The evolution of money is interesting, starting with the exchange of goods to coins and paper money, and now digital currencies. However, the basic characteristics of money are always the same. It is used to store assets, can be used as a stock exchange and serves as an accounting unit.
Today, the concept of Central Bank Digital Currency (CBDC) has received a lot of attention and interest around the world and federal banks are now investigating and assessing CBDC opportunities. CBDC is a digital form of fiat currency issued by a central bank and is equivalent to fiat currency.
A 2021 Bank for International Settlements survey found that 86% of central banks around the world were actively researching opportunities for CBDCs, 60% were experimenting with related technologies, and 14% were implementing experimental projects. In a recent speech, the vice-governor of the RBI emphasized India’s long-awaited position and the need for CBDC in India.
As these debates and considerations continue, we present our point of view outlining how CBDC can impact lives in retail. I would like to point out to readers that the scope of this article is limited to just the retail aspect of CBDC and not wholesale.
First, let’s understand what retail CBDC is. Retail CBDC serves as a digital fiat currency format intended for the general public and to be used to conduct financial transactions for day-to-day activities. CBDC exchange is typically based on Distributed Ledger Technology (DLT), similar to a government-funded private blockchain network that aids in anonymous transaction tracking. It also helps to reduce the involvement of the private parties, thus preventing any illegal activity, such as money laundering or fraud. The CBDC can be delivered directly to the people by a Federal Bank.
Alternatively, Retail CBDC can be issued to intermediaries (which could be public/private banks) who then offer the same as fiat money.
Advantages of CBDC in the context of Retail
1.Direct transfer of the beneficiary
CBDCs are an excellent way to ensure that money spent by the government on programs and schemes goes directly to the recipients and is used only for their intended purpose. The Federal Bank can pay the recipients of the pre-arranged CBDC, which can only be allowed for a specific purpose. For example, CBDCs could be issued for LPG subsidies in the form of Direct Benefit Transfer. Such CBDC may only be accepted at authorized LPG agencies and will otherwise be rejected. LPG agencies can convert this CBDC into a CBDC for general use or fiat money to a commercial bank, which may have the required permission to change the CBDC type. Such subsidies can also be extended to other sectors, such as agriculture, where fertilizer subsidies can be transferred through the CBDC.
2. Cross-Border Credit Transfers
CBDCs can be used for fast cross-border payments. International cooperation between major global economies, including India, could help create the necessary structure and arrangements for the transfer and exchange of the CBDC. In such a case, CBDC delivery can take place in real time, reducing the time it takes to receive the payout from the proposed payee. Moreover, SWIFT itself could evolve with the rise of CBDC. As a cooperative that is neutral and currency independent, reaching 11,000 institutions in over 200 countries, SWIFT is well placed to be deeply involved in the debate and any future evolution of money. SWIFT is already orchestrating a cross-border transaction experiment between a traditional wholesale RTGS payment system and a DLT-based CBDC platform. As an integral part of the financial services infrastructure, SWIFT will play a vital role in supporting its members as CBDC begins to transform the landscape.
CBDCs will be used for making payments. The CBDC distributed by the RBI and commercial banks is held in e-wallets by end users. This would enable payments between consumers to consumers or to a business where an exchange of CBDC can take place between their wallets.
Retail CBDC enables wallet creation directly with RBI, which is unprecedented. This directly affects consumers’ ability to build a history with the RBI and will ultimately help them get loans and access to other financial products directly from the Central Bank. In addition, CBDC will enable immediate loans to SMEs. As more SMEs opt for CBDC, banks will be better able to build a more accurate borrower risk profile, helping SMEs with their financial needs. Also, during crisis or uncertain times, CBDC can be used for the distribution of stimulus measures by the Federal Bank. In addition, CBDC tracking can help SMEs prove their creditworthiness. However, it would be worth seeing if RBI will go down this road and risk disintegrating legacy banking channels.
5. Smart contracts
Let’s look at a realistic scenario where smart contracts can be used effectively. Suppose you are at the airport and your flight is delayed. ACME, an insurance company, provides insurance for flight delays using smart contracts. So, how do they compensate you in case there is a flight delay?
The smart contract is linked to the database that records the flight status. The smart contract is created based on terms and conditions. A condition for the insurance is a delay of two hours or more. Based on the code, the smart contract holds ACME’s money until that particular condition is met. The smart contract is submitted to the nodes on EMV (a runtime compiler to run the smart contract code) for evaluation. All nodes on the network executing the code should arrive at the same result. That result is recorded in the distributed ledger. If the flight is delayed by more than two hours, the smart contract will execute itself and you will be compensated. Smart contracts are immutable; no one may change the agreement.
Their use makes the transactions traceable, transparent and irreversible.
The fear of exclusion is the biggest challenge CBDC has to overcome. In a country like India, where more than half a billion people still use numpad phones, it is important to ensure that CBDC is not relegated to a few with technological know-how. In addition, the success of CBDC will depend on the inclusion of people from lower socioeconomic groups in the country. If we want the CBDC ecosystem to be sustainable, we need to tackle several issues and make the CBDC work as an inclusion tool. We must solve problems by innovating, such as with offline payments.
The above views are those of the author.