In last 2
months, Reserve Bank of India has launched 2 digital currency projects. Digital Rupee - Wholesale segment (e₹-W)
commenced on 1st November 2022. An independent project for
retail digital rupee (e₹-R) was
launched on 1st December 2022. These actions indicate increasing willingness
to experiment with new technologies by an institution often perceived as
risk-averse.
As the name indicates,
Central Bank Digital Currency (CBDC) is a digital form of currency notes issued
by a central bank. Most central banks across the globe are exploring CBDC,
though not necessarily for the same objectives.
The advent of private
crypto-currencies using blockchain technology has triggered this interest in
looking at digital currency. As RBI Deputy Governor T. Rabi Shankar stated on 3rd
December, “If there is anything that a private crypto-currency can do, we should be able to create a product that will do that…”
Central banks are keen
to retain full control over currency. Private crypto-currencies using
blockchain technology were perceived as a potential risk to this hegemony. Even
as the market of private crypto-currencies is going through unsurprising mayhem
globally, central banks are taking steps to protect their turf. Towards that
end, they want to issue digital currency which can provide all the services
that may attract users to private crypto-currencies.
With improvements in
technology, our modes of holding and transferring money have evolved. The
advent of NEFT and RTGS eliminated cheques and demand drafts. With IMPS-based
UPI, small transactions have already moved from physical currency notes to
digital transactions. In UPI payments, funds are instantly transferred from
sender’s bank account to recipient’s bank account, with NPCI facilitating
settlement between the concerned banks. The e₹ (digital
Rupee) seeks to take this process further.
The e₹ is
not intended to displace current system of currency notes and bank balances. It
is an experiment to create additional options for holding and transferring
money.
It is
similar to physical currency notes in the sense that each note (here token)
retains its own identity and money is not transacted as transfer of account
balance but by transfer of individual tokens. Like physical notes, holding e₹
does not result in any interest income, unlike money in a bank account.
In the
Union Budget speech on 1st February 2022, the Finance Minister
noted:
“Introduction of Central Bank Digital
Currency (CBDC) will give a big boost to digital economy. Digital currency will
also lead to a more efficient and cheaper currency management system. It is,
therefore, proposed to introduce Digital Rupee, using blockchain and other
technologies, to be issued by the Reserve Bank of India starting 2022-23.”
Accordingly,
the Reserve Bank of India Act, 1934 was amended by the Finance Act, 2022 to
provide that ‘bank notes’ may be in physical or digital form, thus paving way
for issue of digital currency by RBI. It may be noted that ‘Bank notes’, which
now includes digital currency, can be lawfully issued only by RBI.
The
Finance Act, 2022 also amended the Income Tax Act, 1961 to impose tax on income
from Virtual Digital Assets (VDA) and for TDS on transactions in VDA. These
provisions have been introduced with focus on private crypto-currencies and
NFTs. It is important that necessary clarificatory provisions are included
within Income Tax Act itself so as to ensure that there is no confusion on
taxation of transactions involving digital Rupee.
Cash offers a high
level of anonymity, it is difficult to trace its movement as it changes hands.
Ten years ago, many
transactions had to be in cash only: Many people did not have bank accounts;
even if they did, bank transactions involved delay in clearance of cheque, and
there was a risk that the cheque would bounce. With the success of Jan-Dhan
Yojana, almost everyone has a bank account. UPI and RTGS instantly transfer
money, ensuring finality of payment and eliminating delay. After the launch of
Jio, data connectivity is no longer restricted to the rich. Digital transactions
are now more convenient and have very high levels of acceptabilty. Yet, cash
continues to be preferred by many players because of the anonymity it offers.
Private
crypto-currencies claim to offer anonymity. However, when faced with legal
notices, companies running wallets have happily blocked and frozen accounts.
From a policy
perspective, RBI or any central bank cannot allow complete anonymity. The
question is how much anonymity should central bank offer. Anonymity will expand
the user base for CBDC and will increase its acceptability and usage. However,
it can undermine efforts to curb money-laundering. A recent Concept Paper by
RBI talks of ‘Managed Anonymity’ described as ‘anonymity for small value and
traceable for high value’.
The Concept Paper thus recognizes that protecting personal information and data
privacy are important to foster usability and wider adoption.
The retail digital Rupee (e₹-R) is a token based
system. Under this system, RBI will issue digital
tokens representing a claim on RBI. Each token would have a unique serial
number. It is thus the digital equivalent of holding a physical currency note.
In contrast, e₹-W (i.e.
digital Rupee for wholesale segment) is an account-based system, analogous to
bank accounts. Here, payments will be by change in account balance.
RBI is thus working
with two independent models of e₹ simultaneously. This indicates a willingness
to experiment, and to consider the opportunities offered by technology with an
open mind. In the long run, both e₹ may continue to function, or only one may
survive. RBI will actively monitor both, and each e₹ will evolve with time.
e₹-R is a
“bearer-instrument” meaning that whoever ‘holds’ the tokens at a given point in
time would be presumed to own them.
