Central Banks Are Hastening The Move Towards Digital Currencies

The BIS, in an Oct.9 report, laid down principles and core features of central bank digital currencies.

A  bitcoin miner, is silhouetted as he uses his computer that is set up to mine the crypto-currency at his home in Tokyo, Japan (Photographer: Yuriko Nakao/Bloomberg)
A bitcoin miner, is silhouetted as he uses his computer that is set up to mine the crypto-currency at his home in Tokyo, Japan (Photographer: Yuriko Nakao/Bloomberg)

The idea of central bank digital currencies has been around for some time. Studies around the feasibility of these digital units have been conducted by a few countries, while others have attempted small pilot projects. In India, too, committees have suggested a digital rupee.

The Covid-19 crisis, seems to have nudged central banks to hasten these studies as digital payments gather steam across nations.

On October 9, the Bank of International Settlements along with seven central banks laid down core principles that should be followed by monetary authorities when issuing and designing a CBDC. The European Central Bank, Bank of Japan, Swiss National Bank, Bank of England and the U.S. Federal Reserve, among others contributed to the report.

A CBDC could be an important instrument for central banks to continue to provide a safe means of payment in step with wider digitalisation of people’s day-to-day lives. Public trust in central banks is central to monetary and financial stability and the provision of the public good of a common unit of account and secure store of value. To maintain that trust and understand if a CBDC has value to a jurisdiction, a central bank should proceed cautiously, openly and collaboratively
BIS Paper On Central Bank Digital Currencies

A CBDC is a digital payments instrument that is denominated in a national currency and issued by a central bank. Unlike private virtual currencies whose value is based on its ownership, distribution and trading on exchanges, a CBDC’s intrinsic value is equivalent to any other form of money issued by the central bank.

Principles For Issuing CBDCs

There are several factors that a central bank must take into account when issuing CBDCs, the BIS report said. It laid down three broad principles that should be followed by central banks while deciding to issue a digital currency.

The ‘Do No Harm’ Principle

The first of these is that any forms of money supplied by the central bank should not interfere with its broader public policy objectives.

Ensure Co-Existence & Complementarity With Other Forms Of Money

CBDCs must also exist alongside systems like cash, reserve or settlement accounts. All these mediums of exchange must exist in the broader payment system.

Promote Innovation & Efficiency

Finally, the idea behind issuing a CBDC should be to drive innovation and efficiency. Without such innovation, users may adopt less safe instruments or currencies.

Core Features Of A CBDC

The BIS report also lays down core features of a CBDC, prime among which is the ability to use a CBDC as easily as cash.

  • A CBDC should exchange at par with cash and private money. Payments should be as easy as cash, tapping a card or using a mobile phone to transact.
  • A CBDC should be usable across as many transactions as cash. This should include the ability to make offline payments.
  • CBDCs should come at no cost or low cost to users and the investment in technology to use these units should be minimal.
  • The CBDC system should be available round the clock, be resilient to operational failure, cyber attacks and other threats.
  • The system should be able to expand to accommodate increased volumes in the future.

Designing A CBDC

Beyond those basic features, the BIS said two key decisions would need to be taken by central banks. The first is whether CBDCs would be interest-bearing and whether a cap or limit should be imposed on individual holdings.

Designing a “deposit-like” CBDC could hasten any disintermediation of existing deposit takers. Limits could mitigate the financial stability impact of such disintermediation, including by impeding a possible “run to CBDC” during a crisis, but they would also limit the effectiveness of making a CBDC interest-bearing and come with a wider set of potential drawbacks.
BIS Paper On Central Bank Digital Currencies

Understanding of the interactions between these design features and the potential trade-offs involved is in its relatively early stages, the BIS said. “A central bank should have robust means to mitigate any risks to financial stability before any CBDC is issued.”

There are other decisions related to technology that may need to be taken.

Central banks could either create a centralised ledger, decentralised ledger based on blockchain or a combination of the two.

A centralised ledger will record the total issuance of CBDCs and the amount used by customers across the banking system, which will also require specialised operators to manage and transfer liabilities. Whereas a decentralised, or blockchain-based ledger, could be operated by both public authorities like a central bank and private entities, which will allow peer-to-peer and offline transactions, the report said.

“A CBDC system would require a rulebook formalising the roles and responsibilities of the operator(s), participants and potentially other service providers and stakeholders,” it said. “Beyond the rulebook, other governance arrangements would also need to be considered.”

CBDCs On The Drawing Board

Even before the BIS paper, several central banks has stepped up studies around CBDCs.

In a May 2020 speech, Yves Mersch, member of the executive board, European Central Bank, said a survey among 66 central banks by the Bank for International Settlements found that more than 80% are working on CBDCs.

Some of the leading central banks like the Bank of Canada, the Federal Reserve, the Bank of England and other central banks like the Philippines Central Bank are evaluating the contours of creating and issuing a CBDC.

The Bank of Japan will start testing its CBDC next year and the ECB is working on a digital euro which could be launched by mid-2021.Further, according to recent reports in Cointelegraph, Lithuania launched its CBDC for limited purposes in July, Sweden is in the midst of a one-year long testing for a digital currency. The Central Bank of the Bahamas plans to launch its CBDC sometime this year and the Bank of Korea will begin its CBDC pilot scheme next year.

Brazil may see a CBDC developed by 2022, the Bank of Thailand is testing its digital baht, Jamaica’s central bank has begun developing its CBDC and Cambodia’s CBDC could become operational in the coming months.

Where India Stands

In India, the idea of a digital rupee has been explored but has not gained much traction.

In its 2017-18 annual report, the Reserve Bank of India said that “an inter-departmental group has been constituted by the Reserve Bank to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency.”

In 2019, a panel headed by then Finance Secretary Subhash Chandra Garg had recommended a digital rupee, while simultaneously suggesting a crackdown on private cryptocurrencies.

The panel in its recommendations said that it would be advisable to have an “open mind” regarding the introduction of an official digital currency in India. “It may be possible to visualise some models of future official digital currencies but as of date it is unclear whether there is clear advantage in the context of India to come up with an official digital currency,” the report said.

Garg, speaking at a conference organised by legal firm Khaitan and Co. in July, had re-iterated that view. “The DLT based virtual currencies is one option to create a digital Rupee or we can conceptualise a demated currency in a depository for every currency note and deposit money a person has,” he said.

But discussions do not appear to have progressed. “It is very early to speak on a central bank issuing digital currencies. Some discussions are going on. Technology has not fully evolved yet. It is still in very incipient stage of discussions and at RBI we have examined it internally,” RBI governor Shaktikanta Das said at a press conference in December 2019.

According to Mandar Kagade, a fintech policy consultant, the use-cases for a CBDC are still not clearly defined globally. Developing economies look at CBDCs as a financial inclusion tool, while developed economies maybe looking it for either improving their payments systems or for geo-political reasons, he said.

“In terms of use-cases for India the regulator should first begin with creating a wholesale CBDC for inter-bank transfers and settlements. Such a CBDC can also be used by payment companies for settling transactions through a reserve CBDC account with the central bank,” he said. If India is to pursue creating a retail CBDC for the purposes of improving financial inclusion, the regulations may need to include a “light” know-your-customer model otherwise adoption of CBDC may be low, Kagade added.