The Reserve Bank of India (RBI) has finally launched a pilot program for India’s own central bank digital currency (CBDC), the e-rupee. The program, which will launch on November 1, will be India’s first attempt at an electronic currency. In recent years, several central banks around the world have jumped on his CBDCs bandwagon, studying the feasibility of digital currencies and finding the best ways to implement them.
According to the RBI, the E Rupee will simply be a digital form of the already used Indian Rupee. The central bank released a concept note on his CBDCs on October 7th. In the document, the central bank outlined the rationale for introducing the e-rupee, the design and technical considerations going into it, and the political aspects that would bring about such a drastic change in Indian currency trading.
The introduction of CBDCs in India raises a number of important issues. What would the central bank move mean in a country that wants to ban cryptocurrency practices? Not to mention Finance Minister (FM) Nirmala Sitharaman, who previously urged the public to exercise caution when trading cryptocurrencies says India will have full adoption of CBDCs by 2023. Therefore, it is important to know what CBDCs is cryptocurrencies and how he differs from UPI transactions and he security concerns related to CBDCs.
What is CBDC?
CBDC is a digital currency issued by the central bank of a sovereign nation. By definition, they are freely convertible against physical currencies issued by the same central bank. As with physical currency, you don’t even need to have a bank account to trade with CBDC. However, the main factor that distinguishes CBDCs from physical currencies is that CBDCs have an indefinite lifespan in the sense that they cannot be damaged or lost in physical form. It is managed on a digital ledger that may or may not be blockchain-enabled.
There are two types of CBDC: retail (CBDC-R) and wholesale (CBDC-W). The wholesale type is used for interbank payments and other wholesale transactions, while CBDC-R is used for retail transactions as an electronic form of cash. CBDC-W aims to reduce transaction costs and make the interbank market more efficient. The RBI pilot program starting November 1 is for CBDC-W only, and another pilot program for CBDC-R is expected to start next month. Several other central banks around the world are currently exploring the possibility of implementing CBDCs.
CBDCs Across The World
A study by the Atlantic Council Center for Geoeconomics found that nearly 105 countries are considering the possibility of adopting his CBDC, which will be used primarily for interbank transactions. From an estimated 35 countries in 2020, this is a huge leap. About 19 countries out of the Group of 20 (G20) are considering issuing his CBDC, most of which have advanced beyond the early research stage.
Among developed countries, China has made the greatest progress in her large-scale use of CBDC. There are several successful pilot projects running in several cities in China.
WeChat, China’s leading payment platform and messaging app, recently launched a feature that allows users to select e-CNY, China’s CBDC, as the payment method on the platform.
In light of these global trends, India’s foray into CBDC was announced by FM Nirmala Sitharaman during this year’s budget presentation. This is not so long ago compared to years of research invested in CBDC in other countries.
The Center was warm to the idea of having a CBDC as a response to the growing popularity of cryptocurrencies, which both the RBI and the government say could be used for criminal activities.
CBDC vs Crypto
RBI Governor Shakktanta Das previously described the crypto ecosystem as “clearly dangerous”. He went on to say that anything with derived value that has no underlying asset and only fictitious value is nothing more than speculation.
The Center also echoed a similar view by imposing heavy taxes on cryptocurrencies and virtual digital assets. According to FM Sitharaman’s announcement at this year’s budget presentation, all income from the transfer of virtual digital assets such as cryptocurrencies should be taxed at the 30% rate. In addition, the government has imposed a 1% withholding tax (TDS) on all payments related to the transfer of virtual digital assets. If the government has very strong views on cryptocurrencies, it is clear that they see cryptocurrencies as something very different from the CBDC they wish to implement.
Risks associated with CBDCs
Some countries have been studying CBDC much longer than India. The Central Bank of Sweden has yet to accept a final call to issue e-krona, even though he has spent five years working on a pilot project and studying the architecture of his own CBDC. The US Federal Reserve has reached out to the public on whether to issue an official bid for a CBDC competing with private sector stablecoins. A digital euro is still under study and will take another two years. Japan will likely delay its decision until 2026, and Singapore has withdrawn the idea after weighing the pros and cons.
A survey of CBDCs around the world raises many concerns about data security and financial stability. Federal Reserve Chairman Jerome Powell has said cyber risk is his top concern for financial stability. A UK Senate report highlights that privacy risks and cybersecurity are the main reasons he avoids developing a CBDC.
These concerns are not unfounded. CBDC has the ability to collect sensitive user and payment data at scale. If misused, this data can easily be used to spy on citizens’ private transactions, protect security-related details about organizations and individuals, or steal money. “If implemented without appropriate security protocols, a CBDC could significantly increase the scope and scale of many security and privacy threats that already exist in today’s financial system,” said the International Monetary Fund. “Central Bankers’ New Cyber Security Challenge”.
This does not mean that there is no way around the concerns surrounding CBDC. The risk of centralized data pools can be mitigated by not collecting big data at all. Or you want a validation architecture that allows each component to display only the amount of information required for its functionality.
Cryptographic tools like zero-knowledge proofs, used to validate private information without compromising it, or cryptographic hashing techniques can help in providing data security.
India’s Hasty Sprint
CBDCs will have a long path towards public adoption, asserts Sunil Aggarwal. “It will take at least 10 years and will probably impact 1 per cent of India’s money supply. So, if it will impact just 1 per cent, what kinds of goals is it planning to achieve?” he points out.
India’s timeline seems a little rushed to understand the various nuances of introducing CBDC. The last time India made a hasty decision to affect its currency supply, people stood in long lines for hours desperately trying to withdraw their money. Following other countries that have long considered a CBDC, India could do better by setting a more realistic timeline. A risk-free CBDC requires a secure and resilient infrastructure that can scale appropriately given India’s large population. It is therefore important to have more discussions involving all stakeholders that will help consolidate all requirements for her CBDC infrastructure in India.