Central Bank Digital Currency- Creating Digital Future

By Smriti Bhujel Chhetri 12 MIN Share Post

Image Source: Analytics Insight

Keywords - CBDC, Bank for International Settlements, Sand Dollar, Central Bank, Research, Blockchain, Digital Currency

A central bank digital currency (CBDC) uses an electronic record or digital token to represent the virtual form of a fiat currency of a particular nation (or region). A CBDC is centralized; it is issued and regulated by the competent monetary authority of the country.

CBDC is a digital form of fiat money that can be used as a legal tender and be generated by the country’s central bank. As it is in digital form, it differs from the traditionally issued coins and banknotes. Similarly, it also differs from the cashless payments instruments like credit cards, debit cards, and e-payment systems because it directly claims the central bank, not to the other financial intermediaries.

Figure: CBDC is aimed at complementing cash and bank deposits

Unlike decentralized cryptocurrency, CBDC will be centralized, administered, and managed by the central bank. There are two forms of CBDC:

Wholesale CBDC refers to CBDC, which is traded and exchanged between central and private banks. It is used for interbank payments and specially designed for financial institutions with reserve deposits with a central bank, increasing the efficiency of payments and securities settlements and reducing counterparty credit and liquidity issues.
Retail CBDC is for the general public. It is not limited to central banks and private banks like in wholesale CBDC. Like banknotes, retail CBDC can make payments by the people, non-financial institutions, and corporations. The retail CBDC is gaining popularity among the central banks of emerging economies. They want to take the lead in the fast-growing FinTech industry, promote financial inclusion, and shift into a cashless society.

According to a BIS Survey (2021), The vast majority of central banks in the survey – 86% are actively researching the potential for CBDCs, 60% are experimenting with the technology, and 14% are conducting trial projects. Central Banks all around the world are considering CBDC because of a variety of reasons which include:

Transparency and security
Reduce dependency on physical cash
Provides financial inclusion
Monetary policy execution.
Programmable money for open banking and Fintech Revolution

Blockchain has brought the paradigm shift in digitalizing the business and transforming the economy. It helps to bring unique advantages to a CBDC in terms of privacy and scalability and enables central bank money to improve the needed control and security. CBDC is built on a token-based approach to money; it brings innovation and benefits that cash cannot provide.

Current CBDC Landscape

In 2021, more countries are exploring the possibility of a Central Bank Digital Currency (CBDC) than in the previous year. According to the Atlantic Council, eighty-one countries (representing over 90 percent of global GDP) are now exploring a CBDC. 83 Countries Stand on CBDC Progress where:

5 Launched
14 Pilot
16 Development
32 Research
10 Inactive
2 Canceled
4 Other

Meanwhile, The CBDC has already been implemented in the five different countries, with the Bahamas being the first. The Bahamas has already commercially launched CBDC while China is piloting the CBDC, and India is still in the research phase.

The Bahamas (Sand Dollar)

The Bahamas' Central Bank has launched the Sand Dollar, the world's first state-backed digital currency which is now available to all Bahamas citizens. In 2018, the Sand Dollar began a pilot operation in Exuma. It later expanded to Abaco Island, devastated by Hurricane Dorian, where they had no access to ATMs or bank branches. Sand Dollar aided the Bahamians much, throughout the crisis as it was operated on mobile phones. The Sand Dollar's key goals are to modernize and streamline the country's financial system, minimize service delivery costs, increase transactional efficiency, and improve financial inclusion among the Bahamas' many remote islands.

The Bahamas is ‘disaster proofing’ payments with its first-ever digital currency - The sand dollar. “We want to accelerate the ease by which we can plan for recovery,”- John Rolle, Governor of the Central Bank of The Bahamas. It is a safe & easy alternative to cash which allows greater flexibility and accessibility for residents who want to participate in financial services via either a mobile phone application (iOS and Android) or a physical payment card to access a digital wallet. It also provides an excellent record of income and spending, which can be used as supporting data for micro-loan applications. It is built on mobile wallet platforms that our financial institutions are introducing. One can use the sand dollar for personal and business transactions by using QR codes, unique custom names, or even with the Sand Dollar card.

China (Digital Yuan)

Since 2014, The People's Bank of China has been researching digital currency (Yuan) to digitize existing banknotes and coins. It is currently conducting trials in Shenzhen, Chengdu, Suzhou, and other cities across China. China has largely transitioned to a cashless society, with digital payments accounting for nearly 85 percent of all transactions.

The main goal of e-CNY is to provide a convenient yet more efficient and secure retail payment system to increase financial inclusion, preserve monetary sovereignty, and provide a "backup" payment infrastructure for the private sector payment solutions. Further, fair competition and interoperability should be promoted. The government can check every transaction that happens in the digital platform to eliminate counterfeiting, money laundering, and other illicit activities.

As per the State media, China's digital currency pilots are gaining popularity and have now reached more than 10 million people. In addition, the central bank plans to broaden the scope of the pilot, possibly allowing foreign visitors to the 2022 Beijing Winter Olympics to use it too.

India

With the increased popularity of CBDC, countries such as the United States, the United Kingdom, Russia, China, etc., are exploring this domain, and India is no exception. The Reserve Bank of India will launch its digital currency by the end of this year, but it is currently in its research phase.

