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The Reserve Bank of India (RBI) has kicked off a pilot run of its wholesale central bank digital currency (CBDC), which will be followed by a test of its retail CBDC. Unlike volatile cryptocurrencies, a CBDC is seen as a trusted and transparent way to transact digitally. CBDCs also hold the potential to disrupt the digital payments ecosystem in India and the world. It could emerge as an alternative to mobile money in the future, possibly competing with the likes of Paytm and Google Pay.

What is a CBDC?

Essentially, a CBDC is a digital form of a country’s fiat currency issued by its central bank. It may be fresh currency, or it may replace existing money in the system. CBDC may be used for peer-to-peer payments or for transactions between consumers and merchants. It can also enable transactions between commercial banks and clearing houses (wholesale CBDC) in the wholesale interbank market, possibly streamlining domestic or cross-border interbank payments. To begin with, RBI's pilot will use wholesale CBDC to settle government securities transactions. A retail CBDC pilot will be tested after a month.

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What are its objectives?

One of the primary objectives is promoting financial inclusion, which enables greater access to financial services to the masses, particularly the poor and the underprivileged. CBDCs can be held in an account with the central bank, or as electronic tokens on mobile devices, prepaid cards or other forms of digital wallets.

About 1.7 billion adults don’t have a bank account, according to the World Bank. In India, one-third of account holders had inactive accounts in the past year. By giving easy and safe access to money, CBDCs are expected to power a big leap towards financial inclusion.

A second reason is that many central banks, including the RBI, are wary of the rising popularity of cryptocurrencies. CBDCs are digital copies of a country’s national currency, and won’t be endemically volatile like private digital currencies such as Bitcoin and Ether.

Another objective is to check illicit use of money, from tax evasion to money laundering to terror funding. Cash offers anonymity and doesn’t have an audit trail, lending itself to potential abuse.

Still, there are operational risks associated with CBDCs, from cyber-attacks, to the need for an overarching regulatory framework to ensure consumer protection and prevent money laundering.

What’s the difference between CBDC and mobile money?

CBDC is digitalized national currency, and will replace or coexist with the cash in the system. Mobile money leverages customer wallets linked to commercial bank accounts facilitating cash transfers and credit. Also, the central bank is the issuer of the CBDC, while mobile money is the liability of commercial banks and financial institutions.

Now comes the fundamental question. Can a CBDC muscle into the turf of mobile money wallets? Both CBDC and mobile money will enable retail transactions, and there may well be competition between the two channels. However, people prefer to have multiple payment options, and it’s quite likely CBDCs, credit/debit cards, mobile wallets and net banking will all coexist and flourish. But, no doubt, CBDCs may eventually emerge as alternative digital payment options, possibly competing with the likes of Paytm, Google Pay, and others in India. Eventually, a single wallet may offer CBDC units and mobile cash, and other payment options.

How many countries have plans for CBDCs?

“As per the results of 2021 Bank for International Settlements (BIS) survey on CBDCs conducted on 81 central banks, 90% of central banks are engaged in some form of CBDC work and more than half are now developing them or running concrete experiments," a recent RBI report said.

Indeed, central banks of several countries – from South Africa, Canada, Japan, Thailand, Saudi Arabia, Singapore, and Cambodia – have plans to experiment with a CBDC. The Biden administration in the US too has plans for a digital currency to retain the country's pre-eminence in the global financial system.

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