Markets have been abuzz with India’s new Bill, “The Cryptocurrency Regulation of Official Digital Currency Bill 2021”. The Bill would ban all private cryptocurrency in India. It has already had an impact on prices, with key cryptocurrencies seeing their prices drop even before the Bill was passed.
On November 30, Union Finance Minister Nirmala Sitharaman stated that the Bill would only be introduced to Parliament after approval by Cabinet.
The Bill proposes that the Reserve Bank of India (RBI), create a digital currency called a Central Bank Digital Currency or CBDC. It also makes exceptions to encourage the technology behind cryptocurrency.
Let’s talk about the RBI issuing a cryptocurrency .
How will a CBDC get created? Is the RBI going to use its centralised ledger or the decentralised blockchain model? A centralised system is more manageable, while a decentralised system is more efficient. Rainer Boehme (a professor at University of Muenster) and Raphael Auer, BIS economist, discussed in their research note the different technologies that could be used to create a CBDC. The RBI will have to draw on global experience and create its own technology based on the context and history.
Is the CBDC to be sold wholesale or retail? A wholesale CBDC is a digital currency that financial institutions can use, while a retail CBDC is a digital currency that the general public can use. A wholesale CBDC is a digital currency that financial institutions can use to transact in central bank money and settle their accounts. Many of this activity can be digitized, with central bank reserves being used by institutions to settle transactions. Even if the RBI switches from digital reserves to wholesale CBDC it may not affect the overall development.
The real deal is creating a retail CBDC. This will allow for multiple interrelated questions about distribution, bank stability and technology mediums. The RBI utilizes the vast currency vault and network of bank branches to distribute physical banknotes. While it is possible to use the current system for distribution of CBDC, the central bank issues CBDC directly to the public.
We have seen people open accounts at their banks, which can be used to access banknotes. The RBI can use technology to open bank accounts and distribute CBDC directly to its customers. Technology allows people to open accounts with the RBI to directly invest in government securities. Similar accounts can also be opened to issue the CBDC.
This direct distribution model can cause instability in the banking sector. Public deposits are a major liability for banks, and banks are often seen to be its guardians. There is a high chance that the CBDC will be distributed directly by the RBI to individuals. What could be safer than keeping one’s money with a central bank? The transfer of deposits could lead to a bank run and cause instability in the banking system. Deposits, which are an essential part of their liabilities, also go to the banks.
This will lead to the central bank becoming a narrow bank. This is a strategy that has long been promoted as a way to end the banking crisis. A bank that does not lend but invests its deposits in the most secure securities is called a narrow bank. The RBI invests its assets in the most secure securities. Commercial banks will be like other financial institutions that rely more heavily on bonds to meet their liabilities.
How can people get RBI-issued CBDCs. People can hold money and make payment in many ways right now. They have RBI-issued cash in their wallets. They also have digital cash issued to them by their banks in mobile wallets that are operated by the bank or another payment provider.
How will this all work in the case of a CBDC-issued by the RBI? Is the RBI going to create its own wallet? What will happen to the existing wallets that are provided by other services? Anyone can hold physical cash. This ensures anonymity and privacy in transactions. Digital money requires only a phone and an internet connection. All transactions leave a digital footprint. There will always be people without a phone or internet connection. While private options may exclude certain people, public options must be inclusive.
It is also important to take into account the cases where technology fails and people still have the ability to pay. People often pay in cash even when digital payment platforms are not available. These cases can be ignored by private digital payment options, but public digital payments made by the RBI must take into account all possible scenarios.
What will the impact of a CBDC in monetary policy? In a speech , Fabio Panetta from the European Central Bank stated that central banks lose control over monetary policy if there is less physical cash. Panetta believes that central banks like the ECB need to issue a digital currency. Sajjid Chinoy, JP Morgan expands the discussion and writes about the impact of private cryptocurrencies upon fiscal and monetary policy. He believes that private cryptocurrencies can undermine the effectiveness and efficiency of monetary policies, which will increase fiscal policy’s ability to stabilize economies. This will lead to capital outflows, as money flows to these cryptocurrencies.
India’s cash usage has not fallen and we will ban private cyptocurrencies. So Panetta’s view and Chinoy’s add to the list. The Bill will allow for the creation of a digital currency, which presents many challenges that will be of interest to monetary policy researchers.