When Bitcoin was introduced in 2009, the aim was clear: to create a decentralized transaction system that was not dependent upon the political and economic powers and aspirations of any individual state. However, with the increase in popularity of cryptocurrencies and other digital currencies, states are attempting to introduce their own Central Bank Digital Currency (hereinafter, “CBDC”) to better regulate this emerging market trend.
As of July 2021, five countries have fully launched CBDCs (all in the Caribbean), and fourteen more (such as South Korea and Saudi Arabia) are in the pilot stages of introducing the same. In October 2020, the Bahamas was the first country to officially launch a nationwide CBDC, the Sand Dollar. With the initiative to curb money-laundering and ensuring accessibility to digital currency, the Sand Dollar is a digital fiat that is stored on digital wallets maintained and offered through commercial banks, money transmission businesses, credit unions and payment service providers. In August 2021, the Reserve Bank of India (hereinafter, “RBI”) admitted that Indian regulators have been sceptical about digital currencies including CBDCs, but the RBI would be ready to introduce a pilot project by the end of the year.
This paper aims at analysing the regulation of CBDCs in India, the challenges to regulation, and attempts to make a comparison of CBDCs in the jurisdiction of China. The paper begins by providing a background on CBDCs and their general regulation before moving onto regulation in India. It then delves into the challenges for regulation in India and makes a jurisdictional comparison before concluding with the way forward for India.
A decentralized system is when “transactions go directly from peer to peer without the need for a third-party to build trust and connect two potential transacting parties.”[i] Blockchain (the technology on which digital currencies are based) intends to eliminate traditional third-party institutions like banks or brokers or individuals like lawyers.
CBDC is a “new form of money” that combines “traditional and new forms of central bank money”.[ii] It is also “a central bank liability and is denominated in an existing unit of account that serves both as a unit of exchange and a store of value”. In short, CBDCs are the same as fiat currency but in digital form, as they are exchangeable one-to-one with fiat currency. They can, however, utilize blockchain systems and be encrypted instead of the existing anonymous central bank currency system.
With this background, we now move onto understanding the regulation of CBDCs in India.
CBDC in India
India has had a turbulent past with digital currencies. In 2018, the case of Internet and Mobile Association of India v. Reserve Bank of India, (hereinafter, “Cryptocurrency Case”) challenged the validity of the RBI Circular that banned regulated financial institutions from trading in cryptocurrency. While the Supreme Court stated that the RBI was in fact within its power to issue such a circular, in this particular instance, it was not considered a ‘proportionate action’ as the need to ban the trade of cryptocurrencies to prevent damage was not adequately established.[iii]
In April 2021, the ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’ was a proposed-to-be-introduced bill in the Lok Sabha. The Bill aims to ban private cryptocurrencies and lay out the framework for the RBI to issue CBDC.
In July 2021, the Deputy Governor of the RBI, Rabi Sankar, delivered a keynote address and stated that the RBI is planning on introducing CBDCs in a phased manner after weighing the policy implications. The following section gives an analysis about the changes required.
Regulatory Challenges for CBDC In India
It is seen that there are broadly three regulatory challenges that would need to be addressed before the introduction of CBDCs in India. These entail defining nomenclature, deciding payment systems type, and introducing enabling legislation.
Broadly, there are three forms CBDCs can take: currency, money or payment instruments. Currency is an official means of payment denominated in the official monetary unit and recognized by the monetary law, generally encompassing coins and banknotes. In India, the Coinage Act, 2011 confers legal tender status on coins and the RBI Act, 1934 (hereinafter, “RBI Act”) confers legal tender status on bank notes. Money is broader than currency and includes legal tender as well as money circulated by commercial banks and book money etc. Payment instruments are used to facilitate payment, such as cheques or bills of exchange.
