Perspectives from ISB

Thu, Jan 19 2017. 04 31 AM IST Sovereign digicoin: a road map for RBI

By pushing banks to issue wholesale debt on the capital markets, a central bank digital currency may induce market discipline

The emergence of cryptocurrencies like Bitcoin have led central banks around the world to develop a research agenda around digital currencies, both private and sovereign. Photo: Bloomberg In July 2016, an editorial in this newspaper had queried, “Should RBI issue a new digital Bharatcoin?” and ended on a futuristic note encouraging policymakers and regulators to have a “discussion on Bharatcoin”. It is a testimony to the prescience of this newspaper that its early exhortation to explore the issue of Bharatcoin has found an echo in the report of the committee on digital payments. The report, recently made publicly available for comments, notes several benefits of introducing a central bank digital currency (CBDC). It concludes the discussion by recommending that the Reserve Bank of India (RBI) evaluate the possibility of RBI-issued digital currency and testing proof of concept.

However, the report itself does not explore the issue further. This op-ed will attempt to bridge that gap by analysing its likely design, the mechanics of issuing it and the political economy of issuing it (without necessarily taking a stand on the desirability of issuing it). The emergence of cryptocurrencies like Bitcoin have led central banks around the world to develop a research agenda around digital currencies, both private and sovereign. The Bank of England and the Central Bank of Canada are leading producers of scholarship surrounding it. The op-ed borrows from their thought leadership in the instant discussion.

First, the design: The report notes that a CBDC would be like “e-cash”, essentially a non-interest-bearing liability of the central bank issued in digital form. That is correct but it need not be issued merely as e-cash. The central bank may choose to issue the CBDC as an interest-bearing instrument as well (for an example, visit.

In fact, it would be more consequential to financial stability and more relevant to monetary policy if the RBI were to issue it as an interest-bearing instrument. Issued simply as “e-cash”, it would function exactly as physical cash functions presently, as a medium of exchange between peer-to-peer and peer-to-business transactions and as a counter-cyclical store for value. Issued as an interest-bearing instrument, it would compete with the deposits issued by commercial banks. Given that it would be issued by the central bank, it is possible that subject to its widespread accessibility, it would raise the cost of capital for commercial banks as households may flock to it.

If it is as easily accessible as bank deposits or “mobile money”, it may catalyze capital structure changes in the way commercial banks fund themselves by eating into their current and savings account ration. If so, they may have to fund themselves on the wholesale markets, thus introducing much-needed market discipline through bond-holder monitoring and run-risk. Over time, if the flight to CBDC is substantial, the need for deposit insurance may also require a rethink, thus saving taxpayer money.

Second, the mechanics of issue: The report offers no guidance here but three elements appear critical. Unlike private currencies that do not have a specific issuer and essentially rely on the trust of the participants to circulate, a CBDC will create a liability on the balance sheet of the RBI. Operationalizing the CBDC would also sequentially require validation and settlement.

Validation is necessary to avoid the so-called “double-counting” problem that arises in the context of digital currencies. Simplified, it means ensuring that the payer has not already used the “same” CBDC to pay another payee prior to the current transaction.

Borrowing from the Bitcoin architecture, the RBI may choose to outsource the validation function to several licensed nodes on the blockchain. Again, on the lines of Bitcoin, these payment system participants may perform the validation function against the incentive of receiving CBDCs, the value whereof is contingent upon the complexity of the mathematical code-crunching that goes into validation. Finally, settlement finality is critical; the RBI may develop a standard consensus procedure that determines the precise moment at which the “transfer” from the payer to the payee is completed; this may involve determining the number of “nodes” necessary to validate the transfer for it to be deemed complete by the payment-system participants. A key challenge would be to balance the competing interests of latency and robustness.

The benefit of issuing the CBDC on a distributed ledger technology like blockchain (as against the RBI itself acting as “bookkeeper”) is that it would make the system “anti-fragile”, to use the expression popularized by Nassim Nicholas Taleb. By dispersing the record-keeping among several participants, the use of blockchain-like distributed ledgers make the system resilient to black-swan events like say, for instance, 9/11.
Finally, the political economy issuing a CBDC: Since the RBI is also the regulator of the banking system, public-choice economics would in theory suggest that the RBI issue a non-interest-bearing CBDC so that its constituents do not have competitive pressures to contend with. On the other hand, subject to scale effects (which appear easier to achieve given it’s the central bank issued liability), it appears that by pushing banks to issue wholesale debt on the capital markets, a CBDC may induce market discipline in the origination of loans and should in theory help the taxpayer.

Author of the Op-ed, Mandar Kagade is a policy analyst with the Bharti Institute of Public Policy, Indian School of Business.
The author thanks Aditi Sinha of BITS, Pilani for inputs.

DISCLAIMER : Any comments, speeches, articles, blogs, podcasts, videos/vlogs, opposite the editorial page/opinions andeditorials page (OP-ED), interview response etc. made by individuals should be accompanied by a clear disclaimer from the ones given below.

“The views expressed in this article are personal. Mandar Kagade is  Analyst at the Indian School of

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