Central Bank Digital Currency (CBDC)
Central Bank Digital Currency (CBDC) are digital tokens issued by a central bank.
Updated: November 10, 2024
Central Bank Digital Currency (CBDC):
Central Bank Digital Currency (CBDC) are digital tokens issued by a central bank.
Some facts about Central Bank Digital Currency (CBDC):
- The digital form of fiat currency of a country is known as a central bank digital currency.
- A CBDC is issued and regulated by the monetary authority or central bank of a country.
- Financial inclusion can be promoted and the implementation of monetary and fiscal policy can be simplified by a central bank digital currency.
- They may not anonymize transactions as a centralized form of currency, the way some cryptocurrencies do.
- The affect of CBDS on economies, existing financial networks, and stability of a country is now on explore by many countries.
- Although the idea for central bank digital currencies are produced from cryptocurrencies and blockchain technology, CBDCs are not cryptocurrencies.
- CBDCs are controlled by a central bank, whereas cryptocurrencies cannot be regulated by a single authority as they are almost always decentralized.
What is Central Bank Digital Currencies (CBDCs):
- Fiat money is a currency issued by the government and considered a form of legal tender that can be used to exchange goods and services.
- It is not backed by a physical commodity like gold or silver.
- Fiat money traditionally came in the form of coins or banknotes.
- However, physical fiat money can now be supplemented with a credit-based model by governments and financial institutions, where balances and transactions are recorded digitally.
- While some developed countries have seen a significant decrease in the use of physical currency, it remains widely exchanged and accepted.
- The trend toward digital currency usage accelerated during the COVID-19 pandemic.
- Governments and central banks are now exploring the potential of government-backed digital currencies as the evolution of cryptocurrency and blockchain technology has generated interest in digital currencies and cashless societies.
- If implemented, these digital currencies will have the full faith and backing of the issuing government, just like traditional fiat money.
Aim of Central Bank Digital Currencies:
- Many people do not have access to financial services in many countries.
- Some adults even do not have a bank account and other use some alternative services although they have bank accounts.
- The aim of CBDCs is to provide privacy, transferability, convenience, accessibility, and financial security to businesses and consumers.
- The maintenance of a complex financial system can be decreased by CBDCs.
- Cross-border transaction costs can also be reduced, and lower cost options can be provided for those who currently use alternative money transfer methods
- The means to implement monetary policies can be provided to the central bank of a country by a CBDC to provide stability, control growth, and influence inflation.
- The risks of using digital currencies in their current form can be reduced by central bank digital currencies.
- Cryptocurrencies could cause severe financial stress in many households and affect the overall stability of an economy as they are highly volatile, with their value constantly fluctuating.
- But, CBDCs will provide households, consumers, and businesses with a stable means of exchanging digital currency, as it is backed by a government and controlled by a central bank.
Types of CBDCs:
Wholesale and retail are two types of CBDCs.Wholesale CBDCs are mainly used by financial institutions, where as Retail CBDCs are generally used by consumers and businesses, much like physical forms of currency
Wholesale CBDCs:
Wholesale CBDCs are like holding reserves in a central bank, in which an institution is granted an account by the central bank to deposit funds or use to settle interbank transfers.Monetary policy tools such as reserve requirements or interest on reserve balances are then used by central banks to influence lending and set interest rates.
Retail CBDCs:
Retail CBDCs are government-backed digital currencies intended for use by consumers and businesses.
Retail CBDCs can eliminate intermediary risks, such as the chance that private digital currency issuers might go bankrupt and lose customer assets.
Retail CBDCs are further divided into two types.
These types differ in how the currency is accessed and used by individual users.
Token-based retail CBDCs are accessible through private or public keys, allowing users to make transactions anonymously.
Account-based retail CBDCs require digital identification to access an account.
Both wholesale and retail CBDCs are not mutually exclusive.
It is possible to develop both types and have them operate within the same economy.
