CBDC and Its Impact On The Financial System

5 mins read
by Angel One

In the union budget 2021, Finance Minister Nirmala Sitharaman made a significant announcement to launch India’s own Central Bank Digital Currency (CBDC), an idea that was mauled by the center for a long time.

The announcement from the government itself has made CBDC a household term as it has been the latest buzzword for many, who are wondering about its objective and functions.

Those, who are newbies to the crypto or blockchain world, a Central Bank Digital Currency or CBDC is a government-issued digital currency and is backed by the central monetary authority of the state. In India’s case, it is the Reserve Bank of India (RBI).

In simpler terms, CBDC is a legal tender of the host country, but in digital form, being issued by the central bank. It is an electronic record or digital token as an official currency issued by the monetary authority of a nation.

According to a 2021 survey conducted by International Settlements (BIS), it was revealed that 86% of the global central banks were exploring the potential of CBDCs and about 15% of the countries are set to launch their pilot projects.

The CBDC fulfills the basic functions as a medium of exchange, unit of account, store of value, and standard of deferred payment. CBDC is the same as currency issued by a central bank but takes a different form than paper.

Even India’s Prime Minister Shri Narendra Modi said that the CBDC launched by the Reserve Bank (RBI) will be as good as India’s fiat currency – Indian National Rupee (INR) and will be exchangeable to the cash at par.

According to the RBI’s website, CBDC is sovereign currency in an electronic form and will appear as liability (currency in circulation) on a central bank’s balance sheet. It will be counted as currency in circulation.

Why a sudden focus on CBDC?

Adoption of a Central Bank Digital Currency has been justified for the following reasons:-

* Central banks seek to popularize a more acceptable electronic form of currency. This will reduce the usage of the paper currency or printed currency and India can move towards the mission of a cashless economy.

* Jurisdictions with significant physical cash usage seeking to make issuance more efficient and economical.

* There is a huge demand for the digital currencies and the central banks seek to cater the demand.

* The apex lender is also skeptical and critical over the rising popularity of the private crypto assets or virtual currencies, which pose a serious threat to the country’s financial stability, according to the RBI.

Why does India need CBDC?

CBDC will be backed by distributed ledger technology (DLT) but will be a permissioned blockchain which will make it different from other permissionless crypto assets.

The central monetary authority will have control access to the blockchain. It will only decide the supply, quantum and denomination of the CBDC. Digital currency will be more efficient and will avoid the consequences of private currencies.

Advantages of CBDC

CBDC will be the final payment and eliminate the risk of settlement in the financial system, particularly the interbank settlements. The CBDC will be the actual store of value and will transfer the value from one entity to another.

It will lead to lower transaction cost and make the flow of money easier as in the current digital payment system, the value is transferred from one bank/account to another via a gateway, making it a cost inclusive transaction.

Bridging the global gap

CBDCs will move towards real time transactions and cost-effective payment settlement systems at a global level. It would not require the US Federal Reserve system to be open for settlement.

For Instance, Indian importers can pay an American or Chinese exporter on a real-time basis in digital dollars or yuan without the need of any intermediary.

Time zone differences would no longer matter in international currency settlements. This transaction would be final as CBDCs are as good as the fiat currencies.

According to a note released by State Bank of India (SBI) the CBDC has the potential to offer benefits in terms of liquidity, scalability, acceptance, ease of transactions and faster settlement in comparison with existing forms of money. It can be a pragmatic shift to a cashless economy in the near future.

The adoption of CBDC will improve and make it easier for people to use with the supporting infrastructure provided by the central government.

It will boost the government’s mission to move towards the digital and cashless economy. It can establish an environment created for interoperability whereby faster real-time remittance occurs for all at everytime.

India vs World in CBDCs

India is expected to launch CBDC or the digital rupee in the financial year 2022-23, as said by the Finance Minister and RBI governor Shaktikanta Das. However, the government is hinting at it from 2021.

Ahead of the launch of its pilot project, the RBI will analyse and assess the CBDCs scope in retail and wholesale payments, the underlying technology, use cases, validation mechanism (token based or amount based) and architecture of issuance.

Among the global peers, Nigeria is set to launch its digital currency named Naira. Venezuela is also planning to launch its CBDC, ie, the digital Bolivar. South Korea is pilot testing digital Yuan. The European Central Bank (ECB), US, Russia, China, Turkey is also mulling their plans for the CBDCs.