The CBDC landscape is new and swiftly evolving. Therefore, it is crucial to monitor not only technological advancements but also regulatory developments globally
The surge in central bank digital currencies (CBDCs) is evident, with 130 countries, representing over 98 percent of global GDP, actively involved in CBDC-related initiatives. The potential of CBDCs is vast, promising innovation, enhanced financial inclusion, and fostering an environment conducive to the emergence of cutting-edge payment applications and digital businesses.
However, the introduction of CBDCs carries significant implications for the stability and operation of financial and payment systems. Careful design choices are crucial for a central bank launching a CBDC, impacting risks in performance, interoperability, privacy, and security. Meticulous risk management is vital throughout the CBDC lifecycle—from research to operations. India is embarking on its CBDC journey, navigating the early stages with optimism despite not achieving massive success yet. The key to unlocking adoption lies in managing risks associated with this new digital currency.
Identifying problems serves as the preliminary step toward successful deployment, establishing the groundwork for large-scale adoption. However, with CBDCs, the situation is one of learning as you go. A recent Bank of International Settlements report underscores the potential risks associated with CBDCs for countries globally. While CBDCs represent a cutting-edge development aligning with the latest technological advancements in finance, nations must exercise caution in their development and deployment. The uncharted territory of CBDCs could bring about structural changes, making it imperative for countries to approach this innovation with care and diligence.
The significance of cybersecurity cannot be overstated, especially in the context of CBDC initiatives, which could be vulnerable to various threat actors. Even successful minor attacks could erode trust in the system among the public. Although there have been no reported attacks on CBDCs thus far, the potential for hacking and gaining control over a currency issued by a central bank poses substantial and worrisome challenges.
The significance of cybersecurity cannot be overstated, especially in the context of CBDC initiatives, which could be vulnerable to various threat actors.
From the outset, a crucial structural challenge that may arise is the potential problem of distributed ledger technology (DLT) scalability, identified as a significant risk in the availability of CBDCs in various pilots. This emphasises the importance of considering technological limitations when initiating any CBDC project to mitigate issues throughout its lifecycle. The Bank of England already expressed concerns about the scalability of DLT for CBDCs, stating that the technology is too cumbersome to be reliably utilised for a central bank digital currency.
The complexity and size of a CBDC technology infrastructure may give rise to unforeseen security vulnerabilities. The ongoing digital transformations pursued by numerous central banks, aimed at promoting innovation and digital expansion, lead to swift system migrations, creating operational hurdles for both IT and security as a consequence of the rapid adoption of technology. While CBDC is not necessarily synonymous with DLT, some central banks explore DLT during the research and implementation stages, introducing challenges due to the ongoing evolution of DLT technology and processes.
It is challenging to entirely eliminate the human element from technology. Therefore, acknowledging the inevitability of human error is essential, especially in the context of phishing attacks—crafted social engineering attempts aimed at extracting user data, including login credentials. Instances where users are deceived into bypassing security measures, through tactics like pretexting, tailgating, or vishing, may potentially rise in prevalence with the integration of CBDCs.
Several factors contributed to the inception of India's CBDC. The global competition for CBDC development, coupled with the enthusiasm among nations to embrace digital solutions, played a pivotal role. The introduction of India's CBDC, the digital rupee, might have been influenced, at least partially, by the rising prevalence of cryptocurrencies, especially stablecoins. The Deputy Governor of the Reserve Bank of India (RBI) emphasised the need for caution in permitting such instruments. While stablecoins offer certain advantages, their applicability is confined to a limited number of developed countries.
The success of UPI in India has raised questions about the necessity of deploying CBDCs in the country, perhaps making it look like an inconspicuous addition to an already largely developed payments landscape. The RBI Deputy Governor cited the ascent of cryptocurrencies and concerns about policy sovereignty as one of the reasons for considering CBDCs, along with improving digital transactions. However, India presents a unique case with the well-established UPI system already in place. UPI, an instant real-time consumer payments system facilitating money transfers between banks without revealing account details, has significantly contributed to the surge in India's digital payment volume. UPI poses significant competition for the retail use of the e-rupee. The clear advantages of UPI have contributed to its widespread popularity. When there is already a seamless and efficient digital transaction system in place, the transition may not happen organically and could result in a less enthusiastic response in consumer transactions compared to wholesale CBDCs.
The success of UPI in India has raised questions about the necessity of deploying CBDCs in the country, perhaps making it look like an inconspicuous addition to an already largely developed payments landscape.
To assert that the RBI hasn't contemplated the aforementioned risks of cybersecurity and scalability would be inaccurate. The digital rupee concept note explores the feasibility of utilising DLT for the digital rupee and assesses its scalability for handling a substantial volume of transactions. Additionally, the note emphasises the necessity for forward-looking technology considerations in the deployment of CBDC, emphasising strong cybersecurity, technical stability, resilience, and robust technical governance standards. Therefore, it is prudent to acknowledge that these considerations were taken into account during the planning and initial implementation phases. Subsequently, with the assessment of the pilot programmes, the implementation of robust solutions could be anticipated.
Recognising and anticipating challenges is crucial for the effective implementation of CBDCs. When problems arise, solutions can be developed in retrospect; however, issues that are proactively avoided through foresight often receive less attention—a positive outcome in this context. By identifying and acknowledging systemic problems in advance, nations intending to adopt CBDCs can now focus on proactively building solutions to ensure a smoother implementation process.
India's CBDC has not experienced remarkable success thus far, with pilot projects currently in progress. Public opinion will likely require time to adjust to these new technological developments, especially given the prevailing success and dominance of the UPI system in India. However, this doesn't necessarily imply that the digital rupee has no place in India. Adoption and usage take time. Meanwhile, authorities must establish mechanisms to mitigate the risks associated with CBDC implementation. Numerous risks are linked to CBDC, and while it's still early days not only for India but for all nations experimenting with CBDCs, it is imperative for India to address these concerns for any degree of success. Without doing so, there's a risk of planting CBDC seeds in barren ground—an entirely futile and unproductive endeavour.
India's CBDC has not experienced remarkable success thus far, with pilot projects currently in progress.
The CBDC landscape is new and swiftly evolving. Therefore, it is crucial to monitor not only technological advancements but also regulatory developments globally. The iterative nature of technology is the heartbeat of progress, however unsteady the rate of improvement, and CBDCs in India will likely follow a similar trajectory.
Sauradeep Bag is an Associate Fellow at the Observer Research Foundation
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Sauradeep Bag is Associate Fellow at ORF. Sauradeep has worked in several roles in the startup ecosystem and in international development with the United Nations Capital ...Read More +