India’s digital payments, such as digital wallets and UPI, have made significant growth over the past few years. Notably, it marked a new record of over 2.8 billion USD transactions in June this year (1). Simultaneously, it is also evident that we are still stuck with the traditional banking system. But, what would happen if the Indian central bank issues a digital currency, similar to private virtual currencies, without their misuse and volatility?
According to the RBI (2), “the CBDC, Central Bank Digital Currency can be transacted instead of bank balances as if cash has been handed out, hence eliminating the need for interbank settlement.”
The latest media reports suggest that the RBI would introduce this digital currency in phases. Notably, even though the government has been talking about launching its own virtual currency for a while now, it has never given such detailed insights on its CBDC plans until now.
Still, it appears that the RBI is struggling with a legal framework, technology, and cybersecurity concerns.
In the latest speech, the deputy governor of RBI, T Rabi Sankar, explained that the central bank’s stand on digital fiat currencies is entirely different from present cryptocurrencies (3). His speech highlighted the following points:
- The RBI has recognized the need for digital currencies amid the rising popularity of cryptocurrencies.
- It envisions CBDC as India’s fiat currency to exchange one-to-one with the INR fiat currency.
- The government doesn’t perceive popular crypto-assets like ether and bitcoin as “currencies” since no central banks back it and can’t be converted one-to-one into fiat currency.
- At present, the RBI is working towards a phased implementation strategy and scrutinizing use cases that it can implement with little to no disruption, retail payments, for example.
- The central bank is still exploring the pros and cons.
What is Central Bank Digital Currency?
Central banks worldwide have started exploring CBDC. And India seems to have no plans to stay behind.
A CBDC is a cryptocurrency or digital payment token issued by the central bank of a country.
There are two types of CBDC (4): wholesale and retail. Wholesale CBDCs are for financial institutes that hold reserve deposits with the central bank. Whereas retail CBDCs are for individual, household, and corporate use.
The objective with which India would introduce a CBDC would determine its adoption (5, 6). If India wants to improve the wholesale settlement system and gain efficiency in cross-border transactions, then a wholesale CBDC would be the correct choice. However, then it would not be available to the general public and won’t increase interest. Usually, banks from developed countries endorse this model.
On the other hand, the retail model is preferred by emerging countries, including China, because of its ability to enhance financial inclusion and shift to a cashless society. Such a kind of CBDC would be available to the general public, anonymous, and possibly increase interest.
Distributed Ledger Technology and CBDCs
DLT or Distributed Ledger Technology is often associated with the adoption of CBDCs (7). However, it is not the case. CBDCs can exist without DLT too. In a way, CBDCs are non-physical digital tokens the central banks have issued to substitute cash. Hence, the central bank can rely on any existing technology to issue digital money without DLT.
Countries like the US prefer DLT infrastructure because of its advantages like cost, efficiency, security, traceability, and non-repudiability (8).
Notably, popular private cryptocurrencies like Ether and Bitcoin are decentralized and are based on a public permissionless blockchain network. There is no central authority approving transactions in such a network, and anyone can be a validator.
A CBDC, in contrast, is likely to be on a permissioned blockchain network. It means that the central bank would appoint specific authorities, functioning as nodes, to approve the transactions recorded on the blockchain network. It would enable the relevant central bank to control the money supply.
The Benefits of CBDC
Supporters of CBDCs believe that it can attain financial stability, inclusion, and easy cross-border payments with a well-designed framework. They can enhance financial stability by offering a secure and resilient payment system.
The use of cash is declining worldwide. In its absence, CBDC with DLT can offer a resilient alternative to people as it is less susceptible to tampering, attacks, and technological disruptions. CBDC is also a stable and less risky alternative to crypto-assets like Bitcoin.
In short, CBDCs are programmable money that allows certain transactions to be programmed into the CBDC, which can leverage smart contracts like automatic payment of dividends to shareholders. But, the trade-off associated with enabling programmable money on the ledger would significantly slow down transactions.
It is highly likely for central banks to address it via creating an additional module, separating the core ledger to handle smart contracts.
As noted, CBDCs also promote financial inclusivity, especially in developing nations like India with low banking penetration. Notably, there is a wide disconnect between the number of bank accounts and the overall mobile connection in the country. There are over 1.2 billion internet connections, but only 582 million bank accounts as of 2020.
