CBDC (Central bank Digital Currency)
CBDC is worldwide initiative from various Central Banks. The Govt of India also talked about CBDC in last budged session and its tentative rollout in 2023 but didn’t provide much details about how and what changes it will bring, resulting a lot of speculation. I read some of the articles in leading Indian Newspaper and compelled to say — they need improvements.
Let’s try to understand various aspects of it.
CBDC Vs Crypto (Perhaps the mostly asked question)
Blockchain network show the world that you don’t need intermediaries (like banks) and can perform point-to-point transactions. At the same time, you can maintain a digital ledger where all the transactions are recorded. Some people see CBDC is the answer to Crypto by various Central Banks, but both are fundamentally different apart from underlying technology perhaps. CDBC is pegged with given fiat currency, while the crypto tokens, which are store of value like Bitcoin, are not backed by any fiat.
All the fiat currencies are trust based, people of given country and around the world trust the Central Bank/govt to maintain the regulated supply of currency. Failing to do so will result into what we witnessed in Zimbabwe, Venezuela, Turkey etc. On the other hand, supply of Bitcoin is fixed, halving cycle is pre-decided, and everything is burned inside the code. So, the trust is inherent.
CBDC is Worldwide
As per the report from https://www.atlanticcouncil.org/cbdctracker/ 87 countries (representing over 90 percent of global GDP) are exploring a CBDC. Following is where they stand
The father of paper money, China, has put all efforts to make it’s CBDC a global success. China became the first major country to launch a large-scale pilot for its CBDC in cities like Shenzhen, Suzhou, Chengdu, and Xiong’an. Foreign travelers to China will be able to use the government-developed digital yuan without a local bank account, meaning foreign travelers won’t need to fiddle with Chinese currency notes.
In Africa, Nigeria also launched eNaira at the end of 2021. US on the other hand is legging behind in race of CBDC.
Why 85% of World Central Banks are working on CBDC
Banking to everyone by cutting down printed cash
Unlike India where e-KYC can be done with Aadhar data, in many countries they don’t have such central database. Meaning banks must do costly KYC for each customer. Then banks want people to maintain certain low balance, interest of which pays for their banking services. Central Banks with CBDC can enable small amount transaction without intermediaries (banks) involvement. Meaning with CBDC wallet people can transact money point to point without any banking come in-between. The important point to note here is technically, if CBDC is designed on Blockchain/DLT, then central bank won’t need Banks as intermediaries at all. However, that would mean people will move their money into CBDC wallet, creating liquidity crunch at Banks. This will make banks to increase the landing rates which is a potential threat to any economy.
Keeping your money safe with CBDC also reduces the risk of rare scenario wherein banks go bankrupt. Because you are keeping your money in CBDC, hence are directly in relation with Central Bank. However, like I said, it’s very unlikely that Central Banks will remove banks from intermediaries, at least for bigger transaction amounts.
CBDC is also easy to track given the very nature of underlying technology of Blockchain/DLT.
More Control over International transactions
Cross border transactions over SWIFT payment rails, which are ultimately settled in dollars or have at least one leg of the transaction that involves a U.S. financial institution, gives US the power to control world finances. US leverages this to impose unilateral sections. These sanctions can damage the international trade of affected country, Iran used be primary example now it’s Russia. Once a country is cut loose from SWIFT rails, it’s very difficult for it to carry on its business with rest of the world.
To prove how it benefits US. Let’s look at some figures. In 2020, China overtook the United States and became the European Union’s (EU’s) top trading partner. In 2021, it overtook the United States as India’s top trading partner. In contrast, despite China being the world’s largest trading partner, its currency still makes up less than 2 percent of the world’s reserve currency while the USD is apx 60% [Ref: China’s Digital Yuan: An Alternative to the Dollar-Dominated Financial System — Rajesh Bansal and Somya Singh].
The second problem, which is for businesses and individual (for remittance) during international transactions is the transaction costs, settlement risks, and delayed payments. According to the World Bank, the global average cost of sending remittances is 6.51 percent of the transaction amount. This is painful. Those who have used cryto, knows that millions of dollars can be transacted internationally withing minutes, without any intermediaries.
With CBDC, courtiers are trying the create Multiple CBDC (m-CBDC) Bridge for bilateral currency swap. China is in very advance state here and it has all the rights to be. PBoC (People’s Bank of China) and the Central Bank of the United Arab Emirates joined the Multiple CBDC (m-CBDC) Bridge already. More information about m-CBDC bridge be read from — BIS Papers No 115, Multi-CBDC arrangements and the future of cross border payment.
CBDC and India
UPI has grown tremendously in past few years, thanks to demonetization and COVID-19. According to The Times of India News paper Mar31, 2022, UPI transactions has hit 5Billion/Month figure in month of March 2022.
The natural question surges in mind why CBDC while India has battle tested UPI system, which is replacing master, visa and Amex. UPI is also a digital money, you don’t need cash, it’s fast and widely accepted in India.
One of the reasons is international transactions. In recent events when India wants to directly buy fuel from Russia, given India’s well justified relationship with Russia, US threaten India with sanctions. m-CBDC bridge can help circumvent SWIFT payment rails here.
The other reason is CBDC can easily be tracked, given that it’s designed on blockchain/DLT wherein you can link all the transactions.
Financial inclusion is also one reason RBI talks about.
In future, CBDC can also be used to cut down the monopoly of any prominent payment wallets like Paytm.
