What are CBDC : Central Bank Digital Currency is electronic cash ; CBDCs are simply a digital version of cash—the physical money issued by central banks. It will be a Reserve Bank digital e-Rupee .

We are already using Digital currency when we make payments or receive money using our bank accounts to make transfers or using Apps such as Paytm , Google Pay , Phone Pe , Amazon Pay or Credit and Debit cards . so what is new about CBDC ? Whereas the above modes of payment are backed by commercial banks the CBDC would be backed by the Central Bank just like the Rupee is by the Reserve Bank . Further unlike crypto currency it will be backed by the government meaning it will be more universally recognised as ‘money’ .

CBDCs can be categorized as wholesale and retail CBDC by usage. Retail CBDC is a digital version of cash and mainly used for payments among individuals and businesses. Retail CBDC can increase access and usability for users, reduce costs for e-commerce and cross-border payments, and help to enhance monetary policy. Wholesale CBDC is a new infrastructure for inter-bank settlements, such as payments between banks and other entities that have direct relationship with the central bank. Wholesale CBDC can improve inter-bank payment settlement, reduce risks and costs of cross-border payment transactions.

The Central Bank does not want us to be dependent on private players for online transactions with the concurrent risk it carries . The main motivation of CBDC are to promote safety, robustness and efficiency of payments, reduce issuing cost and increase transaction convenience. The Central Banks want to have a strong presence in cashless transactions and lessen the risk in the financial system through private payment Apps ; One of the reasons why China stepped in early into digital currency was a reaction to the rise and dominance of the private sector digital platforms like Alipay and Wechat Pay .  

As the world moves away from physical cash which it is rapidly as in China , India and Brazil – when did you last use physical cash to make a payment ? increasingly we are tapping our cards / mobiles or using the QR code in India and PIX in Brazil to make a transaction and the world is swiftly moving to a cashless era ; as this volume keeps increasing the Reserve Bank would find the necessity of stepping in with its digital Rupee & not let private players to dominate .

Another aspect of CBDC would be its use in offline mode . This is important as only then would it serve those in remote areas or with lack of communication net work and also be able to withstand outages as it happened recently in Canada and also when the Caribbean Central Bank’s (ECCB) DCash went offline for weeks. Offline digital payment systems could verify availability of funds and validate transactions without the need to check in with an online ledger. They could use old-tech, non-internet-driven mobile phones or something like a stored-value card. This may pose a thorny challenge for designers .

Some of the benefits of CBDC are :

• Digital Currency is cheaper than minting coins . As per a report in economic times for every Rs 100 note, the cost works out to be about Rs 15-17 rupee (15-17% on each tender) in its four-year life cycle .

• Digital currency would be more secure as cash is vulnerable to loss and theft . Electronic hacking could be a risk but that could be managed with new technology .
  
  
• Digital currency would be less susceptible to counterfeiting
• It will be easier to monitor how digital currency is used making it harder to fund criminal activities such as drug dealing and terrorism.
• Bring  ‘ off the book ‘ transactions into the economy , curb black money generation and increase tax revenues .
• Unbanked citizens can be brought into the financial system thus boosting economic development  .
• Central Bank or the government could use digital wallets to send money directly  – as in the case of the pandemic when money was provided to the needy .
• A central bank could also impose negative interest rates on digital currency and incentivise spending and investment as a means of stimulating the economy .
• Innovation in cross-border payments .
• Adoption of block chain for financial services .

The issue of digital currency would be a gradual process and for years to come the Central banks would continue to issue physical currency as people would want to hang on to cash or may not have smartphones or mobiles . Central banks could either issue the digital currency through their Apps or it could be a part of the commercial bank network or private payment apps linked to the central bank account .

One likely fall out of CBDC could be people not wanting to keep money in banks ( which anyway is not fully insured ) which could cause a run on bank money causing liquidity issues . With commercial banks deprived of cash deposits they would need to borrow from elsewhere raising the cost of lending .Instead the Central banks liabilities would increase ( with the increase in public deposits )  The central banks would then need to lend more to the banks .With the Central bank becoming the all powerful lender and being able to influence as to who gets credit – would the Central banks want to take such an responsibility ?

This could be addressed by putting restrictions on how much money could be held in Digital currency or on its transfers .Further the central banks would not pay interest on digital currency balances unlike the interest paid by commercial banks .so it’s a paradox the Central banks wants to make digital currency successful but not very successful . In a report to the European Parliament Mr Brunnermeier and Jean-Pierre Landau of Sciences Po in Paris suggest that a central bank “will have to ensure that the CBDC is present everywhere but important nowhere”.

Presently according to the Atlantic Council, a think-tank in Washington, 105 countries comprising 95% of global GDP are exploring a CBDC. The Bahamian sand dollar, the East Caribbean d-Cash and Nigeria’s e-naira are already circulating. China’s trial of its digital currency, e-cny, has expanded to more than 260m wallets. With the present system running so well the attractiveness of CBDC would need time to catch up as can be noticed that the average balance in the E-cny accounts is just three yuan ( 47 cents ) .

CBDC & Crypto : The CBDCs shall operate on authorized (private) blockchains, whereas cryptocurrencies operate on permissionless (public) blockchains. The former is centralised, whereas the latter is not.

Anonymity is a benefit for cryptocurrency users. CBDC customers’ identities will be linked to an existing bank account as well as a similar quantity of personal information.

A central bank determines the regulations for CBDC networks. The authority in crypto networks is given to the user base, which makes choices through consensus.

India and CBDC : The RBI has announced its first pilot project to use central bank digital currency (CBDC) in the wholesale market for secondary trade in government securities from November 1. A second pilot project on retail use of the digital rupee will start within a month.

The RBI stance on CBDC is aimed at complementing, rather than replacing, existing forms  of money . To provide an additional payment avenue to users .
The Reserve Bank of India prefers a centrally-controlled, conventional database infrastructures for CBDC instead of DLT (distributed ledger technology)-based infrastructure due to the latter’s limitations.

While both conventional and DLT-based infrastructures store data multiple times and in separate physical locations, the key difference is in how data is updated. In conventional databases, data is stored over multiple physical nodes, controlled by one authoritative central entity, which ensures resilience.

On the other hand, in DLT-based systems, the ledger is usually managed jointly by multiple entities in a decentralised manner and each update needs to be harmonised amongst the nodes of all entities. This consensus mechanism requires additional overhead owing to which DLTs enable lower volumes of transactions, RBI said in its CBDC concept note, issued in October. 

The end of cash may not happen anytime soon but can be seen in the distant horizon and the world’s central banks are getting ready .