Context: Recently, Reserve Bank of India (RBI) has announced the launch of India’s much-awaited Central Bank Digital Currency (CBDC), a sort of official cryptocurrency, for retail users.

• The pilot will initially cover the four cities of Mumbai, New Delhi, Bengaluru, and Bhubaneswar, where customers and merchants will be able to use the digital rupee "e-rupee". Four banks will be involved in the controlled launch of the digital currency in these four cities: State Bank of India, ICICI Bank, Yes Bank, and IDFC First Bank.

• The pilot will work in a closed user group (CUG) comprising participating customers and merchants. Select customers from the selected cities will get CBDC wallets with notes printed digitally with the RBI Governor’s signature.

• The scope of the pilot may be expanded gradually to cover more banks, users and locations.

About  CBDC or the digital rupee

• CBDC is a legal tender issued by the RBI in digital form. It is the same as the fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different — it is not paper (or polymer) like physical cash. 

• It is a fungible legal tender for which holders need not have a bank account.CBDC will also appear as ‘liability’ (currency in circulation) on the RBI’s balance sheet.

What are the types of e-rupee?

• Based on usage and the functions performed by the digital rupee, and considering different levels of accessibility, the RBI has demarcated the digital rupee into retail and wholesale categories.

• Retail e-rupee: It is an electronic version of cash primarily meant for retail transactions, which can potentially be used by almost everyone, and can provide access to safe money for payment and settlements.

• Wholesale CBDC: It is designed for restricted access to select financial institutions. It has the potential to transform the settlement systems for financial transactions undertaken by banks in the government securities (G-Sec) segment and inter-bank market, and make the capital market more efficient and secure in terms of operational costs, use of collateral, and liquidity management.

How can an individual use the e-rupee?

• E-rupees will be issued in the same denominations as paper currency and coins and will be distributed through the intermediaries, that is banks. Transactions will be through a digital wallet offered by the participating banks, and stored on mobile phones and devices.

• Transactions can be both person-to-person (P2P) and person-to-merchant (P2M). For P2M transactions (such as shopping), there will be QR codes at the merchant location.

• A user will be able to withdraw digital tokens from banks in the same way s/he can currently withdraw physical cash. S/he will be able to keep his/her digital tokens in the wallet and spend them online or in person or transfer them via an app.

How is this different from other wallets?

• Not very different in terms of how it will be used. However, UPI-based apps like Google Pay and Paytm have a daily and per-transaction spending limit. The RBI has not fixed any limit on holding digital rupees in wallets. Digital rupee transactions above Rs 2 lakh are likely to be reported for tax matters.

CBDC benefits

• It has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, reduced settlement risk.

• It would possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option.

• It is likely to be in the arsenal of every central bank going forward. Setting this up will require careful calibration and a nuanced approach in implementation.

• It CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems.

• The wider adoption of CBDC may also mean that the monetary policies have to be formed in a way to inject more liquidity in the system than needed to plug currency leakage from the banking system.

Impact on bank deposits

• According to the RBI deputy Governor, since CBDC is a currency that does not pay interest, its impact on bank deposits may “actually” be limited.

• “Depositors that require CBDCs for transactional purposes are likely to sweep day end balances to interest-earning deposit accounts".

Difference between CBDCs and virtual currencies

• CBDC as a “legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.”

• Where as “Private virtual currencies sit at substantial odds to the historical concept of money. They are not commodities or claims on commodities as they have no intrinsic value; some claims that they are akin to gold clearly seem opportunistic.”

• CBDC is different from cryptocurrencies and stable coins which are issued by private entities. Unlike CBDCs which will be a liability of the central bank, cryptocurrencies are no one’s liability and their value is derived from the expectation that they will be valued and used by other.