CBDC introduction faces three difficult challenges

If the pilot is successful, the adoption of CBDCs will have huge implications, which will not only be limited to the financial world, but will also extend to the data security challenges.

A CBDC is a digital form of paper currency and unlike cryptocurrencies that operate in a regulatory vacuum, they are fiat currency issued and backed by a central bank.

The introduction of CBDCs poses three important challenges that need to be addressed: first, the increasing threats to the privacy of individuals; second, selecting the privacy and security enhancement technology that needs to be employed; And third, the regulatory framework that has to be established to deal with an issue such as a data breach.

The first issue to deal with is the increased risk to users’ privacy – given that central banks could potentially handle vast amounts of data regarding user transactions. This has serious implications as digital currencies will not offer users the level of privacy and anonymity provided by transactions in cash. Furthermore, data stored with a central bank in a centralized system would have serious security risks, and robust data protection systems would have to be in place to prevent data breaches. Thus, it is important to employ the right technology that will support the issue of CBDCs.

The second concern of the choice of technology employed for a CBDC is important because it needs to be scalable, with near-zero latency, secure and, without needing to add, privacy protection. However, if the central bank deploys a system similar to a core banking solution, the transaction will not be private and the RBI will be secretive for all settlements and will incur confidentiality risks. The most logical candidate for a CBDC should be a traditional multi-tiered web architecture, but this also has a potential downside. If payment transactions are done using the same system, the size of the infrastructure required for a CBDC will remain difficult. RBI has to map the technology landscape well and proceed carefully with choosing the right technology to launch the CBDC.

Lastly, the regulatory framework that India needs to issue digital currency does not exist. India is yet to pass the Data Protection Bill and set up a data protection authority that will oversee the extent of privacy compliance by institutions, including grievance redressal in case of personal data breaches.

Financial data collected on digital currency transactions will be sensitive in nature, and the government will have to think carefully through regulatory design. This would require closer liaison between banking and data protection regulators, where conflict between authorities could also become an issue. Institutional mechanisms will need to ensure that there is no overlap between various regulators and chart out clear actions in case of digital currencies data breaches.

Over the past decades, India has seen several conflicts between regulators—between the RBI and the Competition Commission of India (CCI) over control of mergers, and between the Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority of India. (IRDA) on ULIP (Unit-Linked Insurance Scheme) issue. This pitfall needs to be avoided as such battles have created huge amounts of uncertainty and delays, costing the regulator as well as the regulated entities.

Despite all these challenges, it would be prudent not to abandon the idea of ​​CBDCs altogether, as they would reduce transaction costs, and help in instant cross-border transaction settlement and easier transmission of monetary policy. A centralized network of data collection and storage, and the data collected on these digital transactions by central banks, could lead to innovative practices and practices such as charting credit histories of individuals, issuing loans and tracking their spending and fraudulent transactions. It can be easy to stop.

Therefore, it is important that we address the various risks so that CBDCs can be introduced in a way that is beneficial to the system as a whole.

Hemant Adarkar is Technology Consultant and Resident Senior Fellow and Sharmadha Srinivasan is Senior Associate with IDFC Institute affiliated to Data Governance Network.