What is (CBDC) Central Bank Digital Currency?

What is (CBDC) Central Bank Digital Currency?

CBDC: Central Bank Digital Currency, India?
Central Bank Digital Currency (CBDC) is a digital form of currency notes issued by a central bank. While most central banks across the globe are exploring the issuance of CBDC, the key motivations for its issuance are specific to each country’s unique requirements. This Concept Note explains the objectives, choices, benefits and risks of issuing a CBDC in India, referred to as e₹ (digital Rupee). The e₹ will provide an additional option to the currently available forms of money. It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.

The purpose behind the issue of this Concept Note is to create awareness about CBDCs in general and the planned features of the digital Rupee, in particular. The Note also seeks to explain Reserve Bank’s approach towards introduction of the digital Rupee. Reserve Bank’s approach is governed by two basic considerations – to create a digital Rupee that is as close as possible to a paper currency and to manage the process of introducing digital Rupee in a seamless manner.

The Concept Note also discusses key considerations such as technology and design choices, possible uses of digital rupee, issuance mechanisms etc. It examines the implications of introduction of CBDC on the banking system, monetary policy, financial stability, and analyses privacy issues.

The Reserve Bank will soon commence limited pilot launches of e₹ for specific use cases. It is expected that this note would facilitate a deeper appreciation and understanding of digital Rupee and help members of public prepare for its use.

A central bank digital currency (CBDC) (also called digital fiat currency or digital base money) is a digital currency issued by a central bank, rather than by a commercial bank. A report by the Bank for International Settlements states that, although the term “central bank digital currency” is not well-defined, “it is envisioned by most to be a new form of central bank money that is different from balances in traditional reserve or settlement accounts.” The present concept of CBDCs was inspired by Bitcoin and similar blockchain-based cryptocurrencies, but differs from such a virtual currency and cryptocurrency in that a CBDC is or would be issued by a state. Most CBDC implementations will likely not use or need any sort of distributed ledger such as a blockchain.

On December 1, the pilot project for testing digital currency started by the Reserve Bank of India in which four banks are participating across four cities.

All the wallet-to-wallet transactions of the central bank digital currency (CBDC) in the retail segment are anonymous as those transactions are not reflected in the core banking system of banks — a feature that shall boost customer confidence to use the digital rupee in India.

In the first pilot of the retail digital rupee, four banks including SBI, ICICI Bank, Yes Bank and IDFC First Bank will issue e₹-R. Four more banks — Bank of Baroda, Union Bank of India, HDFC Bank and Kotak Mahindra Bank — will join the pilot later.

The Reserve Bank of India (RBI) launched the first pilot for retail digital Rupee (e₹-R) on December 01, 2022, allowing individuals in 4 Indian cities to access and transact through the central bank-backed digital tender.
The Central Bank Digital Currency (CBDC) will be issued in the same denominations in which paper currency and coins are issued currently by the RBI. It is similar to regular currency notes issued by the RBI but in electronic form. A CBDC is an electronic currency issued by the central bank just like traditional currency notes and is backed by the faith and credit of the central bank.

The first phase of the Central Bank Digital Currency- Retail (CBDC-R) pilot will begin with four banks, viz., State Bank of India, ICICI Bank, Yes Bank and IDFC First Bank in four cities Mumbai, New Delhi, Bengaluru and Bhubaneswar.

How will Digital rupee (e₹) work & how will it be issued?
The digital rupee will be issued though Digital Rupee e-wallets of select banks, and will allow users to conduct Person to Person (P2P) and Person to Merchant (P2M) transfers through QR codes. The aim of e₹ is to replace traditional currency notes with digital currency, which could be used to make and receive payments via QR codes or through Digital Rupee Wallets held by payer and payee.

How is digital rupee different from UPI?
UPI transactions involve entries in two bank account statements which are maintained by commercial banks. Since digital rupee, which aims to replace cash, is a currency itself, it would not make an entry in your commercial bank accounts and its records would be maintained centrally by the RBI.

How can I get digital rupee?
Users may buy digital currencies from RBI-approved banks. You can buy e₹ from issuing banks even if you don’t have a bank account with such a lender. It will be like cash withdrawals from your bank account, wherein instead of receiving cash, banks would credit your e₹ to your wallet. You may then use it to transact like traditional cash.

Can I invest in digital rupee. How will e₹ transactions be different from cash?
Unlike regular currency, the digital rupee deposits will not bear any interest. So, it is not an investment instrument; rather, it is an trsanction instrument to transfer and receive money. However, digital rupee aims to provide the same level of anonymity that cash provides. The banks have been instructed by the RBI to not record transactions lower than Rs 50,000.

What are pros & cons of digital rupee
For the government, the digital rupee will reduce costs related to handling and printing of cash. It will further the cause of cashless economy and reduce UPI transaction costs. For the general public, digital rupee saves the user from the hassle of handling, securing and holding cash. It also allows for better management of receipts and payments in the digital format.

Here are the five major differences between UPI and e-Rupi/CBDC

No need to have a bank account

Experts pointed out that to carry out payments through UPI, individuals need to have a bank account and often a functioning debit card, but for accessing the e-Rupi wallet, there will be no need to have such a bank account. “With a retail CBDC, people should be able to transact without any bank involved (like physical cash) and it’s a digital transfer from people to people direct minus a bank intermediary. It will have the same denominations as physical cash,” said Vishwas Patel, Executive Director, Infibeam Avenues Ltd, which owns CCAvenue, a payment gateway brand.

