Reserve Bank of India comes up with a comprehensive concept note on Central Bank Digital Currency (“CBDC”) referred to as e₹ (“digital rupee”), to create a deeper appreciation of digital rupee among people and prepare public for its prospective use. Concept note places CBDC as a digital form of currency notes which are issued by the Reserve Bank, same as cash but in digital form which can be used as a medium of exchange. The concept note includes the objectives, structure choices, benefits, and risk related with issuing CBDC in India. It elaborates upon the key considerations of CBDC like motivation behind issuance, design and technology to be used for its issuance, the manner it can be used, and other major challenges related to its issuance in India.
The note also discussed the implications of issuance of a digital currency on Indian banking system, monetary policy, privacy issues and financial stability of CBDC. Furtherance to this, on November 1, 2022, RBI launched pilot CBDC-W (as defined below) with 9 major banks of India, to use it for settlement in secondary market transactions in government securities. This pilot project is launched to analyze the feasibility and efficiency of CBDC-W in inter-bank transactions. This writeup summarizes the concept note and provides an idea about the roadmap for issuance of CBDC by central bank.
CBDC is a form of currency to be issued by Reserve Bank in alignment with its monetary policy, as a legal tender in a digital form. It is akin to and exchangeable at par with the existing paper currency. CBDC not only offers a wide range of benefits such as reduced dependency on cash, lesser overall currency management cost, and reduced settlement risk but also offers people and business a convenient, electronic form of central bank money with safety which includes trust of regulated and legal tender-based payment option. Being issued as a currency in digital form CBDC carries almost all unique features of paper currency in digital form. The concept note lists the key features of the CBDC as:
- CBDC is a sovereign currency issued by Reserve Bank in alignment with its monetary policy;
- It appears as a liability on the Reserve Bank’s balance sheet;
- Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizen, enterprises, and government agencies;
- Freely convertible against commercial bank money and cash;
- Fungible legal tender for which holders need not have a bank account;
- Expected to lower the cost of issuance of money and transaction.
As per the concept note, one major motivation to RBI for issuing CBDC is to provide a safe alternative of private virtual currencies. The other motivations for introducing CBDC includes reducing the cost of physical cash management which includes cost of printing, storage, transportation and replacement of paper currency, furthering digitization and innovation in payments, financial inclusion, improving cross-border payments, and countering the rise of crypto assets in the Indian economy. These motivations are in line with the policy motivations of other central banks in developed and developing economies that are either in process of issuing or already launched their form of digital currency.
One of the main considerations for design of CBDC is the function it is expected to perform. In countries like India financial inclusion is a major issue to be considered before considering design features of new form of currency.
A suitable design option for CBDCs could potentially promote financial inclusion by making financial services more accessible to the unbanked and underbanked rural population of the country. This would require suitable design choices including offline functionality of CBDCs. Through concept note RBI clarified that CBDC would have offline feature and would also be beneficial in remote locations and offer availability and resilience benefits when electrical power or mobile network is not available. The second important feature of its design feature is that it should be least disruptive.
The key design factors to be considered for issuance of CBDC provided in concept note includes (i) Type of CBDC to be issued (Wholesale CBDC and/or Retail CBDC), (ii) Models for issuance and management of CBDCs (Direct, Indirect or Hybrid model), (iii) Form of CBDC (Token-based or Account based), (iv) Instrument Design (Remunerated or Non-Remunerated) and (v) Degree of Anonymity.
MODEL FOR ISSUANCE AND MANAGEMENT OF CBDC
RBI is considering two models for issuance and management of CBDC namely:
Single Tier model (Direct CBDC Model)
In direct model the central bank would be responsible for managing all the aspects of CBDC like issuance, account-keeping and transaction verification. In this model Reserve Bank’s server will involve in all payments and keep record of every transaction. We can say that in this model Reserve Bank directly interacts with the end user. There are two major drawbacks of this model, firstly it will be a major technological and monetary challenge for the Reserve Bank to deal with huge amount of data of all the transactions running in their servers at all the time. Secondly it will end the role of intermediaries like banks and NBFCs from the financial ecosystem and disrupt the current financial system.
Two-Tier Model (Intermediate Model)
Looking into the drawbacks of single tier model, Reserve Bank is considering the options having intermediate architecture or two-tier system, where along with Reserve Bank, intermediaries shall also play their respective role. Under this architecture two models are explained by RBI.
- Indirect Model: In indirect model, users will hold their CBDC in their respective accounts with an intermediary. Unlike direct model, here intermediaries will provide CBDC to the user and not the Reserve Bank. Reserve Bank would only track the CBDC-W balances of the intermediaries. In this model central bank will issue CBDC to the intermediaries in wholesale form and intermediaries will forward these to end users in retail form. Indirect model is akin to the current physical currency management system where banks look into distribution and account keeping etc. and RBI will be only concerned with the issuance of the currency.
