Preface:
CBDC, or Central Bank Digital Currency, is a digital version of currency issued by a central bank.
Different countries have unique motivations for exploring CBDC issuance.
India is planning to introduce a digital Rupee (e₹) as a form of CBDC, which will be similar to physical banknotes but more convenient, fast, and cost-effective.
The Concept Note aims to raise awareness about CBDCs and the specific features of the digital Rupee in India, explaining the Reserve Bank's approach.
Key considerations discussed in the Concept Note include technology choices, use cases, issuance mechanisms, impact on the banking system, monetary policy, financial stability, and privacy concerns.
Limited pilot launches of e₹ will soon begin to familiarize the public with this digital currency.
Summary:
The Reserve Bank of India (RBI) manages the nation's currency, derived from statutory powers in the RBI Act.
Currency has evolved from barter to metal coins and paper money, with various forms and functions.
Money serves as a medium of exchange, unit of account, and store of value
in any economy.
India has made significant progress in digital payments, with systems like RTGS, NEFT, IMPS, and UPI.
The RBI is exploring the introduction of a Central Bank Digital Currency (CBDC) called Digital Rupee (e₹).
CBDC is defined as a digital form of legal tender issued by a central bank, aiming to provide the benefits of virtual currencies with consumer protection.
Key motivations for CBDC include cost reduction, financial inclusion, efficiency, and innovation in the payment and settlement systems.
CBDC design choices include the type (retail or wholesale), issuance models, form (token-based or account-based), technology, instrument design (interest-bearing or not), and degree of anonymity.
CBDC is intended to complement existing forms of money and enhance the digital economy.
Introduction:
The Reserve Bank of India (RBI) aims to maintain monetary and financial stability while promoting safe and efficient payment systems.
The history of money has evolved from bartering to metal coins and paper money, with a focus on innovations in finance.
Currency in modern economies is issued by sovereign authorities or central banks, serving as a medium of payment, unit of account, and store of value.
Payment systems are rapidly changing, with a growing demand for fast and convenient digital payments, and India has seen significant advancements in this area.
The RBI is exploring the introduction of a Central Bank Digital Currency (CBDC) to complement or replace traditional money.
The RBI has set up an internal working group to study the design and implementation of CBDCs in India.
Various risks associated with private cryptocurrencies challenge financial stability, and the RBI has expressed concerns about their impact.
CBDCs have gained global interest, with many countries researching or piloting their own digital currencies.
The introduction of CBDCs in India is expected to reduce cash dependency, enhance efficiency, and provide a trusted digital payment option.
However, CBDCs also come with potential risks to financial stability, monetary policy, and financial markets.
The Indian government announced the launch of the Digital Rupee (CBDC) in the 2022-23 budget.
The RBI has formed a high-level committee to study various aspects of CBDC and suggest measures for its successful introduction.
CBDC Conceptual Framework:
CBDC, or Central Bank Digital Currency, is a type of central bank money that is distinct from physical cash or reserve accounts and serves as a medium of exchange and store of value.
It is characterized by four properties: issuer (central bank or not), form (digital or physical), accessibility (wide or narrow), and technology (peer-to-peer tokens or accounts).
CBDC can be broadly categorized into general purpose and wholesale, with general purpose CBDC having two varieties.
It is a legal tender issued by a central bank in digital form and is exchangeable on a one-to-one basis with the fiat currency.
CBDC is a sovereign currency, appears as a liability on the central bank's balance sheet, and is widely accepted as a medium of payment, legal tender, and a store of value.
It is freely convertible against commercial bank money and cash, fungible legal tender, and does not require holders to have a bank account.
CBDC is expected to reduce the cost of issuing money and conducting transactions.
Motivations for Issuance of CBDC:
3.1 Reasons for adopting Central Bank Digital Currency (CBDC):
Various jurisdictions adopt CBDC for different reasons, including:
Promoting electronic currency in response to reduced paper currency usage (e.g., Sweden).
Enhancing efficiency in issuing physical cash (e.g., Denmark, Germany, Japan, the US).
Overcoming geographical barriers for cash movement (e.g., The Bahamas and the Caribbean islands).
Meeting the public's demand for digital currencies to mitigate risks posed by private virtual currencies.
3.2 Advantages of CBDC:
As a sovereign currency, CBDC ensures settlement finality, reducing settlement risk.
Potential for real-time, cost-effective integration of cross-border payment systems.
India's progress in digital payments illustrates these advantages.
3.3 Motivations for India to Consider CBDC:
Reduction in costs associated with physical cash management.
