Central Bank Digital Currency (CBDC)

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Central Bank Digital Currency (CBDC)
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• Management of currency is one of the core central
  banking functions of the Reserve Bank of India
  for which it derives the necessary statutory
  powers from Section 22 of the RBI Act, 1934.
  Along with the Government of India, the Reserve
  Bank is responsible for the design, production
  and overall management of the nations currency,
  with the goal of ensuring an adequate supply of
  clean and genuine notes in the economy. The
  history of money is fascinating and goes back
  thousands of years. From the early days of
  bartering to the first metal coins and eventually
  the first paper money, it has always had an
  important impact on the way we function as a
  society. The Concept of Money has practiced
  progress from Commodity to Metallic Currency to
  Paper Currency to Digital Currency now. In modern
  economies, currency is a form of money that is
  issued exclusively by the sovereign (or a central
  bank as its representative). It is a liability of
  the issuing central bank (and sovereign) and an
  asset of the holding public. Currency is fiat, it
  is legal tender. Currency is usually issued in
  paper (or polymer) form, but the form of currency
  is not its defining characteristic.

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• What is a central bank digital currency CBDC? A
  CBDC is the legal tender issued by a central bank
  in a digital form. It is the same as a ?iat1
  currency and is exchangeable one-to-one with the
  ?iat currency. Only its form is different. It is
  also important to understand what a CBDC is not.
  CBDC is a digital or virtual currency but it is
  not comparable to the private virtual currencies
  that have mushroomed over the last decade.
  Private virtual currencies sit at substantial
  odds to the historical concept of money. They are
  not commodities or claims on commodities as they
  have no intrinsic value some claims that they
  are akin to gold clearly seem opportunistic.
  Usually, certainly for the most popular ones now,
  they do not represent any persons debt or
  liabilities. There is no ISSUER. They are not
  money (certainly not CURRENCY) as the word has
  come to be understood historically.

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• Key Motivations for CBDC The adoption of CBDC
  has been justified for the following reasons
  CBDC, being a sovereign currency, holds unique
  advantages of central bank money viz. trust,
  safety, liquidity, settlement finality and
  integrity. The key motivations for exploring the
  issuance of CBDC in India among others include
  reduction in operational costs involved i There
  are no sources in the current document.  physical
  cash management, fostering financial inclusion,
  bringing resilience, efficiency, and innovation
  in payments system, adding efficiency to the
  settlement system, boosting innovation in
  cross-border payments space and providing public
  with uses that any private virtual currencies can
  provide, without the associated risks. The use of
  offline feature in CBDC would also be beneficial
  in remote locations and offer availability and
  resilience benefits when electrical power or
  mobile network is not available. Jurisdictions
  with significant physical cash usage seeking to
  make issuance more efficient Central banks seek
  to meet the publics need for digital currencies,
  manifested in the increasing use of private
  virtual currencies, and thereby avoid the more
  damaging consequences of such private currencies.
  It is not clear what specific need is met by
  these private VCs that official money cannot meet
  as efficiently, but that may in itself not come
  in the way of their adoption. If these VCs gain
  recognition, national currencies with limited
  convertibility are likely to come under threat.
  To be sure, freely convertible currencies like
  the US Dollar may not be affected as most of
  these VCs are denominated in US Dollar. In fact,
  these VCs might encourage the use of US Dollar,
  as has been argued by Randal Quarles2. Developing
  our own CBDC could provide the public with uses
  that any private VC can provide and to that
  extent might retain public preference for the
  Rupee. It could also protect the public from the
  abnormal level of volatility some of these VCs
  experience.

