Spare a thought for the trilemma of central bank digital currencies

Source: The post is based on an article “Spare a thought for the trilemma of central bank digital currencies” published in Live Mint on 14th November 2022.

Syllabus: GS 3- Growth and Development

Relevance: challenges with CBDC

News: Central banks around the world have started to issue their own digital currencies (CBDC) but it has challenges too.

Why are central banks issuing CBDC?

One of the reasons behind issuing CBDC is that it will be accessible to masses that will bring financial inclusion and ease of payments. However, there are other ways of financial inclusion which India has already tried.

How has India tried to achieve financial inclusion?

The Prime Minister’s People’s Wealth Scheme has addressed the issue of offering zero-balance, low-cost accounts to underbanked rural residents. This led around 400 million people to open the account.

Further, the United Payments Interface (UPI) is also a low cost electronic-payments infrastructure that has also helped in financial inclusion.

What are the challenges with CBDC?

It is argued that CBDC will help in facilitating the cross-border payments and might be a digital alternative to the dominance of the US dollar.

Central banks with help from the Bank for International Settlements have also experimented with a platform ‘mBridges’ to globally exchange CBDC.

However, there are political concerns with the use of CBDC globally and it would also be difficult to adopt such a common platform worldwide.

For example, it would be difficult for China and the US to come to an agreement on a single platform of exchanging CBDC.

Therefore, central banks face a trilemma when issuing CBDC as they can have only two of three things – a digital currency, confidentiality of transactions and financial stability.

Further, if CBDCs are used for bank transfers then commercial banks will be disintermediated from the system which will raise financial risk and imbalances for the central banks.

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