Explained | What is a central bank digital currency, what does RBI say? 8 key questions answered

Image: Shutterstock

Amid a raging debate over the future of a central bank digital currency (CBDC) and private cryptocurrencies, Reserve Bank of India (RBI) Deputy Governor T Rabi Sankar on July 22 delivered a speech shedding light on the central bank’s thoughts on the contentious but important matter.

Moneycontrol answers some of the questions on the hot-button issue and the central bank’s views on it.

1 What is a central bank digital currency?

A central bank digital currency is the legal tender issued by a central bank in digital form. It is the same as a fiat currency but the form is different and is exchangeable one-to-one with the government-issued money. In other words, CBDC is the same as the legal currency we use. Just that it's in a digital form.

2 How is CBDC different from private coins such as bitcoin and ethereum?

CBDC is the digital form of a legal tender but private virtual currencies are entirely different. In Sankar's words, 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.

3 How does RBI respond to the claims that private cryptos are assets like gold?

The deputy governor said the claims that they are akin to gold clearly seem opportunistic. Sankar said they (private virtual currencies) do not represent any person’s debt or liabilities. "There is no issuer. They are not money (certainly not currency) as the word has come to be understood historically," said Sankar. What this effectively means is that according to the RBI, no banking entity can treat private virtual currencies as assets or liabilities for transactions.

4 What is RBI's view on CBDC?

Sankar said the introduction of CBDC has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs and reduced settlement risk.

It will also possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option, Sankar said.

5 What is RBI's take on CBDC vis-a-vis private cryptocurrencies?

Sankar said the advent of private virtual currencies may well be another reason why CBDCs may be necessary. “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,” Sankar said.

6 What are the risks associated with CBDCs, according to RBI?

Sankar outlined certain risks associated with CBDCs, saying the availability of these currencies will make it easy for depositors to withdraw balances if there is stress on any bank. "Flight of deposits can be much faster compared to cash withdrawal," Sankar said.

On the other hand, just the availability of CBDCs might reduce panic “runs” since depositors have knowledge that they can withdraw quickly. One consequence could be that banks would be motivated to hold a larger level of liquidity, which could result in lower returns for commercial banks, the deputy governor said.

7 When is RBI planning to introduce CBDC?

The deputy governor didn't commit to a timeframe but left enough hints that the work is on. "It would be RBI’s endeavour, as we move forward in the direction of India’s CBDC, to take the necessary steps which would reiterate the leadership position of India in payment systems. CBDCs is likely to be in the arsenal of every central bank going forward," Sankar said.

Also, setting up of a CBDC will require careful calibration and a nuanced approach in implementation, the deputy governor said. Drawing board considerations and stakeholder consultations are important, he said.

8 What is the future of private VCs in India?

There is no clarity yet on this. The government is working on a bill to regulate cryptocurrencies but this bill is not listed for the ongoing monsoon session. Until the government come clear on regulation, the central bank is likely to remain in a wait-and-watch mode as far as private virtual currencies are concerned. At the same time, CBDC may happen sooner, going by the indications available so far.