- Hybrid Model: In this model, intermediaries handle the retail payments but, CBDC would be a direct claim on the Reserve Bank. In this Reserve Bank will issue CBDC to intermediaries which are ultimately responsible for all customer associated activities and services, and Reserve Bank will retain the ledger of all retail transactions and operates a backup technical infrastructure allowing it to restart the payment system if intermediaries run into insolvency or technical outages.
Comparison between three models
|Liability||Reserve Bank||Reserve Bank||Reserve Bank|
|Issuer||Reserve Bank||Reserve Bank issues and intermediaries distribute it||Reserve Bank issues and intermediaries distribute it for retail use|
|Ledger||Reserve Bank||Intermediaries||Intermediaries as well as Reserve Bank|
FORMS & FEATURES OF CBDC
The RBI is exploring a token-based CBDC-R for general purpose (retail) which will be like a “bearer instrument” like a banknote. It will be an electronic version of cash primarily meant for retail consumption. It could be used by all private sector, non-financial users, and business. Transactions using token based CBDC will involve verification of the authenticity of the token itself.
The RBI is also exploring an account-based CBDC-W for wholesale transactions / inter-bank payments and will be available for restricted access by financial institution. CBDC-W could be used for improving the efficiency of interbank payments or securities settlement by financial institutions and intermediaries. Transactions using account based CBDC-W will involve verification of the account holder.
An important perspective of CBDC design is the degree of anonymity that CBDC should provide if it seeks to akin features like banknotes. However, it is a big challenge for any digital currency to ensure anonymity as all digital transactions leave some digital trails. The RBI is of the opinion that anonymity in a digital world is a “misnomer”, and it can be misused for illicit purposes. However, RBI discussed “anonymity for small value and traceable for high value,” akin to anonymity associated with physical cash.
To ensure that CBDC would be able to support financial inclusion objectives, the RBI proposes that it should have offline functionalities. This is important for locations where there are connectivity issues. Digital payments usually rely on the online communication of the devise used with the servers of the banks and other intermediaries. There will be situations where the user may have connectivity issues or even no access to network. This should not imply that in this situation user will not be able to use CBDC due to connectivity unavailability. Therefore, to ensure widespread use of CBDC, offline capabilities need to be incorporated.
Accordingly, it will be important to consider the following issues vis-à-vis offline functionality – transaction limit, the need to have a cap on offline transactions, rules for offline transactions, and risk-sharing between the RBI and intermediaries.
TECHNOLOGY CHOICE: DISTRIBUTED LEDGER TECHNOLOGY (“DLT”)
In terms of technical design, the RBI notes that the CBDC infrastructure could be based on a conventional centrally controlled database, or on a distributed ledger. Unlike centralised systems, where a single entity is responsible for controlling and updating the data on the transaction ledger, there can be multiple entities which carry out such functions in a decentralised system, subject to the rules of the network. However, due to this feature, it may be challenging for DLT systems to process a large volume of transactions as each participant has to confirm the transaction before the ledger is updated.
RBI notes that it may not be suitable to rely only on DLT for the CBDC system and therefore suggests that some layers of the CBDC tech stack can be on a centrally controlled system and the remaining on distributed networks. RBI is of the opinion to use DLT to support important requirements of CBDC such as customer identification, permissioned payment networks, high-volume and value transactions, scalability, and privacy and confidentiality of user and transaction data.
Payment systems in India has seen a revolutionary change after the enactment of a separate law for payment and settlement systems which results in changing of changing of payment systems at an accelerating pace. Now users of the money want alternatives of the conventional paper currency to be used as faster, convenient and reliable method of payment. People either use digital money which reflects in their bank accounts or in digital payment application wallets, since these payment methods are digital, they could be faster, but in terms of settlement they are not reliable.
There are myriad of virtual currencies providing alternatives to the conventional paper currency, but they are neither commodities nor claims on commodities as they have no intrinsic value like a conventional sovereign currency has. Different non reliable private currencies are available in the market that rapidly mushroomed in last few years, disrupting the traditional, established and regulated financial ecosystem, cryptocurrencies are well known example of it.
RBI being consistent in highlighting the various risks related to cryptocurrencies, trying to provide a reliable alternative to the conventional paper currency, that can provide a faster payment and settlement solution. CBDC could be a reliable and stable alternative provided by the RBI, that not only facilitate the faster and reliable online payment systems but also helps in achieving the goals of financial inclusion and digital economy.