The Reserve Bank of India (RBI) will soon start the pilot release of e-rupee or central bank digital currency (CBDC) for certain use applications. Here, let us try to understand the concept and characteristics of the digital rupee (e₹).

What is CBDC? What is its purpose?

CBDC or central bank digital currency is simply a legal tender issued by the central bank in digital form. Once it has been formally issued, it can be used as a form of payment and legal tender.

This digital currency can be converted into money or any form of commercial bank currency. Financial inclusion would be advanced because holders could use it as fungible legal tender without a bank account.

More significantly, it would give the general public a substitute for unregulated cryptocurrencies and the risks they possess.

Who issues CBDC?

As the name suggests, the central bank or the RBI will issue the e-currency as it is a sovereign or fully autonomous currency in compliance with the nation’s monetary policy.

How does it work?

RBI’s proposal has two versions of the e-rupee based on their usage and functions. CBDC-W — Wholesale for interbank settlement, and CBDC-R — retail for the public.

According to the RBI, the whole supply chain is managed by the central bank, including the issuance of CBDCs, account maintenance, and transaction verification. Every payment will be processed through its server. Users will hold the digital rupee in a wallet with a bank or service provider.

The central bank will create and issue tokens to authorized entities called Token Service Providers (TSPs). The tokens would then be given out to end users who conduct retail transactions by these TSPs. The token-based system is set to circulate like a banknote and will be transferable from one entity to another electronically.

How is CBDC different from cryptocurrencies?

The RBI is primarily concerned about the growing acceptance of cryptocurrencies in the country. CBDCs are digital representations of a nation’s official currency and won’t be as volatile as other digital currencies like Bitcoin.

Moreover, cryptocurrencies like Bitcoin and Ethereum are ‘private’ in nature as they are mined and created by people. The RBI, on the other hand, will be the one that issues and manages the digital rupee.

Will Internet be used for CBDC transactions?

Offline transactions would be highly beneficial in remote locations in India. One should be able to transact even without the internet as the RBI has proposed offline functionality for digital currency. However, using an offline method could lead to a duplication issue when the same rupee is transmitted to several recipients.

What are the potential risks of e-rupee?

It is anticipated that the CBDC will generate a lot of data in real time. In the concept note, specific issues were raised with data collecting and anonymity, cyber-security, conflict resolution, and accountability.

It will be challenging to efficiently utilize the Data, protect its privacy, and satisfy concerns about its anonymity. The RBI does point out that CBDC will provide public usage, just as any private virtual money may, but without the potential downsides.

Is India the first to launch its own CBDC?

No. The Bahamas, Nigeria, and Countries in the Eastern Caribbean Union have created their own form of digital currency to help speed transactions and serve people without the involvement of bank accounts.

Several other countries like South Africa, Canada, Japan, Thailand, Saudi Arabia, Singapore, and Cambodia have plans to experiment with their own CBDCs.

How is CBDC different from UPI?

CBDC or the digital rupee is a virtual currency that can be used for making digital payments. They are very similar to making payments made through Unified Payments Interface (UPI), but they are inherently different.

Digital Rupee in itself will be the underlying payment mode that can be used for digital payments in place of cash. In the case of payment rails like UPI or IMPS, they use the underlying currency to transfer the funds. UPI payments are made using the digital equivalent of existing currency notes, meaning every rupee transferred by UPI is backed by physical currency.

The digital rupee will be legal tender in and of itself and need not necessarily be backed up by physical currency. However, the digital rupee is no different from your normal rupee; it can be used to do normal transactions like NEFT, and UPI.