What a digital currency from RBI must get right

Source: The Hindu, Live Mint,  Business Standard

Relevance: central bank digital currencies (CBDCs) are becoming reality. However, before their adoption, a proper cost-benefit analysis will require.

Synopsis: The RBI must consider the following issues before rolling out Central Bank Digital Currency.

Background

Today, many of the world’s central banks are racing to launch their own virtual currencies, or central bank digital currencies (CBDCs). In India too, an inter-ministerial committee, 4 years ago, recommended that India should launch fiat money in digital form.

In line with its recommendation, RBI is currently working towards a phased implementation strategy and examining use cases that could be implemented with little or no disruption. Further, the much-awaited Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, is yet to be introduced.

What is CBDC? – Read in detail

Developments around the world

• According to the BIS survey of central banks 2021, 86% were actively researching the potential for such currencies, 60% were experimenting with the technology, and 14% were deploying pilot projects.
• The PwC Global CBDC Index shows more than 60 central banks in various stages of launching a digital currency.
• China had already engaged in pilot projects for its digital RMB, and it is planning a major roll-out soon.

Reasons for the creation of Central Bank Digital Currencies

1. India is witnessing the emergence of cryptocurrency exchanges, which are using gray zones of regulation. Most of these exchanges are asking people to invest and trade in cryptos without providing basic information about the product and the inherent risks.
   • Even more dangerous is the aggressive outreach to retail investors, who stand to lose a large proportion of their savings, in case of market reversal.
2. Cryptocurrencies are not backed by any commodity. They do not have any intrinsic value, and, their tradeable value is determined by an artificial shortage that has led to extreme volatility.
3. Further, with the rapid spread of technology and growing acceptance of alternative payment solutions, there is indeed a growing need for virtual currencies and e-wallets.

 Points to be taken care of by RBI before launching CBDC in India

1. One, the design of the currency with regard to how it will be issued, the degree of anonymity it will have, the kind of technology that is to be used, etc., needs to be sorted out. For instance,
   • Whether CBDCs be used only in retail payments, or also in wholesale transactions?
   • Should CBDCs be issued via a distributed ledger (synchronised between the RBI and scheduled banks) or a centralised ledger held by the RBI?
   • Should each CBDC be validated and identified by a unique serial number or token, or else how would validation be done?
   • Distribution only through the RBI, or via banks?
2. Two, possible impacts of an official digital currency on people, the monetary policy, and the banking system. For instance, if CBDCs are indeed efficient vehicles for retail savers, this could adversely affect bank deposits and eventually the growth of bank credit.
3. Three, risks emerging from cyberattacks need to be considered.
4. Four, given the public preference for cash and the comfortable blanket of anonymity it offers, CBDCs have to create foolproof systems for privacy protection.
5. Five, central banks will have to figure out how to manage cross-border flows vis-à-vis CBDCs.

Way forward

Other central banks have started experimenting with either retail or wholesale CBDCs. RBI too needs to create a sandbox, with limited participants and pre-specified uses, before launching its own digital currency. Only then can the rupee hold its own against other currencies.