The time for central bank digital currencies has come

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A digital currency is like any other currency, money, or other monetary asset that is primarily managed, stored, or traded on a digital computer system, especially over the internet. They are different from printed banknotes or minted coins and generally have no physical form.

Digital currencies, however, express properties similar to physical currencies. The different types of digital currencies are virtual currency (cryptocurrency) and central bank digital currency (CBDC). A digital currency can reduce transaction processing costs and enable seamless transfer across borders.

Virtual currency is an electronic representation of monetary value that can be issued, managed and controlled by private issuers. They are often represented in terms of tokens and can remain unregulated without legal tender. They are based on a trust system and cannot be issued by a central bank or any other banking regulatory authority.

They derive their value from the underlying mechanism like mining in cryptocurrency cases. They have no intrinsic value. They do not represent the debt or liability of any person and there is no issuer.

The concept of CBDC is quite old. Nobel laureate James Tobin, an American economist, suggested in the 1980s that Federal Reserve banks could make widely accessible medium available to the public with the convenience of deposits and currency security. Yet it is in the last decade that this issue has been widely debated.

Money has taken either the form of commodities (which have intrinsic value) or in terms of debt instruments. When money has no intrinsic value, it must be a title to commodities or a title to other debt obligations. Paper money is such a representative currency and it is essentially a debt instrument. The owner of the currency knows who owes him or who has the underlying responsibility. Money is a form of money that belongs exclusively to the sovereign or to a central bank. It is a liability of the issuing central bank and an asset of the holding public.

The CBDC is an electric form of central bank money. It is an electronic record of official currency and is issued and regulated by the monetary authority. The introduction of cryptocurrencies paved the way for CBDCs. The advantages of CBDCs are:

Simplify the implementation of monetary and fiscal policy by facilitating the spread of money directly into the economy. The current system involves commercial banks as intermediaries between central banks and the consumer.

Promotion of financial inclusion in an economy by integrating the unbanked into the financial system. Costs associated with opening accounts, paying benefits, collecting taxes and other government functions. It eliminates expensive infrastructure.

The costs of transaction processing are very low for CBDCs and allow seamless transfer across borders.

The invention a secure and immutable ledger capable of tracking transactions.

A CBDC eliminates the risk of third parties (due to rumors or external events).

A CBDC is universally accessible.

Many countries are exploring the possibility of introducing and using CBDCs in their economies. The main disadvantage of a centralized currency is that it can erode the privacy of citizens. In addition, the CBDC has the disadvantage of introducing cumbersome regulations from a central bank / monetary authority.

Why a CBDC

A CBDC will keep track of all transactions and could be used to eliminate corruption / black money. The cryptocurrency ecosystem could potentially disrupt the existing monetary and financial infrastructure and hence the attempt by central banks / monetary authority to anticipate such an eventuality.

CBDC will act as a general representation of the country’s currency. It will function as a unit of account, a store of value and a medium of exchange for daily transactions. A CBDC will be backed by appropriate monetary reserves such as gold and / or foreign currency. CBDCs would also potentially enable a real-time baseline and more cost-effective globalization of the payment system.

It is conceivable that an Indian importer would pay their US exporter in real time in digital dollars without the need for a middleman. This payment would be final as if cash dollars were handed over, nor would it require the US federal system to be open to settlement. The difference in time zone would no longer matter in currency settlements.

Crypto vs. CBDC

Cryptocurrencies as we know them today are extremely volatile and do not enjoy government backing. CBDCs overcome this loophole by using the same underlying cryptocurrency technology. Governments recognize the CBDC as legal tender in the jurisdiction of the issuing central bank, which means anyone can use them for payments and every merchant must accept them.

It increases the security and efficiency of wholesale and retail payments. In a digital society, no tickets or coins are available and the country becomes cashless. As private electronic money increases the pressure on the government issue, a CBDC is strong. The CBDC is available 24 hours a day and is also an excellent tool to avoid the credit risk of private counterparties.

Country experiences

While interest in CBDCs is now almost universal, very few countries have even reached the pilot stage of launching their CBDCs. A 2021 BIS survey of central banks found that 86% were actively seeking the potential of CBDCs, 60% were experimenting with the technology, and 14% were deploying pilot projects. They include: China, the Digital Yuan; Sweden, e-Krona; Bahamas, sand dollar; Eastern Caribbean, DXCD; and Marshall Islands, sovereign.

The advantage of issuing a CBDC might be sufficient to justify India’s issuance of a CBDC. India is the world leader in digital payments innovations. Its payment systems are available 24/7 for retailers and wholesalers. They are largely real-time and the cost of transactions is almost zero or very low.

Digital payments have grown at an impressive 55% CAGR. It’s hard to find a payment system like UPI that allows transactions up to ₹ 1. Yet cash remains the preferred method of payment for receiving cash for everyday expenses. For small transactions up to 500, cash is the preferred medium. India’s high currency-to-GDP ratio offers another advantage to CBDCs.

The costs of printing, transporting, storing and distributing change can be reduced. The advent of private virtual currencies (VCs) may well be another reason why CBDCs may become necessary. If these CVs are recognized, national currencies with limited convertibility will be threatened.

Currencies like the US dollar will not be affected as most of these CVs are denominated in dollars. Developing our own CBDC could protect the public from the abnormal level of volatility experienced by some of these venture capital firms. Thus, CBDCs for emerging economies are desirable not only for the benefits they create in payment systems, but might also be necessary to protect the general public in a volatile private venture capital environment.

Like other central banks, the RBI has also been exploring the pros and cons of introducing CBDCs for quite some time. The RBI is currently working on a phased implementation strategy and is looking at use cases that could be implemented with little to no disruption.

Central banks pay considerable attention to CBDCs and, therefore, they will soon become a reality. CBDCs will contribute to the financial inclusion of the unbanked population. CBDCs will have far-reaching implications for the future of finance, including the buying and selling of digital assets and securities. There should be a dedicated legal framework to facilitate transparency, distribution and issuance of a digital form of currency by global governments.

As regulators and central banks take concrete steps to establish CBDCs, the world will begin to embrace digital currencies as the norm. The introduction of CBDCs has the potential to provide significant benefits such as reduced reliance on cash, lower transaction costs, and reduced settlement risk. This could lead to more robust, efficient, reliable, regulated and bid-based payment options. Any idea should bide its time. It could be the time of the CBDCs.

The author is responsible for treasury, Finrex Treasury Advisors


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