Anonymity can be maintained

Transactions in digital rupee may offer the same anonymity as cash transactions. The Reserve Bank has asked lenders not to report low-value transactions made through the digital rupee. Once the Central Bank Backed Digital Currency Retail is transferred to customer wallets, banks will not track or report these transactions, bankers said. Currently, most cash transactions over Rs 50,000 require customers to disclose their permanent account number. While no limit has been set for digital rupee transactions, it is believed that retail transactions up to Rs 50,000 will not be reported. Transactions in excess of Rs 2 lakh will have to be reported for tax purposes. Experts suggest that the move will ensure the virtual currency will offer a similar degree of anonymity associated with paper money for business exchanges below a value threshold.

No need for physical currency backup

UPI transactions are backed by physical currency. This means the payment will not go through if the user’s bank account does not have enough funds. The e-rupee, however, can be used for digital payments in lieu of currency/cash. “The e-rupi is issued by RBI and is a legal tender in itself. It need not necessarily be backed by physical currency. The UPI transactions, on the other hand, are completely backed by a physical currency,” added Sudhir Pai, Executive Vice President and Chief Technology & Innovation Officer (CTIO), at Financial Services, Capgemini.

Single handle for all Depending upon the banks and platforms, the UPI handle or ID varies. Even linking two different platforms with the same bank account may generate different UPI ID, but such will not be the case for e-Rupi. “The digital rupee will be operated by RBI and not by bank intermediaries in the case of UPI where each bank has a different UPI handler,” added Kunal Chowdhry, CEO, Apollo Singapore Investments. E-rupi will have a single public key (address).

Transaction without a smartphone

Experts believe that another major benefit of using the e-rupee is that it will allow offline transactions which can be carried out on feature phones, promoting its adoption in rural and remote areas as well. Since the e-rupee voucher will be shared with the beneficiary through an SMS or QR code. This will enable its use in rural and remote areas as well where internet connectivity can be a problem. And if it’s in the form of an SMS, anyone without a smartphone can utilize it as well.

The legal cash issued by a central bank in digital form is known as CBDC (Digital Rupee (e)), according to the Reserve Bank of India. Similar to sovereign paper money but in a different format, it can be exchanged at par with current money and will be recognised as a means of payment, legal tender, and a secure place to keep wealth.

According to the Ministry of Finance, “CBDC is a digital or virtual currency but it is not comparable to the private virtual currencies that have mushroomed over the last decade. Private virtual currencies sit at substantial odds to the historical concept of money. They are not commodities or claims on commodities as they have no intrinsic value.”
Two broad categories of CBDC can be distinguished: general-purpose or retail (CBDC-R) and wholesale (CBDC-W).

The private sector, non-financial customers, and enterprises might all potentially use retail CBDC (e-R), but wholesale CBDC (e-W) is only intended for certain financial institutions.

Retail CBDC is an electronic version of currency primarily intended for retail transactions, as opposed to Wholesale CBDC, which is intended for the settlement of interbank transfers and related wholesale transactions.

The structure of CBDC can be either “token-based” or “account-based.” A token-based CBDC is a bearer instrument, similar to banknotes, meaning that whoever is in possession of the tokens at any one time is assumed to be their owner. In contrast, an account-based system would necessitate the upkeep of records of the transactions and balances of all CBDC holders as well as the identification of the owners of the financial balances.

“Considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash, while an account based CBDC may be considered for CBDC-W,” as per the release by Ministry of Finance.

Here are important features of CBDC

Sovereign currency issued by Central Banks

Liability on the central bank’s balance sheet

Accepted as a medium of payment, legal tender

Freely convertible against commercial bank money and cash

Holders need not have a bank account

Lowers the cost of issuance of money and transactions

The e-rupee will be in the form of a digital token representing a claim on the central bank, and will effectively function as the digital equivalent of a banknote that can be transferred electronically from one holder to another.

In simple terms, a central bank digital currency (CBDC) would be a digital banknote. It could be used by individuals to pay businesses, shops or each other (a “retail CBDC”), or between financial institutions to settle trades in financial markets (a “wholesale CBDC”).

How Is Central Bank Digital Currency (CBDC) Different From Unified Payment Interface (UPI)?
India started a trial for retail central bank digital currency (CBDC) today. Although both CBDC and UPI payments use a QR code, there are some subtle differences.

Every Indian banknote reads: “I promise to pay the bearer the sum of…” So, each banknote is a liability of RBI or the central bank.

CBDC is not expected to replace India’s premier instant payment solution, Unified Payment Interface (UPI), instead, it is touted to replace physical cash.

So, what is CBDC and how is it different from UPI?

What Is a Central Bank Digital Currency (CBDC)?
Central bank digital currencies are digital tokens, similar to cryptocurrency, issued by a central bank. They are pegged to the value of that country’s fiat currency.

Many countries are developing CBDCs, and some have even implemented them. Because so many countries are researching ways to transition to digital currencies, it’s important to understand what they are and what they mean for society.

KEY TAKEAWAYS
A central bank digital currency is the digital form of a country’s fiat currency.
A CBDC is issued and regulated by a nation’s monetary authority or central bank.
CBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.
As a centralized form of currency, they may not anonymize transactions as some cryptocurrencies do.
Many countries are exploring how CBDCs will affect their economies, existing financial networks, and stability.

Understanding Central Bank Digital Currencies (CBDCs)
Fiat money is a government-issued currency that is not backed by a physical commodity like gold or silver. It is considered a form of legal tender that can be used to exchange goods and services. Traditionally, fiat money came in the form of banknotes and coins, but technology has allowed governments and financial institutions to supplement physical fiat money with a credit-based model in which balances and transactions are recorded digitally.

The introduction and evolution of cryptocurrency and blockchain technology have created further interest in cashless societies and digital currencies. Thus, governments and central banks worldwide are exploring the possibility of using government-backed digital currencies. When, and if, they are implemented, these currencies would have the full faith and backing of the government that issued them, just like fiat money.

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