Limitation of CBDCs:
- Issues that may be created by CBDC need to be addressed before one can be successfully design and implement it.
- Financial structure changes, Financial system stability, Monetary policy influence, Privacy and protection and Cybersecurity are some issues that need to be addressed.
- Free from credit and liquidity risk, Cross-border payment improvements, Supports the international role of the dollar, Financial inclusion and Expands access to the general public are issues that are already addressed by CBDCs.
Advantages of CBDC:
- A CBDC can eliminate third-party risks such as bank failures or runs, as it is legal tender and not reliant on physical currency.
- Any remaining residual risk in the system would be managed by the central bank.
- High cross-border transaction costs can be reduced by increasing jurisdictional cooperation between governments and simplifying complex distribution systems.
- A U.S. CBDC could help maintain the dollar's dominant position as the world's most widely used currency.
- The cost of establishing a financial infrastructure within a country can be lowered, improving financial access for the unbanked population.
- A CBDC could create a direct connection between consumers and central banks, reducing the need for expensive infrastructure.
- International money transfers and obtaining paper money from banks would become hassle-free with a CBDC.
- With a CBDC, people will have direct access to the central bank.
- The payment process can be simplified and authenticated by placing it under the control of the RBI.
- The core banking system would record a one-time debit entry for currency purchases in the CBDC, with all subsequent transactions moving from wallet to wallet, offering more convenience than carrying physical cash, which is limited by the capacity of a physical wallet compared to a digital currency wallet.
Issues Created by a CBDC Need to be Explained:
- The financial structure of a country could drastically change by implementing CBDC.
- It is unknown how the change would affect household expenses, banking reserves, investments, interest rates, the financial services sector, or the economy of a country.
- The effects on a financial system's stability of a country are also unknown by switching to CBDC.
- For instant, there may not be enough central bank liquidity to facilitate withdrawals during a financial crisis.
- The employment rates may get affected as a result of implementing monetary policy to influence inflation, interest rates, lending, and spending.
- It should be ensured by central banks that they have the right tools they need to positively influence the economy.
- An appropriate amount of intrusion would be required by authorities to monitor for financial crimes.
- Monitoring of financial crimes is also important because it supports efforts to combat money laundering and the financing of terrorism.
- System penetration and theft of assets and information need to be prevented as a central bank-issued digital currency would likely be the target of hackers and thieves.
CBDCs vs. Cryptocurrencies:
- Cryptocurrency ecosystems offer a glimpse of an alternative currency system, where cumbersome regulations do not control the terms of each transaction.
- Cryptocurrencies are difficult to counterfeit or duplicate.
- They are secured by consensus mechanisms that prevent tampering.
- Central bank digital currencies (CBDCs) are similar to cryptocurrencies in many ways.
- However, CBDCs do not require blockchain technology or consensus mechanisms.
- Cryptocurrencies are unregulated and decentralized, making them volatile assets.
- Their value is driven by investor sentiment, usage, and user interest.
- Cryptocurrencies are not suitable for financial systems that require stability and are better suited for speculation.
- CBDCs, on the other hand, are more like fiat currency and are designed for stability and security.
Implementation of Central Bank Digital Currencies:
The viability and usability of a CBDC in the economy of a country is determined by many central banks with pilot programs and research projects.There were nine countries and territories that had launched CBDCs as of March 2022. These include:- The Bahamas
- Antigua and Barbuda
- Saint Lucia
- St. Kitts and Nevis
- Monserrat
- Dominica
- St. Vincent and the Grenadines
- Grenada
- Nigeria
80 other countries are there with CBDC initiatives and projects underway. Some of these are:- The central bank of India announced that it would introduce a digital rupee by the end of 2023 in February 2022.
- Jamaica made its first batch of CBDC in August 2021.
- The Bank of Jamaica is expected to launch its CBDC in the year 2022.
- The Riksbank of Sweden started developing an electronic version of the krona, called as e-krona, after the country experienced a decline in the use of cash.
