ForumIAS announcing GS Foundation Program for UPSC CSE 2025-26 from 10th August. Click Here for more information.
Contents
Relevance: Future of Central bank digital currency
Synopsis: CBDC is likely to be in the arsenal of every central bank going forward. Factors behind sudden global interest of CBDC, its need and associated challenges.
Context
RBI may come out with a model for the implementation of a government-backed digital currency by the end of this year.
Must Read: What is a CBDC? |
Why a sudden global interest in CBDC’s?
Globally, there are two factors behind this sudden interest in CBDCs.
- First is the rise of cryptocurrencies such as bitcoin, and
- Second, the proposed launch of a Facebook-backed digital stablecoin called Diem (formerly known as Libra).
- A stablecoin is a digital currency that is linked to an underlying asset, such as a national currency like the US dollar or a precious metal like gold. For example, Tether, the largest stablecoin, is backed by the US dollar on a 1:1 basis.
Also, there is intense competition between central authorities and private players who are simultaneously attempting to bring in greater efficiency to payments. Central banks certainly don’t want to end up on the losing side.
Must Read: Private partners could help RBI run a digital currency |
Need for CBDC
- Much effective than traditional financial system to effectively handle cross-border trade and movement.
- Existing SWIFT system of (international) money transfer ensures that the US has a disproportionate control of the (current) global settlement process. CBDC can ensure a level playing field.
- Enables Faster money transfer at low cost.
- Reduction in the compliance burden
- CBDC’s are necessary to protect the public in an environment of volatile private virtual currencies
- Will help India to slowly move towards a cashless economy
CBDCs role in welfare schemes
Over the years, one major shortcoming of traditional money has been in the area of delivering welfare schemes.
In India, the DBT program is currently in place to enable the transfer of subsidies directly to a person’s bank accounts.
- However, sending money via traditional banking channels is costly, as banks have to adhere to KYC and anti-money laundering requirements.
- Since CBDCs are programmable money and can be embedded with a computer code, a digital rupee can hold KYC information within itself.
Therefore, a central bank-issued digital currency can ultimately lower the cost incurred by banks.
Must Read: Merits of an RBI currency outweigh the risks |
The challenges
- Operational challenges: The RBI will need to decide about
- the degree of anonymity when transacting via CBDC.
- whether CBDC can be utilized for both retail payments (peer to peer) or will it be limited to wholesale payments (among banks and financial institutions for the settlement of transactions);
- whether CBDC units will be interest bearing
- Privacy concerns: Centralized ownership would make all money traceable by the government.
- Managing Future risks: Governance and control structures will need to be updated to manage the unique risks which will arise with CBDC.
- Legal challenges: Several amendments to existing banking norms will be required to enable a digital currency (as opposed to paper currency).