The Reserve Bank of India (RBI) may begin a pilot of its central bank digital currency with a soft launch this month. When it does, it will join a small cohort of central banks researching central bank digital currencies (CBDCs) that have advanced past the conceptual stage to the pilot stage. Only two central banks in the world have currently reached the stage of issuing CBDCs to their public.1 The Central Bank of The Bahamas introduced the Sand Dollar in October 2020, and the Central Bank of Nigeria unveiled the eNaira more recently, on October 25, 2021. Notably, the eNaira is the first CBDC to be introduced by a major economy. Nigeria is also the largest country in Africa by GDP and population. Any lessons from the introduction of the eNaira could therefore be instructive for other central banks, including the RBI.
In India, much of the discussion around the design of an Indian CBDC, or a digital rupee, has largely centered around its macroeconomic implications—like the impact on financial stability due to potential disintermediation of the banking sector (which would occur if consumers moved their savings to CBDCs instead of depositing them with commercial banks, thereby reducing the banks’ ability to mediate savings toward credit in the economy). But a key question the RBI will have to address as it seeks to introduce a digital rupee is: why should the Indian consumer choose a digital rupee over cash or over the other digital payment methods that are currently available?
As the eNaira’s initial experience following its launch illustrates, CBDCs are demand-based projects. The RBI will therefore need to do more than rely on its status as a central bank and, by implication, the issuer of safe and trusted forms of payment and settlement.2 It will need to design the digital rupee in a user-centric manner to encourage its wide acceptance—or risk failing to meet the intended objectives of introducing it in the first place.
CBDCs Are Demand-Based Projects
Several motivations, both positive and negative, are driving central banks’ research into CBDCs. Some central banks are hoping to leverage the potential benefits from a digital form of their fiat currencies. For instance, unlike cash, CBDCs can bear interest. With interest-bearing CBDCs, central banks can bypass commercial banks and transmit interest rates directly to individuals and businesses in order to conduct monetary policy more effectively.3
Some others, including the RBI, are exploring state-backed alternatives, especially as private digital currencies like stablecoins and cryptocurrencies raise concerns around monetary sovereignty of central banks and consumer protection, specifically because of the potential for rapid scalability and price volatility, respectively.
Objectives may also differ between advanced and emerging economies. For instance, the interest-bearing capabilities of CBDCs may be more useful for developed economies, where interest rates are already low and may even need to go into negative territory to boost economic activity.4 However, disintermediation from interest-bearing CBDCs could negatively impact an emerging economy like India’s, where banks continue to play a dominant role in the financial system.
Ultimately, though, whatever the objective, central banks will not be able achieve their goals unless there is sufficient uptake of the CBDCs from the target users. In the above example, unless individuals and businesses adopt and use the interest-bearing CBDCs, the central bank won’t achieve its objective of direct monetary policy transmission. CBDCs must therefore be designed to meet some consumer need or demand currently not catered to—or meet existing needs more efficiently than other forms of money. A recent report by a collaboration between the Bank for International Settlements and a group of central banks goes one step further, positing that central banks would also need to anticipate future needs of users in order for CBDCs to be effective.
In other words, CBDCs will be demand-based projects, as it is consumer demand that will spur adoption and use of CBDCs and their success. Central banks will therefore need to design CBDCs that are user centric. This is not a novel finding. But it is crucial to reiterate as the user perspective is largely missing in current CBDC-related research and discussion.
A User-Centric Design
In a staff discussion note, several International Monetary Fund officials discuss a useful conceptual framework of cost-benefit analysis to identify how users may evaluate different forms of money including CBDCs. Applying this framework, users will prefer a CBDC design that maximizes their private benefits while minimizing costs and risks—and that strikes this balance for them more efficiently than other forms of money do. Private benefits include liquidity, universal acceptance, and returns on the money. Potential costs include the lack of ease of use or inconvenience; transaction costs in the form of speed of settlement and fees; lesser degrees of anonymity; higher exposure to theft, fraud, and other risks; and the inability to recover losses. For the merchants at the point of sale or service, costs could mean fresh expenditures on any new devices necessary to transact in CBDCs.
While the eNaira is in its early stages, it has had some reported drawbacks, specifically related to ease of use, convenience, and robustness of legal frameworks, which may have impacted user uptake. For instance, the process for onboarding customers onto wallets in order to access the eNaira appears to have been cumbersome.5 Users were also concerned by legal provisions that absolve the central bank and its representatives for any losses arising from service disruptions, loss of revenue or profits, delays, loss or corruption of data, losses from system failures or malfunctions, security breaches, and even the information provided on the eNaira website. The benefit of this limitation of liability has been extended to independent contractors and agents of the central bank too.