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• In addition, CBDCs have some clear advantages
  over other digital payments systems payments
  using CBDCs are final and thus reduce settlement
  risk in the financial system. Imagine a UPI
  system where CBDC is transacted instead of bank
  balances, as if cash is handed over the need
  for interbank settlement disappears. CBDCs would
  also potentially enable a more real-time and
  cost-effective globalization of payment systems.
  It is conceivable for an Indian importer to pay
  its American exporter on a real time basis in
  digital Dollars, without the need of an
  intermediary. This transaction would be final, as
  if cash dollars are handed over, and would not
  even require that the US Federal Reserve system
  is open for settlement. Time zone difference
  would no longer matter in currency settlements
  there would be no Herstatt 3 Indias high
  currency to GDP ratio holds out another benefit
  of CBDCs. To the extent large cash usage can be
  replaced by CBDCs, the cost of printing,
  transporting, storing and distributing currency
  can be reduced. Types of Central Bank Digital
  Currencies (CBDC) CBDC is Classified Broadly
  into Two Types, viz. General Purpose or Retail
  (CBDC-R) Digital Currency and Wholesale (CBDC-W)
  Digital Currency. The Retail CBDC (e?-R) would be
  purportedly available for use by all entities,
  viz., Private Sector entities, Nonfinancial
  Consumers and also Business Entities. While
  Wholesale CBDC (e?-W) is intended for limited use
  or access to the selected Financial Institutions
  in the Financial System like Banks / Insurance
  Companies in India. While Wholesale CBDC is
  proposed for the settlement of Interbank
  Transactions like (Payments / Transfers) from One
  Bank to another Bank and related Wholesale
  Transactions, Retail CBDC is an Electronic
  Variety of Cash mostly for Retail Transactions
  i.e., by the Public.

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• Model for issuance and management of CBDC There
  are two models for issuance and management of
  CBDCs viz. Direct model (Single Tier model) and
  Indirect model (Two-Tier model). A Direct model
  would be the one where the central bank is
  responsible for managing all aspects of the CBDC
  system viz. issuance, account-keeping and
  transaction verification. In an Indirect model,
  central bank and other intermediaries (banks and
  any other service providers), each play their
  respective role. In this model central bank
  issues CBDC to consumers indirectly through
  intermediaries and any claim by consumers is
  managed by the intermediary as the central bank
  only handles wholesale payments to
  intermediaries. The Indirect model is akin to the
  current physical currency management system
  wherein banks manage activities like distribution
  of notes to public, account-keeping, adherence of
  requirement related to know-your-customer (KYC)
  and anti-money laundering and countering the
  terrorism of financing (AML/CFT) checks,
  transaction verification etc.Various Forms of
  Central Bank Digital Currency CBDC can be
  Classified into as Token-based or
  Account-based. A Token-based CBDC is a
  bearer-instrument and it is similar to Bank
  Notes, meaning whosoever holds the tokens at a
  given point in time would be supposed to own
  them. The difference, an Account-based system
  would require upkeep of record of Balances and
  Transactions of all Holders of the Central Bank
  Digital Currency and designate the ownership of
  the Monetary Balances / Value. In view of the
  above features offered by these both Forms of
  CBDCs, a Token-based CBDC is regarded as a
  favoured means for CBDC-R as it would be Nearer
  to the Physical Cash, while an Account-based CBDC
  may be measured for CBDC-W. CBDC e? and its
  Technology Considerations Convenience For the
  users tap-to-pay with relatively modern
  Smartphones, Storage of Value Cards and Custom
  Devices fitted with NFC (Near Field
  Communications) is been well understood and
  straightforward. There should be various
  user-friendly payment alternatives which may be
  in order to support the various use cases. For
  example e-commerce or person-to-person
  payments.

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• Secure and Resilient To protect the end user
  data, there are a variety of mature Cryptographic
  Techniques flexible enough to be used across the
  Centralised or Distributed Ledgers. Typically, in
  a Centralised Platform, it is the System
  Administrator who enforces the privacy policy,
  while distributed or device-based environments
  with less straight forward governance
  arrangements that can face complications from the
  software-based privacy enforcement. As Critical
  Infrastructure, the resilience of Central Bank
  Digital Currency will likely need to be similar
  to the Current Payment Systems and Operate for
  24/7/365 service. Fast and Scalable The Central
  Bank Digital Currency system will need to be able
  to meet the volume and also throughput
  (transactions per second) requirements at a
  justifiable cost. Preferably, the volumes can
  drive with marginal costs to tremendously at low
  levels. The Present large centralised systems
  like Card Networks demonstrate which are having
  very high transaction capacity for the large
  populations may also possible with the
  conventional technologies. Interoperable
  Technologies in order to support the platform of
  various business models, permitting third parties
  in order to build the services on top of a
  Central Bank Digital Currency System, are well
  recognized. Challenges in interoperating with the
  existing payment arrangements will be based on
  their designs but most of it have mechanisms
  which are standardised to make inter-account
  transactions. The Common Data Standards Most
  notably ISO 20022, will likely play a part in
  enabling the interoperability with other payment
  systems. With intermediaries, in a Central Bank
  Digital Currency System, its design will support
  payments (Be it Online or Offline) between the
  Customers of one Intermediary and another and
  support portability, in order to avoid users
  which are being locked in to a single
  intermediary.

