India is going to have its own official currency by early 2023. Finance Minister Nirmala Sitharaman talked about an RBI backed digital rupee in the coming days. She added that introduction of the Central Bank Digital Currency or CBDC will give a big boost to the digital economy. According to her Digital Currency will also lead to a more efficient and cheaper currency management system.
India is the second latest-major economy to announce its official virtual currency, China being the first. China has been trailing the digital Yuan. The central bank indicated that the digital rupee would be ready by the end of next financial year. The blockchain will be developed by the RBI and it would be able to trace all transactions unlike the current system of mobile wallet offered by private companies. However, the regulation pertaining to digital currencies is yet to be finalised.
Days are not far when instead of holding a note, we will be holding a digital currency in our phones. The money would be with the Reserve Bank of India and it would be transferred to any merchant. Central Bank Digital Currency cannot be compared to the private virtual currencies or even cryptocurrency. As there is no issuer in the case or private virtual currencies, they do not represent any person’s debt or liabilities. Such currencies are never going to be considered as legal tender.
Private cryptocurrencies have been opposed by the RBI on the grounds of its impact on national security and financial stability. Further the Finance Minister hinted about a 30% tax on income from digital assets. So anyways it would put profits from trading and transferring cryptocurrencies and non-fungible tokens in the highest tax slab. The tax would also apply to gifts of digital assets, with recipients being liable to pay the levy. Other transactions would be tax deducted at source.
In this article we shall try to understand the meaning and other aspects of Digital Currency.
What is Digital Currency?
Digital money or digital currency is any form of money or payment that exists only in electronic form. It does not have any tangible form such as a bill, cheque, or coins.
According to the RBI website, CBDC is the same as currency issued by a central bank but takes a different form than paper or polymer. It is sovereign currency in an electronic form and will appear as liability ( currency in circulation) on a central bank’s balance sheet. CBDC should be exchangeable at par with cash.
It’s use is mainly by using electronic codes in computers both for the accounting and transfer of money. We are living in a digital world and more and more payments are becoming digital thereby replacing use of tangible money. Digital currency can be transferred between entities or users with the help of technology like computers, smartphones and the internet.
Why is there a need to have Digital Currency?
Digital Currencies are the most talked about thing these days but if we look at its success ratio, there are only a few countries that have been able to reach the pilot stage. As low as 14% of them are deploying pilot projects against 86% just researching the potential for CBDC.
According to a report by a Bank for International Settlements CBDC enjoys a combination of factors-it has universal access, it is an electronic form and has the backing of a central bank. Volatility and unaccountability of cryptocurrencies have given birth to the idea of CBDCs. It will facilitate numerous cross border transactions with ease.
Why does India need CBDC?
Our nation could witness a tremendous change in the ecosystem through an efficient,robust, regulated, trusted and legal tender based payments option. The cost of printing, transporting, storing and distributing currency will be reduced. And it is not just India that is planning a CBDC. Emergence of cryptocurrencies have made the economies of the world to think. It has ignited to have a regulated digital currency.
Implementation of CBDC is going to take place in a phased manner while examining use cases that could be implemented with little or no disruption. The RBI is working towards this direction. India’s high currency to GDP ratio holds out another of CBDCs. Large cash usage can be replaced by CBDCs.
How does CBDC work?
It is a digital representation of a country’s existing fiat money. There could be differences in the way various countries’ CBDC works. The mechanism could differ but the basic model will be the same. When you transfer money from your bank account to say a relative’s account at another bank, it will happen digitally. This might take some time ranging from a few hours to a few days. But with CBDC, transfers can happen instantaneously on one digital ledger and the transaction need not pass through multiple banks taking more time.
The infra provided by the government will be better used by the people of India. The development will make digital currencies more accessible to the people just as UPI made digital cash easier to use. We could even witness a pragmatic shift to a cashless economy in the near future. This could have a positive effect on the banking system.
Following are the points that highlight the features as well as advantages of CBDC-
- Private virtual currencies are getting more and more popular. Central Banks need to consider the need for having digital currencies. If CBDC is not introduced timely, the private currencies such as cryptocurrencies are likely to damage the economy.
- Countries like Denmark, Germany, Japan and the United States of America are seeking to make issuance more efficient despite having availability of substantial physical cash. The physical currency in the U.S is just about one-tenth of the overall money supply. The rest is held in various bank deposits in electronic form.
- The Reserve Bank of India is already thinking about other ways to replace usage of paper currency, and aims to popularise a more acceptable electronic form of currency.
- Nowadays, several banks and other financial service providers facilitate digital money transfers and other online transactions that transfer money between parties across long distances. Globalisation of economies is possible as trade is made more easy by sending and receiving digital money.
