In the 2022 Union Budget, Finance Minister Nirmala Sitharaman proposed the launch of Digital Rupee – India’s version of a CBDC (Central bank digital currency). The RBI is expected to launch as well as regulate the digital currency, which will be backed by blockchain technology, from the financial year 2022-23.
The digital rupee will be the digital form of our physical rupee that can be exchanged for cash. It is expected to open new opportunities in the fintech sector.
CBDC- central bank digital currency- is essentially fiat currencies issued in digital form. The digital rupee, which will also be a CBDC, is the same as the legal currency we use. It’s just in a digital form. It is a sovereign currency in an electronic form and would appear as a liability (currency in circulation) on the RBI’s balance sheet. CBDC’s appeal or the interest in issuing them is gaining traction because of the increased use of cryptocurrencies, the increasing popularity of blockchain technology, and the benefits that stem from its adoption.
There are some countries which have already introduced CBDCs in some form. For example, the central bank of Bahamas issued a digital currency in 2020. Many central banks across the world have begun to explore the viability, value and usefulness of digital currencies. Countries like China, Sweden, Japan and Singapore are currently examining the various facets of such a transition. Recently, the US Federal Reserve has also released a report outlining the benefits and costs of issuing a central bank-backed digital dollar.
Type of Blockchain- While cryptocurrencies use permissionless (public) blockchains, CBDCs use permissioned (private) blockchains. The former is a decentralized structure, the latter is not.
Centralization- On crypto networks, decisions are made by reaching a consensus among the user base to whom the authority is delegated. However, in case of CBDCs, a central bank decides the rules
Use case- While both CBDCs and cryptocurrencies can be used for payments and other monetary transactions, the latter can also be used for speculative purposes.
The digital rupee will create new opportunities and lessen the burden in printing, handling & logistics management of cash.
The supply of money is tracked through bond purchases, sale and purchase of currencies and tinkering with the reserve ratios of banks. However, CBDC usage could help in analysing the demand for money and aid in policy management.
With help of digital rupee’s underlying technology- blockchain, ownership record transfers can provide irrefutable evidence of proof of ownership. It could possibly aid in curbing illegal activities like corruption and money laundering.
Multiple currencies, several institutions, country-specific financial regulations & laws in foreign trade transactions lead to slow or delayed cross-border payments. Such transactions are expensive and difficult to track too. These issues can be reduced by the CBDC since payments can be made to a foreign party immediately without having to face currency appreciation or depreciation risks.
There are obviously implications for the banking system. Availability of digital currency will make it easy for depositors to withdraw balances if there is stress on any bank. If during periods of extreme uncertainty, depositors may choose to migrate away from commercial banks. This could cause financial upheaval for the banks. That is, flight-risk of deposits could be high.
On the other hand, the possibility of panic “runs” might get reduced just because of the availability of CBDCs since depositors have knowledge that they can withdraw quickly.