On July 22, T Rabi Sankar, deputy governor of the Reserve Bank of India (RBI), said- "The regulatory body is considering a phased implementation of a central bank digital currency (CBDC) and is examining use cases that could be implemented with little or no disruption.” He further added- "We are internally evaluating issues such as the scope, technology, distribution mechanism, and validation mechanism, etc."

Financial inclusion is a challenge in India, as it is in many other developing countries as it only has 582 million bank accounts and 1.21 billion mobile connections, a digital currency would make cash more accessible and encourage spending. RBI attempts to develop the CBDC and various initiatives are being taken to realize India's vision on payment systems. The RBI wants to create a payment environment that allows everyone to make safe, quick, and economical digital payments.

Possible Next Steps for Nepal:

Roadmap for Nepal

Over the last five years, government-backed digital currencies have gained popularity globally, and central bankers are beginning to see the benefits. Nepal should consider exploring CBDC to support its Digital Nepal Framework. The Digital Nepal Framework program is designed to enable Nepal to harness its growth potential by leveraging disruptive technologies and driving socioeconomic growth.

As many countries explore and research CBDC, our neighboring countries with the largest economies, i.e. China and India are also doing so. The People's Bank of China has been researching digital currency since 2014 (Yuan) and still piloting in various cities of China. Meanwhile, the Reserve Bank of India plans to launch a digital currency by the end of this year and is exploring a phased implementation of CBDC, but it is still in the research stage. On one side, countries like India, China, and other various countries are in the process of researching and piloting whereas, on the other side of the world, the Bahamas has already launched its digital currency Bahamian Sand Dollar. It has become the alternative cash currency for Bahamian citizens. It provides more flexibility and accessibility to the residents and can be used for both personal or businesses, who want to participate in financial services via a mobile phone application (iOS and Android) or by using a physical payment card to access a digital wallet.

Issuing virtual currencies is significantly less expensive than producing and distributing physical cash. It can also be monitored by the central bank, making it easier to track and detect fraud. People all over the world are becoming more interested in digital currencies. So, CBDC has been explored by many countries, and they are still exploring a lot more. Even though demand for CBDC is growing, several measures must be considered to meet the people’s needs. It takes time to develop a CBDC as each country has unique criteria that require testing customized technical aspects.

Before launching Nepal's digital currency, the CBDC approach should be divided into various phases. Nepal Rastra Bank (NRB) is also showing a keen interest and is positive towards Central Bank Digital Currency. For this, NRB must establish a task force to research and explore new and current technology to build a hypothetical digital currency and also should identify the benefits of CBDC implementation. The brainstorming sessions, seminars, and digital payment awareness training should be held for researchers, academia, banks, the commercial sector, and others who are interested in the issue, to demonstrate the importance of digital currency in the future. Similarly, a feasibility study must be conducted to investigate design possibilities, economics, regulation, and technology to determine how to execute a CBDC framework in Nepal.

However, before doing so, the NRB should prioritize infrastructure building, then adopt a phased approach to CBDC implementation and along with that, the digital currency needs to be piloted with a wide range of users to test its functionality.

Even though CBDC can be technology agnostic, blockchain technology has shown promise for CBDC to be implemented. The decentralized ledger technology is the infrastructure behind cryptocurrencies and has made transactions secure and private. The same robust technology can fuel the CBDC. It has been the subject of research and development for several years but only a few firms have implemented it. Despite being among the world's most cautious and prudent institutions, central banks were among the first to adopt blockchain technology.

The Bank of England was the first central bank to publish research on DLT, starting in 2014 with the papers and now there are already more than 60 research papers and various large-scale technology pilots examining CBDC and other applications.

The Bank of France has fully replaced its centralized process with a decentralized, blockchain-based solution in June 2016. The Bank of France considers the implementation a success. In addition to greater time efficiency, it cites benefits such as process auditability and disaster recovery, along with greater accountability for commercial banks within the process.

Likewise, On October 28, 2020, the National Bank of Cambodia formally launched Project Bakong, a blockchain-powered payment system, making it the first central bank in Asia to use it. With its implementation, the central bank of Cambodia has found ways to employ distributed ledger technology (DLT) to improve financial inclusion and banking sector efficiency.

While central banks from all around the world are experimenting with different blockchain research projects and pilots, the depth, progress, and interest differ tremendously. CBDC can be used to eliminate as many obstacles as possible for persons having access to the equivalent of a deposit account or a mobile wallet account to conduct transactions. Furthermore, all the information and transactions that take place on this platform can also be checked by the government to protect from any counterfeit, money laundering, or any kind of illicit activity. Only a few Caribbean central banks have fully implemented blockchain technology. The majority of central banks are exploring the possibility of unlocking new opportunities and improving inefficient processes.

On February 2022, India’s Finance Minister Nirmala Sitharaman announced that its central bank would launch a digital version of its currency in the financial year 2022-23.

As stated by Mr. Prithivi Man Shrestha in his article Nepal has begun its study on digital currency. As a part of this initiative, eSatya provided a Central Bank Digitial Currency (CDBC) session in 2021.

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