E-Rupee: India's Foray Into Digital Currency – Explained

The Reserve Bank of India (RBI) has finally launched its pilot programme for the e-rupee, India's own Central Bank Digital Currency (CBDC). The programme, which commences on November 1, will be India's first tryst with e-currencies. Over the past few years, several central banks around the world have jumped on to the CBDC bandwagon, researching the feasibility of digital currencies, and figuring out the best way to put them to practice.

According to the RBI, e-rupee will simply be a digital form of the Indian rupee that is already in use. The central bank released their concept note regarding CBDCs on 7 October. In the document, the central bank has laid down their motivations behind introducing the e-rupee, the design and technological considerations that go into it, as well as the policy aspects of bringing about such a drastic shift in India's monetary transactions.  

The introduction of CBDCs in India raises many important questions. In a country that has wanted to ban the practice of cryptocurrencies, what is to be understood from the central bank's move? Not to mention, the finance minister (FM) Nirmala Sitharaman, who had earlier asked the public to exercise caution while dealing in cryptocurrency, herself has said that CBDCs will be fully launched in India by 2023. This makes it important to know what CBDCs are, how they are different from cryptocurrencies and UPI transactions, and also about the safety concerns associated with CBDCs.  

What Is CBDC?

CBDC is a digital currency that is issued by the central bank of a sovereign nation. By definition, it is freely convertible against the physical currency issued by the same central bank. Similar to physical currency, one need not have a bank account to transact using CBDCs either. However, one major distinguishing factor between CBDCs and physical currency is that CBDCs will have an infinite life, in the sense that it cannot be damaged or lost in any physical form. It will be managed on a digital ledger that may or may not be blockchain-enabled.  
 
CBDCs can be of two types: retail (CBDC-R) and wholesale (CBDC-W). The wholesale kind would be used for interbank settlements and other wholesale transactions whereas CBDC-R would be used for retail transactions as an electronic form of cash. CBDC-W is expected to reduce transaction costs and make the inter-bank markets more efficient. The RBI pilot programme that begins on November 1 is for CBDC-W alone, with another pilot programme for CBDC-R expected to start by next month. Presently, several other central banks across the world are exploring the possibilities of putting CBDCs into practice.  

CBDCs Around The World

A study by Atlantic Council GeoEconomics Center has found that close to 105 countries are considering the possibility of launching a CBDC that would be primarily used for interbank transactions. From an estimated 35 nations in as recently as 2020, this is a significant jump. About 19 of the Group of Twenty (G20) countries are exploring the issuing of CBDCs and most of them have made progress beyond initial research stage.  

Among the developed nations, China has made the maximum progress as far as large-scale use of CBDCs is concerned. There are several successful pilot projects that are running across several cities in China. WeChat, the country's foremost payments platform and messaging app, recently launched a feature allowing users to select e-CNY, China’s CBDC, as a mode of payment on the platform.  

In the light of these global trends, India's foray into CBDC was announced by the FM Nirmala Sitharaman during this year’s budget presentation, which is not too long ago when viewed against the years of research that have gone into CBDCs in other nations. The Centre warmed up to the idea of having CBDC as a counter to the growing popularity of cryptocurrencies, which, according to the RBI as well as the government, has the potential to be used for criminal activities.  

CBDC Versus Crypto

Shaktikanta Das, the governor of RBI, had previously described the crypto ecosystem as a “clear danger.” He went on to say that anything that derived value that is only notional, without any underlying asset, was just speculation.   

The Centre also echoed similar sentiments when it went ahead and imposed heavy taxes on cryptocurrencies and virtual digital assets. Following FM Sitharaman's announcement during this year's budget presentation, any income from transfer of virtual digital assets, such as cryptocurrencies, has been liable to be taxed at he rate of 30 per cent. Additionally, the government also imposed another tax deducted at source (TDS) of 1 per cent on any payment made in relation to transfer of virtual digital assets. If the government has such strong views against crypto, then it is clear that they see it as something very distinct from the CBDCs that they wish to implement.  

