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Reserve Bank of India (RBI) governor Shaktikanta Das on Friday said that the central bank may launch a pilot of its digital currency by December this year. Das said in an interview that the RBI is working on a phased implementation strategy for the same.

He added that the bank is "extremely careful" about the central bank digital currency (CBDC), which is a new product for it.

This is an important statement from the governor of the country's central bank, in view of the rise in popularity of cryptocurrency. The Supreme Court has already quashed a 2018 circular of the RBI to ban banks and financial institutions from providing services to any individual or business entities dealing with or settling cryptocurrencies, including Bitcoin.

At a webinar last month, RBI deputy governor T Rabi Sankar had said that the time for CBDCs has come.

What is a central bank digital currency?

The RBI defines 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.

It also said that the idea is not new. At his keynote address, Sankar said in July that the origins of CBDCs can be attributed to American economist and Nobel laureate James Tobin, who proposed a digital form of payment in 1980s.

What is the need for a CBDC?

Across the globe, the adoption of CBDC has been justified for three main reasons: Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency; Jurisdictions with significant physical cash usage seeking to make issuance more efficient and Central banks seek to meet the publics need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.

Moreover, the RBI says that payments using CBDCs are final and thus reduce settlement risk in the financial system. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems, according to the central bank.

Difference between cryptocurrency and CBDC

Virtual private currencies like Bitcoin have gained wide acceptance in the last few years. Sankar said that if these private currencies gain recognition, national currencies with limited convertibility are likely to come under threat.

Virtual currencies like Bitcoin are digitally encrypted, decentralised and not linked to or regulated by any government. A CBDC, on the other hand, will be a digital version of the fiat currency - one backed by the government.

While cryptocurrency operates independently, a fiat currency is issued by a country's central bank. The latter requires intermediaries to make transfers.

Moreover, the supply of fiat currency is regulated by the central banks, and can be increased of decreased depending on the usages, whereas the supply of cryptocurrency is limited.

Also, a currency marked as a legal tender can be kept in bank accounts; the cryptocurrencies need to be stored in digital wallets.

CBDCs, depending on the extent of its use, can cause a reduction in the transaction demand for bank deposits and reliance on cash.

Why we need CBDCs in India?

According to RBI, India's high currency to GDP ratio calls for a switch to CBDCs. If large cash transactions can be replaced by CBDCs, the cost of printing, transporting, storing and distributing currency can be reduced.

It also said that freely convertible currencies like the US dollar may not be affected as most of the private virtual currencies in vogue are denominated in US dollar. The RBI said that virtual currencies might encourage the use of US dollar. So, a digital currency developed by India could help retain public preference for the Rupee.

Read more:
RBI may launch e-currency: How will it be different from cryptocurrency? - Hindustan Times