- The United States is exploring CBDCs to improve the domestic payments system, increase efficiency, and reduce costs.
- Federal agencies are directed by President Biden to evaluate the infrastructure that would be needed to issue a U.S. CBDC in March 2022.
- The Bank of England (BoE) is still exploring to integrate CBDC into its financial system.
- The Bank of Canada (BOC) continues to research for implementing CDBC into its financial system.
Launch of CBDC Pilot in India:
- The Reserve Bank of India (RBI) announced the launch of CBDC on December 1st, 2022.
- A pilot project has been launched for the retail e-rupee to test the robustness of the digital rupee creation, distribution, and retail usage in real-time.
- This pilot will serve as the foundation for testing various features and applications of the e-rupee token and architecture in future pilots.
- In the first phase of the pilot, selected locations and banks will form a closed user group (CUG) comprising participating customers and merchants.
- Initially, the pilot will cover the cities of Mumbai, New Delhi, Bengaluru, and Bhubaneswar, where customers and merchants can use the digital rupee or e-rupee.
- State Bank of India, ICICI Bank, Yes Bank, and IDFC First Bank will be the four banks involved in the controlled launch of the digital currency in these four cities.
- The plan is to expand the facility to other cities, including Ahmedabad, Guwahati, Gangtok, Hyderabad, Indore, Kochi, Lucknow, Patna, and Shimla.
- Bank of Baroda, Union Bank of India, HDFC Bank, and Kotak Mahindra Bank will also participate in this pilot.
- The scope of the pilot will gradually expand to include more users, banks, and locations as needed.
- CBDC will be accessible to all private sector, non-financial consumers, and businesses.
- It will provide access to safe money for payment and settlement, as it will be a direct liability of the central bank.
- CBDC is similar to fiat currency and can be exchanged one-to-one with fiat currency; the only difference is its form.
How CBDC works?
- The currency would be in the form of a digital token that represents legal tender and will be issued in the same denominations as paper currency and coins.
- The digital rupee will be distributed through banks who will be the intermediaries.
- Users can make transaction with these digital rupee through a digital wallet offered by the participating banks and also store on mobile phones and devices.
- Transactions can be done for both person to person (P2P) and person to merchant (P2M).
- QR codes displayed at merchant locations can be used to make payments to merchants.
- Features of physical cash like trust, safety and settlement finality can be offered by the digital rupee.
- CBDC is expected to replace physical cash in India and other countries as it is a tokenized digital currency by which all the paperwork formalities done before actual payment can be replaced.
- CBDCs can serve as digital banknotes in the future digital economies with the world evolving towards more digital than physical.
- The scope of it evolving to a larger use case is there as the distributed ledger technology (blockchain) is used as its underlying technology.
- The digital form of fiat currency of a country is known as a central bank digital currency.
- A CBDC is issued and regulated by the monetary authority or central bank of a country.
- Financial inclusion can be promoted and the implementation of monetary and fiscal policy can be simplified by a central bank digital currency.
- They may not anonymize transactions as a centralized form of currency, the way some cryptocurrencies do.
- The affect of CBDS on economies, existing financial networks, and stability of a country is now on explore by many countries.
- Although the idea for central bank digital currencies are produced from cryptocurrencies and blockchain technology, CBDCs are not cryptocurrencies.
- CBDCs are controlled by a central bank, whereas cryptocurrencies cannot be regulated by a single authority as they are almost always decentralized.
- Fiat money is a currency issued by the government and considered a form of legal tender that can be used to exchange goods and services.
- It is not backed by a physical commodity like gold or silver.
- Fiat money traditionally came in the form of coins or banknotes.
- However, physical fiat money can now be supplemented with a credit-based model by governments and financial institutions, where balances and transactions are recorded digitally.
- While some developed countries have seen a significant decrease in the use of physical currency, it remains widely exchanged and accepted.
- The trend toward digital currency usage accelerated during the COVID-19 pandemic.