While these nomenclatures are at times used interchangeably, it is essential to clearly define what a CBDC would entail so that the requisite regulation can be enabled. For example, in the event that a CBDC is money (for example, bank note), as suggested by the Inter-Ministerial Committee Report on Virtual Currencies (hereinafter, “IMC Report”), it would severely restrict the role and influence of the CBDC. It would also affect it’s denomination, remuneration value etc., and thus, it is important that there is a clearly defined terminology and accompanying regulation for CBDCs.
Payment System Type
Like any other payment mechanism in circulation, CBDC can either be retail or wholesale payments.
Retail payment systems are typically for payments made by households or businesses that handle large volumes of low-value payments, and include card, digital or e-wallet payment mechanisms. Wholesale payment systems on the other hand mainly process large-value payments for inter-bank settlements.
The payment system type would impact the regulation of the CBDC as it would determine the changes required to be made to the existing monetary infrastructure. For example, presently only banking institutions are allowed to open accounts with the RBI. However, if retail CBDC payments are introduced, and the RBI chooses a centralized, single tier model of regulating the CBDC, the RBI would necessarily need to be empowered to open accounts for other users.
Requirement of Enabling Legislation
As IMF posits, in the event that the regulation of CBDC goes beyond the mandate of the Central Bank, the regulation would be vulnerable to political and legal challenges. Thus, it would further disincentivize citizens from using CBDC. As mentioned by the Deputy Governor of the RBI himself, the current legislative framework in India is made keeping in mind paper currency and thus requires legislative changes.
Section 6 of the Coinage Act 2011 specifically excludes e-money issued by any Bank, Post Office or Financial Institution in its definition for ‘Coin’. However, since ‘Bank’ is undefined, it is unclear whether a Central Bank can issue CBDC as a ‘Coin’. Thus, there is a need for an amendment or a clarification for the same. Further, Section 25 of the RBI Act, defines bank notes, and Section 26 grants a legal tender status to bank notes. Similarly, coins issued under Section 6 of the Coinage Act 2011 are legal tenders.
Thus, while there exists a legal infrastructure to introduce CBDCs, there needs to be extensive legislative reform in the form of enabling provisions that need to be introduced. These changes need to be not only to the monetary legislations such as the RBI Act etc., but also to connected legislations such as the Information Technology Act, 2001, since CBDCs are heavily reliant on technology. The Government would also need to introduce laws and provisions on anti-money laundering and combating financial terrorism to ensure that there is compliance by users, and misuse does not occur.
The next section compares the regulation of CBDCs in China to analyse how it has tackled regulatory challenges.
Comparison with China
Unlike India, China is in the pilot stage of introducing its CBDC, the “e-CNY”. The e-CNY is the digital version of the fiat currency issued by the People’s Bank of China (hereinafter, “PBOC”) and is a ‘value-based, quasi-account-based and account-based hybrid payment instrument, with legal tender status and loosely-coupled account linkage’. Given China’s diverse population with varying degrees of digitization and literacy, such a hybrid model that still allows for cash transactions while enabling digital transactions seems most suitable. Based on a two-tiered system, the PBOC is the only authorized body that issues the e-CNY to the authorized operators such as commercial banks and other commercial institutions who in turn exchange and circulate it to the public. According to the PBOC White Paper (hereinafter, “White Paper”), it is a substitute for cash in circulation and would be circulated parallelly to the liquid Chinese Yuan (RMB), and is thus a retail payments system.
Key features also include that while it will be interoperable with existing digital payment platforms such as WeChat etc., it is different because it is a legal tender. Moreover, it does not require a bank account, supports offline payments, and provides anonymity. Interestingly, however, the White Paper proposes a limit on the amount of e-CNY citizens can have in their wallets, based on the strength of the customer’s personal identification information. This classification is perhaps introduced to automatically regulate the amount of e-CNY in circulation.
