Understanding nuances of Central Bank Digital Currency
(16.12.19 to 20.12.19)

Dr. Kembai Srinivasa Rao, Former Director, NIBSCOM

Our economy is poised to emerge as a leading advocate of digital economy by putting all pillars in place, more so after the launch of ‘Digital India’ in July 2015. The spread of mobile density, broad band connectivity coupled with built up of digital banking infrastructure, cyber security measures and data privacy norms and many more support initiatives have formed a formidable digital ecosystem.  With the backdrop of digital imprint through trinity –jandhan, Adhaar and mobile (JAM), the society is ready to accept the debut of Central Bank Digital Currency (CBDC). It will be yet another strategic initiative to move towards less cash society. Any big change will have merits and challenges. It will take considerable time for the stakeholders to join in integrating CBDC to strengthen digital transformation.  

The way digital banking is adopted in India in the last decade despite the low level of digital and financial literacy demonstrates the iron will of the society to accept newer developments with open arms. That exactly is the differentiation of entrepreneurship of the society to adopt the nuances of advancement that keeps us ahead of the rest. CBDC is a logical development from one stage of digital society to innovate yet another. 

CBDC can be delayed but cannot be avoided if digital transformation is to be pursued on a sustainable mode. Union budget 2022-23 rightly announced the intent of the government to launch CBDC. RBI is set to go ahead to reduce the use of physical currency thereby mitigating part of operational risks in handling physical cash when compatible tools – Information, communication and Technology (ICT) can be appropriately explored. 

Among the nuances of ICT tools, block chain technology is tool to float secured CBDC. It is a peer-to-peer decentralized distributed ledger technology that makes the records of any digital asset transparent and unchangeable and works without involving any third-party intermediary that fits the CBDC needs.  

What is CBDC 
It can be well understood in modern times that currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative). It is a liability of the issuing central bank (and sovereign) to assure value against the asset (of underlying value) of holder such currency by the public. Currency is fiat and is a legal tender. Currency is usually issued in paper (or polymer) form, but the form of currency is not its defining characteristic. It can be in coins and it was earlier even in the form of leather/metal tokens embossed by the issuing authority. RBI issues the legal tender – currency that carries money value that can be exchanged for another commodity/service of equal value. Currency is thus a store of value. 

Extending the same utility value of paper currency, it’s easy to make out that CBDC will be issued by RBI but in a digital form instead of paper currency. Physical currency needs a place to hold, may be in a wallet, bag, purse, wardrobe etc. Similarly, CBDC will need an electronic device to carry it, may be mobile, laptop, I-pad like people hold demat account. Therefor a CBDC is the legal tender issued by a central bank in a digital form that can be exchanged for value. 

CBDC is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different. Hence, money is usually issued by a sovereign – RBI in India that represents the government.  Private issuance of money – whether under sovereign license or otherwise – has existed in the past but has over time given way to sovereign issuance, for two reasons. Firstly, being a debt issuance, private money is only as good as the credit of the issuer whereas the CBDC is sovereign backed. 

It is a good development that RBI is planning to come out with a digital currency using blockchain technology in 2022-23. It cuts out the middlemen in financial transactions – primarily banks – and allows transactions to travel directly from person to person or customer to vendor. This helps to eliminate risks to the consumer, such as the collapse of a commercial bank, and creates a direct connection between   consumers and a central bank.

Global trends: 
Many central banks have either floated the digital currencies or are contemplating to do so with ongoing CBDC pilot projects. Basel Committee on Banking Supervision (BCBS) brought out a joint report of its subcommittee – Committee on Payments and Market Infrastructures and the Markets Committee of Bank for International settlements (BIS) in March 2018 that discussed various issues of CBDCs with their implications for payments, monetary policy and financial stability. It highlighted points of consideration before launch of the CBDCs. 

Recently, after the outbreak of Covid19, BIS came up with yet another set of guidance on April 3, 2020 when there were increased apprehensions that the virus could be transmitted through handling of physical currency in circulation though its chances are stated to be low. Digital currencies are becoming popular after the onset of cryptocurrencies catching up in circulation with growing fear of money laundering and illicit financing. 

According to IMF, around 100 countries are toying with the idea of evaluating CBDC while some have already rolled out. Bahamas has been the first economy to launch its nationwide CBDC – Sand Dollar. Nigeria is another country to have rolled out eNaira in 2020 and by January 2021 got 7,00, 000 downloads. China became the world’s first major economy to pilot a digital currency in April 2020. The People’s Bank of China is aiming for widespread domestic use of the e-CNY, or digital yuan, in 2022. Bank of Korea, Sweden, Jamaica, Ukraine etc. are some of the countries to have begun testing its digital currency too and many may soon follow. European Central bank and US Federal Reserve are contemplating the issue of CBDC.

Risks in CBDCs
While the potential gains out of CBDC are enormous, there remain numerous risks that needs to be measured and mitigated. CBDC will increase too much dependence on technology leading to increase in operational risks that may exacerbate due to faster obsolescence of technology. The inevitable centralisation of CBDC will be vulnerable to single point failure and cyber-attacks and could also increase the surface area and vectors of attack. Central banks should leverage the inherent cyber resilience of distributed systems, public blockchains alongside a competitive free market for the movement of value on the internet is a better long-range posture to overcome some of such risks. 

With the potential rising risks due to expansion of businesses in the society, complex systems and technology interconnectedness fail in complex ways. CBDC will call for transitioning a rapidly evolving blockchain-based business model to the public sector for something as fundamentally critical as money and monetary oversight, could offset the value addition coming from the it unless the digital literacy and robustness of cyber security and data privacy norms are fine-tuned with integration of compatible macroprudential framework. 

It will call for accelerated public education and digital literacy for safeguarding their CBDC possessions as it could be more vulnerable to wholesale theft when compared to physical cash and tracing it will become challenging for guardians of law and order. Notwithstanding the challenges, CBDC will pave way for less cash society and could reduce the operational risks in the movement of enormous volume of physical cash.