Promoting digitization and achieving a less cash-dependent economy.
Supporting competition, efficiency, and innovation in payments.
Exploring CBDC's use for improving cross-border transactions.
Enhancing financial inclusion by providing accessible, sovereign digital money.
Safeguarding public trust in the national currency amid the proliferation of crypto assets.
Design Consideration for CBDC:
4.1 Central Bank Digital Currency (CBDC) Foundational Principles
BIS (Bank for International Settlements) outlined three foundational principles for CBDC issuance:
Do not interfere with public policy objectives or monetary stability.
Complement existing forms of money.
Promote innovation and efficiency in the payment system.
4.2 CBDC Design Considerations
CBDC design depends on domestic circumstances.
No one-size-fits-all approach to CBDC.
CBDC design affects payment systems, monetary policy, and financial system stability.
Each jurisdiction's design and risks require thorough research by central banks before implementation.
4.3 Key Design Considerations
Two types of CBDC: Retail (CBDC-R) for public use and Wholesale (CBDC-W) for financial institutions.
CBDC-W can improve interbank payments and securities settlement.
Different models for CBDC issuance: Single Tier, Two-Tier (Indirect and Hybrid).
Considerations for interest-bearing or non-interest-bearing CBDCs.
A choice between account-based or token-based CBDC systems.
Anonymity should balance privacy and compliance with anti-money laundering and counter-terrorism financing regulations.
4.4 Fixed Denomination vs Minimum Value-Based CBDCs
Consideration of issuing CBDC with fixed denominations similar to physical currency for trust and familiarity.
4.5 Summary of Design Features (Bahamas, Canada, China, ECCU, Sweden, Uruguay)
Varying features include interest, quantitative restrictions, anonymity, offline capability, and cross-border payments.
4.6 Preferred Design Choices
CBDC (Retail and Wholesale) with an intermediate issuance model.
Non-interest bearing CBDC.
CBDC-R in token-based form.
Managed anonymity, offering anonymity for small transactions and traceability for high-value transactions.
Technology Considerations for CBDC:
CBDC's technology considerations are fundamental to its development, translating abstract policy objectives into concrete forms.
Key technical principles include strong cybersecurity, technical stability, resilience, and sound technical governance.
The choice of technology platform, whether distributed ledger or centralized, must align with policy objectives and consider financial inclusion, security, and energy efficiency.
CBDC should be developed as a large-scale enterprise-class digital platform with features like scalability, robustness, access control, cross-platform support, and fraud prevention.
The technology architecture options should prioritize zero downtime, zero frauds, decentralization, confidentiality, and high transaction volume.
The choice between Distributed Ledger Technology (DLT) and conventional database infrastructure should consider data throughput and efficiency, with DLT possibly used in hybrid architectures.
Scalability is crucial, with CBDC projects starting small but designed to be easily extended for large-scale deployments.
Ensuring a trusted environment is essential, including preventing double-spending, malicious token manipulation, and data sharing only with relevant parties.
Third-party validation should verify identity information for CBDC network participants.
Policy Related Tech Considerations:
5.5 Recoverability:
Account-based models don't have recoverability issues because user identity is always available.
Token-based models can support two types of wallets: the Custodian Model and the User Held Model, each with its implications for recoverability and anonymity.
5.6 Offline Functionality:
Traditional digital payments rely on online communication, but offline capabilities are crucial for wider CBDC adoption.
Various solutions, such as chip-based options and Visa's proposed Offline Payment System, are explored for offline CBDC transactions.
5.7 Programmability:
CBDCs can have programmable features, allowing specific use cases or restrictions.
Programmability may have implications for monetary policy and can be achieved through smart contracts and token versioning.
5.8 Integration with Existing Payment Systems and Interoperability:
Integration with existing payment systems, like UPI and digital wallets, is essential for an Indian CBDC.
Achieving interoperability between different payment systems and cross-border transactions is crucial for efficiency and risk mitigation.
5.9 Security Considerations:
Cybersecurity is a significant concern for CBDC ecosystems.
Key principles for addressing cyber risks include security as a prime design concern, quantum resistance, vertical segmentation, and recall features.
5.10 Data Analytics:
CBDCs generate a vast amount of real-time data, which can be useful for policy-making, financial insights, money laundering prevention, and risk-based approaches.
5.11 Technology Choices:
Technical choices should remain flexible to adapt to evolving technology and policy/security considerations.
Energy efficiency and environmental friendliness are essential aspects of technology choices for CBDC issuance.
