In a historic step towards a Central Bank Digital Currency - CBDC - the Reserve Bank of India (RBI) has kicked off a pilot launch for specific use cases. This pilot is currently only for banks – but the aim is to extend it to corporates, and eventually individuals like us. But how exactly does CBDC function, and will an e-rupee really make a difference for us - considering we are already avid users of UPI apps like Google Pay and Paytm?

 

RBI had proposed to the government in October last year to broaden the scope of the paper rupee to include digital currency.

 

Union Finance Minister Nirmala Sitharaman had earlier announced that the RBI will launch a Central Bank Digital Currency (CBDC) in 2022-23, which is the first official statement from the Union government on the much-anticipated digital currency's launch. According to the FM, the introduction of CBDC will boost the digital economy and will be based on blockchain technology (more on this later).

 

What is CBDC?

 

The Reserve Bank of India defines Central Bank Digital Currency (CBDC) as a digital form of legal tender issued by a central bank. Simply put, it is a digital form of fiat currency, i.e. The Indian Rupee. As a result, it can be exchanged for fiat currency one for one.

 

As per RBI, “CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.” The currency will be exchanged through blockchain-based wallets. It will also be exchangeable with government-issued money. CBDC offers an alternative to western payment systems.

 

How does the pilot work?

 

According to the notification, the first digital rupee pilot began in the wholesale segment on 1st November. The pilot has been rolled out through nine banks --  State Bank of India, Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank, and HSBC. 

 

These nine banks have a rupee and government bond account with the RBI. They have to open a CBDC account connected to RBI’s CBDC node/ server.  For instance, lets say one of these banks (Bank ABC) sends a note to RBI asking it to transfer Rs100 crore from its rupee account in RBI to its CBDC account in RBI As of now, RBI does this kind of transfer through the NPCI, but now the money can be transferred through the new system.  Now assume that another bank (Bank XYZ) has also done a similar transaction.  Both banks (Bank ABC and Bank XYZ) will then watch the CCIL (Clearing Corporation of India) screen - which is like a stock exchange for bonds. The CCIL screen displays requests for sale and purchases of bonds sent by various banks. 

 

So let’s say Bank ABC sends a request to Bank XYZ  to buy Rs90 crore of 10 year bonds at a certain price. Bank XYZ has those bonds and likes the price that is being quoted by Bank ABC. So Bank XYZ accepts the transaction request and agrees to send those bonds. 

 

The order is placed at the CCIL terminal which is connected to the RBI CBDC server.Since both money and bonds are available with the respective buyer and seller, the bonds are transferred by the RBI server to the buyer and the funds are also transferred without any RBI intervention from ABC bank CBDC account to XYZ bank CBDC account. The fund transfer happens via the distributed ledger technology also called blockchain technology.

 

How is CBDC different?

 

As of now, all banks buy bonds from the CCIL and sell bonds to CCIL - similar to what happens in stock exchanges. At the end of the day, they get a message from   the CCIL about the net amount which needs to be transferred to their account or transferred from their account with the RBI. This basically  is net settlement by CCIL. 

 

Under the new CDBC pilot process this will not need to take place. The money will  be exchanged between the banks themselves (gross settlement) without the intervention of the CCIL. 

 

The second important difference is at the moment, it takes over a day for CCIL to match all the trades, arrive at the net amounts and then transfer the net amounts to respective (buyer/ seller) banks. So settlement is on T+1 basis (day you trade plus one day). 

 

Under the CBDC pilot process, money can be transferred immediately. Hence settlement is T+0 basis or actually almost on real-time basis. 

 

Of course all this is on an experimental stage currently with just nine banks. When it becomes smooth, the pilot will most likely be rolled out to all banks and not just government bonds, corporate bonds, but also expanded to corporates as well. Eventually, CBDC will come to retailers like us. We can transfer some CBDC and add to our wallet and then use it to pay each other or mechants like we pay in cash taking out currency notes from our purse. 