CBDCs would allow people to access government-backed digital payment systems even if they don’t have any bank account, with their smartphone and an internet connection.
At last, CBDCs would also make easy cross-border payments. At present, cost-border payments are quite costly and are subject to long delays. CBDC would allow the digitalization of money and also the digitization of identity. Hence, with CBDCs, central banks of two nations can work closely by turning to a shared set of digital identity infrastructure and data standards – leading to seamless and instant cross-border payments. It would also assist in complying with the AML, anti-money laundering by making traceable transactions. Especially for India, where most transactions happen in cash (9).
Debates Surrounding CBDCs
Since CBDCs come with complex design, technological, policy, and economic issues, their implementation raises several hurdles.
To begin with, CBDCs can detrimentally impact a nation’s banking sector. It is called “disintermediation.” As consumers shift their deposits from banks to CBDCs, it can put commercial lenders under severe stress (10).
To keep their position, banks would charge a higher interest rate on deposits or rely on overseas funding or wholesale, which can impact the cost of the credit the banks offer. Hence, policymakers need to carefully approach the design issues around CBDC to tackle the adverse effects of disintermediation on financial stability and the banking systems.
Moreover, there is a privacy concern. Cash payments offer people some privacy and anonymity. However, it is not something CBDC can offer. CBDCs need to comply with AML management. Hence, it can’t be entirely anonymous. Its digital nature can make it an easy target for government surveillance. It is a violation of privacy. In addition, it can also allow the government to track and suppress political dissent.
Last but not least, the CBDC ecosystem would be a honey pot for cybercriminals with fraud, hacking, and malware attacks. It could be particularly attractive to those who intend to disrupt an economy by attacking its payment systems. Therefore, it is essential for any nation dealing with CBDC to ensure high standards of cybersecurity. It could, however, develop a trade-off between user security and the user-friendly nature of the payment system by adding certain elements of friction to the user experience (11).
Why is RBI Emphasizing CBDC for India?
- It would reduce the costs of currency for the government and would help tackle the threat of cryptocurrencies.
- Developing CBDC would help the public with the uses that any private virtual currency can offer, to the extent that it may retain the public preference for the Rupee.
- It can protect people from the abnormal volatility of virtual currencies (12, 13).
The Key Concerns
If we talk about the consequences of CBDC on banks, it can reduce the need to maintain deposits, but it would have a limited impact since they can’t pay interest.
Moreover, the RBI has also expressed other key concerns regarding the implementation of CBDC (14):
- Whether digital currency should be used in wholesale payments or retail payments?
- Should it be a centralized ledger or distributed ledger?
- Should it be account-based or token-based?
- Should it be directly issued by the RBI or via banks?
- And lastly, what would be the anonymity degree?
Does India need a Digital Rupee?
We are all aware that the RBI has been pretty averse to cryptocurrencies. It even went to the extent of banning virtual cryptocurrencies in 2018. However, it seems that the RBI is getting comfortable with the idea of a virtual Rupee.
In its vision document, released in early 2019, the RBI recognized the potential DLT has in enhancing the financial system. However, at that time, it had not shed any light on CBDC (15). In 2020, RBI released another circular titled, “Distributed Ledger Technology, Blockchain, and Central Banks.” The RBI talked about several countries adapting to CBDC projects and briefly explored its possibility in the circular (16).
In July 2021, we are getting reports about the central bank exploring a legal framework to start the pilot project on CBDC. Notably, however, the long-pending Cryptocurrency and Regulation of Official Digital Currency Bill is not yet presented in Parliament.
While talking about the latest development, the founder and CEO of Bitbns, a Bengaluru-based crypto exchange, Gaurav Dhake, stated that “Even with CBDC in place, there would still be some ambiguity about its control and governance. In episodes like demonetization, the government can take immediate action for digital currency by reducing it.”
As per Nischal Shetty, the founder of WazirX, while welcoming the phased implementation strategy, “we already have a few international references about similar cases.” Shetty believes that while a CBDC can be helpful, it solves entirely different issues compared to what the existing cryptocurrencies are doing.
Nonetheless, a digital currency would help India achieve financial inclusion, a shift to a cashless and resilient society while also reducing the cost of handling and printing cash. As we mentioned, there is a wide disconnect between the number of bank accounts and the overall mobile connection. There are over 1.2 billion internet connections, but only 582 million bank accounts as of 2020 (17).
