The idea of issuing central bank digital currency ("CBDC"), either as a substitute or complement of other forms of money, arguably dates to the 1980s, when James Tobin, an American economist, suggested that federal reserve banks in the United States could make available to the public a widely accessible 'medium with the convenience of deposits and the safety of currency.' It was a novel concept which was only taken seriously in the last decade owing to the technological advancement that has ushered in a wave of digital assets with the characteristics synonymous with the money. Currently, central banks around the world have been engaged in exploring the implications of, and options for, issuing a CBDC and analyzing how a CBDC could fit into their payment landscapes.

T Rabi Sankar, Deputy Governor, Reserve Bank of India ("RBI"), while addressing a webinar on 'Central Bank Digital Currency – Is This the Future of Money', described CBDC as 'the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.' Meaning thereby, CBDC is recognized by the RBI to be equivalent of sovereign currency which is (a) issued exclusively by the sovereign or a central bank as its representative; (b) is a liability of the sovereign/ issuing central bank; and (c) is an asset for the holding public. Further, it has also been clarified that CBDCs should be exchangeable at par with the paper-based/ metal currency.

The RBI's concept note on CBDC ("Concept Note"), on the basis of the usage of CBDCs within the payment ecosystem, broadly categorizes it into two: general purpose or retail CBDCs ("CBDC-R") and wholesale CBDCs ("CBDC-W"). CBDC-R is an electronic version of cash which is primarily meant for retail transactions and is intended to be made available for use by all viz. private sector, non-financial, consumers and businesses. On the other hand, CBDC-W is designed for restricted access to select financial institutions and is intended for the settlement of interbank transfers and related wholesale transactions.

Based on the issuance and management of CBDCs, the Concept Note further categorizes the models of CBDCs into two i.e., direct model and indirect model. A direct model is the one where the central bank would be responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification. In this model, central bank will issue CBDC to consumers indirectly through intermediaries and any claim by consumers will be managed by the intermediary, as the central bank only handles wholesale payments to intermediaries. Intermediaries could potentially include commercial banks and regulated non-bank financial service providers. However, the indirect model is akin to the current physical currency management system wherein the banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer and anti-money laundering and countering the terrorism of financing ("AML/CFT") checks, transaction verification etc.

CBDC vis-à-vis Cryptocurrencies

'CBDCs' and 'cryptocurrencies' are digital or virtual currencies that exist in online infrastructure and is based on the concept of blockchain technology. Generally, owing to the similarities between the two, questions are raised around the core differences between them. Primarily, cryptocurrencies, which are based on the decentralized ledger and issued without having any central governing authority, were introduced to allow people and their monetary transactions to be free from government control whereas on the contrary, CBDCs are government-backed and government-controlled currencies which are introduced to minimize the time and costs involved in the transaction settlement.

Evidently, the CBDCs are not comparable to cryptocurrencies as there exists core differences between the two, which emanates from the very nature and origin of both CBDCs and cryptocurrencies. Firstly, CBDC is issued and controlled by the central bank of a nation whereas cryptocurrencies are not governed by any central governing authority. Secondly, CBDCs utilize private permissioned blockchain network, while cryptocurrencies use a permission-less open network. Thirdly, CBDCs users' identity is not anonymous as the same is attached or linked to an existing bank account while, the cryptocurrency users are offered features such as anonymity while they are making transactions. Fourthly, CBDCs are used as a medium of exchange rather than as an asset, while cryptocurrencies such as Bitcoin are generally used as an asset and not medium of exchange.

Latest Developments in India with respect to CBDCs

Recognizing the global trends in respect of the CBDCs, the RBI constituted internal working group in October 2020 to undertake a study on appropriate design/ implementation architecture for introducing CBDCs in India. Further, as per the Finance Act, 2022, the definition of 'bank note' was amended to include digital currency as well. Furthermore, with an aim to create awareness about CBDCs in general and the planned features of the Digital Rupee ("e₹") in particular, RBI vide circular dated October 07, 2022, issued the Concept Note.

In a recent development, the RBI has announced the first pilot project in the Digital Rupee - Wholesale segment ("e₹-W") which has commenced its operation from November 01, 2022. The use case for this pilot is settlement of secondary market transactions in government securities, and the use of e₹-W is expected to make the inter-bank market more efficient. Significantly, the RBI is also planning to launch the first pilot in Digital Rupee – Retail segment within a month, in select locations in closed user groups consisting of customers and merchants.

Key considerations around the introduction of CBDCs in India

The Concept Note sheds light on the possible approach of the RBI towards the CBDCs. Accordingly, in respect of the CBDCs design considerations, the RBI is keen on introducing both the CBDC-R and CBDC-W, considering their advantages and the use cases. Taking note of the expertise of the banks in providing the customer-facing activities such as account-keeping services, customer verification such as KYC and adherence to AML/CFT checks, transaction verification, etc., the RBI has suggested that the indirect model would be the most suitable for the introduction of CBDC in India. In terms of providing degree of privacy to the end users, the RBI is inclined towards providing them 'managed anonymity' i.e., "anonymity for small value and traceable for high value," akin to anonymity associated with physical cash.

