Digital Currency: RBI issued Press Release

Central Bank Digital Currency – Is This the Future of Money1

Introduction

The concept of “Central Bank Digital Currencies” (CBDC) has been around for a while. Some credit Nobel Laureate James Tobin2, an American economist, with the invention of CBDCs in the 1980s, when he stated that Federal Reserve Banks in the United States should create a widely accessible’ medium with the convenience of deposits and the safety of money.’ The concept of digital currency, on the other hand, has only been widely explored by central banks, economists, and politicians in the last decade.

2. Except for currency notes, all other uses of paper in the current financial system have been supplanted by digital and electronic forms, including bonds, securities, transactions, communications, correspondences, and messages. According to anecdotal data, the use of physical cash in transactions has decreased in recent years, a tendency that has been exacerbated by the ongoing Covid19 pandemic. As a result of these advances, several central banks and governments have increased their efforts to investigate a digital equivalent of fiat currency. Some of this interest among central banks stems from a desire to achieve specific policy goals, such as facilitating negative interest rate monetary policy. Another motivator is to give the general public with virtual currencies that have the same valid benefits as private virtual currencies but without the negative social and economic implications.

What is a CBDC?

3. It is critical to comprehend and appreciate what a CBDC is, and to do so, one must first comprehend what a currency and money are.

What is a currency?

4. Let’s start with the basics: money. Material requirements rose as cultures evolved from hunters and gatherers – to build a house, wear clothes, produce weapons and equipment, and so on. People had to buy these things from others because they couldn’t manufacture them on their own. Initially, these purchases were made on the basis of barter – perhaps a leather skin cloak in exchange for a spear. Barter became standardised in terms of metals or cowrie shells as it reached its limits – how many cloaks for a spear, for example. People could now calculate the worth of the cloak and the weapon in metal or cowrie shells. Because both bronze and shells had intrinsic worth, this was still barter (shells were desired for their beauty). Over time, this system evolved into metal currencies. Gold and silver coinage were an extension of this system, with aspects of both barter and money (both gold and silver had inherent value) and were standardised representations of value. People innovated somewhere along the way, and instead of using actual items for barter, they started utilising claims on goods, essentially a bill of exchange. These could be clay tablets in Mesopotamia or paper cash in China in the eleventh century.

5. In terms of money, two historical truths arise.

(i) Money has taken the shape of either commodities (which have intrinsic value) or debt instruments (which have no intrinsic value). When money has no intrinsic worth, it must reflect ownership of commodities that do or ownership of other debt instruments. Paper cash is a type of representational money that functions as a debt instrument. The owner of the currency is aware of who owes him money or who is responsible for the underlying debt. There is always an ISSUER of representative money.

(ii) Money is usually issued by a sovereign. Private issuance of money – whether under sovereign license or otherwise – has existed in the past but has over time given way to sovereign issuance, for two reasons. Firstly, being a debt issuance, private money is only as good as the credit of the issuer. By definition, there can be multiple issuers. This makes private currency unstable. On the other hand, public currency, as it is backed by a sovereign, is unique to an economy and has better credit standing; therefore, it is more stable. Secondly, paper currency involves seignorage – the difference between the intrinsic value and the representative value which accrues to the issuer. This seignorage should not accrue to any private individual. It should accrue to the Government and thus used for public spending.

6. Now we are in a position to provide a definition of a currency. In modern economies, currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative). It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. Currency is fiat, it is legal tender. Currency is usually issued in paper (or polymer) form, but the form of currency is not its defining characteristic.

What is a central bank digital currency?

7. Having defined a currency as a liability issued by the central bank, we are now in a position to define a CBDC. A CBDC is 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.

8. It is also important to understand what a CBDC is not. CBDC is a digital or virtual currency but it is not comparable to the private virtual currencies that have mushroomed over the last decade. Private virtual currencies sit at substantial odds to the historical concept of money. They are not commodities or claims on commodities as they have no intrinsic value; some claims that they are akin to gold clearly seem opportunistic. Usually, certainly for the most popular ones now, they do not represent any person’s debt or liabilities. There is no ISSUER. They are not money (certainly not CURRENCY) as the word has come to be understood historically.

9. A line of argument that has helped private virtual currencies gain some degree of legitimacy is that most money in modern societies is in fact already private since they represent deposit liabilities of private banks. There are two factors that are conveniently pushed under the carpet. One, deposits are issued by banks under license of the sovereign issuer of currency (usually the central bank). Two, deposits are accepted by the public only because they are convertible one-to-one into sovereign currency. A simple way to understand the distinction is to look at deposits as lending of sovereign currency to banks by the public, on interest (credit, its opposite side, is lending of sovereign currency by banks to the public, on interest). Bank deposits are money, certainly, but they have no independent existence as money, shorn of sovereign authority and the resultant public confidence. In any case bank deposits are very different from private currencies which (a) do not have an issuer, and (b) are not convertible one-to-one into the sovereign currency.

10. To sum up, CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash.

What is the need for a CBDC?

11. While interest in CBDCs is near universal now, very few countries have reached even the pilot stage of launching their CBDCs. A 2021 BIS survey of central banks found that 86% were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects. Why this sudden interest? The adoption of CBDC has been justified for the following reasons:-

(i) Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency (like Sweden);

(ii) Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, or Japan or even the US);

(iii) Central banks seek to meet the public’s need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.

12. In addition, CBDCs have some clear advantages over other digital payments systems – payments using CBDCs are final and thus reduce settlement risk in the financial system. Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk.

Do we need CBDC in India?

13. The advantages of issuing a CBDC discussed briefly in the previous paragraph might be enough to justify India issuing a CBDC, although to realize benefits of global settlements, it is important that both the countries in a currency transaction have CBDCs in place. Let us, however, look at it from India’s own point of view.

14. India is leading the world in terms of digital payments innovations. Its payment systems are available 24X7, available to both retail and wholesale customers, they are largely realtime, the cost of transaction is perhaps the lowest in the world, users have an impressive menu of options for doing transactions and digital payments have grown at an impressive CAGR of 55% (over the last five years). It would be difficult to find another payment system like UPI that allows a transaction of one Rupee. With such an impressive progress of digitisation, is there a case for CBDCs?

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