Explaining the difference between CBDCs and crypto, Sharat Chandra, co-founder of India Blockchain Forum, says, “The basic difference is that CBDC is backed by a sovereign nation or its central bank whereas crypto is a form of private money that is not backed by any sovereign entity. In terms of payments, there would not be much difference because the very reason why CBDCs came into being is because cryptos were able to fulfill the payments functionality. In both cases, payments and settlement happen instantaneously.”

Chandra elaborates that in the case of UPI (Unified Payments Interface), any transfer on the platform might seem instantaneous but the settlement happens on the backend between two banks. “Settlements happen in batches. Payments and settlements are disjointed processes in the current context. But if we are using CBDC or crypto, the programmable nature of money allows you to make settlements instantly,” he adds.  

Some experts are sceptical of RBI's push for an e-rupee. Sunil Aggarwal, Dean of Blockchain Programmes at TalentSprint, believes that through CBDC, RBI is trying to capture the cryptocurrency space but is unlikely to be successful. “RBI wants to enter the virtual money space by creating a stablecoin. But it doesn’t have network effects because that needs an underlying utility. All the transactions and payments space that there was in India has already been captured by UPI,” he says.   

Aggarwal added that virtual currencies like Ethereum or Bitcoin have an ecosystem of cryptocurrency exchanges and other technology developers, while nothing of that sort is available with the RBI. Interestingly, more than a year ago, El Salvador announced that Bitcoin was to be made legal tender in the country. However, what followed was far from a success story. The value of Bitcoins has more than halved since the central American country adopted it as its legal tender. Subsequently, El Salvador's credit rating has also been downgraded this year, marking their Bitcoin move an official failure. If popular cryptos like Bitcoin can be so risky, what about CBDCs?

Risks Associated With CBDCs

Several countries have been researching on CBDCs for far longer than India. Sweden’s central bank explored pilots and architecture of its own CBDC for five years but is yet to take a final call on issuing e-krona. The US Federal Reserve has sought public view on whether to come up with an official tender on CBDCs that would compete against private stablecoins. Digital euro is still under investigation and that would continue for another two years. Japan is likely to delay its decision until 2026 whereas Singapore has let the idea pass after weighing in its pros and cons.

A large number of concerns, relating to data security and financial stability, have come up in the investigations surrounding CBDCs around the world. US Fed Chair Jerome Powell said that cyber risk was his primary concern around financial stability. A UK House of Lords report has highlighted that privacy risks and cybersecurity were the primary reasons to avoid developing CBDC.  

These fears are not unsubstantiated. CBDCs have the capacity to accumulate sensitive user and payment data on a massive scale. In the wrong hands, this data can be easily used to spy on the private transactions of citizens, secure security-sensitive details about organisations as well as individuals, and also theft of money. “If implemented without proper security protocols, a CBDC could substantially amplify the scope and scale of many of the security and privacy threats that already exist in today’s financial system,” International Monetary Fund says in a paper titled Central Bankers’ New Cybersecurity Challenge.   

This does not mean that there are no ways around the concerns associated with CBDCs. The risks of having a centralised data pool could be mitigated by not collecting such vast data at all. Or there has to be a validation architecture that enables each component to view only the amount of information that is required for functionality. Cryptographic tools like zero-knowledge proofs, used to validate private information without compromising it, or cryptographic hashing techniques can help in providing data security.  

India's Hasty Sprint

CBDCs will have a long path towards public adoption, asserts Sunil Aggarwal. “It will take at least 10 years and will probably impact 1 per cent of India’s money supply. So, if it will impact just 1 per cent, what kinds of goals is it planning to achieve?” he points out.

India’s timeline seems a little rushed to understand the various nuances of introducing CBDC. The last time India made a hasty decision that had an impact on its money supply, people were left stranded in long queues for many hours, desperately trying to withdraw their own money. Taking a cue from other nations that have been researching CBDCs for a long time now, India can do better by putting out a more feasible timeline. A risk-free CBDC would need a secure and resilient infrastructure that can be scaled accordingly, keeping in mind India's large population. As such, it is important to have more discussions, involving all stakeholders, that would help incorporate all of India's requirements to its CBDC infrastructure.