Project of GE - ECONOMICS

MONEY AND BANKING

TOPIC - CENTRAL BANK DIGITAL

CURRENCY, THEIR BENEFITS &
CHALLENGES AND HOW IT IS
DIFFERENT TO CRYPTOCURRENCY

HINDU COLLEGE,UNIVERSITY OF DELHI

NAME - SATISH KUMAR SAH

ROLL NO - 463
COURSE - BA(H) POLITICAL SCIENCE
 Introduction
Central banks are an important pillar of the nancial ecosystem.
Fundamentally they have always provided e cient ,quick, seamless,
stable solutions for their respective economies. This includes payment
systems and the issue of currency . Recent advancements in
technology and the global economy have pushed these apex bodies to
revisit their basic functions and adapt.

The Reserve Bank of India (RBI) has de ned Central

Bank Digital Currency (CBDC) as the legal tender
issued by a central bank in a digital form. It is the
same as a at currency and is exchangeable one-to-one with the at
currency.

Money as a concept has evolved over time, beginning with the barter
system where goods were exchanged as ‘money’ to metallic and paper
currency, banking instruments and now digital currency.

A Central bank digital currencies (CBDCs) is a digital form of the at

currency issued by the central bank of a country and is in lieu of the
paper/metal currency issued which is the direct liability of the central
bank - that is, it is denominated in the national unit of account. A CBDC
acts as a safe, government-backed, and ultimate medium of settlement
by eliminating all claims that occur during transactions.

In other words, Central bank digital currencies (CBDCs) are a form of

digital currency issued by a country's central bank. They are a little bit
similar to cryptocurrencies, except that their value is xed by the central
bank and equivalent to the country's at currency.

◦ CBDCs are a digital form of a paper currency and

unlike cryptocurrencies that operate in a regulatory
vacuum, these are legal tenders issued and backed by a
central bank.
◦ It is the same as a at currency and is exchangeable one-to-
one with the at currency.
• A at currency is a national currency that is not pegged
to the price of a commodity such as gold or silver.
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 ◦ The digital at currency or CBDC can be transacted using
wallets backed by blockchain.
◦ Though the concept of CBDCs was directly inspired
by Bitcoin, it is different from decentralised virtual currencies
and crypto assets, which are not issued by the state and lack
the ‘legal tender’ status.

Many countries are developing CBDCs, and some have even

implemented them. Because so many countries are researching ways to
transition to digital currencies, it's important to understand what they are
and what they mean for society.

Understanding Central Bank Digital Currencies

(CBDCs)
Fiat money is a government-issued currency that has no backing from a
physical commodity like gold or silver. It is considered a form of legal
tender that can be used to exchange for goods and services.
Traditionally, at money came as banknotes and coins, but technology
has allowed governments and nancial institutions to supplement
physical at money with a credit-based model that records balances and
transactions digitally.

Physical currency is still widely exchanged and accepted; however,

some developed countries have experienced a drop in its use, and that
trend accelerated during the pandemic.

▪ Global Trends:
◦ Bahamas has been the rst economy to launch its nationwide
CBDC — Sand Dollar in 2020.
◦ Nigeria is another country to have roll out eNaira in 2020.
◦ China became the world's rst major economy to pilot a
digital currency e-CNY in April 2020.
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Stages of global adoption of CBDC

Canada Despite assessing its

pros and cons, Bank of
In April 2020, China
England in UK has not
became the first
reached a decision to
major economy to
launch CBDC. Sweden pilot digital currency.

United Kingdom Ukraine

France

The Bahaman
CBDC or “Sand China Japan
Dollar” was officially Turkey Korea
launched in 2020. UAE
Bahamas !"#$%
Hong Kong
Thailand
Eastern Caribbean Cambodia
Retail CBDC
Analysis phase Uruguay launched its pilot Singapore
Ecuador CBDC e-peso in 2017.
Pilot stage
Though the pilot was free
Implemented and operational of technical snafu, it has
not been launched at a
Wholesale CBDC full scale yet.
Analysis phase Uruguay
Trial phase South Africa
Pilot stage
Implemented and operational

Source: PwC Global CBDC Index 2021

5 PwC Central Bank Digital Currency in the I

 Central banks around the world, including those of China, Russia,
Bahamas or the USA, are developing or researching the use of CBDC. A
survey conducted by the Bank for International Settlements (BIS) in
2021 revealed that 86% of Central banks around the globe were actively
researching the potential for CBDCs, 60% were experimenting with the
technology and 14% were deploying pilot projects.

Goals of CBDCs

◦ The main objective is to mitigate the risks and trim costs in

handling physical currency, costs of phasing out soiled notes,
transportation, insurance and logistics.
In the U.S. and many other countries, many individuals don't have
access to nancial services. In the U.S. alone, 5% of adults didn't have a
bank account in 2020. An additional 13% of U.S. adults who had bank
accounts, instead used costly alternative services like money
orders, payday loans, and check-cashing services.

