- a has recently launched a pilot project for Central Bank Digital Currency.
- India’s CBDC will be called the Digital Rupee and should help in its economic growth.
Apart from being the fastest-growing economy on the planet, India is also venturing into digitization of currency with the Central Bank Digital Currency (CBDC). In December 2021, the Indian economy surpassed that of the United Kingdom to become the fifth-largest economy in the world.CBDC pilot project
In 2023, India’s Gross Domestic Product (GDP) touched the $3.75 trillion mark and is lower than the USA with $26.85 Trillion, China with $19.37 Trillion and Germany with $4.30 Trillion. On October 7, 2022, the Reserve Bank of India issued the concept note for CBDC and launched the pilot project for both wholesale (e₹-W) and retail (e₹-R) markets. Entering the club of over 130 countries exploring the possibilities of CBDCs.
What Exactly in Central Bank Digital Currency?CBDC pilot project
Before understanding CBDC, let’s talk about digital currency or cryptocurrencies. Bitcoin, Ehtereum and similar currencies were created to transfer the power from centralized entities like banks and financial institutions to people through decentralization.
Crypto currencies do not have any central entity governing their functions, instead, a dedicated community oversees their operations. All these currencies are based on blockchain technology providing transparency and security. However, they are highly volatile and come with underlying threats.
Digital photos are digitization of photography, music apps are digitization of music, streaming platforms are digitization of videos and movies, similarly digital currency is digitization of money. Leveraging on the power of blockchain technology, its transparency, and security, central banks of many countries in the world are exploring the possibilities of Central Bank Digital Currencies (CBDCs).CBDC pilot project
Cryptocurrency vs. CBDC
Cryptocurrency emerged to replace banks and intermediaries by shifting the power to common people. Cryptocurrencies are based on blockchain technology and use a peer-to-peer network for transactions. Meaning anyone in the network who wishes to be a validator can validate the transaction.
Every transaction on the blockchain network is available on an open ledger but due to blockchain technology no one can edit anything. Imagine 100 persons scattered all over the world are sending and receiving money to every other person at the same time. In a normal banking scenario it has to go through a chain of banks and international intermediaries to facilitate transactions. But if they transfer cryptocurrency to each other they do not need any banks or intermediary as it’s a peer-to-peer transaction.CBDC pilot project
But cryptocurrencies are not backed by anything and have no governing body safeguarding investors. In November 2022, the world’s third biggest crypto exchange FTX filed Chapter 11 bankruptcy causing millions of dollars of its investors to wash out. Detailed analysis of the collapse showed that FTX mishandled investor money and such incidents caused massive distrust in the investors.CBDC pilot project
Hence governments stepped in and took the best of cryptocurrency and blockchain technology and removed the uncertainty and distrust from the equation. Giving rise to the Central Bank Digital Currency (CBDC). This is a crypto currency backed by the country’s fiat currency and the government.
Importance of CBDC
Cryptocurrencies are not backed by anything, and their value depends upon its use cases, community, and transaction volumes etc. These factors make crypto highly volatile and not fit for daily transactions. As CBDCs are backed by a country’s central bank, its value is kept equivalent to the current value of its fiat currency.CBDC pilot project
CBDC are basically a digital form of fiat currency, enabling the governments and population to have a real cashless economy. It is like a digital representation of the money in your pocket into a digital wallet. You can perform similar transactions with CBDC with extra protection. Moreover the government can keep an eye on transactions and strengthen the economic structure of the country.
There are multiple benefits of CBDC, like providing a secure and efficient medium of exchange. Due to the involvement of blockchain technology, it is open to programmability and smart contract capabilities. Experts argue that CBDC can be the missing puzzle in the exponential economic growth of India.
Why is India venturing into CBDC?
India’s interest in CBDC can be driven by multiple factors. First one is the need to modernize the existing financial infrastructure. The Reserve Bank of India is tasked with maintaining the financial stability and growth of the Indian economy. With CBDC, RBI wishes to harness the benefits of a streamlined payment system, significant reduction in transaction costs, and boost financial inclusion.
Additionally, Central Bank Digital Currency can grow as an option for the emerging cryptocurrency market, offering a regulated and secure digital alternative. Although India has not banned cryptocurrency trading, it also has not allowed any cryptocurrency to be a legal tender.
Digitization of currency comes with multiple advantages. Inclusion of blockchain technology can allow revolutionary features like smart contracts. For instance, allowing users to experience seamless insurance transfers, as soon as the condition is met. Also the government can now have a better scrutiny over illegal money transfer, black money, terror funding etc.
India’s CBDC Pilot Project
On October 7, 2022 India issued the concept note for CBDC, explaining the outline of the project. On November 1, 2022 launched the pilot project for both wholesale (e₹-W) and retail (e₹-R) markets. e₹-W had its use case limited to settlement of secondary market transactions in government securities.
It is also expected to make the interbank market more efficient. If banks make settlement in CBDC it could reduce transaction costs by eliminating the need for settlement guarantee infrastructure, or for collateral to eliminate settlement risks.
Related Read: White Paper of Indian Economy: A Story of Two Decades
On December 1, 2022, the retail (e₹-R) CBDC was launched in a closed user group (CUG) of participating customers and merchants. As of July 11, 2023, a total of 13 banks are participating in the pilot project including the State Bank of India, ICICI Bank, IDFC First Bank, Bank of Baroda, Union Bank of India, HDFC Bank, Kotak Mahindra Bank, Punjab National Bank, Canara Bank, Federal Bank, Axis Bank and IndusInd Bank.
Users can transfer their cash reserves into Digital Rupee from the bank to be stored in their digital wallets and use it for transactions. Similar to paper currency and coins the RBI will be responsible for issuance of digital tokens and distribution to intermediaries called Token Service Providers (TSPs). Banks can obtain these tokens through TSP merchants.
Key Features of Digital Rupee
Digital Rupee or India’s CBDC is aimed at providing following features:
- Interoperability
- RBI wants Digital Rupee to seamlessly integrate with existing financial systems. If included this would facilitate compatibility and uniformity with various payment platforms and services.
- Privacy and Security
- As the project is based on blockchain technology, the infrastructure prioritizes the privacy of transactions while maintaining the highest standards of security. The integrated advanced cryptographic techniques are employed to safeguard user data.
- Financial Inclusion
- The primary goal of Digital Rupee is to extend the financial services to the unbanked and underbanked populations. It is envisioned as a tool for financial empowerment and inclusion.
- Programmability
- Smart contract capabilities are an advanced feature allowing the possibilities for programmable transactions. It enables the inclusion of innovative financial products and services.
- Reduced Transaction Costs:
- With a streamlined payment system and elimination of intermediaries, Digital Rupee can significantly reduce transaction costs for businesses and consumers.
- Monetary Policy Tools:
- CBDC provides central banks with new tools to seamlessly implement monetary policies. With proper digitization of currency, the government can have a stiffer control over money supply.
Experts argue that India’s Central Bank Digital Currency pilot project is a significant stride towards the digital future of the Indian Rupee. As the pilot project progresses and the underlying technology matures, the potential benefits of CBDC in terms of financial inclusion, efficiency and security could reshape the economic landscape of India.
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