The rapid introduction of a central bank digital currency is fraught with risks, especially for end users

In his February 1, 2022 budget speech, Nirmala Sitharaman announced the GoI’s commitment to issuing a digital rupee. The relevant text contained three sentences in its entirety. ‘Introduction of [a] central bank digital currency (CBDC) will give a big boost to the digital economy. Digital currency will also lead to a more efficient and cheaper currency management system. It is therefore proposed to introduce the digital rupee, using blockchain and other technologies, which will be issued by the Reserve Bank of India from 2022-23.

These remarks give the impression that time is running out and that the RBI must move forward as quickly as possible. Other central banks, including the People’s Bank of China, are already piloting their digital units. The early movers, it is said, will set design standards, not just for themselves, but globally. Their digital currencies will dominate international markets. Countries that lag behind will lose digital talent to – who knows? – the Bahamas, Dubai or another early entrant. Valuable opportunities to foster financial inclusion and improve payment efficiency will be wasted.

In fact, this emergency is overworked. The case for a CBDC has yet to be consistently presented. And a premature move in the direction of issuance would create costs and risks.

Certainly, a CBDC would facilitate payments. It would be safer and more hygienic than cash, and cheaper than credit and debit cards. But India already has an efficient and all-encompassing low-cost electronic payment infrastructure, the Unified Payments Interface (UPI), which instantly transfers funds between retail bank accounts, using mobile platforms (e.g., smartphones) at negligible cost.

Arguments based on financial inclusion are also exaggerated. A wholesale CBDC – where commercial banks act as agents of the central bank – would only be accessible to customers of those banks, not also to unbanked people. A retail CBDC, where the central bank transfers the CBDC directly to users’ mobile phones or smart cards, would also be available to others. But only if they had a smartphone capable of downloading a digital wallet or an internet connection capable of loading a smart card.

Can you run with the hare?

These interventions would face the same geographic and infrastructural challenges as existing financial inclusion efforts channeled through the traditional banking system. And, furthermore, they would have no clear incentive to adopt among those already included in the banking system. In any event, India has more direct ways to foster financial inclusion, including Basic Savings Bank Deposit Accounts (BSBDAs) and the Pradhan Mantri Jan Dhan Yojana.

Some cite the danger that the RBI, by failing to issue its own digital unit, will lose control of the payment system to private payment platforms and stablecoins. If so, the simple solution is to regulate them, rather than introduce costly sovereign competition.

Another argument in favor of a CBDC is to provide a global platform for the design and dissemination of smart contracts and other decentralized finance (DeFi) applications. Smart contracts are loans and related financial instruments that do not rely on the intermediation and monitoring of a bank. They can be built on a public blockchain, whose nodes then verify the transaction, and can be executed using the native coin circulating on that blockchain.

Currently, the majority of DeFi transactions take place on the public Ethereum blockchain, where Ether is the native coin. It is argued that a CBDC-based smart contract platform, mounted on a public blockchain, would be preferable. Its native currency would be more stable. It would be universally used. It would be a breeding ground for financial innovations.

We have our doubts. There have been a number of significant disasters with smart contracts running on the Ethereum blockchain due to programming errors. Smart contracts have allowed hackers to embezzle funds from naïve investors. Programming issues were subtle and remained hidden despite security audits and code reviews. One wonders if digital auditors working for central banks can do better. And there are fears of reputational damage to the RBI if it provided a platform for such ventures.

Finally, there are the risks associated with the rapid development of CBDCs specifically involving end users, especially if the CBDC effectively replaces cash. Vulnerable populations – even in economies plagued by digital payments – rely on physical cash as a bearer instrument. India’s experience in 2016 with the initial rollout of demonetization shows the pitfalls of rapid changes in cash-based segments of the economy.

Just hunt with the dogs

Imposing acceptance among merchants in ways that limit cash transactions could deprive vulnerable end users of key goods and services. If the CBDC is implemented through an account access framework, its ability to truly expand financial inclusion—a stated goal of several projects, including India’s—could backfire without a parallel effort to target other causes of financial exclusion, including infrastructure problems.

All of these arguments speak in favor of deliberate speed, not faster. Careful development, not rapid development, is the prudent way to go.

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