The Cryptocurrency and Regulation of Official Digital Currency Bill 2021 signals India’s first clear intent to launch the ‘digital rupee’. Once passed, the Reserve Bank of India will join a growing list of central banks across the world that are seriously exploring the introduction of a Central Bank Digital Currency, or CBDC.
The Bank of International Settlements (BIS) defines CBDCs as “central bank-issued digital money denominated in the national unit of account, and it represents a liability of the central bank.” Most central banks view CBDCs as sovereign-backed issuance of M0 — the monetary supply measure in an economy that includes currency notes and coins-in-circulation and reserves. While the text of the Bill is not public yet, it is highly likely that this is the type of CBDC that India is looking at. A survey by the Bank of International Settlement (BIS) found that the key motivations for ‘retail’ CBDCs are financial inclusion and enhancing payments efficiency. India is a diverse country with varying levels of digital literacy. For the ‘digital rupee’ (India’s CBDC) to gain acceptance, it would need to be designed in a manner that makes it easily recognisable, accessible, and usable, much like physical cash. Further, its design would have to consider the various languages and varying levels of digital literacy across India.
With this backdrop, the design of the proposed CBDC for India would need to consider the following key elements to ensure widespread acceptability and usage:
Offline vs online capabilities
Ease of use will be crucial to the wide-spread adoption of India’s CBDC. For this, it would be necessary that the ‘digital rupee’ has offline functionality. Several countries are exploring the possibility of enabling offline digital currency transactions. The primary medium being explored for offline transactions are smartphones, smart cards, and wearable devices. However, for a country like India, options such as feature phones or other low-cost technologies accessible to a common man should also be considered.
Smartphone–based vs feature phone/wearable devices
To reach the last mile, it is important to consider the devices that people can use for digital rupee transactions. Anything that is ‘digital’ needs to be stored on a digital medium (e.g. laptop, PC, USB drive, phone, etc.). Although smartphones currently show considerable promise for offline transactions, the reality is that, as of December 2019, smartphone penetration stood at less than 40 per cent in India. Smart sim card-based feature phones, smart cards, wearable devices, and other low-cost technologies should be explored as alternatives or even supplemental options. The RBI must also look into accessibility and storage options — will the digital rupee be stored only on the phone? Can it be stored on any form factor? Can it be accessed from any device – e.g. browser-based laptop as well as phones? What happens if someone loses the device?
Distributed ledger-based currency vs a centralised one
Another key consideration will be the underlying technology of the ‘digital rupee’. Technology that is based on a distributed ledger relies on a database that is consensually shared and synchronised across multiple sites, institutions, or geographies, and is accessible by multiple people. This allows external validators to adjust the balance sheet of the central bank. This infrastructure is more resilient in situations such as a hacking attack because there is no single point of failure. On the other hand, this infrastructure has many legal and technical challenges. In a centrally controlled ecosystem, data stored over multiple physical nodes is controlled by an authoritative entity, i.e., the central bank. This entity will have the sole authority to validate transactions.
Unlike private cryptocurrencies, CBDCs need not be based on Distributed Ledger Technology (DLT), as they can reside on any non-physical digitally issued token. According to the BIS, there is not much acceptance for DLT-based proofs-of-concept that are currently being carried out. However, as most central banks maintain a high level of public trust, they need not maintain an entirely decentralised DLT system. The BIS predicts that most central banks will only look at “permissioned” DLT, where a network of approved entities will perform the updating function.
One of the concerns surrounding CBDCs is the ability of central banks to trace individual transactions. While this prevents money laundering and tax evasion, it raises concerns over increased State surveillance, which could affect the ease with which the public will accept and use the digital currency. However, research conducted by the Bank of Canada has shown that the privacy choice in CBDCs is broader than just the binary choices of anonymity and full disclosure. Systems designers can decide which types of data should remain private, and the people or institutions that can access this information. Striking the right balance is likely to have a heavy bearing on CBDC adoption.
One of the features that makes India’s digital payments landscape a success story is the interoperability between different mobile wallets and payments services. While channels such as UPI could be helpful for transacting in ‘digital rupee’, building technical interoperability with other products such as e-wallets and bank accounts would be an important consideration for large-scale adoption of the new currency type.
India’s CBDC would also need to address the cybersecurity and consumer protection concerns. Another design choice for RBI will involve the digital payments acceptance infrastructure: Do we build a new parallel acceptance infrastructure, or can we upgrade the existing infrastructure, and ensure acceptance of digital rupee by using ‘Bharat QR’?
UPI is considered to be one of the great Indian success stories in the last few years. However, it currently has only over 100 million users, despite there being over 600 million smartphone users and over 80 per cent of the population having unique bank accounts. If the ‘digital rupee’ is designed and executed properly, it could be India’s chance to move from having one of the highest cash to GDP ratios (12 per cent) to a much reduced cash-in-circulation economy. This would achieve what 800 million debit cards, 600 million smartphones, and millions of acceptance points have not been able to so far and set yet another example for the world.
Rajesh Bansal is a senior adviser at Carnegie India. His research focuses on financial technologies, particularly electronic payment systems, electronic cash transfers, and digital financial services to enable inclusive development. Prateek Jha is a research assistant and program coordinator at Carnegie India. Views are personal.