What is the Central Bank Digital Currency and how does it work?

As the world becomes increasingly digitized, central banks are exploring their digital currencies. These digital currencies are known as Central Bank Digital Currencies (CBDCs), and they could revolutionize the way we think about money and payments.

Let's understand what CBDCs are, how they work, and their potential benefits and drawbacks.

What is CBDC?

The government of India proposed the digital rupee in India in January 2017 and the launch in December 2022, which is controlled and managed by the Reserve Bank of India.

This digital form of currency is known as CBDC and is issued and backed by a central bank. It is a digital version of physical cash but with some key differences. Unlike physical cash, CBDCs are entirely digital and can be stored on a digital wallet or account. They can be used for transactions just like physical cash but with the added convenience of being able to use them online or through mobile devices.

There are two main types of CBDCs:
 

Retail CBDCs (CBDC-R): Retail CBDCs are meant for use by the general public. They are further divided into two categories: account-based and token-based. Account-based CBDCs are linked to a specific account. In contrast, token-based CBDCs are anonymous and can be transferred between users without the need for an account.
 

Wholesale CBDCs (CBDC–W): Wholesale CBDCs are meant for use by financial institutions and other large organizations.
 

How does CBDC work?

CBDC is designed to work similarly to physical cash. A central bank issues them, and they can be used for transactions just like physical cash. However, there are some key differences in how they are created, stored, and transferred.
 

Creation

The central bank creates it, and it can be issued in two ways: through direct issuance or a two-tier system. In direct issuance, the central bank creates and distributes the digital currency directly to users. In a two-tier system, the central bank issues e-₹ to authorized intermediaries, such as commercial banks, who then distribute the CBDC to their customers.
 

Storage

They are stored on digital wallets or accounts, which can be accessed through mobile devices or computers. Users can store and transfer CBDCs just like they would with physical cash, but with the added convenience of being able to use them online or through mobile devices.
 

Transfer

Money Transfers between users through a digital payment system, such as a mobile app or online banking. Transactions can be made instantly and securely without the need for intermediaries such as commercial banks or payment processors.

Benefits of CBDC

Central Bank's Digital Currency offers several benefits over traditional forms of currency. Here are some of its potential benefits:

1. Increased financial inclusion: 

It could increase financial inclusion by providing access to financial services for people who are unbanked or underbanked.

2. Reduced transaction costs: 

CBDCs have the potential to reduce transaction costs by eliminating the need for intermediaries such as commercial banks or payment processors.

3. Increased efficiency: 

The increased efficiency of e-₹ enables instant and secure transactions without the need for intermediaries.

4. Improved monetary policy: 

It will improve monetary policy by providing central banks with more tools to manage the money supply and control inflation.

5. Enhanced security: 

It will enhance the security by providing a secure and tamper-proof digital payment system.

Drawbacks of CBDC

While CBDCs offer several potential benefits, there are also some potential drawbacks to consider. Here are some of its drawbacks.

1. Privacy concerns: 

It could raise privacy concerns, as central banks would have access to detailed information about users' transactions.

2. Cybersecurity risks: 

It can be vulnerable to cybersecurity risks, such as hacking or data breaches.

3. Disruption to the banking system: 

It may disrupt the banking system by reducing the need for intermediaries such as commercial banks or payment processors.

4. Implementation challenges: 

Implementing CBDCs could be a complex and challenging process, requiring significant investment in technology and infrastructure.

Conclusion

Central Bank Digital Currencies are revolutionizing the traditional methods of payments. They offer several potential benefits, such as increased financial inclusion, reduced transaction costs, and improved efficiency. However, there are also some drawbacks to consider, such as privacy concerns, cybersecurity risks, and disruption to the banking system. As the pilot run of CBDC has already started, it is important to carefully consider these potential benefits and drawbacks. If you are interested in exploring the opportunities in CBDCs. It's a good idea to consult with a reliable share broker who can provide valuable insights. 

Frequently Asked Questions

Q1. How does CBDC work in India?

Ans: CBDC is a legal tender which is issued by the Central Bank of India. It is similar to fiat currency but is available in digital form. One can easily exchange it with the physical currency as it holds the same value as the cash money. 

Q2. What is CBDC in simple words?

Ans: CBDC is also called e-₹ or digital fiat currency.

Q3. On which technology does CBDC work?

Ans: CBDC works on Blockchain Technology.

Q4. Who launched CBDC in India?

Ans: The Reserve Bank of India launched the first pilot of digital rupee in the retail segment.

Q5. Which 9 banks are in CBDC in India?

Ans: The RBI has chosen these banks to participate in the retail pilot program in stages

• The State Bank of India
• ICICI Bank
• Yes Bank
• IDFC First Bank
• Bank of Baroda
• Union Bank of India
• HDFC Bank 
• Kotak Mahindra Bank