When you make a UPI payment, your bank settles the amount on your behalf at the end of the day. Digital payments like UPI are electronic instructions that authorise intermediaries such as banks to facilitate transactions. Even if they are ‘cashless’ modes of payment, they involve transfer of fiat money (government issued currency).
Now imagine a UPI-like system where digital currency issued by a central bank is transacted instead of bank balances. The need for interbank settlement disappears and you have the option to pay someone securely, without third-party risks. What if money itself could be ‘digital’?
The RBI has called for a complete ban on crypto as it believes partial restrictions won’t work. But, at the same time, it is considering issuing its own digital currency by leveraging the technology that powers crypto. “A central bank digital currency (CBDC) would also potentially enable more real-time and cost effective globalisation of payment systems. Time zone difference would no longer matter,” said T Rabi Shankar, RBI deputy governor, in a speech last year.
The RBI defines a CBDC as a legal tender issued by a central bank in a digital form. “It is the same as a fiat currency and is exchangeable one to-one with the fiat currency. Only its form is different,” said Shankar. The RBI is working towards a phased implementation strategy.
But what is the need for a CBDC in India where cash is popular? According to Shankar, countries with significant cash usage are seeking to make issuance more efficient as CBDCs can reduce the cost of distributing money.
Cryptocurrencies came up in the last decade promising secure, anonymous, and efficient transactions. However, being decentralised which means no authority can regulate them privately issued virtual currencies threaten state control over money.
A US Fed paper released last week noted that CBDCs’ foundation a combination of cryptographic and distributed ledger (blockchain) technologies was created by crypto. But apart from the underlying technology, there are no similarities between crypto and CBDCs, say legal experts. “People are not acquiring crypto to transact, they are investing because they believe the asset would appreciate as the value of fiat currency deteriorates due to excess supply,” said Manvinder Singh, partner, J Sagar Associates. He added that the CBDC is expected to be a mode of payment and not an asset like crypto.
According to a report by the Bank for International Settlements (BIS), about 86% of the world’s central banks are doing research on CBDCs.
However, CBDCs could disrupt the status quo of banks, IBM associate partner Mahesh Nair has said. “The central bank can allow (CBDC) wallets to be created directly with it rather than with commercial banks. The latter’s role as a custodian of cash could diminish,” Nair said. The RBI’s deputy governor too noted the risk of banks’ credit-creation ability getting constrained. “It is important to design & implement CBDC in a way that makes the demand for CBDC, vis a vis bank deposits, manageable,” he said.
A legal framework would need to choose either a distributed or centralised ledger, define the level of anonymity and role of banks, and address cybersecurity concerns.
