Decrypt: The arguments in favour of CBDC

NEW DELHI: CBDC - yes, we hear this buzzword every day. But what exactly is it? We also know the move towards Central Bank Digital Currency is gaining momentum, with the Finance Minister in her Budget proposal announcing the issuance of a Digital Rupee by the Reserve Bank of India (RBI) starting financial year 2022-23.

So what functions might a digital rupee issued by the RBI, serve?

It is important to identify the use-cases of a CBDC as it is critical to the design of the digital rupee alongwith the infrastructure for its issuance, distribution and transfer.

Central banks are rolling up their sleeves and familiarising themselves with the bits and bytes of digital money.

These are still early days for CBDCs and we don’t quite know how far and how fast they will go.

What we know is that central banks are building capacity to harness new technologies—to be ready for what may lie ahead.

Designed prudently, CBDCs can potentially offer more resilience, more safety, greater availability, and lower costs than private forms of digital money. That is clearly the case when compared to unbacked crypto assets that are inherently volatile.

And even the better managed and regulated stablecoins may not be quite a match against a stable and well-designed central bank digital currency.

Besides India, over 100 countries are exploring CBDCs at one level or another. Some researching, some testing, and a few already distributing CBDC to the public.

Sweden’s Riksbank has developed a proof of concept and is exploring the technology and policy implications of CBDC. In China, the digital renminbi (called e-CNY) continues to progress with more than a hundred million individual users and billions of yuan in transactions.

Generally, money is issued in two forms. First, where the Central Bank issues currency notes which are also their liability.

The second kind of money are the deposits that depositors keep with commercial banks.

The liability underlying these deposits is not that of the central bank and if a commercial bank becomes insolvent or has liquidity problems, one cannot directly claim the value of the deposit from the central Bank.

So, this is where a CBDC’s biggest value proposition is to the average Indian household or business. Since the CBDC is a liability of the central bank, it minimises depositors’ exposure to their bank.

The idea that a central bank will default on its obligation to honour a payment or settle a transaction is currently unthinkable. A CBDC is, therefore, a risk-free settlement asset.

Yet another use case for a central Bank-issued CBDC lies in cross-border payments. Globally, these are expensive as they involve multiple banks across jurisdictions.

The time and costs involved in the settlement of cross-border remittances are considerably higher compared to domestic payment transactions.

CBDCs have the potential to bring down the costs of making cross-border payments as they dispense with correspondent banks.

A CBDC, being issued by the central bank, can be directly settled through digital ledger without having to go through the entire chain of banks otherwise involved in a cross-border transaction.

The history of money is entering a new chapter. Countries are seeking to preserve key aspects of their traditional monetary and financial systems, while experimenting with new digital forms of money. Let’s embrace the change when it happens.