Undoubtedly, it is a welcoming and progressive step by the RBI towards the development of CBDC for India. Given the RBI proposes to adopt a graded approach to the introduction of CBDC through stages of proof of concept, pilot projects and the launch, it is quintessential to address several gaps or questions which remains unaddressed, keeping in mind the need for balance between the introduction of CBDCs in the payment ecosystem and safeguards against the potential risks posed by the CBDCs. Below are some of the key issues which require thorough consideration of the RBI.

Adoption of CBDCs by the intermediaries & end-users

The RBI intends to adopt indirect model for issuance and management of CBDCs in India. Notably, the RBI via this model plans to leverage the services of third party service providers ("TSPs") for providing customer-facing activities such as distribution of CBDCs to public, account-keeping services, customer verification such as KYC and adherence to AML/CFT checks, transaction verification, etc.

Pertinently, regarding the economic design of the CBDC, the RBI is in favor of offering non-remunerated CBDC/ non-interest bearing CBDC, which means that there would be no payment of positive interests on the digital assets held by both TSPs and end users. The intermediaries would also be able to limit the holdings of CBDCs available to the public for transactional purposes in case there is a threat to their bank deposits.

While the RBI in the Concept Note has clarified its stance by stating that the CBDC would be introduced in the payment ecosystem with the least disruption to the existing financial system, however, more clarifications are required with respective to the incentives provided to the TSPs to bear the cost of issuing and managing CBDCs and the end users to switch from holding bank deposits to CBDCs.

Significance of CBDCs in light of the existing Unified Payments Interface and other payment methods

As per the RBI, CBDC based payment system is not expected to substitute other modes of existing payment options, rather it will supplement by providing diversified payment options to end users. Thereby, the CBDC and the multiple payment options such as UPI, digital wallets would co-exist in the payment ecosystem.

With the creation of RTGS, NEFT, IMPS, UPI, Bharat Bill Payment System (BBPS), and National Electronic Toll Collection (NETC), India has made a considerable and noteworthy progress towards the innovation in the payment system. As highlighted in the Concept Note, the use of CBDCs have advantages over the other payment methods which includes reduction in operational costs involved in physical cash management, fostering financial inclusion, bringing resilience, efficiency, and innovation in payments system, adding efficiency to the settlement system, boosting innovation in cross-border payments space and providing public with uses that any private virtual currencies can provide, without the associated risks.

While it is understood that the use of CBDCs over other payment methods, would increase the financial inclusion, resilience, and efficiency in the payment system, however, it is understood that the effect would be nominal or marginal, which requires to be compared against the proposed advantages of the CBDCs.

The Central Government is required to carefully examine and lay out in detail the additional advantages or features of CBDC to users in comparison of the other payment methods used in India and specifically identify the problems that in the opinion of the RBI would specifically be answered by the introduction of CBDCs. Additionally, in order to make CBDC attractive for the end users, the RBI is required to provide real incentives to the end users like offering discounts for the users making payments through CBDCs etc. in order for them to move from other payment methods to CBDCs. Additionally, there is a need for awareness among the end users of the use cases that a CBDC would support, which are not effectively supported by existing payments and settlement infrastructure.

Impact on privacy and cybersecurity of the individuals

The attributes of physical currency are (a) anonymity i.e., financial transactions are carried out without recording the identity of the transacting parties; (b) universality i.e., physical currency can be used for any financial transaction; and (c) finality i.e., payment of currency unconditionally settles the transaction. The use of government backed CBDC entails the concentration of the sensitive personal data i.e., financial transaction details including spending habits of the users etc. with the government authorities. Therefore, RBI has proposed the principle of managed anonymity i.e., "anonymity for small value and traceable for high value," akin to anonymity associated with physical cash.

It is pertinent to note that the Concept Note fails to examine in detail as to how the privacy of the users would be maintained in the CBDC ecosystem, considering that, the Government, on one hand is obliged to carry out AML/ CFT measures and on the other, protect the privacy of the end users. In absence of the overarching data protection law in India, the RBI is required to integrate certain principles like limited processing of data, purpose limitation, collection limitation, lawful processing, storage limitation etc., in the CBDC ecosystem.

Therefore, given the introduction of CBDCs would eventually lead to unprecedented level of state surveillance on the financial accounts of users, the RBI would be required to strike a balance between identity verification done with the intention of combating illegal activities and providing confidentiality to the users. Furthermore, the concentration of financial data at a centralized location would be vulnerable to data breaches and leaks. Therefore, the RBI would be required to adopt procedural safeguards and protocols for ensuring security of the users.

While realising the development of CBDCs around the world and promising impacts of CBDCs, such as transparency, low cost of operation among other benefits, the RBI has launched the CBDC pilot project which signifies the readiness of the RBI in making CBDC a reality for India. The launch of the pilot project would be crucial in understanding the operational, technology, policy and regulatory concerns that might need to be addressed in the operation of a CBDC in India.

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