The markets have been buzzing with the Government of India’s new Bill, ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’. The Bill proposes to ban all private cryptocurrencies in India. Even before passing of the Bill, it has created an impact with prices declining across key cryptocurrencies.

Union Finance Minister Nirmala Sitharaman on November 30 said that the Bill will be introduced in Parliament only after Cabinet approval.

The Bill proposes the Reserve Bank of India (RBI) create an official digital currency, a Central Bank Digital Currency (CBDC), and it makes certain exceptions to promote the underlying technology used by cryptocurrency.

Let’s discuss the RBI issuing a digital currency.

How will a CBDC be created? Will the RBI use its centralised ledger system or use the decentralised blockchain model to create it? The centralised system gives more control, whereas a decentralised model is supposed to be more efficient. BIS economist Raphael Auer and Rainer Boehme, a Professor at University of Muenster, in their research note discussed different technologies that can be deployed to create a CBDC. The RBI will need to learn from global experiences, and shape its own technology given the context, and history.

Should the CBDC be wholesale, or retail, or both? A wholesale CBDC means a digital currency for financial institutions, whereas a retail CBDC means a digital currency for the general public. In a wholesale CBDC, the idea is that financial institutions use it to transact with each other in central bank money to settle their accounts. In several ways, much of this activity is already digitised with institutions using central bank reserves to settle transactions. So even if the RBI shifts from digital reserves to wholesale CBDC, it might not change much in terms of the overall development.

The real deal is the creation of a retail CBDC, which leads to multiple inter-related questions of distribution, bank stability, and technology mediums. For distribution of physical banknotes, the RBI uses the extensive currency chest, and bank branch network. For distribution of the CBDC, while one can stick to the current system, there is a more efficient way wherein the central bank issues the CBDC directly to the people.

So far we see people opening accounts at respective banks which becomes a medium to access banknotes as well. Technology can enable the RBI to open bank accounts with itself, and distribute the CBDC directly to the people. Due to technology people can open an account with the RBI to invest directly in government securities. Similar accounts can be created to issue the CBDC.

However, this direct distribution model could create instability in the banking system. One of the major liabilities of banks is public deposits, and banks are often seen as its guardians. If the RBI chooses to distribute the CBDC directly to people, there is a strong possibility that people transfer their deposits to the central bank. What could be more secure than keeping one’s deposit with a central bank. This transfer of deposits will resemble a bank run, and destabilise the banking system. The banks also lose deposits which are a vital part of their liabilities.

If the central bank takes this route, it will become a narrow bank, which for long has been touted as one of the ways to limit the crisis in banks. A narrow bank is a bank which does not lend, but invests deposits in the safest of securities. The RBI does invest its assets in the safest securities. On the other hand, commercial banks will become like financial institutions which rely more on bonds for liabilities.

How will people hold RBI-issued CBDCs? Currently, people hold money and make payments in multiple ways. They hold RBI-issued physical cash in their wallets. They also hold digital cash issued by their respective banks in mobile wallets operated either by the bank or other payment providers.

In the case of an RBI-issued CBDC, how will all this work? Will the RBI develop its own wallet? If it does, what will happen to existing services providing wallets? Physical cash can be held by anyone, ensures privacy, and anonymity in transactions. With digital money people at least need a phone with Internet connection, and all these transactions leave a digital imprint. There will always be some people who do not either have a phone or Internet. Private options can choose to exclude people but public options need to be all inclusive.

One also needs to consider cases when technology fails, and still people are able to pay. We often see people pay with physical cash when digital payment platforms fail. While private digital payment options can ignore these cases, public digital payment by the RBI needs to consider all the possible cases, and not leave anything to imagination.

Finally, what will be the implications of a CBDC on monetary policy? Fabio Panetta of the European Central Bank in a speech pointed out that with the reduction in the usage of physical cash, central banks lose the lever of monetary policy. Panetta says that central banks such as the ECB should issue a digital currency for this very reason. Sajjid Chinoy of JP Morgan broadens the discussion by writing on the implications of private cryptocurrencies on fiscal and monetary policies. He argues that private cryptocurrencies could undermine the effectiveness of monetary policy which will put additional pressure on fiscal policy to stabilise economies. It will also lead to capital outflows as money moves to those economies which have these cryptocurrencies.

In India, cash usage has not declined, and we are going to ban private cyptocurrencies, so Panetta’s and Chinoy's views add to the list of questions posed above. To sum up, designing a new digital currency leads to several challenges which will interest the monetary policy researchers once the Bill is passed.

Amol Agrawal is faculty at Ahmedabad University.