Nepal Rastra Bank (NRB) announced last month that it has developed a prototype for its digital currency, though it has not yet been officially named. The announcement was made during a programme organised by NRB to discuss issues related to Central Bank Digital Currency (CBDC) with stakeholders.

The CBDC is a digitally issued and regulated currency designed to provide the benefits of digital transactions while preserving the stability of traditional fiat money. Countries like the Bahamas, Jamaica, and Nigeria have successfully launched retail CBDCs, while major economies such as China, India and Russia are in the pilot phase. However, there also are countries like Denmark and Kenya who have decided against launching retail CBDCs after thorough evaluations, according to an NRB study titled "Exploring the Global CBDC Landscape: Comparative Study of Selected National Initiatives".

Central banks began exploring CBDCs following the rise of stablecoins issued by the private sector and the involvement of big tech in financial systems following the ban on the use of cryptocurrencies by some countries given their high volatility. According to the CBDC Tracker maintained by the Atlantic Council, 132 countries and currency unions, representing 98% of global GDP, are now engaged in CBDC projects.

When NRB began revising its Act to issue the digital version of Nepali currency around two years ago, observers cautioned it against haste and asked it to first observe global practices. The central bank then commissioned a study which submitted a concept report titled ‘Central Bank Digital Currency (CBDC): Identifying Appropriate Policy Goals and Design for Nepal’ in August 2022. 

The central bank has since studied data from 42 central banks globally. As of March this year, three countries had launched CBDCs, 23 were in pilot phases, and several others were in various stages of development or research. NRB plans to launch a pilot for wholesale CBDC in August 2026 and retail CBDC in June 2027, with a decision on cross-border CBDC expected by December 2026. The retail CBDC will be accessible to the public for everyday transactions, while the wholesale version will be used for interbank transactions and large-scale transfers, according to the central bank officials.

"We have developed the basic prototype, which can be used for both wholesale and retail CBDC," said Krishna Man Dhunju, head of the CBDC division at NRB. "We will gradually add more design and features, and once it matures, we will pilot it on a small scale." 

Experts see the central bank's initiative as progressive but call for the need to strengthen other ecosystems, such as digital public infrastructure, before piloting. "The pace of digital transformation, especially post-COVID-19, along with efforts to combat terrorism financing, has pushed authorities towards developing a transparent and trackable CBDC," said fintech expert Sanjib Subba. “Since CBDC is a product prone to cyber threat, there should not be any compromise when it comes to cyber security.”

The study suggests that CBDC could enhance the resilience of payment systems, expand financial inclusion, promote innovation in the financial sector, reduce costs, simplify cross-border payments and reduce currency management costs. Reducing currency management costs is one of the reasons why India is preparing for the CBDC. The Reserve Bank of India spent nearly INR 50 billion on security printing between 2021 and 2022, according to the report.

The study says NRB can initially focus on wholesale CBDC to support inter-bank and government security settlements, later transition to retail CBDC, and eventually explore cross-border applications in collaboration with key trade partners like India and China.

Of the three CBDC architecture models - direct, indirect and hybrid - the study has advised the central bank to adopt the hybrid model, where the central bank issues wholesale CBDC to financial institutions and payment service providers, who manage customer onboarding, KYC procedures and distribution. Similarly, it has recommended a token-based access model which does not require a bank account and offers a secure alternative to traditional systems. “Each token distributed or supplied by the central bank is uniquely identifiable and tokenized, providing a secure and flexible alternative to traditional account-based systems,” the study states.

The study has called for more stakeholder engagement in coming days to refine policy goals. Besides limited adoption and operational challenges globally, NRB acknowledges the cybersecurity risks and the potential impact on existing digital transaction infrastructure once CBDC is launched.

"Stakeholders need to understand the difference between a currency and a mechanism. Can a currency replace a system?" questioned Dhunju. "CBDC is based on three principles—do no harm, co-exist and promote innovation. The existing instant payment system will continue to function as it does now," he added. 

According to a 2022 Bank for International Settlements (BIS) survey, 93% of central banks are exploring CBDC, with more than 80% seeing value in both retail CBDC and fast payment systems. Countries like China and Sweden have made significant progress in piloting retail CBDCs, while the Sand Dollar of the Bahamas launched in 2020, allows residents to access a digital wallet via mobile apps or physical payment cards.

According to the BIS survey, work on retail CBDC is more advanced than on wholesale CBDC, with up to 15 retail and nine wholesale CBDCs expected to be publicly circulating by 2030. However, NRB’s study states that most countries that have launched CBDCs are small economies with lower financial inclusion and access levels.

During a recent interaction programme, NRB Governor Maha Prasad Adhikari clarified that CBDC should not be seen as an alternative to cryptocurrencies and would not affect the existing digital payment system. "NRB regards cryptocurrency as a digital asset but not a currency," Adhikari said. "The price of CBDC does not fluctuate like cryptocurrency, and it may help address some cryptocurrency-related issues."

Dhunju said that the central bank was mid-way through its research, with many issues still needing to be addressed. "CBDC is an evolving concept, and ongoing global developments will shape our future course of action on this," he added.

(The report was originally publihsed on the  September, 2024 issue  of the New Business Age Magazine.)