Picture a world where you don't need physical cash, credit cards, or even a bank account to buy things or pay for services. Instead, you can use a digital currency that is issued and backed by your country's central bank. This concept is not science fiction, but rather the growing reality of Central Bank Digital Currencies (CBDCs).
With the rise of digital technologies and the declining use of cash, CBDCs are seen as a promising solution to modernize and streamline the monetary system. But what exactly are CBDCs, and how do they work?
Source:- https://paytm.com/blog/digital-currency/what-is-central-bank-digital-currency-cbdc/
To understand the concept of a Central Bank Digital Currency(CBDC), we must go back to the roots of the unique concept of money. What is money? Money is a standardised medium of exchange used as the common measure of value. Money gains its value due to the trust placed in it by the users of the commodity and their belief that it will be commonly used.
The Central banking authority plays an important role when it comes to legalising money as a medium of exchange and a measure of value, Money sometimes may not have intrinsic value but can buy commodities that have intrinsic value. Money has taken the form of commodities with intrinsic value or debt instruments. Money is backed by mutual trust and the country’s banking authority further assures this by legalizing it, or making it legal tender to ensure the trust people have put in money.
The CBDC reinvigorates the concept of money. Many experts have commented about CBDC being the future of money. Why has the CBDC concept made an entrance at this point? Around the last decade, the concept of paper money or cash has been declining. The Covid 19 pandemic was one of the nails in the coffin with the facilitation of cashless transactions on the rise.
The digital form of currency has piqued the interest of people and many investors. Central Bank Digital Currency(CBDC) is a legal tender issued by a Central Bank in digital form. CBDC bears many similarities to private virtual currencies like cryptocurrencies in terms of the blockchain technology used in both of them, but by far the biggest difference between a CBDC and a cryptocurrency would be there is no issuer to a private visual currency. In the case of a CBDC, the issuer would be the Central bank. CBDC is something like a private cryptocurrency but with regulation thereby without the immense volatility that is associated with a private cryptocurrency.
CBDC at this point has justified itself with the diminishing use of physical cash in transactions and due to the development of new digital currencies. CBDC is a more acceptable e-form of cash and reduces the dependence on cash in the economy. The vital shove that made it possible for CBDC to be launched was the increasing influence of virtual currency and the catastrophic impacts it was causing on the economy due to its volatility.
CBDC has several advantages that accompany it like, it reduces the final settlement risk which is one of the big flaws currently plaguing the existing system. CBDCs or their form of digitalized tokens are transacted instead of the bank balance amounts which eliminates the process of inter-bank settlement. CBDCs can ensure a more real-time, cheaper globalisation of payment systems, provided digital CBDC systems of the respective countries are connected. It especially helps in the time zone problems encountered during foreign transactions. Also, the cost of storing, distributing and transporting paper currency can drastically reduce with the introduction of CBDC as it’s digital.
Source;- https://mycelium.xyz/research/cbdc-objectives-and-design
CBDC provides a safe option for money compared to private VCs which have less usability and serve more of the investing purpose. CBDC has parity with the rupee in value(i.e. 1 rupee=1 CBDC(1-1 value), eliminating most of the fears held by common people regarding it. According to reports, CBDC will be launched in two versions: Wholesale and Retail. The retail version of the CBDC will be used in the economy for day-to-day transactions for consumer demand, etc and the wholesale version would be used in the banking system between banks for settling transactions. It is still not clear with how countries will go about it but this is the basic framework given by countries already implementing the pilot program of the CBDCs. CBDC is not an instrument which will pay interest as it might lure people to invest in CBDCs and leave lenders out.
There is still a profusion of possible issues that one has to face with the implementation of CBDC. CBDCs propose a huge risk to the existing banking system and if overused will cause a reduction of transaction demand for demand deposits. They have the ability to cause a shift away from bank deposits as they provide a risk-free alternative to bank deposits which might reduce the government’s guarantee o deposits. It also reduces the huge role played by banks as intermediaries in the system which constrains their credit creation ability thereby increasing the cost of credit. Banks will also focus on more liquidity due to CBDCs thereby increasing the cost of credit again. The availability of CBDCs helps depositors to withdraw their bank balances quite conveniently when the bank is under pressure. Also, the common enemies of technology like cyber-attacks are omnipresent.
The Reserve Bank of India (RBI), the country’s central bank and leading banking authority introduced the concept note on October 7 2022 following the pre-planned introduction of the Digital rupee as announced in the Union Budget 2022.
Time will only tell whether the RBI manages to successfully implement the pilot program of the digital rupee in the economy and able to tackle the humungous challenges proposed by the introduction of CBDC to the banking system in the country.
Article by:- Sudarshan G
Edited by:- J Shree Nidhi
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