The other goal of CBDCs is to provide businesses and consumers with

privacy, transferability, convenience, accessibility, and nancial security.
CBDCs could also decrease the cost of maintenance that a complex
nancial system requires, reduce cross-border transaction costs, and
provide those who currently use alternative money-transfer methods
with lower-cost options.

CBDCs would also reduce the risks associated with using digital
currencies, or cryptocurrencies, in their current
form. Cryptocurrencies are highly volatile, with their value constantly
uctuating. This volatility could cause severe nancial stress in many
households and affect the overall stability of an economy. CBDCs,
backed by a government and controlled by a central bank, would give
households, consumers, and businesses a secure means of exchanging
digital currency.
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 Retail CBDC System

A CBDC also provides a country's central bank with the means to

implement monetary policies to ensure stability, control growth, and
in uence in ation.

Types of CBDCs
There are two types of CBDCs, wholesale and retail. Financial
institutions are the primary users of wholesale CBDCs, whereas
consumers and businesses use retail CBDCs.

Wholesale CBDCs
Wholesale CBDCs are similar to holding reserves in a central bank. The
central bank grants an institution an account to deposit funds or use to
settle interbank transfers. Central banks can then use monetary policy
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 tools, such as reserve requirements or interest on reserve balances, to
in uence lending and set interest rates.

Retail CBDCs
Retail CBDCs are government-backed digital currencies used by
consumers and businesses. Retail CBDCs eliminate intermediary risk—
the risk that private digital currency issuers might become bankrupt and
lose customers' assets.

There are two types of retail CBDCs. They differ in how individual users
access and use their currency:

• Token-based retail CBDCs are accessible with private

keys or public keys or both. This method of validation allows users
to execute transactions anonymously.
• Account-based retail CBDCs require digital identi cation to access
an account.5

It is possible to develop two types of CBDCs, wholesale and retail, and

have them function in the same economy.

Beni ts of Central Bank Digital Currencies for

India

▪ Cross-Border Transactions:
◦ CBDCs possess unique attributes that can revolutionize
cross-border transactions.
◦ Instant settlement feature of CBDCs as a signi cant
advantage, making cross-border payments cheaper, faster,
and more secure.
• Faster, cheaper, transparent, and inclusive cross-
border payment services can yield substantial
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 bene ts for individuals and economies worldwide.
These improvements can support economic growth,
international trade, and nancial inclusion on a global
scale.

▪ Traditional and Innovative:

◦ CBDC can gradually bring a cultural shift towards virtual
currency by reducing currency handling costs.
◦ CBDC is envisaged to bring in the best of both worlds:
• The convenience and security of digital forms like
cryptocurrencies
• The regulated, reserved-backed money circulation of
the traditional banking system.

▪ Financial Inclusion:
◦ The increased use of CBDC could be explored for many
other nancial activities to push the informal economy into
the formal zone to ensure better tax and regulatory
compliance.
◦ It can also pave the way for furthering nancial inclusion.
Apart from that it is also from credit and liquidity risk and expands
access to the general public.

Issues Created by CBDCs

What are the Challenges in Adopting CBDC

Across India?
▪ Privacy Concerns:
◦ The rst issue to tackle is the heightened risk to the
privacy of users—given that the central bank could
potentially end up handling an enormous amount of data
regarding user transactions.
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 • This has serious implications given that digital
currencies will not offer users the level of privacy and
anonymity offered by transacting in cash.
◦ Compromise of credentials is another major issue.
▪ Disintermediation of Banks:
◦ If suf ciently large and broad-based, the shift to CBDC can
impinge upon the bank’s ability to plough back funds into
credit intermediation.
◦ If e-cash becomes popular and the Reserve Bank of India
(RBI) places no limit on the amount that can be stored in
mobile wallets, weaker banks may struggle to retain low-cost
deposits.

▪ Other Risks are:

◦ Faster obsolescence of technology could pose a threat to
the CBDC ecosystem calling for higher costs of upgradation.
◦ Operational risks of intermediaries as the staff will have to be
retrained and groomed to work in the CBDC environment.
◦ Elevated cyber security risks, vulnerability testing and the
costs of protecting the rewalls.
◦ Operational burden and costs for the central bank in
managing CBDC
◦ Financial structure changes
◦ Financial system stability
◦ Monetary policy in uence
• .

Difference between Central Bank Digital

Currency (CBDC) and Cryptocurrencies
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Digital Currency – is the digital format of at currency that you carry around in
your wallet or withdraw from an ATM. It’s the same currency that is backed by
an authority, the Reserve Bank of India in case of Indian currency, and can be
exchanged for actual currency if and when it is scheduled to be launched in
2023.

Cryptocurrency – is not backed by a central gure but derives its

purchasing power from its community of users. Technically, they are
pieces of code created by ‘mining’ that are managed through a digital
ledger called as blockchain to ensure transparency at each stage of its
journey. Although coins like Bitcoin and Ethereum have many uses when
it comes to NFTs and the upcoming metaverse, they cannot be utilised
outside of blockchain as these are digital assets that can be traded but
not used as a legal tender in India.
Now that we know about them, here are ve major differences between
digital currency and cryptocurrency.