RBI will issue digital
tokens representing a claim on RBI. Four banks (State
Bank of India, ICICI Bank, Yes Bank and IDFC First Bank) will function as Token
Service Providers (TSPs). The TSPs will interface with the end-users holding
e₹-R and transacting in them. Each TSP will provide users with a mobile app
wallet. Users can load tokens in the wallet, paying one rupee for each digital
Rupee. Then, these tokens can be used by users for any payment.
RBI
will keep a record of total e₹-R held by each TSP. RBI will check that the
total of balances with TSPs is same as total e₹-R issued, to ensure there is no
counterfeiting. Further, it will ensure that the TSPs have proper safeguards
and total of balances of e₹-R held by accountholders is same as balance with
TSP in RBI records. Where payer and recipient are on different TSPs, the
payment will kick-in an inter-TSP settlement through RBI.
In the
pilot project, four cities (Mumbai, New Delhi, Bengaluru and Bhubaneswar) are
being covered. Later, the project will be expanded to include Ahmedabad,
Gangtok, Guwahati, Hyderabad, Indore, Kochi, Lucknow, Patna and Shimla.
The
decision to exclude Kolkata from the pilot project is interesting, given that
Kolkata is both larger and more financially savvy than most cities in the
pilot. Similarly, the absence of the HDFC Bank – a large and tech-savvy bank--
in the initial choice of banks is interesting, though it has been included
within the next 4 banks (Bank of Baroda, Union Bank of India, HDFC Bank and
Kotak Mahindra Bank) which will be included in the project.
While
RBI Governor recently stated that digital Rupee will dis-intermediate banks,
only banks have been taken onboard as TSP. Thus, far from dis-intermediating
banks, RBI is ensuring that users are accustomed to having banks as the
intermediary even in digital Rupee.
e₹-R is for consumption
of common public with features akin to physical cash viz. anonymous, unique
serial number etc. The unique token number will enable the detection of
counterfeiting of tokens and potentially also the restoration of value if an
individual loses his mobile phone.
As per the Concept
Paper by RBI, under a token-based CBDC-R regime, users would be able to
withdraw digital tokens from banks in the same way they can withdraw physical
cash. They would maintain their digital tokens in a wallet and could spend them
online or in person or transfer them via an app. The token based CBDC also
supports innovation with an ability to include programmable feature that
supports efficiency such as standardisation of compliance rules, fraud
detection, wrapped CBDC to other use cases in future. Further, token-based CBDC-R
can be used to accomplish financial inclusion goals.
The ‘wholesale segment’
(e₹-W) is intended primarily for banks, financial institutions and other
financial intermediaries, apart from any large transactions. Currently, the
pilot project is restricted to settlement of
secondary market transactions in government securities
The use of e₹-W can improve
efficiency of interbank payments or securities settlement. The e₹-W can
facilitate conditional payments, whereby a payment is visibly authorized but
settles only if certain conditions are met.
Currently, conditional
payments are standardised in some situations like ASBA for public issues where
money is blocked but not debited unless shares are allotted. By building in
conditionality as a basic feature of e₹-W, RBI can simplify settlements in
secondary markets and other wholesale transactions.
Conditional payments
can drastically reduce settlement risks, where payments are automatically made
on delivery or where payment is automatically triggered for margin money
requirements. Reducing settlement risks will improve confidence in the markets,
while reducing the role of collateral. It will also reduce the operational cost
of maintaining settlement guarantee infrastructure.
[On a side note, RBI is
also working on a model of payments within UPI which can potentially provide ASBA-like
facility for secondary markets: investor will be able to block money in favour
of broker, but the funds will be released as and when actually required. As
noted by Zerodha founder Nithin Kamath in a series of tweets,
this new model in which the investor mandates ‘single block and multiple
debits’ can upend the ‘float’ currently enjoyed by stock brokers.]
The adoption of e₹-W
requires upgradation of exchanges and trading infrastructure and integration of
e₹-W with RTGS payments system. The speed of adoption will depend on whether
the cost of e₹-W settlement (net of savings in liquidity, margin funding, etc.)
is less than the cost of existing settlements.
Based on
learning from the pilot project in G-secs, future pilots will cover other
wholesale transactions and cross-border payments.
In each country that is
evaluating it, CBDC is in conceptual, development, or at pilot stages. RBI has
taken a leadership role by launching 2 CBDCs in an environment bereft of
precedence. Both e₹-W and e₹-R are in pilot project where RBI is continually
learning. Working with pilot projects allows RBI to test out its approach while
ensuring that existing financial markets are not disrupted.
In the opinion of the
author, the retail digital Rupee (e₹-R) does not confer any notable advantage
as users already enjoy the convenience of digital transactions through
bank-linked UPI transactions for small transactions and RTGS for larger ones.
For e₹-W, if the advantage of conditionality can be integrated into financial
markets, it can add a lot of value.
It is important for
stakeholders, including potential stakeholders, to play with this new
technological tool, and to publicly share their experiences.
