What is CBDC?
The RBI has said that CBDC or Central Bank Digital Currency is broadly defined as legal tender (or currency) in digital form. It is a store of value that can be converted into paper currency and would appear as a liability on the central bank’s balance sheet. It is based on the same Digital Ledger Technology as cryptocurrencies, but unlike cryptocurrency which is decentralised, CBDCs are issued and regulated by the RBI (or any central bank).
It will be a fungible legal tender whose holders need not have a bank account. Therefore, it is aimed to increase financial inclusion as well as enable quicker implementation of monetary and fiscal policies.
Situation so far
The RBI and other institutions of India, such as the government and the Supreme Court, had been going through a dilemma regarding introducing cryptocurrency in the Indian economy – it was touted as too dangerous to allow a decentralised currency in India for concerns related to security and speculation.
The CBDC being a digital currency that is regulated by the RBI seems to be a compromise between security concerns and ease of use. It can thus be a bedrock for all future developments in the field of digital currency in India.
RBI’s pilot project on the CBDC
The RBI has launched its pilot project on the digital rupee on 1st November 2022. It announced that nine banks, namely SBI, HDFC, Kotak Mahindra, Bank of Baroda, Union Bank of India, ICICI Bank, Yes Bank, IDFC First bank and HSBC are participating in this pilot project.
How will the pilot project work?
Currently, the banks have a rupee account and a bond account with the RBI. Under the pilot project, they will be opening an additional CBDC account which will be connected to RBI’s CBDC node/server. The banks can then transfer CBDCs to their CBDC accounts in exchange for cash. Thereafter, sales or purchases of bonds can be done between CBDC accounts through the CCIL platform without any intermediaries.
What difference will CBDC make?
The pilot project will firmly put India on the list of countries who are in advanced stages of having their own digital currency. It will make the following changes in how banks operate in relation to the central bank and to each other:
- Currently, interbank transfers are made through the CCIL and settled through net settlement (i.e. at the end of the period, CCIL gives the figure of the amount of money to be paid/received by the bank for the overall quantum of transactions). However, with the CBDC, banks will transfer currency directly and thus, gross settlement will take place.
- Currently it takes one day under the T+1 system for money to be transferred. But under the CBDC regime, money can be transferred almost immediately between banks. The facility will most likely be available 24*7 for 365 days a year.
Impact of CBDC on the Indian economy
- For banks and corporates, CBDC can make a significant difference in terms of electronic payments, reducing settlement risk, increasing liquidity and cross-border payments, making transactions faster and cheaper for all.
- Efficient and secure payment will increase the velocity with which money changes hands in the economy and encourage banks to inject more money into businesses.
- Many believe that the RBI’s introduction of the CBDC will allow the Indian rupee to be catapulted onto the global stage through easier cross-border payments, thus facilitating ‘internationalisation of the rupee’.
- It will also help create the ecosystem for the Web 3.0 economy.
- It is hard to predict the impact of the CBDC on the cryptocurrency exchanges in India such as WazirX, CoinSwitch Kuber or CoinDCX. This is because on one hand, the CBDC will increase awareness about cryptocurrencies among the general populace while on the other hand, people may start dealing only in CBDC (which is more reliable and useful because of RBI-backing as legal tender) and not invest in any decentralised cryptocurrency, making these exchanges and cryptocurrency traders lose business.
- The long run motive is to expand the user base to corporate and retail users – however, it is only meant to be an addition to the current system of general currency and not to replace it.
Difference between Wholesale CBDC (e₹-W) and Retail CBDC (e₹-R)
Wholesale CBDC is applicable to financial institutions that hold reserve deposits with a central bank – it includes institutions which can lend money and make cross-border payments. In case of cross border agreements, the central bank acts as a counterparty.
In contrast, the digital currency issued to the general public is known as Retail CBDC. RBI has said that it plans on introducing retail CBDC within a month in specific localities among closed user groups made of customers and merchants.
A popular CBDC can outcompete privately run cryptocurrencies such as Bitcoin. Moreover, it will definitely make the Indian banking system more active. It will ease business transactions and increase economic activity in India.
Someday, you may use CBDC as often as paper currency. However, before that happens, you may want to know what is cryptocurrency and what is the step by step guide to investing in cryptocurrency.