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• Flexible and Adaptable Several Factors to
  determine how it is adaptable a Central Bank
  Digital Currency system and is-how accurately the
  fundamental concepts of the Money and Payments
  are enacted a careful, layered design with a
  clear separation of the concerns designing with
  foresight into how the environment may evolve
  (e.g., Micro Transactions, Changes in
  Cryptography) and so on. Technology choice CBDCs
  being digital in nature, technological
  consideration will always remain at its core. The
  infrastructure of CBDCs can be on a conventional
  centrally controlled database or on Distributed
  Ledger Technology. The two technologies differ in
  terms of efficiency and degree of protection from
  single point of failure. The technology
  considerations underlying the deployment of CBDC
  needs to be forward looking and must have strong
  cybersecurity, technical stability, resilience
  and sound technical governance standards. While
  crystallising the design choices in the initial
  stages, the technological considerations may be
  kept flexible and open-ended in order to
  incorporate the changing needs based on the
  evolution of the technological aspects of CBDCs.
  Instrument Design The payment of (positive)
  interest would likely enhance the attractiveness
  of CBDCs that also serves as a store of value.
  But, designing a CBDC that moves away from
  cash-like attributes to a deposit-like CBDC may
  have a potential for disintermediation in the
  financial system resulting from loss of deposits
  by banks, impeding their credit creation capacity
  in the economy. Also considering that physical
  cash does not carry any interest, it would be
  more logical to offer non-interest bearing CBDCs.
  Degree of Anonymity For CBDC to play the role as
  a medium of exchange, it needs to incorporate all
  the features that physical currency represents
  including anonymity, universality, and finality.
  Ensuring anonymity for a digital currency
  particularly represents a challenge, as all
  digital transactions would leave some trail.
  Clearly, the degree of anonymity would be a key
  design decision for any CBDC. In this regard,
  reasonable anonymity for small value transactions
  akin to anonymity associated with physical cash
  may be a desirable option for CBDC-R.Read more
  at https//taxguru.in/rbi/central-bank-digital-cu
  rrency-cbdc-e-r-e-w-financial-landscape-india.html
  Copyright Taxguru.in

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• Features of Central Bank Digital Currency The
  Sovereign Currency Issued by Central Bank of the
  Country i.e., RBI. It shown as Liability Side in
  the Central Banks Balance Sheet. It is
  Recognized as a Medium of Payment or the Legal
  Tender of the Country. It is Freely Convertible
  into Cash whenever required. The Holders need not
  have a Bank Account to use the Central Bank
  Digital Currency. It Lowers the Cost of Issuance
  and Managing of the Money and Transactions in the
  Country. CBDC-The Global Scenario All over the
  World, more than 60 Central Banks have stated
  interest in introducing the CBDC in their
  Country, with a few enactments already been made
  under Pilot across both the Retail (R) and
  Wholesale (W) Categories and several others are
  doing Research, Testing, and/or launch their own
  CBDC as their Agenda. As of July 2022, there are
  105 Countries in the process of Discovering the
  CBDC, and the number that Covers 95 of the
  Global Gross Domestic Product (GDP) and 10
  Countries have already implemented a CBDC, and
  the first of which were The Bahamian Sand Dollar
  in 2020, and The latest was Jamaicas JAM-DEX.
  Currently, 17 other Countries in the World,
  together with the Major Economies like China and
  South Korea, are in the Pilot Stage and
  formulating for probable launches. China was the
  ?irst Large Economy to Pilot Lunch of Central
  Bank Digital Currency way back in April 2020 and
  their intentions for extensive domestic use of
  the e-CNY by 2023 by the People of the Country.
  Gradually, the CBDCs are being seen as a gifted
  invention and as the Next Step in the
  Evolutionary Development of Sovereign Currency in
  the World. Pilot / Trial Run-Central Bank Digital
  Currency The first experimental in the Digital
  Rupee-Wholesale segment (e?-W) commenced on
  November 1, 2022 in India which was the Historic
  Event of the Country. The used case for this
  pilot is the clearing of the Secondary Market
  transactions in government securities etc. The
  use of e?-W is expected to make the interbank
  payments market and it is a more competent.
  Settlement in central bank money would reduce the
  transaction costs by anticipating the need for
  settlement guarantee set-up or for collateral to
  alleviate settlement risk. Going forward, other
  wholesale transactions and cross border payments
  (Country to Country) will be the focus of
  upcoming pilots, based on the learnings from this
  pilot run. RBI has recognized Nine Banks for
  Trail Run for partaking in the Digital Rupees
  Wholesale Pilot Project, and the following Banks
  were identified by the Reserve Bank of India
  State Bank of India. Bank of Baroda. Union Bank
  of India. HDFC Bank. ICICI Bank. Kotak Mahindra
  Bank. Yes Bank. IDFC First Bank. HSB.Read more
  at https//taxguru.in/rbi/central-bank-digital-cu
  rrency-cbdc-e-r-e-w-financial-landscape-india.html
  Copyright Taxguru.in