 

At the moment we use online wallets like Paytm, Google pay and Amazon Pay. Hence the CBDC may not make much difference to people like us but for corporates, instantaneous transfer can make a huge difference. Eventually it can even be used for cross-border transactions. The RBI governor, Dr Shaktikanta Das, in his speech highlighted that in future, we could also see this technology being employed for Kisan Credit Card loans. This can mean bringing more and more people into the financial sector (financial inclusion). Big promises!

 

What is blockchain technology? 

 

A blockchain is a system of recording data that is almost impossible to change, hack or cheat. It is a digital ledger of transactions that is copied and distributed to the entire network of devices on the blockchain. In simple words, the technology helps store and transact digital currency. As it is difficult to tamper with, it is also one of the safest ways to exchange currency digitally.

 

Why is RBI introducing CBDC?

 

CBDC is aimed to complement, rather than replace, current forms of money and is envisaged to provide an additional payment avenue to users, not to replace the existing payment systems.

 

RBI believes that the digital rupee system will "bolster India’s digital economy, enhance financial inclusion, and make the monetary and payment systems more efficient.” Pointing out the motivations for India to consider issuing CBDC, RBI mentioned these reasons:

 

a) Reduction in cost associated with physical cash management

b) To further the cause of digitisation to achieve a less cash economy.

c) Supporting competition, efficiency, and innovation in payments

d) To explore the use of CBDC for improvement in cross-border transactions

e) Support financial inclusion

f) Safeguard the trust of the common man in the common man in the national currency vis-a-vis proliferation of crypto assets.

 

Features of Digital Rupee 

 

1. CBDC is a sovereign currency issued by central banks in alignment with their monetary policy. 

2. It appears as a liability on the central bank’s balance sheet. 

3. It must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies. 

4. CBDC is freely convertible against commercial bank money and cash.

5. CBDC is a fungible legal tender for which holders need not have a bank account. 

6. CBDC is expected to lower the cost of issuance of money and transactions.

 

How is digital rupee different from money in digital form? 

 

Explaining the difference between CBDC and money in digital form, RBI said, "A CBDC would differ from existing digital money available to the public because a CBDC would be a liability of the Reserve Bank, and not of a commercial bank."

 

CBDC can be classified into two types

 

1) Retail (CBDC-R): Retail CBDC would be potentially available for use by all

2) Wholesale (CBDC-W) is designed for restricted access to select financial institutions.

 

Digital rupee vs cryptocurrency

 

CBDC will have all of the advantages that we see with cryptocurrencies and digital forms of payment. To begin with, a digital currency can never be torn, burned, or physically damaged. They are also not physically lost. In comparison to notes, the lifeline of a digital form of currency will thus be infinite.

 

Difference between digital rupee and cryptocurrency

 

A cryptocurrency is a decentralised digital asset and a medium of exchange based on blockchain technology. However, it has been controversial due to its decentralised nature, meaning its operation without any intermediary like banks, financial institutions, or central authorities. On the contrary, Central Bank Digital Currency (CBDC) issued by the Reserve Bank of India (RBI) will be a legal tender in a digital form.

 

The digital rupee will be different from Bitcoin, Ethereum and other cryptocurrencies in the sense it will be backed by the government. Secondly, having an intrinsic value on account of government backing, the digital rupee will be equivalent to holding a physical rupee equivalent.

 

Benefits of digital rupee

 

Apart from reducing the transaction cost, having a digitised currency will make it easier for governments to access all transactions happening within the authorized networks. It will become impossible to avoid the gaze of the government, thus subjecting every transaction to relevant laws within the country. Hence, the government will have better control over how money leaves and enters the country, which would allow them to create a space for better budgeting and economic plans for the future, and overall a much safer environment.

 

The RBI has been exploring the pros and cons of a CBDC for some time and is said to be working towards a strategy to implement it in a phased manner, it said earlier this month.