Context:Recently,the People’s Bank of China (PBoC), the Chinese central bank said that it has explored approaches to designing an inclusive, prudent and flexible trial-and-error mechanism. This marks the initiation of China’s central bank digital currency (CBDC)


Fintech innovation regulation in China

  • The PBoC is carrying out the trial work of fintech innovation regulation to cover prominent Chinese cities by guiding licensed financial institutions and tech companies to apply for an innovation test.
  • It is named as Digital Currency Electronic Payment (DCEP) 
  • It is available via a mobile wallet app, pegged at 1:1 ratio with fiat currency.
  • It is designed to replace M0 (narrow money).
    • Fiat currency is legal tender whose value is backed by the government that issued it. The U.S. dollar is fiat money, as are the euro and many other major world currencies. This approach differs from money whose value is underpinned by some physical good such as gold or silver, called commodity money.

Money Supply in an economy:

  • The money supply is all the currency and other liquid instruments like cash deposits in a country's economy on the date measured. 
  • Governments issue paper currency and coin through some combination of their central banks and treasuries. 
  • Bank regulators influence money supply available to the public through the requirements placed on banks to hold reserves, how to extend credit and other regulation.

How Money Supply is Measured?

  • The various types of money in the money supply are generally classified as Ms, such as M0, M1, M2 and M3, according to the type and size of the account in which the instrument is kept.
  • M0 and M1 are also called narrow money and include coins and notes that are in circulation and other money equivalents that can be converted easily to cash.
  • M2 includes M1 and, in addition, short-term time deposits in banks and certain money market funds.
  • M3 includes M2 in addition to long-term deposits.

About the design of DCEP

  • In simple terms, official digital currencies are a representation of paper currency and a bit more. 
  • Access, Identification and Interest are the three basic design principles of a Central Bank Digital Currency (CBDC).
  • A country may design CBDC depending on the use case and objectives.
  • CBDC may be designed with universal access to the entire public (retail) or restricted to commercial banks/financial institutions (wholesale) or a hybrid model. 
    • The public may have direct digital currency accounts with the central bank or only deal with commercial banks. 
    • If it is wholesale functionality, the impact would be majorly on the payment system and intermediation function would be retained. 
    • If the public is allowed to have CBDC with central banks directly, it may threaten banking intermediation and high-powered money and credit creation. 
    • People may prefer to keep CBDC with central banks if they fear for safety of the banks.  Electronic money in a way represents the wholesale model.
    • PBoC Deputy Governor favoured a two-tier CBDC model where instead of directly interacting with the public, the central bank would involve financial intermediaries such as commercial banks. 
  • Identification: CBDC may have anonymity like paper currency or be identified like bank deposits. Governments generally would not like anonymity as it may lead to use of CBDC for illegal activities. Identification feature also enables quicker dispute resolution.
  • Interest: CBDC may be zero interest bearing like paper currency or interest bearing like bank deposits.

Cryptocurrencies Vs. CBDCs

  • Primacy to central bank: It is believed that the DCEP uses a distributed ledger technology (DLT) architecture (with central controls) which preserves the primacy of the monetary authority, unlike private cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH) that are truly decentralised.
  • Scepticism about cryptocurrencies: Wild fluctuations in the value of cryptocurrencies, the implied challenge to the monopoly of central banks in issuing fiat currencies, the looming possibility of software bugs, the tainted shadow of the dark web have all been responsible for doubts about cryptocurrencies. 

Distributed Ledger System

  • A distributed ledger can be described as a ledger of any transactions or contracts maintained in decentralized form across different locations and people.
  • The need for a central authority to keep a check against manipulation is eliminated by the use of a distributed ledger.Cyber attacks and financial fraud are reduced by the use of distributed ledgers.
  • Underlying distributed ledgers is the same technology that is used by blockchain, which bitcoin uses as its distributed ledger.

Significance of Chinese CBDC: This is the first such serious initiative in the whole world.

  1. Checking cruptocurrencies:It is aimed to curb and tackle Chinese runaway cryptomarket practices. 
  2. Challenging Dollar:  on the world economic stage, it may want DCEP to challenge the hegemony of the U.S. dollar as the default global reserve currency. 
  3. Countering private digital payments system: In its war with American BigTech, it may want to showcase DCEP as its weapon of choice to counter Facebook’s Libra, which is planning to offer a common cryptocurrency to 2 billion-plus FB users across the world. 