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• The Reserve Bank has launched the first pilot for
  Retail Digital Rupee (e?-R) on December 01, 2022.
  The Experimental would cover select locations in
  the Country in a Closed User Group (CUG) covering
  active customers and merchants of the various
  Banks. The e?-R would be in the form of a digital
  token that denotes the legal tender. It would be
  issued in the same values that paper currency and
  coins are currently issued in India. It would be
  distributed through intermediaries, i.e., through
  Commercial Banks. Users will be able to perform
  with e?-R through a digital wallet offered by the
  active banks and stored on mobile phones/devices.
  The Transactions can be both in Person to Person
  (P2P) and Person to Merchant (P2M). The Payments
  to Merchants can be made using QR Codes shown at
  various merchant establishments. The e?-R would
  offer structures of physical cash similar
  available in the Country i.e., The Trust. The
  Safety and The Settlement Finality. As in the
  case of Cash, it will not earn any interest at
  present and can be changed to other forms of
  money, like Deposits with Commercial Banks, loan
  repayments etc. The Eight Commercial Banks that
  have been identified for phase-wise participation
  in this pilot stage of CBDC are The First Stage
  will begin with Four Banks, viz., State Bank of
  India. ICICI Bank. Yes Bank and IDFC First Bank
  in four major Cities across the Country.Read
  more at https//taxguru.in/rbi/central-bank-digit
  al-currency-cbdc-e-r-e-w-financial-landscape-india
  .htmlCopyright Taxguru.in

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• Adding Four more Commercial Banks in due course,
  viz., Bank of Baroda. Union Bank of India. HDFC
  Bank and Kotak Mahindra Bank join this pilot
  afterwards. The Pilot would ?irstly cover Four
  Major Cities in India, viz., Mumbai, New Delhi
  Bengaluru and Bhubaneswar. Later on, extending to
  the other Centres like Ahmedabad, Gangtok,
  Guwahati, Hyderabad, Indore, Kochi, Lucknow,
  Patna and Shimla. Conclusion The Central Bank
  Digital Currency (CBDC) is proposed to match,
  rather than to replace, the current forms of
  money and it is predicted to provide an
  additional payment system to users of the
  Country, and not to substitute the existing
  payment systems of the Country. As it is proposed
  to be supported by up-to date payment systems
  that are inexpensive, reachable, suitable,
  well-organized, safe and secure. The Digital
  Rupee (e?) system will further strengthen Indias
  Digital Economy, and make the Monetary and
  Payment Systems more Efficient and Subsidize for
  broadening Financial Inclusion in India, with an
  added advantage of discouraging the trade or
  investments in private virtual digital
  currencies. References 1. www.rbi.org.in 2.
  Concept Note on CBDC by the RBI. 3. Keynote
  address delivered by Shri T Rabi Sankar, Deputy
  Governor, Reserve Bank of India, on July 22nd,
  2021 at the webinar organised by the Vidhi Centre
  for Legal Policy, New Delhi. 4.
  https//www.federalreserve.gov/newsevents/speech/q
  uarles20210628a.htm Notes 1 Fiat currency in a
  broad sense refers to a type of currency that is
  not backed by a commodity but are made legal
  tender by a government degree or fiat.  2
  https//www.federalreserve.gov/newsevents/speech/q
  uarles20210628a.htm 3 Herstatt Risk also known as
  settlement risk or cross-currency settlement
  risk, is the risk associated with settlement of
  foreign exchange transactions.
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