Date : 16/12/2023

Relevance: GS Paper 3- Economy- Digital Currency

Keywords: Digital Rupee, Distributed Ledger Technology (DLT), Cryptocurrencies, UPI, Central Bank Digital Currencies (CBDCs)

Context-

• The global landscape of Central Bank Digital Currencies (CBDCs) is rapidly evolving, with over 130 countries, representing more than 98 percent of the global GDP, actively engaged in CBDC-related initiatives.
• The potential benefits of CBDCs are extensive, promising innovation, improved financial inclusion, and fostering an environment conducive to cutting-edge payment applications and digital businesses.
• However, the introduction of CBDCs is not without challenges, and careful consideration of design choices is crucial to managing risks in performance, interoperability, privacy, and security.

The Global Surge in CBDCs

• The surge in CBDC initiatives worldwide underscores the growing recognition of their potential. With innovation at the forefront, countries are keen on exploring the benefits of CBDCs, envisioning a future with enhanced financial systems and digital economies.

The Indian Context: Digital Rupee and Regulatory Landscape

• India, with its significant role in the global economy, has embarked on its CBDC journey with the digital rupee. Despite being in the early stages, the Reserve Bank of India (RBI) approaches the endeavor with optimism, recognizing the need to manage risks associated with this transformative digital currency.
• The regulatory framework surrounding CBDCs requires meticulous attention to ensure successful integration into the existing financial and payment systems.

The spectrum of Risks Associated with CBDCs

• Cybersecurity Challenges: The significance of cybersecurity cannot be overstated in the context of CBDC initiatives. The potential vulnerability to various threat actors raises concerns about the trustworthiness of the system. While there have been no reported attacks on CBDCs, the looming threat of hacking and gaining control over a currency issued by a central bank poses substantial challenges that demand proactive risk management.
• Distributed Ledger Technology (DLT) Scalability: One structural challenge that may arise is the scalability of Distributed Ledger Technology (DLT), identified as a significant risk in various CBDC pilots. The Bank of England has expressed concerns about the scalability of DLT for CBDCs, highlighting the importance of considering technological limitations during the initiation of CBDC projects to mitigate issues throughout their lifecycle.
• Technology Infrastructure Vulnerabilities: The complexity and size of a CBDC technology infrastructure may lead to unforeseen security vulnerabilities. Ongoing digital transformations pursued by central banks may create operational hurdles for both IT and security due to the rapid adoption of technology. The potential integration of DLT during the research and implementation stages introduces additional challenges, given the evolving nature of DLT technology and processes.
• Human Element and Phishing Attacks: Acknowledging the inevitability of human error is essential in the context of CBDCs. Phishing attacks, which involve social engineering attempts to extract user data, pose a significant threat. Instances, where users are deceived into bypassing security measures, may rise in prevalence with the integration of CBDCs, necessitating robust measures to mitigate such risks.

India's CBDC: Motivations and Doubts

• Global Competition and Rising Prevalence of Cryptocurrencies: The inception of India's CBDC, the digital rupee, is influenced by global competition in CBDC development and the rising prevalence of cryptocurrencies, particularly stablecoins. The Deputy Governor of the RBI has emphasized caution in permitting instruments like stablecoins, leading to the exploration of CBDCs as a viable alternative.
• The success of UPI and Questions About Necessity: The success of the Unified Payments Interface (UPI) in India has raised questions about the necessity of deploying CBDCs in the country. UPI, as an efficient real-time consumer payments system, has significantly contributed to the surge in digital payment volumes in India. The competition posed by UPI in the retail payments landscape may impact the organic transition to CBDCs for consumer transactions.
• The Digital Rupee Concept Note: To assert that the RBI hasn't contemplated cybersecurity and scalability risks would be inaccurate. The digital rupee concept note explores the feasibility of utilizing DLT and assesses scalability, emphasizing the necessity for forward-looking technology considerations in the deployment of CBDC. These considerations were taken into account during planning and initial implementation, with anticipated robust solutions following the assessment of pilot programs.

Proactive Risk Mitigation and Future Outlook

• Anticipating and Addressing Challenges: Recognizing and anticipating challenges is crucial for the effective implementation of CBDCs. Proactively identifying systemic problems allows nations to build solutions, ensuring a smoother implementation process. The emphasis on addressing challenges associated with CBDCs is essential for their long-term success.
• Public Opinion and Adoption: India's CBDC is in the early stages of implementation, with pilot projects currently underway. Public opinion may require time to adjust to these technological developments, especially given the established success of the UPI system. While the digital rupee may not have experienced remarkable success thus far, adoption and usage take time, and authorities must establish mechanisms to mitigate associated risks.
• Lessons from Global Experiences: Drawing lessons from global experiences with CBDCs is imperative for India. Understanding both success stories and challenges faced by other nations can inform strategic decisions and enhance the effectiveness of India's CBDC implementation.

Conclusion

The landscape of CBDCs is dynamic, with India navigating the uncharted territory of digital currencies through the introduction of the digital rupee. The success of CBDCs hinges on effective risk management, proactive mitigation strategies, and a nuanced understanding of the global and domestic context. As India progresses on its CBDC journey, addressing cybersecurity concerns, scalability challenges, and competition from existing payment systems like UPI will be critical to ensuring the fruitful adoption of the digital rupee. Without overlooking these concerns, India can pave the way for a transformative future in the digital financial landscape, avoiding the risk of planting CBDC seeds in barren ground.

Source- Indian Express