- Digital currency eliminates the need to carry physical currency. It also allows people to manage their personal banking without visiting a branch physically and that makes banking a much more convenient service. It reduces the risk of transporting physical currency. Safekeeping of money is an issue in case of cash-intensive systems. There is no such risk involved in the case of digital money.
- These days banks are also trying to reduce their retail employee headcount to meet the trend of digital money. When people start using digital money, many branches will be closed.
- Digital currency makes accounting and record keeping very easy. It is largely automated and hence human errors are kept to the minimum.
- It saves the amount of time and cost required to transfer money across borders thus it will revolutionise the way remittances are made by eliminating intermediaries making it further cost effective.
- The unbanked community too can participate in the economy by using digital money present in their online wallet or mobile phones.
- During weekends and outside normal business hours banks are closed and cannot confirm transactions. But when we use digital currency, transactions work at the same speed 24 hours a day, seven days a week.
- CBDC could create a more real-time and cost-effective globalisation of payment systems allowing importers and exporters to settle payment for goods or services directly.
- It allows faster transfer rates, reduced transaction fees with greater transparency.
- Better budgeting and economic plans for the future are possible for the government as it will have better control over how money enters the country or leaves the country.
- Unlike physical notes, Digital Currency is not susceptible to damage. Notes can get torn or burnt but digital currency does not suffer any physical damage.
- Digital mode of payment involves several intermediaries such as software providers and maintenance contractors etc. The system will get more simplified for transacting users and server downtimes will be reduced. A single ledger will be shared across ecosystem participants once CBDC gets implemented and the ledger systems used by the banks and payments networks will not be required. However, the use of other payment gateways shall remain in use.
- There are 1.2 billion mobile phone connections in India but only 582 million bank accounts, a huge gap which CBDC is likely to bridge.
- The settlement risk in the financial system will be reduced. Interbank settlement will not be needed as the system will transact the digital currencies instead of bank balances.
- CBDC could create a more real-time and cost-effective globalisation of payment systems allowing importers and exporters to settle payment for goods or services directly.
- It allows faster transfer rates, reduced transaction fees and with greater transparency.
- Better budgeting and economic plans for the future are possible for the government as it will have better control over how money enters the country or leaves the country.
- Transparent ledger will make it possible for the central bank to track transactions and prevent fraud thereby helping in reducing illegal activities.
- It might support and facilitate the emergence and growth of the fintech industry thus providing an encouraging atmosphere for a new technological landscape.
Despite several advantages there are a few drawbacks of Digital Currency which are as listed below:
- There could be privacy related issues as the central bank would have so much user data. It will have data on every transaction and some data on the CBDC’s users.
- The RBI will have full control over its CBDC. So it would have all the rights to decide and put restrictions on the types of transactions it allows.
- CBDCs will take some time to become user friendly. The entire population won’t have the means to access digital currencies. Then there are those who do not like to use it because they don’t trust digital currencies.
- Physical cash cannot be de-legalised immediately. CBDCs will be introduced as a convenient add-on to the existing system initially. Cash will not disappear from the system all of a sudden. The central bank will have all the control, traceability and transparency in their hands hence it will be anonymous to a certain extent. Your financial activity will be visible to your central bank just like your debit card details.
- Money will become programmable. The price of money or interest rates will be controlled by the central bank but not the velocity of it. It is possible that the bank decides about the expiration of money and puts a condition like ‘if you don’t spend your money in your account by next month, it will expire’.
- The flow of traditionally circulating currency relied to a greater extent on financial institutions but CBDCs are tools of delivering helicopter currency faster and it reaches the pockets of citizens just with the push of a button.
- Commercial banks’ role might diminish as the central bank will have a big role to play in lending decisions.
- Absence of physical cash and programmability pose ethical questions. The chances of personalised monetary policy increase. Individual spending, saving and investing will be known to the central bank and it will form its policy accordingly. And personalised monetary policies often become politicised. A stimulus can be provided to those communities which are found useful in polls.
- You cannot withdraw your Digital Money and hold them in your hands. Banks will be able to implement negative interest rates. In such a scenario people either have to use their money or lose the money resulting in more consumer spending.
As we learn about Digital Currency, there could be a clarification required as to How Digital Currency is different from Crypto currencies-
- All cryptocurrencies can be termed as digital currency, all digital currencies are not cryptocurrencies.
- Issuing authority makes a major difference. It will be the Reserve Bank of India in our country that will issue digital currency like it does regular fiat currency. CBDC is the legal tender issued by a central bank in a digital form and exchangeable one-to-one with the fiat currency. It will be backed by the Government, with seigniorage accruing to the sovereign. Digital currency is a digital format of fiat money but cryptocurrencies are built on blockchain.