Advantages of CBDCs

  • Low handling charges: It has low maintenance charges as compared to paper money comes with high handling charges and eats up 1% to 2% of GDP. 
  • Curbs malpractices: It acts as a powerful antidote for tax evasion, money laundering and terror financing, CBDCs can materially boost tax revenues while also improving financial compliance and national security. 
  • As a tool of financial inclusion, particularly in emergencies, direct benefit transfers can be instantly delivered by state authorities deep into rural areas, directly into the mobile wallets of citizens who need them. 
    • It is noteworthy that the U.S. Congress recently debated the merits of implementing digital dollars in the context of the COVID-19 stimulus bill. 
  • Data insights: CBDCs can provide central banks an uncluttered view and powerful insights into purchasing patterns at the citizen scale. 
  • In the long run, it is believed that CBDCs will make cross-border payments fast and frictionless. 


  • Data privacy: If face-recognition technology enables states to spy on the physical movement of citizens, CBDCs can be used to spy on every movement of their money.
  • Software bugs: In digital currency payments, users are incentivized to use conforming software or risk being split from the correct chain. A bug can disrupt the system.

India and CBDC

  • The government-appointed high-powered CBDC Committee (2017) suggested an open mind on these developments and the constitution of another committee. 
  • The RBI-appointed Nandan Nilekani committee has focused only on use case of CBDC, viz, digital payments. These developments no doubt are worthy but not adequate both in terms of scope and architecting a new operating structure friendly to official digital currency. 

Internet Mobile Association of India v. Reserve Bank of India case: Recently the Supreme Court struck down an earlier ban issued by the RBI on banks and financial institutions from dealing with virtual currency holders and exchanges.

  • Rationale given by RBI for ban on virtual currency exchanges in circular 2018: These currencies had no underlying fiat: Episodes of excessive volatility in their value, and their anonymous nature which goes against global money-laundering rules.
  • The petitioners, who included virtual currency exchanges operational in the country, had told the Supreme Court that the RBI action was outside its purview as the non-fiat currency was not a currency as such.
  • SC judgement: The apex court held that the test of proportionality of any action by the government must pass the test of Article 19(1)(g), which states that all citizens of the country will have the right to practise any profession, or carry on any occupation or trade and business.
  • The court also referred to the Centre’s failure to introduce an official digital rupee despite two draft Bills and several committees. 
    • Crypto­token Regulation Bill of 2018-This Bill found a complete ban on VCs an “extreme tool” and suggested regulatory measures. 
    • Proposed legislation 'Banning of Cryptocurrency and Regulation of Official Digital Currency Act’ in 2019-It recommended a “total ban” on private cryptocurrencies. 
    • It also contemplated the creation of a digital rupee as official currency and a legal tender by the Central government in consultation with the RBI. 

Way ahead: The Internet of money has well and truly arrived. We need to think beyond MDR (merchant discount rate) quarrels. We are at an inflection point and we can leap from UPI to CBDC. Some of the countries, including Singapore and Thailand, are reportedly experimenting with CBDC.

International practices:

  • In April 2018, the EU agreed on the text for the Fifth Money Laundering Directive (5MLD) which will bring cryptocurrency-fiat currency exchanges under EU’s anti-money laundering legislation.
  • The recent survey by Basel-based Bank for International Settlement (BIS) revealed that while in general, central banks have been proceeding cautiously towards introducing central banks digital currencies, some have been planning to issue a fiat digital currency in the short to medium term. 
  • It is now imperative on authorities to find the right “regulatory balance” on cryptocurrencies. The 2019 Bill’s proposal for the creation of a “digital rupee” as official currency should be considered.

As per some rough estimates, CBDC may add 2-3% to the GDP.  Even if we reap 1%, that adds to over US$ 25 billion per year. There is a strong economic and social case for CBDC. We cannot afford to watch from the sidelines. We need to up the antenna and be ready with prototypes and even pilots in the next one/two years.


About the Digital, Virtual, and Crypto Currencies

  • Digital currency:
    • It covers a larger group that represents monetary assets in digital form.
    • It can be regulated or unregulated.
  • Virtual Currency:
    • It is the larger umbrella term for all forms of non-fiat currency being traded online.They are mostly created, distributed and accepted in local virtual networks. 
    • It is currency held within the blockchain network and is not controlled by a centralized banking authority.
    • It is unregulated and therefore experiences dramatic price movements since their trading is driven only by consumer sentiment.
    • Along with use by the common public, a virtual currency can have restricted usage.
  • Cryptocurrency:
    • It is considered to be a part of the virtual currency group.With an extra layer of security, in the form of encryption algorithms. 
    • It uses cryptography technology that keeps the transactions secure and authentic.
    • Such cryptocurrencies exist and are transacted over dedicated blockchain-based networks that are open to the common public.



  • The highly speculative nature: the cryptocurrency traded at a peak of $20,000 in mid-2018 before crashing to $3,000 by the end of the year. 
  • It is not a stable currency that is not backed by any central institution.
  • Anonymity: They are used in illicit transactions over the “dark web”.
  • Adopted by international trading firms for use in lending, raising funds for other cryptoprojects.
  • It facilitates easier cross-border payments.