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Indians largely rely on cash. That could change in the future.

India’s Supreme Court recently lifted the blanket ban imposed by India’s central bank on the use of cryptocurrency exchanges in the country. The Supreme Court held that digitized currencies present no visible damage to the central bank’s entities and should not be outright banned. Since the Supreme Court’s verdict, the central bank has moved away from its 2018 stance and towards one that favors digital currencies. However, the central bank’s idea of a digital currency is quite different from the one that has gained popularity over the past few years.

Cryptocurrencies such as Bitcoin, Ethereum, and more recently Dogecoin, while easy to use, don’t provide the stability that the country’s premier economic institution requires. Alternatively, the central bank wishes to introduce a digital payment(s) portal that has the central bank’s stamp i.e., a centralized digital currency. Central bank digital currencies, or CBDCs, are meant to be an alternative to the currently decentralized mediums and have already seen global acceptance. China has introduced a digital yuan; the central bank of Uruguay uses a CBDC called e-peso while the United Kingdom has created a CBDC task force to explore the possibility of introducing a digital token in their country. India has also shown a favorable stance towards CBDCs; however, implementing such a large-scale economic tool in a country with a billion-strong population is easier said than done.

CBDCs are simply digitized cash. The Bank of England, in March of last year, released a discussion paper centered around CBDCs and the various new opportunities that the medium presents. The paper defined digitized currency as a way to make payments and store value while dividing it into two separate forms. One where the large commercial banks, which have deposits with the central banks, would exclusively use CBDCs, and the other form where individuals and citizens would have direct access to the digital tokens. The former is termed the wholesale model and the latter is its retail version.

Accordingly, the model which a country chooses to adopt will depend on its objectives. For instance, if a country wishes to promote a cashless society and encourage financial inclusion then it may adopt the retail model. However, if the country’s goal is to promote cross-border trade without necessarily emphasizing interest accruements, then the wholesale model would be the better choice. Most developing nations like India, give a lot of importance to financial inclusion and therefore prefer the retail model.

Moreover, the type of model a country wishes to choose will influence the system it eventually adopts. If a country chooses the retail model, then it will have a choice between a token-based and an account-based system. The token-based system is where reliance is placed on the payee’s ability to verify the viability of the payment instrument; whereas, the account-based system emphasizes the participants’ ability to verify the identity of the account holder. A choice between the two systems will depend on the prevailing practices of a country and whichever form is easier to implement.

Central banks will also have an option to choose between a direct or a tiered model. In the case of a direct model, the central bank will act as the sole issuer and controller of CBDCs; whereas in a tiered model, the bank can choose to delegate some of its work to commercial banks such as user access requirements, value-added services, etc.

Accordingly, the inclusion of CBDCs in a country’s financial system clubbed with the various options available to do so seems prima facie uncomplicated; however, the viability of a digital currency has various pros and cons which must be analyzed before making it a part of the economic structure.

A lot of countries have either chosen to adopt a CBDC or are conducting extensive research in this field. Digitized currency is seen as the medium of the future while ensuring easy access to all users; however, introducing a CBDC comes with its own problems. However, before analyzing the cons, it’s imperative to cover the pros of such a medium and study why most surveyed jurisdictions have a positive stance towards digital tokens.

Proponents of digitized currency argue that CBDCs are the pathway to ensuring financial inclusivity and stability. They see it as a medium of increasing trade and promoting access to banking facilities. The CBDCs present a way of creating a cashless economy with easy-to-use mediums. Most developed nations like Finland, Sweden, and the United Kingdom are largely cashless while developing nations like India are gradually reducing the emphasis on a cash-based system. A cashless structure is much more convenient for individual users and CBDCs are a stable medium to introduce such a format.

Moreover, CBDCs work on handled systems, which in many ways has the potential to support financial inclusivity. A majority of Indians remain unbanked and as a result, are excluded from the financial system. However, CBDCs are a far easier alternative where anyone with a mobile phone and an Internet connection can utilize banking features and thereby become a part of the financial system.

CBDCs can also help smoothen cross-border trade. Centralized tokens not only digitize money but digitize the identity behind it as well. CBDCs allow different countries to work on set data standards and configuration systems which makes the movement of money across borders much easier. A digital token with set procedures is much more convenient as compared to cash or other conventional mediums. Accordingly, the introduction of a digitized sector can have various positive outcomes; however, there might be certain negative implications as well.

In the case of a retail model, with an increase in demand for CBDCs, the country’s commercial banks may be adversely impacted. Citizens would shift from bank deposits to CBDCs and to remain competitive, commercial banks would have to increase the rate of interest provided on their deposits. In such a situation, to maintain their profit margins the banks will have to increase the cost of credit, making it more difficult to get a loan.

CBDCs also present a threat to individual privacy as they make it easier for governments to practice surveillance. Cash transactions provide a level of privacy; however, CBDCs would leave digital footprints making it far easier to track everyone involved. This may curtail illegal activities; however, it will also act as a serious impediment to an individual’s right to be forgotten. Additionally, as easy as it will be for the government to track individuals unless adequate cybersecurity measures are employed, various anti-social elements will be able to misuse the CBDC system as well. This economic implementation will be subject to multiple malware attacks, frauds, and hacking attempts creating a high-risk atmosphere for citizenry data.

Accordingly, employing CBDCs involves a mixed bag of elements; however, for the Indian subcontinent, certain issues take prominence over others.

India is set to introduce the Cryptocurrency and Regulation of Official Digital Currency in parliament. The government has, for a few years, tried to draft a possible bill to regulate cryptocurrencies in India. However, in order for it to pass an effective Act, it must cover certain ideas that are particularly important for the country.

One of the primary motives behind introducing CBDCs is to promote financial inclusivity. However, for CBDCs to bring an effectual change, the primary causes of exclusion in the financial system must be addressed. As per an Indian central bank report in 2019, the key reasons behind India’s exclusive financial system are socio-cultural barriers, inadequate connectivity, illiteracy, etc. These impediments are proof that simply introducing CBDCs will not be enough and a range of reforms would be required. The government will have to conduct training workshops, run literacy camps, and ensure that cultural divides don’t act as impediments to the new implementation. Ensuring financial inclusion would require a number of reforms over and beyond the introduction of a digital token.

Additionally, India has taken many steps to support digital payments. From providing 24-hour payment options at optimal costs to encouraging competition via the updated NPCI framework, the country has tried to create an optimal digital sphere. In such an environment, it is imperative to study whether the introduction of CBDCs will actually be able to bring any substantial change or not. A centrally backed token should be more than just another digital option, rather it should build on the existing framework and provide inclusive facilities, making CBDCs a desideratum.

Moreover, CBDCs can likely reduce financial crimes in the country. A digital token makes it easier to track payments and combat offenses like money laundering and tax fraud. However, in order to bring an effectual change, the CBDCs must incorporate high-security standards whilst ensuring transparency and traceability. A well-designed CBDC is necessary to reduce economic offenses.

Centrally backed digital tokens present multiple opportunities for both the country’s citizens as well as the economy; however, in order to introduce an effective implementation, the government will have to ensure that the commercial banks aren’t adversely impacted and individual privacy is respected. Moreover, ideas of financial inclusivity and efforts to curtail economic crimes would require inclusive reforms beyond the simple introduction of a token. CBDCs hold a lot of potential; however, the way India chooses to implement the idea will define the end results.

Sri Hari Mangalam is a Law student at the West Bengal National University of Juridical Sciences. An avid reader and pursuer of the literary arts, Sri hopes to learn more than just the curriculum in his university years. His interests currently lie in the spheres of contract law, IPR law, Public relations management, and Human rights activism.