What is Digital Rupee (CBDC) | How RBI's Digital Rupee works | CA Aleena Rais

Hello, did you know that India is a leader in

digital

payments today? Yes, only India has been able to develop and scale a technology like UPI i.e. Unified Payments Interface and adopt it so quickly. And even if there was a little left, Covid 19 has accelerated the process of

digital

cash transition. Who can stop innovation and disruption anyway? Nowadays every problem opens thousands of paths for a new opportunity, and in the same way globally, when there was a tremendous boom phase of cryptocurrencies, the leaders of countries around the world and their central banks took very seriously this topic.

Now, why would the latter country hand over its country's monetary power to an unknown and anonymous system? But in the demand for this cryptocurrency, perhaps the government and its central bank were forced to think about

what

it is in the cryptocurrency that is capable of generating so much demand. And perhaps with this thought, leaders around the world launched the race for their country's digital currency. Yes, digital currency! That is also related to the government! Sounds interesting, doesn't it? Let's understand it in a little more detail in the context of India in today's video. On November 1, 2022, our Central Bank, the RBI, gave a big winter gift to the Indian economy: CBDC, i.e. the Central Bank Digital Currency.

As the name itself suggests, it will be a currency in digital form. Currency in digital form? Let's understand with an example. Every time you make a cash transaction, for example, you've bought something for an office Christmas celebration. You gave cash to the merchant in exchange for these goods. If you look closely at those notes, it is written: "I promise to give an amount of 100

rupee

s to the holder." Now it can be said that 1

rupee

is not written the same, it is because the Ministry of Finance issues the 1 rupee note, not the RBI. Apart from this, if you see the note, apart from the pledge statement, above it is the signature of our RBI governor.

This means that it is approved by the government and for this reason it is also called fiat currency. Now in digital currency everything will remain the same, government approval, etc., the only difference will be that instead of cash, you will be able to pay it digitally. A CBDC is a legal tender issued by a central bank just like physical cash, only in digital form! Which means it is interchangeable one-to-one with money in any form our central bank issues! Wait a minute, you already do that, right? Correct? Even today, online payments are made through UPI using apps like PhonePe, Google Pay, Bhim, etc.

So how is this CBDC different from the previous one? And leave it aside, everything was still going well, so

what

was the need for the RBI to bring a separate digital currency? If you look at it closely, UPI and CBDC are almost the same from the consumer point of view, both allow you to transfer funds or carry out transactions in digital mode. But if we look at it from a bank's point of view and even from an accounting point of view, there is a big difference. Let's understand how. When you buy a Maggi pack from a store, at the time of payment, you make the normal payment through PhonePe or Paytm, or GooglePay, right?

Now, when you make a payment, you get a notification and a voice on the shop owner's uncle's loudspeaker saying, "Rs 200 has been received on Paytm." Now, the interesting thing is that these funds are not transferred at that time. You will be notified that the amount has been debited or credited, but in reality the transaction would not have taken place at the bank. Confused? If your account is with Indian Bank and the other person's account is with SBI, both banks do not exchange money in every transaction. After all, many transactions would be carried out between the two banks through UPI every day.

Nowadays people order everything from cutting tea to Domino's Pizza through online payment. So every time the bank settles the net transactions at the end of the day or at some fixed interval to escape from frequent transactions. This means that if 150 million rupees were transferred from SBI to Indian Bank throughout the day and 50 million rupees were transferred from Indian Bank to SBI, at the time of settlement, 100 million rupees will be transferred from SBI to Indian Bank . This means that there are 2 banking systems involved. But remember your cash transaction example. You bought something and paid cash in advance.

Was any transaction made between banks? In the same way, when you make a transaction through digital money, no bank settlement will be necessary for it. This means that when you pay someone or make a transaction with someone, the money is directly transferred from your RBI bank account to the opposite party's RBI bank account. In simple language like your cash transaction but in digital format. But one interesting thing is that CBDC is not a new concept, cryptocurrencies also work in a similar way, so where did CBDC suddenly emerge in everyone's conversations? The answer is hidden in this very question.

Yes. As cryptocurrencies became popular among the masses, central banks and world leaders took them seriously. After all, what country will put its economy or its monetary system in the hands of a foreign and also so volatile system? Nations thought it best to create their own digital currency. The main difference between cryptocurrencies like bitcoin and CBDC is that bitcoin is free of government oversight. It becomes very important to regulate a monetary system through one or more regulatory bodies. And for this reason, different countries probably got involved in the race for digital currency. Now that we are talking about cryptocurrencies and CBDCs, it is obvious that we must first talk about their underlying technology, that is, blockchain technology!

Blockchain is a system that records information in such a way that it is impossible for anyone to use, change, hack, or game the system. Basically, a blockchain is a digital ledger distributed over a network that records transactions and ownership of digital assets. And here arises an important difference between stable CBDCs and highly volatile cryptocurrencies. For CBDCs using privately permissioned blockchain net

works

, these recorded transaction details will only be available to the sender, recipient and bank, and not to the public. Private permission blockchains mean that not everyone can access the data on this network and, for this reason, it is considered regulated security or centralized security.

