The Role of Central Bank Digital Currencies (CBDCs) in the Modern Economy
Money is as old as mankind has ever existed. Truly said.
With everything going digital nowadays in the global village, how can money be left far behind?
Be it as a medium of exchange, or as a store of value, the definition of money transformed too. But with the advent of technologies, there also arises an increasing risk of lack of regulation amongst various digital currencies that have sprung up in the past decade.
Lack of regulatory authority behind digital assets being the key hindrance factor for many investors to jump in, it was necessitated by the central agencies to exercise some form of regulation to safeguard the investors’ interests in the larger interest. Enter CBDCs – Central Bank Digital Currencies.
Riddle me more on CBDCs, please!
To put it across in the simplest way possible, CBDCs are interlocutors between innovation and functionality that currencies are supposed to offer. Private digital currencies such as cryptocurrencies and NFTs circulate between people, hence the value of the store is solely determined by their circulation volumes.
But, CBDCs being issued and backed by a central bank, their issuance and transactional volumes are controlled by central banks authorized for the said purpose. The growth of private digital currencies and their immense popularity amongst new-age entities compelled the central regulatory authorities to bring the same under its purview.
A new age alternative to physical cash, CBDCs are steadily transforming the way financial inclusion is being done in a modern regulated economy. They traverse numerous barriers and help address inclusive challenges aided by existing physical banking infrastructure. This also facilitates the ploughing of more participation amongst the uninitiated in the financial world.
Just like the payer of physical cash is untraceable, CBDCs bring in an added benefit of similar anonymity and act as a further catalyst to boosting digitalization on a larger scale in the Indian economy. The Reserve Bank of India (RBI), the nation’s apex regulator issued the E-Rupee or the Digital Rupee in 2022 to bolster India’s digital financial inclusion prospects amongst the unbanked.
Issued in various denominations just like physical currency notes, each unit of CBDC issued by the RBI shall be uniquely identifiable & traceable with numbering and impossible to counterfeit by use of advanced security features.
Delving Deep into Further Benefits and The Need for CBDCs
Apart from the much-obvious benefit of financial inclusion, one of the most notable benefits of implementing CBDCs on a larger scale is reduced cash management costs. Reduction in settlement times and cycles also results in fewer resources used and more transactions, thus speeding up economic growth.
Internationally, India has been the forerunner when it comes to innovation and faster implementation of CBDCs. Downtime of international financial transactions can come down significantly once many central banks across various economies start fully implementing CBDCs in their native economy.
The biggest facilitator for illicit transactions in the black market remains cash, to this date. Add to that certain cryptocurrencies are used solely to finance criminal activities across borders and are becoming a new headache for law enforcement agencies.
CBDCs are traceable by their very nature and hence provide central banks with greater grip over money flow, and law enforcement agencies with larger teeth to combat tax evasion. They also help central banks retain control over interest rates and money flow in an increasingly digitized economy.
Types of CBDCs
Central Bank Direct Model requires the transactor to hold CBDCs in accounts directly managed by the central bank issuing the same, thus maintaining absolute control over its issue and use. This model runs the risk of making the conventional banking system redundant.
A Two-Tiered Model creates a system where the central bank issues CBDCs to commercial banks that further issue them to potential end users. This model gives the central bank a whip while also encouraging private participation by entities for better implementation.
A Hybrid Model brings the best of both together, where commercial banks are entrusted with the issuance of CBDCs for smaller & more frequent transactions and the central bank maintains a hold over transactions that are of more significance.
As seen with the case of UPI where it was enabled for SMS users with feature phones, we may also see a similar implementation of Offline CBDCs where transactions may be done even without a metered internet connection.
Technologies and Underlying Potential
Blockchain remains the underlying seabed of the ocean of digital transactions conducted using CBDCs. It is the main technology that assists in the conversion of and securitization of digital currencies that form the fundamentals of digital transactions.
Unlike cryptocurrencies where non-permissioned blockchains rule the roost, CBDCs are enhanced with secure blockchains authorized with adequate permissions that regulate participation and restrict access only to officials with adequate controls.
CBDCs are additionally laced with advanced security features to ensure the authenticity and integrity of digital transactions, thus potentially eliminating the risk of counterfeiting and financial fraud. CBDC transactions are also traceable by regulatory agencies, which may help them tackle financial fraud and nullify counterfeiting of currency altogether.
However, the realisation of the same depends solely on the implementation of a robust cybersecurity and international cooperation network, since the entire CBDC transitionary phase from a conventional trading system relies entirely on the backing of a strong and impermeable financial security network.
Challenges to Full Adoption
Never in history had anyone in India must have expected that United Payments Interface (UPI), a seemingly novel payment method would be so successful in a ‘Cash Chalega’ economy. The unharnessed power of CBDCs can significantly transform the payment dynamics in the national economy and it has been successful in the past, with the rapid implementation of UPI by NPCI.
More than merely revamping the financial system, CBDCs require the close cooperation of economies to collaborate and pool their resources to ensure sustainable economic growth through the implementation of CBDCs. However, for this to materialize, it is also imperative that there exists a robust cyberinfrastructure and a conducive atmosphere that involves more participants on board this journey.
Factors such as the level of anonymity to be maintained, the extent of participation extended for commercial banks, and the scale of offline functionality shall collectively play a pivotal role in deciding the final implementation of the CBDC system.
A Sneak-Peek into the Future
Promising a paradigm shift in the way how money shall define the way entities shall transact; CBDCs promise an increase in transactional potential and monetary inclusion envisaged by the central bank for the economy. Economies across the world need to work on significant collaboration, responsibility and a hunger to drive innovation in the field of finance.
CBDCs being reliable, safer and quicker in terms of settlement times; shall aid in streamlining settlement systems, achieving cost efficiency and eliminating downtimes in business transactions. Combating money laundering and cross-border terror financing shall become a thing of the past once such financial transactions are brought under the purview of central regulatory authorities across the globe.
Exchange rates and their dramatic fluctuation in global markets can be significantly controlled once CBDCs become common across major economies thereby encouraging greater cross-border trade and commerce. Smart contracts with CBDC-enabled technologies shall make customs and other import-export documents a thing of the past.
However, protocols & guidelines must be thoroughly defined and laid out by regulatory authorities across the globe to facilitate an easier transition into the newer era of CBDCs. Clarity sought by interested parties will need to be addressed regarding the implementation of CBDCs and emphasis must be laid towards infrastructural development to support the increasing volumes of digital monetary transactions.
In a Nutshell
CBDCs can effectively harness the potential to significantly revolutionise the financial sector in an emerging 21st-century digitized world and bridge the existing geographical gap by eliminating barriers caused due to obsolescence. CBDCs can extensively assist in facilitating trade and economic opportunities for countries by seamlessly integrating with financial systems already placed in operation by central banks and offering interoperability amongst global economies. The real-world impact must be supplemented with sound governance practices that ensure the benefit of maximum participants in the process.
CBDCs possess immense potential to revolutionize how organizations across the globe facilitate and expedite trade processes while also ensuring cost-effectiveness and transparency. Navigating the rougher shores of synchronization, putting effective regulations in place and developing sound infrastructure will all be crucial for achieving the success of CBDCs.
As countries across the globe toy around with the idea of implementing CBDCs, it shall be imperative to witness the way digital currencies play a role in reshaping global trade and ushering in a new era of economic cooperation & monetary dynamism in a post-globalized world.
