CBDC, a game changer

Central Bank Digital Currency (CBDC) has become a matter of considerable interest. According to the Bank of International Settlement (BIS), 80 per cent of the central banks around the world are now studying the feasibility of this new form of digital central bank money for cross-border transactions as well as for internal benefits. CBDC is expected to ensure three basic principles — those of ‘do no harm’, ‘coexistence’,’promote innovation and efficiency’.

India, being at the forefront of digital transformation, is already in the process of ushering in a government backed digital currency and the first ever trials of digital rupee in India may be launched by December 2021, according to RBI Governor Shaktikanta Das.

Digital currency exists purely in electronic form.

Digital money does not have a physical or tangible form, such as a rupee or a coin, and is accounted for or transferred using online systems. The RBI is working towards a phased implementation of CBDC, and is examining the scope of it being a retail, wholesale, token and account based currency, according to Anuj Ranjan, General Manager, RBI.

The CBDC — which will be backed by sovereign — will lower the economy’s reliance on cash, and enable cheaper and smoother international settlements. Not just that, it will also promote financial inclusion and simplify the implementation of monetary and fiscal policy. The transactions will be made using distributed ledger technology (DLT).

In a DLT system, nodes or shared ledgers connect to form a common network to process transactions. This network can also extend to other jurisdictions and minimise the processing time for transactions. It provides transparency to authorities and stakeholders, improving the resiliency of a financial network by eliminating the need for a centralised database of records.

CBDCs represent a unique opportunity to design a technologically advanced representation of central bank money, one that offers the unique features of finality, liquidity and integrity. That said, CBDC is expected to promote financial inclusion. It can help extend the typically insufficient reach of existing payment systems by implementing digital distribution channels and ICT infrastructure to provide access to central bank money to majority population.

Where maintenance of high-volume, low-value payments and other financial services is deemed unsuitable or commercially unattractive for commercial banks, CBDC can provide a government-authorised solution for storing value and making payments.

Likewise, use of CBDC can ease cross-border payments. The current financial infrastructure is a complex system of many entities. Conducting a transaction between financial institutions takes time and money because they work in different technological systems and regulation regimes. For cross-border transactions, the People’s Bank of China has combined with the Hong Kong monetary authority, the Central Bank of United Arab Emirates, and the Bank of Thailand to explore the potential of making CBDC inter-operable between platforms.

These four, with the help of Bank of International Settlement’s Innovation Hub, concluded a successful experiment of settling international payments using a distributed ledger for their respective digital currencies. The payments took seconds, instead of days, as happens with the traditional SWIFT network for cross-border flow of funds. The cost was about half of that for conventional payments.

This is a major step forward in friction-free international payments. Interestingly, the blockchain technology that underpins the distributed ledger is also capable of of producing smart contracts, that is contracts that execute themselves, once payments are made.

So much so, digital currency could serve as a means of settling international payments without using a dollar. India and Singapore said they are working to link their digital payments systems to enable instant low-cost fund transfer in a major push to disrupt cross border transactions between the two nations that amounts to over $1 billion each year.

The main advantage of digital money is that it speeds up the transaction, simultaneously cutting back on costs. Innovations in such payments is an evolving phenomenon.

While making innovations three factors are considered — overall cost, settlement time, and safety and security of payments. The flip side, however is, it could increase terror financing. Efforts need to be expended to ensure that this also gets minimised, if not completely eliminated. Everything put together, it would seem that CBDC is set to become a game changer.

The writer is former Dean & Director-in-Charge, IIM, Lucknow, and Former Director, Jaipuria Institute of Management, Lucknow

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