was the ‘Sand Dollar’ issued by the Central Bank of the Bahamas in October 2020.

105 countries, accounting for a majority of the world’s GDP are exploring the CBDC route – for instance, although the United States has no CBDC, the US Federal Reserve and its branches are exploring ways to implement this technology.

Why is there an opposition to the CBDC?

In a recent interview, Eswar Prasad, a senior official at the IMF (International Monetary Fund) highlighted the possibility of CBDC being used directly to conduct monetary policy – for example a central bank may simply choose to shrink the total value of money in a depositor’s account if it is held in the form of a CBDC instead of using conventional monetary policy tools to implement negative interest rates.

Similar concerns abound over the encroaching of Central bank independence by the Government and the blurring of the line between monetary and fiscal policy.

Conclusion

Will CBDC be successful, going forward? Thus, although the CBDC seems novel as a concept, it is too early to say if it will be successful.

Since there has only been a pilot project at wholesale level, it is hard to say when mass adoption will be seen. RBI should take proactive steps in building both a rule-based framework for its use and a roadmap for large-scale implementation.

Like you… we are watching this space.