- Governments and central banks are now exploring the potential of government-backed digital currencies as the evolution of cryptocurrency and blockchain technology has generated interest in digital currencies and cashless societies.
- If implemented, these digital currencies will have the full faith and backing of the issuing government, just like traditional fiat money.
- Many people do not have access to financial services in many countries.
- Some adults even do not have a bank account and other use some alternative services although they have bank accounts.
- The aim of CBDCs is to provide privacy, transferability, convenience, accessibility, and financial security to businesses and consumers.
- The maintenance of a complex financial system can be decreased by CBDCs.
- Cross-border transaction costs can also be reduced, and lower cost options can be provided for those who currently use alternative money transfer methods
- The means to implement monetary policies can be provided to the central bank of a country by a CBDC to provide stability, control growth, and influence inflation.
- The risks of using digital currencies in their current form can be reduced by central bank digital currencies.
- Cryptocurrencies could cause severe financial stress in many households and affect the overall stability of an economy as they are highly volatile, with their value constantly fluctuating.
- But, CBDCs will provide households, consumers, and businesses with a stable means of exchanging digital currency, as it is backed by a government and controlled by a central bank.
Retail CBDCs are government-backed digital currencies intended for use by consumers and businesses.
Retail CBDCs can eliminate intermediary risks, such as the chance that private digital currency issuers might go bankrupt and lose customer assets.
Retail CBDCs are further divided into two types.
These types differ in how the currency is accessed and used by individual users.
Token-based retail CBDCs are accessible through private or public keys, allowing users to make transactions anonymously.
Account-based retail CBDCs require digital identification to access an account.
Both wholesale and retail CBDCs are not mutually exclusive.
It is possible to develop both types and have them operate within the same economy.
- Issues that may be created by CBDC need to be addressed before one can be successfully design and implement it.
- Financial structure changes, Financial system stability, Monetary policy influence, Privacy and protection and Cybersecurity are some issues that need to be addressed.
- Free from credit and liquidity risk, Cross-border payment improvements, Supports the international role of the dollar, Financial inclusion and Expands access to the general public are issues that are already addressed by CBDCs.
- A CBDC can eliminate third-party risks such as bank failures or runs, as it is legal tender and not reliant on physical currency.
- Any remaining residual risk in the system would be managed by the central bank.
- High cross-border transaction costs can be reduced by increasing jurisdictional cooperation between governments and simplifying complex distribution systems.
- A U.S. CBDC could help maintain the dollar's dominant position as the world's most widely used currency.
- The cost of establishing a financial infrastructure within a country can be lowered, improving financial access for the unbanked population.
- A CBDC could create a direct connection between consumers and central banks, reducing the need for expensive infrastructure.
- International money transfers and obtaining paper money from banks would become hassle-free with a CBDC.
- With a CBDC, people will have direct access to the central bank.
- The payment process can be simplified and authenticated by placing it under the control of the RBI.
- The core banking system would record a one-time debit entry for currency purchases in the CBDC, with all subsequent transactions moving from wallet to wallet, offering more convenience than carrying physical cash, which is limited by the capacity of a physical wallet compared to a digital currency wallet.
- The financial structure of a country could drastically change by implementing CBDC.
- It is unknown how the change would affect household expenses, banking reserves, investments, interest rates, the financial services sector, or the economy of a country.
- The effects on a financial system's stability of a country are also unknown by switching to CBDC.
- For instant, there may not be enough central bank liquidity to facilitate withdrawals during a financial crisis.
- The employment rates may get affected as a result of implementing monetary policy to influence inflation, interest rates, lending, and spending.
- It should be ensured by central banks that they have the right tools they need to positively influence the economy.
- An appropriate amount of intrusion would be required by authorities to monitor for financial crimes.
- Monitoring of financial crimes is also important because it supports efforts to combat money laundering and the financing of terrorism.
- System penetration and theft of assets and information need to be prevented as a central bank-issued digital currency would likely be the target of hackers and thieves.
