CBDC – Significance & Challenges – Explained Pointwise

The RBI has recently recommended to the Central Government that the interlinking of Central Bank Digital Currencies (CBDCs) of BRICS countries be included in the agenda of the BRICS 2026 Summit, which is to be hosted by India. Previously, India has pushed for international cooperation & standardization on cryptocurrencies during its presidency of G-20 in 2023.
In this regard, let us understand the CBDC as a concept.

What is CBDC?

• CBDC i.e. Central Bank Digital Currency is a digital form of a country’s official currency (like the digital dollar, digital euro, digital yuan, etc.) issued and regulated directly by the central bank, rather than by commercial banks or private entities.
• Types of CBDC:
  1. Retail CBDC = Designed for the general public, households, and businesses for everyday transactions (buying groceries, paying bills).
  2. Wholesale CBDC = Restricted to financial institutions (banks) for large-value settlements, such as interbank transfers or government bond trading.
• Examples:
  • China: Digital Yuan (e-CNY) – Already in advanced pilot stages
  • Eurozone: Digital Euro – Under investigation by the European Central Bank
  • USA: Digital Dollar – Still in research and discussion phases
• The RBI has historically been very conservative about private cryptocurrencies, repeatedly calling for a ban, and progressive about CBDC, arguing that they have multiple uses.

What are the key features of CBDC?

1. Sovereign Guarantee: Unlike money in a private bank account, a CBDC is a direct liability of the central bank. It is considered “risk-free” because it is backed by the government.
2. Legal Tender: It must be accepted for all payments, just like physical cash.
3. Digital-Only: It exists purely in electronic form, though it may be accessible via digital wallets, cards, or apps.
4. Non-Interest Bearing: CBDCs do not earn interest, ensuring they act as a medium of exchange rather than a speculative investment. 

Difference between Cryptocurrency & CBDC:

What is the significance of CBDC?

1. Financial Inclusion for the “Unbanked”: CBDC could give unbanked populations access to digital payments via basic digital wallets, without requiring commercial bank accounts. Also, lower transaction costs benefit low-income households and small businesses.
2. Monetary Policy and Stability: CBDCs give Central banks better control over the monetary policy in the following way:
   1. Monetary Policy Transmission: CBDC can help in better transmission of central bank’s policy actions like changing interest rates.
   2. Programmability: Money can be “programmed” for specific uses (e.g., a subsidy that can only be spent on food or fuel), ensuring that public funds are used as intended.
3. Combating Financial Crime: Every unit of a CBDC has a digital “fingerprint,” because of which it is much harder to counterfeit or use for illegal activities compared to physical cash. Thus, CBDC has:
   1. Traceability: It allows authorities to track money laundering, tax evasion, and terrorism financing more effectively.
   2. Digital Transparency: While this raises privacy concerns for some, it ensures that the “shadow economy” is brought into the light of regulation.
4. Cross-border Payments:
   • Cross-border payments are slow and expensive at present, involving multiple “correspondent banks” and high fees (sometimes over 6%). CBDCs can settle transactions instantly, at any time, without waiting for bank opening hours.
   • By removing middleman banks, CBDC can help in reducing the the cost of remittances drastically.
   • CBDC payments would also help India to make its payments to Russia & Iran easier because SWIFT framework is currently not available for either country.
5. Offline Transactions: One of the hardest technical challenges is making digital money work without the internet (like cash does). While “hardware wallets” are being tested, ensuring they can’t be “double-spent” while offline is difficult.
6. Fiscal Policy Efficiency: CBDC allows instant distribution of subsidies, or benefits with reduced leakage or fraud. Thus, help in reducing the corruption in the administration.

What are the risk & challenges involved in CBDC?

1. Bank Disintermediation (“Run Risk”): If people feel a CBDC is “safer” than a bank account, they might move all their savings from commercial banks to the central bank. This could trigger or accelerate bank runs, destabilizing the banking system.
2. Impact on Credit Creation: Commercial banks rely on deposits to fund loans. A large-scale shift to CBDC could shrink banks’ deposit bases, potentially raising lending costs and reducing credit availability for households and businesses.
3. Loss of Financial Privacy: Unlike physical cash, all CBDC transactions are inherently digital and traceable. While designed to combat illegal activity, this creates a potential for state surveillance of citizens’ financial lives.
4. Cybersecurity risks & Systemic Failure: A centralized or semi-centralized CBDC system becomes a single point of failure. A technical glitch, cyberattack, or power outage could cripple a nation’s entire digital payment system.
5. Digital Divide: If CBDC becomes the primary payment method, it could exclude populations with limited digital access or literacy (elderly, rural poor).
6. Tariff Threat: US President Donald Trump has already warned the BRICS countries of additional tariffs if they move away from dollar-based international monetary system. With 50% tariffs already in place, India needs to plan how to accommodate the additional tariffs.

What should be the way forward?

1. Phased Implementation: Many countries are prioritizing “Wholesale CBDCs” (for bank-to-bank transfers) because they offer immediate efficiency gains in cross-border trade without the massive privacy and tech risks of a public-facing currency. For public use, the focus is on starting with small, restricted pilot groups to test “load capacity” and offline functionality before a full national rollout.
2. Privacy by Design: Privacy concerns can be addressed by adopting:
   1. Privacy-Enhancing Technologies: The most successful CBDC frameworks are adopting Privacy-Enhancing Technologies (PETs).
   2. Tiered Privacy: Small, daily transactions (like buying a coffee) could be made anonymous, similar to cash.
   3. Threshold Monitoring: Only large or suspicious transactions would trigger regulatory oversight to prevent money laundering.
   4. Sunset Clause for Data: Mandate automatic deletion of transaction data after a short period for routine payments, preserving auditability for crime prevention but limiting mass surveillance.
3. Offline Functionality: Developing “hardware-based” solutions (like smart cards or specialized phone chips) that allow transactions to occur during internet outages.
4. Universal Access Design: Ensure interfaces are simple, accessible for the disabled and elderly, and usable on basic feature phones.

Conclusion: The ultimate test of a successful CBDC will be to make the monetary system more efficient & inclusive without making it more fragile & authoritarian. Navigating this carefully is the most challenging aspect of the central bank digital currency.