Central Bank Digital Currency (CBDC)
Central bank digital currencies (CBDCs) are digital tokens issued by the central bank of a country. Issuance of physical currencies is one of the major roles being performed by central banks. CBDC is digital currency, the digital form of physical currency. Since issued by the central bank itself, CBDCs too are legal tenders. Many countries are developing central bank digital currencies. India is one of the first few countries to launch CBDCs. Being in digital form, CBDCs exhibits some characteristics of cryptocurrencies. However, there are marked differences between CBDCs and crypto currencies like bitcoins.
What is meant by Central Bank Digital Currency (CBDC)?
Fiat money is the currency issued by legally authorised entity of a country. Fiat money is thus a government-endorsed currency that is normally issued by the central bank of the country. Earlier, money was used to be issued against the backing of a physical commodity like gold. Now a days, the fiat currencies are issued against the guarantee of the government. In other words, the value of fiat currency is derived from the guarantee of the government which assures the value. Therefore, it is a legal tender that can be used to exchange for goods and services. Physical currencies (bank notes and coins) are the traditional forms of fiat money. Now, technology permits the governments to experiment with other options like digital forms of currencies to supplement physical fiat money. In simple terms, CBDC is the digital version of physical currencies.
What are the goals of Central Bank Digital Currency (CBDC)?
Physical currency is the most common form of currency and is widely exchanged and accepted. Migration towards CBDC is contributed by many factors.
• Physical currencies are subject to wear and tear. They also face challenges from fake currencies. Costs associated with Issuance and replacements are high.
• Technology developments such as blockchain technology and evolution of crypto currencies like bitcoin are challenging the supremacy of fiat currencies.
• Enhance financial inclusion
• Prevent usage of physical currency for illegal activities and avoid cash hoarding
• Offer better convenience to business and individuals in terms of transferability, security and accessibility
• Enhance efficiency of monitory policies by having better control on economic growth, inflation and financial stability.
What are the differences between Central Bank Digital Currency (CBDC) and crypto currencies?
CBDCs have the following characteristics
• Legal tenders with stable value and are issued by central banks
• Represents physical currencies in digital form
• Fixed value is associated with each currency/ coin and is guaranteed by the government
• Provides privacy, better convenience and easy transferability to users and ensures economic stability
• No dependency on blockchain technology
Crypto currencies carry the following risks
• Issuance is not regulated by a legal authority. They are managed by private players
• The value fluctuates heavily and suffers from high volatility
• Depends on blockchain technology and tracking is difficult
• High volatility leads to financial stress with impacts on economy
• Due to the difficulty in tracking, crypto currencies are often used in illegal activities like extortion, drug trafficking, terrorism etc.
What are the different forms of Central Bank Digital Currency (CBDC)?
CBDCs can be broadly classified into two; wholesale CBDCs and Retail CBDCs
(i)Wholesale CBDCs
Wholesale CBDCs are similar to holding money as reserves in a central bank. These accounts are permitted for institutions like banks for depositing funds and settling interbank transactions.
(ii)Retail CBDCs
Retail CBDCs are digital currencies that can be used by consumers and businesses for carrying out transactions. There are two kinds of retail CBDCs, depending on the processes for accessing and using the digital currency.
(a) Token-based retail CBDCs can be accessed with private keys or public keys or both. By adopting these methods, users can execute transactions anonymously.
(b) In Account-based retail CBDCs, users have to access digital currencies through digital identification.
Which are the countries that have issued Central Bank Digital Currencies (CBDCs)?
Central banks in many countries including G20 countries are running pilot programs for exploring launch of digital currencies. 12 countries and territories already have CBDCs. They are the Bahamas, Antigua and Barbuda, Monserrat, Dominica, Saint Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Grenada, Nigeria and India. e-Rupee (e₹) is the CBDC of India and it was launched on December 1, 2022 by the Reserve Bank of India(RBI).
