Central Bank Digital Currency (CBDC) has been in the news recently as Minister of Finance, Nirmala Sitharaman, announced that the Reserve Bank of India (RBI) will introduce India’s CBDC, digital rupee, in FY2023.

CBDC refers to the digital form of a country’s fiat currency, which is issued by the central bank of the country. CBDC has evolved from decentralised digital currencies such as Bitcoin and Ethereum.

According to the International Monetary Fund (IMF), around 100 countries are exploring CBDCs. They are used to make payments between individuals, between individuals and businesses or between financial institutions.

What Is CBDC?

• It is a digital form of currency. In India, RBI will issue and supervise India’s CBDC, digital rupee. CBDC can be exchanged with the fiat currency of the country. It is a liability of the central bank.

• The digital currency offers the same convenience and usage as cashless payment instruments such as credit transfers, direct debits, card payments and more. In this sense, it represents a direct claim on a central bank rather than being the liability of a private financial institution.

• With increased digitalisation, the number of investors of volatile assets such as cryptocurrencies has also gone up. CBDC is seen as a counter to the volatility and unaccountability of cryptocurrencies since it is issued and regulated by the country’s central bank, which is the main monetary authority.

How Does It Work?

• Both cryptocurrencies and CBDC, are dependent on networked electronic resources to create, track and validate transactions.

• In the case of most cryptos, resources are distributed and anonymised. In the case of CBDC, a central database, controlled by a central bank, issues the currency and provides every unit of the digital currency with a unique serial number.

• The electronic currency is pegged to the existing national currency. Since national currencies today are fiat, CBDCs are alternatively called digital fiat currencies.

• As CBDC is a digital currency, it can be tracked. The issuing authority will always know exactly where the currency is being used and by whom.

How Can It Be Used/Misused?

• CBDC provides consumers and businesses convenience, speed, privacy, accessibility, transferability, and financial security.

• It can reduce cross-border transaction costs, create options for those already using alternate money transfer methods, enable quick transfer of emergency grants and public funds.

• As transactions will be entirely online, governments can control tax evasion and illicit payments, which helps combat terror financing and money laundering.

• CBDC records are maintained using a digital distributed ledger technology, which is susceptible to hacking. Digital currencies are vulnerable to cyber attacks, account and data breaches and theft. Many cases of fraud, hacking and theft of digital currencies have already come forth.