Its main objective is to maintain the privacy of users. But cryptocurrencies like bitcoin operate on a more public blockchain. Everyone on a public blockchain is free to access the information on that network, meaning the cryptocurrency is in some ways completely decentralized. This is the key differentiator between CBDC and cryptocurrencies. Since everyone on a public blockchain can access transaction details, it becomes an easy target for hackers and those with unscrupulous intentions. Operate a CBDC-sanctioned network, where each CBDC unit or digital rupee is uniquely identifiable and traceable. There are indications that the National Payments Corporation of India (NPCI) network, which hosts the UPI, will also host the CBDC.

That is why, if implemented correctly, Digital Rupee has so much potential that it will be another strategic shift after UPI in our country that will take our banking and payments industry to a new frontier globally. It will not only reduce financial inclusion, transaction time and related costs, but will also be a revolutionary step in making our financial system cashless. Even after 6 years of demonetisation, there may have been a rise in UPI-driven digital transactions, but our country's dependence on cash may not have reduced that much today. Before demonetisation, we had Rs 17 trillion in cash in circulation and by October 21, 2022, this figure had reached a record high of Rs. 30.8 billion.

So now you might be wondering what's the problem with cash? Managing physical cash is difficult. Both for us and for the government. You must have already realized how UPI has made our lives easier, right? But do you know what else we would benefit from if we didn't have cash? Every time a transaction is done digitally, it is authenticated, thereby controlling the circulation of corruption and black money in the country. And in the same way, when the economy is formalized and transparent, its growth is inevitable. The role of digital rupee will be very important here. According to the RBI, the digital rupee system will support India's digital economy, improve financial inclusion and further advance our monetary and payment systems.

Furthermore, since our digital currency will have no geographical borders, cross-border transactions will increase, opening new retail avenues for our country. Experts also believe that unlike UPI, there is no need to open a bank account to use digital money! And when all transaction accounts are settled in real time, you will be able to understand how the economy will remain somehow untouched by fraud and malpractices. The benefits are clear, but can the digital rupee become India's future? Well, the RBI has clearly stated that they are currently introducing the digital rupee or CBDC not to replace the current monetary system but to use it to complement it.

And as we mentioned, the RBI recently launched India's first digital rupee pilot project to test the waters for the wholesale banking segment. Settlement of secondary market transactions in public securities by the RBI will be a pilot use case, for which major Indian banks such as State Bank of India, Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank Banks, Kotak Mahindra Bank, Yes Bank, IDFC First Bank and HSBC were identified to participate. And it was recently announced that RBI will launch a pilot project next month for the retail segment as well. Now, here it is important to understand the difference between wholesale CBDC and retail CBDC.

They are digital rupees, but their purpose is different. The ONU Wholesale CBDC is for financial institutions that transact with each other, with international counterparties and with the RBI, such as banks. While earlier the RBI used to play the role of intermediary in transactions, now financial institutions will be able to carry out seamless transactions directly without the intervention of the RBI. It plays an important role in increasing the efficiency of these banks' transactions with the central bank and their settlement. Through this, financial institutions, including the RBI, will also be able to reduce counterparty credit risk among themselves.

And on the other hand, the retail CBDC that we can use in any store will be issued to the general public like us. So, let us now understand how this digital rupee is going to change our lives. Well, the digital rupee is, in a way, a direct responsibility of the Reserve Bank of India, which uses it as legal tender. And perhaps for this reason the consumer's dependence on cash will slightly reduce. CBDCs can be transacted through blockchain-powered digital wallets just like we use the Paytm wallet. And in the same way, they can also be freely converted into physical currency.

Experts associated with the industry say that going digital will completely transform our purchasing trends, our way of doing business and our saving patterns. Real-time transactions will make our lives much easier. Indian exporters or importers will be able to settle their foreign trade without the risk associated with currency fluctuations related to time differences, which will have a revolutionary effect. And when global net

works

are established and an ecosystem is created to streamline cross-border payments, CBDC can play an important role in the internationalization of the Indian rupee. Furthermore, thanks to traceability and transparency, government subsidies will reach people and companies without leaks.

And its impact on our population of 140 crore should not be underestimated. At the macro level, the digital rupee provides governments and central banks with real-time visibility and insight into the state of our economy to execute their fiscal and monetary policies accurately. So, as we have seen, by introducing the digital rupee, the RBI hopes to address the issues related to existing physical currencies and cross-border transactions. But it is necessary to implement a large-scale reform in such a large country. The rural economy, which has not yet left the traditional payment structure, may not be easily integrated into this initiative.

Online security threats are also a challenge that the RBI needs to be proactive about. The bottom line is that the RBI will have to conduct a full investigation into the impact of these pilots on our section of the digitally ignorant population. But it is a matter of joy that the RBI is moving towards the launch of the digital rupee very cautiously and isis taking care of all these challenges. If we step back from history a little, we see that money has come a long way. From barter system to physical cash and now to digital currency! Let's see what the future holds for us.

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