- Cryptocurrency ecosystems offer a glimpse of an alternative currency system, where cumbersome regulations do not control the terms of each transaction.
- Cryptocurrencies are difficult to counterfeit or duplicate.
- They are secured by consensus mechanisms that prevent tampering.
- Central bank digital currencies (CBDCs) are similar to cryptocurrencies in many ways.
- However, CBDCs do not require blockchain technology or consensus mechanisms.
- Cryptocurrencies are unregulated and decentralized, making them volatile assets.
- Their value is driven by investor sentiment, usage, and user interest.
- Cryptocurrencies are not suitable for financial systems that require stability and are better suited for speculation.
- CBDCs, on the other hand, are more like fiat currency and are designed for stability and security.
- The Bahamas
- Antigua and Barbuda
- Saint Lucia
- St. Kitts and Nevis
- Monserrat
- Dominica
- St. Vincent and the Grenadines
- Grenada
- Nigeria
- The central bank of India announced that it would introduce a digital rupee by the end of 2023 in February 2022.
- Jamaica made its first batch of CBDC in August 2021.
- The Bank of Jamaica is expected to launch its CBDC in the year 2022.
- The Riksbank of Sweden started developing an electronic version of the krona, called as e-krona, after the country experienced a decline in the use of cash.
- The United States is exploring CBDCs to improve the domestic payments system, increase efficiency, and reduce costs.
- Federal agencies are directed by President Biden to evaluate the infrastructure that would be needed to issue a U.S. CBDC in March 2022.
- The Bank of England (BoE) is still exploring to integrate CBDC into its financial system.
- The Bank of Canada (BOC) continues to research for implementing CDBC into its financial system.
- The Reserve Bank of India (RBI) announced the launch of CBDC on December 1st, 2022.
- A pilot project has been launched for the retail e-rupee to test the robustness of the digital rupee creation, distribution, and retail usage in real-time.
- This pilot will serve as the foundation for testing various features and applications of the e-rupee token and architecture in future pilots.
- In the first phase of the pilot, selected locations and banks will form a closed user group (CUG) comprising participating customers and merchants.
- Initially, the pilot will cover the cities of Mumbai, New Delhi, Bengaluru, and Bhubaneswar, where customers and merchants can use the digital rupee or e-rupee.
- State Bank of India, ICICI Bank, Yes Bank, and IDFC First Bank will be the four banks involved in the controlled launch of the digital currency in these four cities.
- The plan is to expand the facility to other cities, including Ahmedabad, Guwahati, Gangtok, Hyderabad, Indore, Kochi, Lucknow, Patna, and Shimla.
- Bank of Baroda, Union Bank of India, HDFC Bank, and Kotak Mahindra Bank will also participate in this pilot.
- The scope of the pilot will gradually expand to include more users, banks, and locations as needed.
- CBDC will be accessible to all private sector, non-financial consumers, and businesses.
- It will provide access to safe money for payment and settlement, as it will be a direct liability of the central bank.
- CBDC is similar to fiat currency and can be exchanged one-to-one with fiat currency; the only difference is its form.
- The currency would be in the form of a digital token that represents legal tender and will be issued in the same denominations as paper currency and coins.
- The digital rupee will be distributed through banks who will be the intermediaries.
- Users can make transaction with these digital rupee through a digital wallet offered by the participating banks and also store on mobile phones and devices.
- Transactions can be done for both person to person (P2P) and person to merchant (P2M).
- QR codes displayed at merchant locations can be used to make payments to merchants.
- Features of physical cash like trust, safety and settlement finality can be offered by the digital rupee.
- CBDC is expected to replace physical cash in India and other countries as it is a tokenized digital currency by which all the paperwork formalities done before actual payment can be replaced.
- CBDCs can serve as digital banknotes in the future digital economies with the world evolving towards more digital than physical.
- The scope of it evolving to a larger use case is there as the distributed ledger technology (blockchain) is used as its underlying technology.