Q. With reference to Central Bank digital currencies, consider the following statements:

  1. It is possible to make payments in a digital currency without using US dollar or SWIFT system.
  2. A digital currency can be distributed with condition programmed into it such as a time-frame for spending it.

Which of the statements given above is/are correct?

  • 1 only
  • 2 only
  • Both 1 and 2
  • Neither 1 nor 2

Answer: (c) Both 1 and 2

Central Bank Digital Currency (CBDC)
  • CBDCs (e-Rupee) 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 fiat currency and is exchangeable one-to-one with the fiat currency.
    • A fiat currency is a national currency that is not pegged to the price of a commodity such as gold or silver.
  • It will be an electronic version of cash. It will be primarily meant for retail transactions. 
  • It will be potentially available for use by all which includes the private sector, non-financial consumers and businesses.
  • It will be able to provide access to safe money for payment and settlement.
  • It will be the direct liability of the central bank.
  • The digital fiat 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.
  • Objectives:
    • 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.
    • It will also wean people away from cryptocurrencies as a means for money transfer.
  • Significance of CBDC:
    • Cross-Border Transactions:
      • CBDCs possess unique attributes that can revolutionize cross-border transactions.
      • Instant settlement feature of CBDCs as a significant advantage, making cross-border payments cheaper, faster, and more secure.
        • Faster, cheaper, transparent, and inclusive cross-border payment services can yield substantial benefits for individuals and economies worldwide. These improvements can support economic growth, international trade, and financial 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 financial 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 financial inclusion.
Cryptocurrencies
  • A cryptocurrency is a digital or virtual currency secured by cryptography, which makes it nearly impossible to counterfeit or double-spend.
  • Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers.
Stablecoins
  • They are cryptocurrencies whose value is pegged or tied to that of another currency, commodity, or financial instrument.
  • Stablecoins aim to provide an alternative to the high volatility of the most popular cryptocurrencies, including Bitcoin (BTC).
  • Unlike cryptocurrencies like Bitcoin, stablecoins’ prices remain steady in accordance with whichever fiat currency backs them.
  • E.g., USDC stablecoin is backed by dollar-denominated assets.