Central Bank Digital Currency

Map of CBDC Phase of exploration

Money has taken many forms over the centuries. In fact, it’s not even always been money at all. It gradually evolved from bartered commodities to pieces of metal, before becoming paper money and eventually debit and credit cards. The next step in this evolution could be central bank digital currencies (CBDCs).

What is a Central Bank Digital Currency (CBDC)?

Central Bank Digital Currency (CBDC) is a new form of money that exists only in digital form. Instead of printing money, the central bank issues widely accessible digital coins so that digital transactions and transfers become simple.

How Central Bank Digital Currency (CBDC) differ from cryptocurrency?

A CBDC would differ from cryptocurrency as it would be issued by a central bank, rather than a private coin like Bitcoin. This means the currency would be backed by the issuing government, ensuring its value would be stable, unlike with cryptoassets where large swings in value can happen for a number of reasons.

Which is the first country to adopt a CBDC?

The Bahamas was the first country to adopt a CBDC. It launched the Sand Dollar in 2020 because it wanted to increase financial inclusion for its citizens, who live across a series of 700 islands, some of which offer limited access to cash machines and banking services.

Why there are efforts towards Central Bank Digital Currency (CBDC) all over the world?

Efforts towards CBDC has grown all over the world for many reasons.

First, the COVID-19 crisis induced a shift in payment habits towards digital, contactless payments and e-commerce due to a now refuted danger of banknotes being way of transmitting infection, which has accelerated the decline of cash use.

Second, cryptocurrencies developed by private organisations or informal communities (e.g. Bitcoin) have seen significant developments and value gain. As a response, 87 countries (representing over 90 percent of global GDP) are now exploring central bank digital currencies, while 11 of them have fully launched a state-owned digital currency.

Third, When migrants send money back to people in their home country, they face an average charge on the transaction of 6.25%, the World Bank says. This is hacking away at the remittances that provide critical support for developing economies. CBDCs could reduce the costs of these cross-border transactions by removing the need for money transfer operators.

Fourth, CBDCs could also speed up cross-border transactions. International payments often take one or two days, but some can take five. With CBDCs, digital payments could happen within seconds at any time of day.

Fifth, CBDCs can help people access money in emergencies.

Sixth, CBDCs can boost financial inclusion. Increasing financial inclusion was one reason Nigeria introduced its CBDC, the eNaira, in 2021. Around a third of people in Nigeria do not have bank accounts.

Seventh, CBDCs can counter criminal activity. CBDCs would allow for the creation of digital records and traces, and this could make it easier to stop money laundering and flows of money used to finance terrorism.

How Central Bank Digital Currency (CBDC) could be developed?

CBDC could be developed in a number of ways:

In a centralised approach, transactions are recorded in ledgers managed by central banks that also provide user-facing services.

In a decentralised approach, a central bank sets rules and requirements for the settlement of CBDC transactions that are then recorded by users and/or financial intermediaries.

The impact of CBDC depends also on the chosen implementation. Conventional money requires many intermediaries in the payment chain, resulting in less efficient and secure payment experiences. CBDC could find solutions to these issues, developing a more efficient, fast, secure and sovereign form of payment process.

What may be the positive foreseen impacts of CBDC on data protection?

Privacy is one of the most important design feature.

CBDC could increase data protection and security in digital payments and provide payers more control over their personal data.

Enhanced possibility to have anonymity in the payment process. Privacy-enhancing technologies could be used to enhance the way anonymity is wired within the entire payment process while allowing the auditing only in pre-determined lawful cases, such as preventing money laundering, counter terrorism financing and tax evasion.

What may be the negative foreseen impacts of CBDC on data protection?

Concentration of data in the hands of central banks could lead to increased privacy risks for citizens. If payment data of all citizens were concentrated in the databases of a central bank, it would generate incentives for cyberattacks and a high systemic risk of individual or generalised surveillance in case of data breaches or, more in general, of unlawful access.

Wrong design choices might worsen data protection issues in digital payments. Payment data already reveals very sensitive aspects of a person. Wrong design choices in the underlying technological infrastructure might exacerbate the privacy and data protection issues that already exists in the digital payment landscape. For example, transactional data could be unlawfully used for credit evaluation and cross-selling initiatives.

Lack of security might turn into severe lack of trust from users. Security concerns in the CBDC infrastructure, whose security requirements and expectations are high, may turn into a significant loss of trust from users.

PRACTICE QUESTIONS

QUES . With reference to Central Bank digital currencies, consider the following statements : UPSC 2023

1 . It is possible to make payments in a digital currency without using US dollar or SWIFT system.

2 . A digital currency can be distributed with a condition programmed into it such as a time-fame for
spending it.

Which of the statements given above is/are correct?

(a) 1 Only

(b) 2 Only

(c) Both 1 and 2

(d) Neither 1 nor 2

Ans (c) EXPLANATION : Countries will be able to directly exchange digital currencies in a bilateral way and without going through SWIFT or similar settlement systems. When the technology allows seamless and instantaneous convertibility from one sovereign currency into another, it changes the practical need for a dominant global reserve currency. CBDC could be employed for fiscal transfers to households or firms, such as relief or stimulus payments. The transfer payments could also be “programmable”, with conditions such as expiration upon a certain date or a requirement to spend the funds at certain vendors.

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