- The transaction across borders will become easier due to CBDC unlike cryptocurrencies. Cryptocurrencies do not have universal acceptance like regular fiat currency. And regular fiat currency is going to be replaced by CBDC making it widely and legally acceptable. Cryptocurrencies use decentralised control where there is no presence of a third party to have authority over transactions.
- You can pay for products or services with bank accounts or digital wallets while using digital currency and also withdraw the same in the form of cash from an ATM by converting it into physical cash. No such options are available in case of cryptocurrencies as they remain in digital form only. They are privately owned.
- Users have to use secure and unique passwords while using cryptocurrencies to protect their digital wallets from hacking or theft, no such fear is attached in case of DBDC.
- Anyone having an online bank account can store and use digital currencies as it is nothing but e-cash. Cryptocurrencies store the virtual currency in ‘wallets’. Cryptocurrencies are bound to fluctuate wildly in value as they are not managed by the RBI. there is no stability in their value as it depends on how many people are eagerly buying that currency.
- Digital currency transactions are available to the sender, receiver and the bank. The RBI gets to decide what information to share. In case of all cryptocurrencies the transaction details are in the public domain and can be accessed on the blockchain.
- Cryotos can do large payments at lesser cost as they are more viable while inter country remittances are made. In the case of digital currency there is a transaction fee every time there is a payment through the digital wallet.
How to prepare for CBDCs
Introduction of CBDC doesn’t mean that it will get adjusted in the system automatically. It is something that cannot happen overnight but will take a few years to get stabilised in the system. CBDCs have been adopted worldwide as a force against cryptocurrency. As we transit to Digital Money, it will reduce fiat currency portfolio allocation.
But the RBI is going to have control over the system, there could be a trend to possess physical assets which are not under the same level of controllability and traceability as the digital currency like precious metals, real estate and so on.
Cryptocurrencies have been some of the most important developments of the 21st century and they serve as the base for the global CBDC ecosystem. However, in absence of tokens that have the characteristics permitting efficient cross border payments, secured and quick domestic transactions, the banks have to work with the key players in the cryptocurrency world in order to understand the mechanism better.
Future of Digital Currency: Pandemic made us value the importance of digital payments. Contactless payments have created history and the kind of convenience it has brought is revolutionary. There was a 40% growth in the adoption of digital payments across the country in a year through September 2021. Both the consumers as well as businessmen started relying on it and looks like it is going to last forever.
Digital currency is different from the money stored in bank accounts. When a normal payment transaction is done via online banking, UPI or cards, the money is reconciled by the bank or a network like Visa settles the change in balances. But digital currencies transfer the actual digital asset just like a payment with cash between parties without involving an intermediary.
The journey of digital currency began in 2009. It has evolved with time and has adapted with other payment networks along with banks and governments across the world. The Bahamas rolled out the world’s first CBDC, the sand dollar. The Bank of England and the European Central Bank are running their own trials.
Cash might disappear from our wallets as digital currency is here to replace it. There could also be a form of cryptocurrency also which might be legalised in future along with CBDC. However, CBDC would need to be widely and easily accessible.
Cryptocurrency, Stablecoins and Central Bank Digital Currencies are the main three types of digital currencies. As we all know cryptos have created quite a concern over the last few years. Stable coins were introduced in mid 2010. There is a likelihood of them being used for payments as they can be backed by assets and fiat currency. But due to the legality concerns and acceptability issues, central banks across the world are researching on developing their own digital currencies and hence CBDC are emerging as legal tender as an emerging payment innovation.
Digital currencies have all the potential to bring a revolution in the world just that more work would be required in the direction of privacy, cybersecurity risk, user education and understanding. Ecosystem is going to evolve once this change takes place. The cost of printing, transporting, storing and distributing currency can be removed by adopting Digital Currency. Paper and metals used to manufacture physical currencies will be saved. Similarly, printing, distributing and storing currency also involves costs. Minting of notes and coins will get reduced thereby considerable saving in all the above mentioned costs.
There shall be an amendment to the Reserve bank of India Act,1934 to improve the scope of the definition of ‘bank note’ to include currency in digital form. In the coming days our dependence on physical currency will reduce and it will slowly get replaced by the Digital Currency. Soon, our wallets are going to get shifted to our mobile phones and other gadgets as we step into a whole new world of monetary digitisation. Mankind has gone through many evolutions and there is no doubt that this is going to be one of its kind.
Bhoi Smrutirekha Dharanidhar