As for regulation, the Chinese Government has recently introduced the Law of People’s Bank of China (Revised Draft for Comments), which amends the definition of RMB to include both physical and digital forms of it. However, the White Paper specifically states that there is a requirement for further tailor-made regulations that emphasize its fiat currency nature, protect consumer interests, support innovative developments and clearly define regulations for authorized operators. Uniquely, the PBOC is also contemplating an e-CNY format that facilitates cross-border transactions, a model that has not been explored by other jurisdictions such as the Bahamas yet. On September 24th 2021, the Chinese Government issued a notification banning all private virtual currencies. According to the notification, the reason behind the introduction of such a conservative measure is to prevent the rise in financial crimes, especially since these private virtual currencies are issued by non-monetary authorities and are thus more difficult to monitor and regulate. The notification also explains the three prong security system implemented with this ban, which includes an updated mechanism for monitoring fund activities both online and offline. This seems to be in line with the steps that Nigeria also took, and as mentioned earlier, India is also considering.
Although the pilot project has been launched in the city of Shenzhen, the citizens are not as impressed by the e-CNY, given that digital payment solutions such as WeChat etc., had already replaced most cash transactions. Alternatively, many are concerned that a government issued digital currency would become another way for the government to track the citizens payments and whereabouts, despite the White Paper mentioning that the information collected would not be shared with third parties.
Way Forward for India
Analysing the above challenges and jurisdictional comparison, the author believes that introducing the Indian CBDC as a legal tender is the most viable solution in a country like India. In fact, the IMC Report relies on Sections 25 and 26 of the RBI Act to propose the regulation of CBDCs as a legal tender. The Report recommends that the Central Government first declare CBDC as ‘bank note’ under Section 25 of the RBI Act. Given that banknotes enjoy legal status under Section 26 of the RBI Act, CBDCs would enjoy the status of a legal tender. However, there necessarily must be a clearly defined enabling provision that authorizes the RBI to govern, issue and regulate CBDCs.
Similar to China, India too has a large and diverse population. In light of the same, a two-tiered system, wherein the RBI issues the CBDC to the authorized financial institutions who in turn facilitate the exchange of CBDCs would be most feasible. This especially since currently the RBI is authorized to only open accounts for banking institutions. Moreover, there is a necessity similar to the Bahamas, that use of the CBDC should not mandate the need for a bank account and that the opening of the digital wallets is done free of cost.
An issue that arises with this model however, is that legal tender as a mode of payment must necessarily be accessible by the majority of the population, else there is little advantage in its introduction. In India, only 38% of households are digitally literate which significantly reduces accessibility to CBDCs, and that is in the event that a token based CBDC is implemented. Thus, in the introduction of CBDCs, the Indian government must prioritize financial inclusion. This would entail multiple features, including not needing a bank account, supporting offline payments, no cost for opening a digital wallet and no interest attached to the CBDC. The last feature, (i.e, no interest attached) is of extreme importance as that would take away from the CBDC’s status as a currency, and would further exclude sections of the population and reduce their incentive to trade in CBDCs.
Presently in India, there is a long way to go to actualize the benefits of CBDCs. Given that there is no data that correlates the introduction of CBDC and financial inclusion in India, (especially in light of India’s abysmal digital literacy rate) perhaps, introduction of CBDC at this juncture is not the best step to take. While CBDC has multiple benefits in terms of ease of payment, the first step India needs to take in its introduction is to improve the digital literacy and financial inclusion statistics, especially since India is not as financially vulnerable as the Bahamas, or as digitized as China.
The views expressed above are soley of the author.
[i] Rani Shulman, Are Centralized Cryptocurrency Regulations the Answer Three Countries; Three Different Directions, 45 BROOK. J. INT'l L. 835 (2020) at 839.
[ii] Marco Dell'Erba, ‘Stablecoins in Cryptoeconomics from Initial Coin Offerings to Central Bank Digital’ Currencies, 22 N.Y.U. J. Legis. & PUB. POL'y 1 (2019) at 40.
[iii] Internet and Mobile Association of India v. Reserve Bank of India, Supreme Court of India, Writ Petition (Civil) No. 528 of 2018, at ¶ 6.167, 6.171, 6.173.