eRupee explained: How will India’s CBDC work

Picking up a page from cryptocurrencies which popularised the block chain technology and distributed ledger, the Reserve Bank of India plans to issue a central bank digital currency named the eRupee. The proposed CBDC is not to be confused with cryptocurrencies as it is backed by RBI and have the same intrinsic value as the legal tender issued by the central bank. The eRupee is conceived as an additional form of currency that will supplement paper money.

The eRupee is a new kind of legal tender that will be digital in character. The idea is to make transactions safe, smooth, cheap and within the country and across the border. Many countries across world are working on their own CBDCs. China was first to issue e-CNY which is currently the only CBDC available, but some other countries have also been conducting trials and research for digital currencies.

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RBI is worried that cryptocurrencies could threaten the financial and macroeconomic stability of the country. The concept note says the eRupee will be an alternative to cryptocurrencies that threaten to limit the central bank’s ability to regulate money supply.

“CBDCs will provide the public with [the] benefits of virtual currencies while ensuring consumer protection by avoiding the damaging social and economic consequences of private virtual currencies,” says the concept paper.

RBI has decided to roll out the pilot of the eRupee as many of the options and phasing needs clarity. Educating the users is equally important to build trust in the digital rupee. The value of the CBDC is constant and it is not a speculative investment like cryptocurrencies. Equally important is not to confuse CBDC with digital payments that are growing in India in geometric proportion. Digital payment is just the payment mode, it is not money which is legal tender.

Issues to be resolved before launching eRupee

RBI looks to create a digital rupee that is as close as possible to the paper currency and wants to manage the process of introducing it in a seamless manner. However, there are several issues that need to be addressed.

1.​Design choices: There is a need to ensure that the digital currency performs all the functions of the printed legal tender in terms of monetary policy, structure and stability of the financial system. The functionalities of e-Rupee will depend on the experience of RBI during the pilot phase.

2.​Type of CBDC to be issued: Another question that begs for an answer is whether to go in for a wholesale CBDC and/or retail CBDC. The pilot will have two versions of a CBDC: One for making retail payments and another for settlement wholesale transactions. The wholesale CBDC is designed for restricted access to select financial institutions and is intended for the settlement of interbank transfers and related wholesale transactions. The retail CBDC is an electronic version of cash primarily meant for retail transactions.

3.​Models for issuance and management of CBDCs: The digital currency can follow direct, indirect or hybrid models. In the direct model or single-tier model, the central bank is solely responsible for the CBDC. In the indirect or two-tier model, the central bank will manage the digital currency with intermediaries such as banks. The advantage of the indirect model is that it is akin to the current physical currency management system wherein RBI releases and the banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer (KYC), anti-money laundering, and stopping terror financing.

4.​Token-based or account-based: A token-based CBDC is a bearer instrument like banknotes. It would be closer to physical cash. Here, the bearer will own the money value. If RBI decides to roll out a retail CBDC, then this the best suited model. The account-based digital currency is more suited for wholesale CBDC that operates through intermediaries in a two-tier system like in the case of the printed currency.

5.​Remunerated or non-remunerated: This will be a major choice for RBI to make as this will have a direct impact on the way banks function. It will be an existential issue for banks. If RBI in centralised form enables earning of interest on eRupees held by individuals, it means a total guarantee by the central bank for the savings of individuals as against the Rs 5 lakh limit at present. This will make banks redundant over time as RBI will take over the savings and transaction business. Banks will be limited to managing the lending business. This will provide universality and finality to the savings, deposits and transactions.

6.​Degree of Anonymity: There is a concern in terms of ensuring privacy that the physical currency provides to its holder. The digital transactions will be on blockchain with complete trail and it will be a key design issue to ensure anonymity through a calibrated and nuanced approach.

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The e-Rupee pilot will address these six issues to ensure smooth introduction of the digital currency. CBDCs are still at experimental stages across the world and there has not been any stakeholder consultation. It will require iterative technology design and needs to adopt and adapt to the international systems of transactions. It will initially co-exist with the physical currency, but will eventually replace printed money in many of its applications.

A major objective of a CBDC is to enable penetration in non-financial institution areas but then off line is not a comfortable mode and will still require better internet-connectivity to ensure comfort, convenience, and safety. Cyber security will have to be dynamic with data protection, privacy and redundancy being built up right from design stage itself. It is the future of how Central Banks will manage its monetary and fiscal policies and the pilot has potential but needs constant dialogues with stake holders for better preparedness and addressing all types of use cases.