There are high possibilities that CBDC would help India bridge this disconnect as people will only need a smartphone and an internet connection. With the digital Rupee, the RBI can control cash supply more efficiently and track its perpetuity on a blockchain network.
Furthermore, it can make a dent in the country’s huge shadow economy, in addition to the industry-specific benefits it can offer in terms of remittances, credit, and payments.
Even from the geopolitical outlook, India needs to explore digital currencies with haste. Today, Chima is winning the CBDC race by creating more than 20 million and executing more than 5.3 billion USD worth of transactions with its new DCEP, E-CNY(18). China is looking to create an alternative currency to the US Dollar as a reserve currency with its new cryptocurrency and maintain its monetary sovereignty.
We believe that India should also jump the bandwagon as soon as possible. Otherwise, it would be left far too behind the world. We believe that even though it is high time for India to start experimenting with virtual rupees, officials need to thoroughly examine its privacy and disintermediation issues.
In addition, while the RBI has recognized the technology and its scope, it still stands firm on the belief that the likes of ether and bitcoin don’t have any intrinsic value as conventional currency. Hence, they must not be confused with currencies. On the other hand, we believe that centralized and decentralized cryptocurrencies can co-exist.
What Would Happen to Bitcoin and Others?
As per the promoters of decentralized cryptocurrencies, Bitcoin is likely to usurp the centralized currencies or fiat as the world’s exchange medium (19).
While it is true that for many years since its inception, Bitcoin has been unsuitable as a currency, making it too cumbersome for daily purchase as transactions take too long to record on the blockchain.
However, while not diving deep into the technicalities, we can say that Bitcoin’s inventor fully understood its shortcomings at its inception and predicted the development of protocols such as Liquid sidechain and Lighting Network (20, 21).
Most users need to know that Lighting Network allows near-instant microtransactions, making it perfect for individual applications, such as payroll settlement or purchasing coffee.
A liquid sidechain is also a leap forward in speed. However, it is more suitable for high-value transactions. Its main USP unique selling proposition is enhanced privacy, making it especially suitable for businesses that don’t wish to reveal sensitive fiscal information.
Lighting and Liquid offer the platform for a whole new range of services such as Strike and Phoenix Wallet, making Bitcoin transactions as easy as using banking applications. These technical advancements were essential to allow Bitcoin to be a way to pay. However, they are not particularly strong drivers for its wide adoption.
Notably, we need to first understand the growing issues with fiat to know why Bitcoin and the likes will become an exchange medium more hastily than many would expect.
Slavery Vs. Sovereignty
For haters, Bitcoin’s privacy and self-sovereignty seem unnecessary. As authorities have argued throughout history that you have nothing to fear if you have nothing to hide.
Yes, some people don’t mind being constantly tracked and categorized by everyone, from digital marketers to government agencies. However, most people change their opinion when they come across concepts such as customer-specific pricing, which raises the price of goods depending on how much one is willing to pay (22).
Tech giants indeed know us better than we know ourselves. And price gouging is only one of the chilling examples of how they manipulate us with our financial data. We don’t have to be a libertarian to lament the idea that our everyday spending would dictate everything from the financial ads we see to the interest rates on our mortgage. General people know that “free” services such as social media platforms need them to sacrifice their privacy. However, when the price is financial, privacy and self-sovereignty suddenly become more attractive.
Notably, the choice between slavery and sovereignty is only one stimulus behind Bitcoin’s rise as an exchange media. Its adoption by corporate for uncensorable and secure transactions, followed by payroll as business is as important as business chasing cheaper overseas talent; understand that Bitcoin can avoid complexity and costs of international fiat transfers.
Some may argue that Bitcoin and the likes would bring a dramatic downfall to “old money”; however, it is hard to see it supplanting banks and other hyperscale payment rails such as EMV overnight (23).
But, what could more likely happen is even more interesting; in the future, we would see the creation of two parallel economies, Bitcoin and fiat, with everyone free to choose the system that suits them best. And experts believe that that is how Bitcoin and other decentralized cryptos would rise to supremacy.
No, they won’t ascend by killing the competition but by providing a fundamentally different model of transferring value via space and time, letting the market decide (24).
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All things aside, India has quickly adopted digitalization and is at the forefront of the fintech revolution, with other countries following its path.
While the world is watching the brawl between the Renminbi and Greenback, it is a good time for India to lay its foundation for a strong currency silently, and CBDC could be one of the ways to do it.