Will CBDC be the Future of Finance Globally?

Cryptocurrencies and Indian regulators were not on good terms for quite a period now. The Reserve Bank of India (RBI), the country’s premier financial regulator and central banking authority, had put up several restrictions on cryptocurrency trading back in 2018. But the Supreme Court of India quashed the restrictive order in March 2020 allowing trading of cryptocurrencies to happen in full swing across the country.

However, RBI is slowly easing their fears about cryptocurrencies and the fundamental technology powering them i.e., Blockchain. In fact, there are reports saying that the central banking authority is thinking about introducing a Central Bank Digital Currency (CBDC) to provide a more credible and regulated cryptocurrency trading environment in India.

The Indian banking regulator is just the latest entrant to an ever-growing list of global financial regulators that are aggressively pursuing the launch of their own CBDC. So, what exactly does CBDC do and what does it mean for the banking system in a country? Let us have a short explanation for this:

CBDC is a regulated cryptocurrency (digital currency) that works on the distributed ledger mechanism followed by the revolutionary blockchain technology and uses digital tokens to represent a new financial or monetary trading entity in a country’s financial system. It is similar to Bitcoin as well as the hundreds of cryptocurrencies available globally, but with a key difference of being regulated and monitored by a country’s financial and monetary authority.

Does CBDC exist in other countries today?

Yes. In fact, surveys show that nearly 80% central banks around the world are exploring CBDC in varying proportions of interest. Some are just scratching the surface to quench curiosity, but others are testing and successfully rolling out pilot programs for CBDC’s within their jurisdictions.

In October of 2020, Bahamas Island launched the world’s first CBDC to support inclusive financial growth for the island’s population. It is, by far, the only fully-functioning CBDC instrument in the world as of the date of this blog. But very soon many global economies are expected to come out with major announcements in this regard. Several countries have begun experimenting with pilot programs for CBDC from as early as 2015 itself. Only the Bahamas Island launched it in full swing and the digital currency of the country is now called Sand Dollar. China has announced that it will be piloting a CBDC program and is expected to be rolling out the same to their citizens anytime soon. The European Central Bank (ECB) has formally announced that there are possibilities of them launching a Digital Euro, the CBDC for EU countries, although no dates have been mentioned.

In the wake of these developments, the comments from RBI are of great significance. If India, along with China and the European Union, launches and promotes its own CBDCs and collaborate on making these CBDCs universally transactable between them, then it could have huge implications on the current global financial mechanisms which largely depend on the US Dollar for base processing. With India, China, and EU countries, more than half of the world population would be able to participate in financial transactions using these CBDCs.

What are the benefits of having a CBDC?

Let’s take a look at the various benefits of a CBDC.

  1. Efficient Payment System: With a CBDC, there is no need for citizens to hold accounts with individual banks as they could own and transact with the currency under the direct supervision of the nation’s central banking authority. This would put to an end to the long and frustrating overheads that exist in today’s complex financial instruments. Central banks could also partner with commercial banks in the country to roll out the CBDC to citizens with the intermediatory banks not having to manage any backend processes for further use of the CBDC.
  2. Costless Medium: The absence of intermediary processing makes CBDC a virtually costless medium for financial transactions. Citizens do not have to pay any fee or commission to any banks nor have to use any of the bank’s costly digital banking infrastructure for making payments. Besides, there is no need for printing and minting of any form of physical currency notes or coins and this adds up to the savings.
  3. Gradual Decline in Physical Cash dealings: With favorable support from government and private organizations for faster adoption and interoperability of digital currencies, it will be possible to eliminate the usage of cash transactions from the economy and create a more transparent and fraud-free financial landscape in a country.
  4. Intelligent Traceability: Every transaction carried out with a CBDC will have a tamper-proof digital trail which will enable financial regulators to seamlessly enforce tax and other compliance policies effectively.

However, CBDCs are not without their share of challenges as well. The primary drawback will be the complex monetary policies that government bodies and central banks have to formulate to enable free flow trade with CBDC. The monetary value of the CBDC needs to stay stable and match with the consumer price index of the nation for the long run. Additionally, in a country like India, where cash transactions are still carried out on a large scale despite radical efforts by the government like the 2016 demonetization, the prospects of implementing and promoting a digital currency are indeed very challenging. Banks and other financial institutions have their own fair share of inhibitions with digital currencies. This was one of the key reasons why cryptocurrencies are still prohibited by most central banking authorities globally. If CBDC comes into existence, the existing financial ecosystem of banks and other financial organizations might be severely impacted due to the presence of a new system that gives more financial independence for citizens.

Before CBDC is deployed on a wider scale, it is important for central banks to hold consultations with all stakeholders in a country’s financial system and arrive at a consensus to build a framework for deployment. This will ensure that everybody is given their fair share of the market and mutually beneficial existence is guaranteed for CBDC and existing financial institutions.

The world is at the cusp of a digital revolution, and the COVID-19 pandemic accelerated the push for adopting digital payments worldwide. As more private decentralized cryptocurrencies begin to flood the markets, there are chances that central banks may lose their control over financial transactions if people flock in plenty to such decentralized mechanisms. The only solution left for them would be to introduce their own CBDC after addressing the challenges that stand in its way and this is why the future looks exciting for CBDC across the globe.

Debasis Mohanty

Debasis heads the delivery for all client engagements at Verinite. He has a long track record of delivering high quality, responsive, secure and cost-effective business and technology solutions in BFSI domain. Outside his work, he is an amateur animator, a sports enthusiast, a voracious reader and a Trivia buff.