5.12 Ownership on Creation and Distribution of CBDCs:
RBI can create CBDCs internally or establish a separate technical subsidiary.
External agencies can be engaged in distributing CBDCs.
Other Considerations:
6.1 Resource Intensiveness:
Consider resource usage in CBDC technology design.
Centralized systems have resource consumption similar to existing payment systems.
Distributed systems' resource use depends on consensus protocols (e.g., "Proof of Work").
CBDC issuance is controlled by the sovereign/central bank.
Token-based systems might require more resources.
Energy consumption for transaction validation and storage is a factor.
6.2 Business Continuity Planning:
CBDC, backed by a sovereign guarantee, requires high-standard business continuity planning.
Planning is needed at the central bank, intermediary, and third-party service provider levels.
6.3 Consumer Protection and Grievance Handling:
CBDC introduces consumer protection challenges.
Benefits include lower costs, speed, and convenience.
Risks include digital fraud, data breaches, and privacy issues.
Privacy risk is linked to CBDC design principles.
Security and technology risks depend on CBDC's technical design.
Accountability risk involves identifying who's responsible in case of loss.
Maintaining consumer trust is vital for financial stability.
Central banks must ensure infrastructure and participants are resilient against cyber threats.
CBDC system must be scalable to meet public demand.
Efficient customer grievance resolution is crucial for CBDC adoption.
A robust grievance redressal mechanism should address CBDC-related complaints.
Policy Implications of the Introduction of CBDC:
7.1 Implications of CBDC for Monetary Policy
CBDC doesn't fundamentally change monetary policy but can enhance its transmission.
Its impact depends on design and usage, including remuneration, accessibility, and anonymity.
CBDC could speed up bank runs in times of economic instability, weakening monetary policy.
Interest-bearing CBDC may improve policy efficiency but require adjustments in liquidity provision.
The overall impact remains uncertain due to limited CBDC issuance in practice.
7.2 Implications of CBDC for Liquidity Management
CBDC affects the central bank's discretionary liquidity measures.
Demand for CBDC may lead to changes in reserve money, money supply, and bank liquidity.
Remunerated CBDC could disrupt monetary policy and financial intermediation.
Non-remunerated CBDC minimizes disruptions.
7.3 Implications of CBDC for Financial Stability
CBDC issuance should consider not harming monetary and financial stability.
Concerns include faster bank runs and potential financial disintermediation.
Safeguards can mitigate these risks, such as limits on CBDC holdings and transactions.
7.4 Legal Implications of CBDC
The legal framework should clarify the central bank's mandate and CBDC's status.
Amendments may be needed in existing laws to accommodate CBDC issuance.
The central bank's power to issue currency in general might be required.
Legal changes in monetary and central bank laws are necessary.
7.5 Balance Sheet Implications of CBDC
The balance sheet impact of switching from deposits to CBDC affects the size of bank balance sheets.
Commercial banks may need more reserves if deposits shift to CBDC.
The central bank's balance sheet expands when issuing new reserves in response.
7.6 Central Bank Digital Currency (CBDC): AML/CFT Perspective
CBDC systems should comply with AML and CFT regulations.
Commercial banks could handle AML/CFT checks, but responsibility delineation is crucial.
CBDC should have mechanisms for transaction identification and monitoring.
7.7 Privacy and Data Protection Considerations
Privacy and data protection should be addressed in CBDC design.
The level of anonymity in CBDC transactions is a societal question.
CBDC should respect privacy and protect user data.
Privacy principles and data subject rights should be defined.
Risk and security frameworks should guide CBDC security measures.
Way Forward:
RBI is considering the introduction of Central Bank Digital Currencies (CBDCs) and is developing a phased implementation strategy.
They are exploring the possibility of account-based CBDCs in the Wholesale segment and token-based CBDCs in the Retail segment.
The implementation phase involves building prototypes, testing in controlled environments, conducting large-scale pilots, and evaluating the results.
An internal high-level committee has provided recommendations on various aspects of CBDCs.
RBI plans to monitor global CBDC developments and engage with international organizations and stakeholders.
They are deliberating on technological choices, security considerations, and use cases for CBDCs.
CBDCs hold the promise of transparency, lower operational costs, and expanding payment systems to cater to a wider user base.
Extensive stakeholder consultation and iterative technology design are essential for developing a successful CBDC solution.
The Concept Note outlines motivations, design features, policy implications, and technology requirements for CBDC introduction in India. The way forward requires detailed planning to ensure timely rollout.
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