Central Bank Digital Currency (CBDC)

A Central Bank Digital Currency (CBDC) is a digital form of a nation’s official currency, issued and regulated directly by the country’s central bank. It represents a legal tender in electronic form and is distinct from cryptocurrencies or private virtual currencies, as it is fully backed by the state’s monetary authority. CBDCs aim to combine the convenience and security of digital payments with the trust and stability associated with traditional fiat money. In India, the Reserve Bank of India (RBI) has initiated the development and pilot testing of the Digital Rupee, making it one of the most significant financial innovations in recent years.

Background and Global Context

The concept of a digital currency issued by central banks gained prominence following the global rise of cryptocurrencies such as Bitcoin and Ethereum, which operate on decentralised blockchain systems. While cryptocurrencies provided innovation in terms of technology and payment mechanisms, they posed concerns over volatility, anonymity, and lack of regulation.
To address these challenges while harnessing the benefits of digital finance, several central banks began exploring sovereign digital currencies. The People’s Bank of China (PBoC) was among the pioneers, introducing the Digital Yuan (e-CNY). Subsequently, the European Central Bank, Bank of England, Federal Reserve (U.S.), and others initiated their own CBDC research projects.
In India, the Reserve Bank of India started formal studies on CBDCs around 2017, influenced by the growing digital payment ecosystem and the need to modernise the monetary framework.

Definition and Characteristics

A CBDC is defined as the digital equivalent of physical cash, representing a direct claim on the central bank. Unlike deposits held in commercial banks, CBDCs are risk-free assets because they are liabilities of the central bank itself.
The primary characteristics of CBDCs include:

• Sovereign backing: Fully backed by the nation’s central bank.
• Legal tender status: Recognised by law for all financial transactions.
• Digital format: Exists only electronically, using secure technologies like distributed ledger or centralised databases.
• Accessibility: Can be used by individuals, businesses, and financial institutions.
• Convertibility: Convertible 1:1 with paper currency and bank deposits.

Types of CBDCs

CBDCs can be broadly categorised into two types based on usage and accessibility:

1. Retail CBDC (CBDC–R):
   • Designed for use by the general public, similar to cash.
   • Enables peer-to-peer (P2P) and consumer-to-business (C2B) transactions.
   • In India, the Digital Rupee–Retail (e₹-R) pilot was launched in December 2022 in select cities.
2. Wholesale CBDC (CBDC–W):
   • Intended for interbank settlements, financial institutions, and large-scale transactions.
   • Aims to improve efficiency and reduce costs in cross-border and interbank transfers.
   • The Digital Rupee–Wholesale (e₹-W) pilot began in November 2022.

Objectives and Rationale

Central banks globally are pursuing CBDCs for several policy, economic, and technological reasons. The major objectives include:

• Enhancing payment efficiency: Promoting faster, cheaper, and more reliable digital transactions.
• Financial inclusion: Providing digital access to unbanked and underbanked populations.
• Reducing dependence on cash: Lowering the costs associated with printing, transporting, and managing physical currency.
• Curbing illicit activity: Creating a transparent system to combat money laundering and tax evasion.
• Strengthening monetary policy: Enabling direct monetary interventions and improved transmission of policy measures.
• Countering private digital currencies: Offering a regulated alternative to volatile cryptocurrencies and stablecoins.

The Digital Rupee in India

India’s CBDC, officially known as the Digital Rupee (e₹), is being implemented in a phased pilot programme by the Reserve Bank of India. The framework was first proposed in the Union Budget 2022–23, and formal guidelines were issued by the RBI later that year.

Phases of Implementation

1. Wholesale Pilot (e₹-W):
   • Launched on 1 November 2022.
   • Involves major banks such as State Bank of India, ICICI Bank, HDFC Bank, and others.
   • Focuses on settlement of secondary market government securities transactions.
2. Retail Pilot (e₹-R):
   • Began on 1 December 2022 in select cities including Mumbai, New Delhi, Bengaluru, and Bhubaneswar.
   • Extended later to more cities and participating banks.
   • Allows individuals and merchants to use the Digital Rupee via mobile wallets or QR codes.

The Digital Rupee is issued in the same denominations as paper currency and coins, and transactions are settled through digital wallets managed by participating banks.

Technological Framework

The RBI has adopted a hybrid architecture that combines features of blockchain technology and centralised control. The Digital Rupee ecosystem ensures:

• Secure encryption to prevent counterfeiting and duplication.
• Offline functionality (being explored) to support areas with poor internet access.
• Anonymity features to preserve user privacy, similar to cash transactions.
• Programmable features for conditional payments, subsidies, and government transfers.

The design choices balance privacy, security, scalability, and regulatory oversight, ensuring that the system remains both efficient and trustworthy.

Advantages of CBDC

CBDCs offer multiple benefits to individuals, businesses, and the broader economy:

• Efficiency in payments: Instant and low-cost transactions, especially for cross-border transfers.
• Financial inclusion: Access for people without bank accounts through digital wallets.
• Reduction in physical cash dependence: Decreases costs of currency management.
• Improved transparency: Better traceability of transactions helps curb black money and illegal activities.
• Enhanced policy control: Facilitates direct disbursement of government benefits and improves monetary policy execution.
• Technological innovation: Promotes a modern digital financial ecosystem compatible with global developments.

Potential Challenges and Concerns

Despite its advantages, CBDC implementation poses several technical, economic, and policy-related challenges:

• Privacy concerns: Balancing transparency and anonymity remains complex, especially in retail usage.
• Cybersecurity risks: Ensuring protection against hacking, fraud, and data breaches.
• Operational readiness: Large-scale deployment demands robust infrastructure and coordination with financial institutions.
• Impact on banking system: If individuals prefer CBDC wallets over bank deposits, commercial banks could face reduced liquidity.
• Regulatory adaptation: Updating existing legal and financial frameworks to accommodate digital legal tender.
• Digital literacy: Ensuring citizens, especially in rural areas, can use digital currency safely.

Global Developments

Several countries have advanced CBDC projects, creating a dynamic global environment for monetary innovation:

• China: The Digital Yuan (e-CNY) is in advanced pilot stages and used widely in cities.
• Bahamas: The Sand Dollar, launched in 2020, became the world’s first fully operational CBDC.
• Sweden: The e-Krona project aims to modernise the country’s cashless economy.
• European Union: The Digital Euro is under active consideration.
• Nigeria: Introduced the e-Naira, Africa’s first CBDC.

India’s Digital Rupee aligns with these international efforts, focusing on interoperability and secure cross-border functionality in future phases.

Economic and Policy Implications

The introduction of CBDC could reshape India’s financial architecture in multiple ways:

• Formalisation of the economy: Encourages traceable, accountable transactions.
• Monetary stability: Reduces reliance on unregulated private digital currencies.
• Cross-border integration: Facilitates faster remittances for the Indian diaspora.
• Enhanced fiscal efficiency: Enables targeted delivery of subsidies and government payments through programmable currency features.