Central Bank Digital Currency 

Syllabus: General Studies Paper 3

• The Reserve Bank of India (RBI) is in the process of implementing the Central Bank Digital Currency (CBDC) in a phased manner for wholesale and retail segments.
• The introduction of CBDC was announced in the Union Budget 2022-23, by Finance Minister.
• The necessary amendments to the relevant section of the RBI Act, 1934 have been made with the passage of the Finance Bill 2022.

Central Bank Digital Currency 

• CBDC is a digital or virtual currency but it is not comparable with private virtual currencies or cryptocurrency.
• In simpler terms, a CBDC is the legal tender of a particular country as it is issued by the central bank but in the digital form. 
• It is an electronic record or digital token of the official currency issued by the monetary authority of a nation.

Advantages of CBDC

• CBDC will be the final payment and eliminate the risk of settlement in the financial system, particularly banks. 
• 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. 
• CBDCs will move towards real time transactions and a globalized cost effective payment settlement system. 
• The increased use of CBDC could be explored for many other financial activities to push the informal economy into the formal zone to ensure better tax and regulatory compliance. It can also pave the way for furthering financial inclusion.

Risks in CBDC

• Low user adoption: This can arise if its usefulness to consumers and merchants are not well perceived. Low CBDC adoption could hinder the policy objectives of the central banks.
• Elevated cyber security risks, vulnerability testing and costs of protecting the firewalls.
• Operational burden and costs for the central bank in managing CBDC.
• Reduced privacy relative to physical cash as the CBDC holdings could be tracked and accounted for.
• Data privacy threats and compromise of credentials.
• Faster obsolescence of technology could pose threat to CBDC ecosystem calling for higher costs of upgradation.
• Operational risks of intermediaries as the staff have to be retrained and groomed to work in CBDC environment.

Way forward

• Robust data security systems will have to be set up to prevent data breaches. Thus, it is important to employ the right technology that will back the issue of CBDCs.
• The financial data collected on digital currency transactions will be sensitive in nature, and the government will have to carefully think through the regulatory design. This would require close interaction between the banking and data protection regulators.