The term central bank digital currency (CBDC) refers to the virtual form of a fiat currency. A CBDC is an electronic record or digital token of a country’s official currency. As such, it is issued and regulated by the nation’s monetary authority or central bank. As such, they are backed by the full faith and credit of the issuing government.1 CBDCs can simplify the implementation of monetary and fiscal policy and promote financial inclusion in an economy by bringing the unbanked into the financial system.

The Reserve Bank of India (RBI) is developing a phased implementation approach for its own digital currency, which it plans to debut in the wholesale and retail markets soon.

Benefits

• CBDC is expected to ensure three basic principles — those of ‘do no harm’, ‘coexistence’,’promote innovation and efficiency’.
• Will lower the economy’s reliance on cash, and enable cheaper and smoother international settlements.
• It will also promote financial inclusion and simplify the implementation of monetary and fiscal policy. The transactions will be made using distributed ledger technology (DLT).
• In a DLT system, nodes or shared ledgers connect to form a common network to process transactions. This network can also extend to other jurisdictions and minimise the processing time for transactions. It provides transparency to authorities and stakeholders, improving the resiliency of a financial network by eliminating the need for a centralised database of records.
• CBDCs represent a unique opportunity to design a technologically advanced representation of central bank money, one that offers the unique features of finality, liquidity and integrity.
• CBDC is expected to promote financial inclusion. It can help extend the typically insufficient reach of existing payment systems by implementing digital distribution channels and ICT infrastructure to provide access to central bank money to majority population.
• Where maintenance of high-volume, low-value payments and other financial services is deemed unsuitable or commercially unattractive for commercial banks, CBDC can provide a government-authorised solution for storing value and making payments.
• The Digital Rupee gives India the chance to build the Digital Rupee as a superior currency for commerce with its strategic partners, eliminating its reliance on the dollar.
• India risks becoming engulfed in a maelstrom of a proxy digital currency war as the US and China compete for dominance in other markets by developing cutting-edge financial products. Today, a sovereign Digital Rupee isn’t only a matter of financial innovation; it’s also a necessity for fending off the looming proxy war that threatens our national and financial security.
• Use of CBDC can ease cross-border payments. The current financial infrastructure is a complex system of many entities. Conducting a transaction between financial institutions takes time and money because they work in different technological systems and regulation regimes.  The payments took seconds, instead of days, as happens with the traditional SWIFT network for cross-border flow of funds. The cost was about half of that for conventional payments.
• the blockchain technology that underpins the distributed ledger is also capable of of producing smart contracts, that is contracts that execute themselves, once payments are made.

Issues

• It could increase terror financing.
• Users would have to give up some degree of privacy since the administrator is responsible to collect and disseminate digital identifications. The provider would become privy to every transaction conducted.
• A strong CBDC issued by a foreign country could end up substituting a weaker country’s currency.

The establishment of a Digital Rupee will allow India to empower its population by allowing them to freely use it in our rapidly expanding digital economy and breaking free from an antiquated banking system.Policymakers must properly assess the potential of the Digital Rupee in India, taking into account its impact on the macroeconomy and liquidity, banking systems, and money markets.

How to structure:

• Give an intro about Central Bank Digital Currency
• Explain the benefits over conventional currency
• Now, mention few challenges
• Conclude

Reference:

1. https://www.thehindubusinessline.com/opinion/cbdc-will-be-a-game-changer/article37075576.ece