1 - Centralisation

The biggest difference digital currency and cryptocurrency is the

question of who has control over the monetary value of your coins. In
case of digital currency, it would be the Reserve Bank in India or Fed in
the US along with the government, banks and other middlemen, all of
whom would have to come together to set the value of the currency in
question. This is why you would read of the Turkish Lira’s depreciation
by over 40% in 2021 or the collapse of nancial systems in Myanmar
and Afghanistan once the central authority is left powerless.
Cryptocurrency, on the other hand, follows a transparent procedure right
from mining to ownership to transfer of crypto assets. Its value is also
independent of central banking authorities and regional geopolitical
problems.

2 - Encryption

Once again, cryptocurrency trumps digital currency when it comes to

encryption. Digital currencies are essentially e-cash that doesn’t need
any special indigenous methods to encrypt them. Cryptocurrencies, on
the other hand, are stored on a blockchain and the coins themselves are
stored in ‘wallets’ that offer a much higher degree of cyber security.
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Also, choosing the right cryptocurrency exchange that offers the best of
security features and a wide range of currencies to transact with, is the
primary requirement to transact using cryptos. WazirX is one such
crypto exchange that does the job reliably and one that we highly
recommend to get started on your crypto journey. Be sure to open your
account here.

3 – Transparency

The biggest advocates for cryptocurrency will cite the transparency

afforded by the platform. Every detail regarding cryptocurrency
transactions is in the public domain thanks to the presence of a
decentralised ledger that records all the blockchain details. With digital
currency, only the banking authorities along with the sender and receiver
are involved in the transaction involved. In case of con ict over any
asset, cryptocurrencies are easier to manage as the records are there
for everyone involved to see, whereas digital currencies could involve
bureaucratic hurdles and other problems in case of any con ict. This
decentralisation of data is, in fact, one of the driving forces leading to the
adoption of cryptocurrencies across the world.

4 – Stability

Digital currency is usually stable and also relatively easy to manage,

thanks to having wider acceptance in the global market. Digital currency,
being the at version of approved currency, is traded and understood by
a vast majority of the population. This, in turn, makes it more stable
when compared to a new technology such as cryptocurrency that has
started gaining attraction but isn’t mainstream yet. Added to that, the
price volatility of cryptocurrencies is another aspect that hampers its
stability even as new tech and features mean that it is slowly but steadily
gaining traction all around.

5 – Legality

Most countries, including India, are now taking a look at the legality and
acceptance of cryptocurrencies. Since these aren’t backed by any
governing body, most traditional frameworks don’t assign any value to
them. However, the swift rise in the number of depositors and various
use cases of blockchain today and the upcoming metaverse, where the
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 only method of payment remains cryptocurrencies, means that some
sort of discussion around the legality of cryptocurrencies is bound to
happen sooner than later. For now, countries around the world are rm
in backing their own at currencies.

Way Forward
▪ Central banks should continue their efforts to research, develop,
and pilot CBDCs. Collaboration with nancial institutions,
technology experts, and other stakeholders is essential to ensure
the successful implementation of CBDCs.
▪ Central banks and nancial authorities from different
countries should collaborate closely on CBDC
initiatives. Cross-border payments inherently involve multiple
jurisdictions, so international cooperation is vital to address
regulatory, security, and technical challenges.
▪ CBDCs must prioritize security and privacy. Robust cybersecurity
measures should be in place to protect against hacking and fraud.
Simultaneously, mechanisms for ensuring user privacy and data
protection should be established and maintained.

Conclusion
The sudden spike in interest in CBDC is due to the value central banks
foresee in terms of ful lling public policy,
maintaining economic stability, and providing people with a
convenient, safe and reliable payments system.
Each country’s position with respect to adopting CBDC varies. A few
countries are conducting research and testing iterations in order to set
up their CBDC in a phased manner, while others are sprinting towards
deployment. In the Indian context, there are ongoing discussions and
e orts to evaluate how and when CBDC can be implemented. This will
unlock signi cant opportunities for the ecosystem players to come up
with services that make it easier and
convenient for citizens to transact and make digital payments for
various use cases and requirements
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References
https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1111

https://www.atlanticcouncil.org/blogs/econographics/the-rise-of-central-bank-digital-
currencies/

https://www.bis.org/about/bisih/topics/cbdc.htm

https://www.pwc.com/gx/en/industries/ nancial-services/assets/pwc-cbdc-global-
index-1st-edition-april-2021.pdf

https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/
RCF26022021FUL14763733401448089D2B70141732D717.PDF

https://www.blockchain-council.org/blockchain/what-is-cbdc-a-comprehensive-guide/

https://www.bis.org/publ/othp33.pd

Board of Governors of the Federal Reserve System. "Report on the Economic Well-Being of U.S.
Households in 2020."

https://www.cnbctv18.com/cryptocurrency/digital-currency-vs-cryptocurrency--whats-the-
difference-12611902.html
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