As public institutions providing public goods in the form of central bank money, central banks are accountable to the public. Further, intermediaries—like payment service and technology providers—also typically operate within robust regulatory frameworks to bolster the safety and security of payment systems. Moreover, central bank money is considered a safe and trusted form of money, an important advantage compared to other forms of money. Legal provisions like the above, however, go against the grain of inculcating trust and confidence in public money, which in turn impacts adoption. Legal frameworks should instead be drafted carefully to reinforce public trust.
As central banks enter this new and complex territory, some issues are expected. Yet, these very experiences also serve as important lessons for other central banks, as either missteps to avoid or appropriate preparations to anticipate.
Furthermore, the above conceptual framework of cost-benefit analysis should also be accompanied by empirical studies to identify country-specific factors in order to determine the user-centric elements of CBDC design.6 A recent study conducted by Guardtime, an Estonian blockchain company, on consumer interest for CBDCs in ten countries (including Singapore, Sweden, the UK, and the United States) found that nearly two-thirds of the consumers surveyed were willing to use a CBDC within a week of its launch. This includes interest in various use cases such as savings, payments, and payment of salaries. These consumers also ranked attributes such as privacy, ease of use, and costs as their top concerns. But there were variations between the countries on both interest and attributes. European consumers ranked privacy as the most important attribute, whereas Asian consumers ranked ease of international use as their top concern.
In India, a survey undertaken by the RBI on retail payment habits of Indians found that convenience scored as the most important factor for using digital payments. The study also found that cash continues to be the preferred mode to make day-to-day transactions. So, if the digital rupee is meant to replace cash, the RBI will need to ensure it has a unique value-add, perhaps beyond convenience of use alone, that will help drive its adoption among such users preferring cash.
There are several private digital payment systems operating in India that enable instant payments, are easy to use, provide a seamless experience, and are available around the clock. Further, the RBI has been actively encouraging this vibrant digital payment systems in the country through various measures. Therefore, what specific problem or user requirement will the digital rupee solve that these private digital payment systems are failing to address?
In addition to designing user-centric CBDCs, two other key elements will define CBDC success. First, the central banks would need to devise a strategy for implementation. Central bank money is often referred to as the plumbing of the financial system. But much like plumbing, its attributes and advantages remain largely hidden to the public behind payment intermediaries like the banks, payment gateways, and mobile payment service providers that the public deals with every day. These private payment methods are safe because, ultimately, they must settle transactions in central bank money (the reserves held by banks with the central banks) and operate within microprudential regulatory frameworks. For the success of CBDCs, then, central banks must complement user-centric designs with strategies for adoption that increase awareness and engagement among their intended users.
Finally, central banks would also need to address the question of what constitutes sufficient uptake or wide acceptance. CBDCs are a nascent area. Precedents are few and new. Nonetheless, central banks will need to develop some metrics for measuring success.
Will these metrics be based on the volume or number of transactions, as current payment systems like those operated by the National Payments Corporation of India are measured by? Will they be based on digital payment transaction turnover in relation to GDP, and if so, what percentage of this aggregate measure would constitute a successful acceptance of a digital rupee relative to other payment systems? Moreover, how soon should such targets be achieved? Are temporal considerations important, given that the digital rupee would be a public good driven by public policy considerations, unlike private payments that are driven by profit as their principal motive? What is the right balance to achieve a wide acceptance of the CBDC yet avoid impeding private innovation in the payments’ space? These will be some of the questions that the RBI will need to address.
In short, the RBI must establish a link between its intended objectives from introducing the digital rupee and the demand for it. If there is no sufficient demand or uptake of the digital rupee, the RBI will have failed to achieve its objectives and to justify the use of public resources to introduce a central bank–issued digital currency. One way to drive wider adoption of the digital rupee could be to mandate its use, to the partial or full exclusion of other forms of private digital payment methods. This would, however, run contrary to the RBI’s own stated objectives of encouraging innovation, competition, and customer centricity in its vision for payments and settlement systems in India. Therefore, the RBI must design the digital rupee in a user-centric manner by identifying the user requirements, attitudes, preferences, and behavior that will drive the demand for a digital rupee.
1 This piece focuses on retail CBDCs, which are central bank liabilities that will be directly accessible by individuals and businesses, much like cash. Another type of CBDCs are wholesale CBDCs, whose availability will be restricted to certain financial institutions only, like banks, much in the same way that central bank reserves are today. A general purpose CBDC would be widely accessible to all. Beyond this broad classification, other types of CBDCs are described based on technology (account- or token-based), whether they replicate the current two-tier payments architecture (direct, synthetic, or hybrid CBDCs) or bear additional features (interest or non-interest bearing). As such, there is no single definition of CBDCs that is universally applicable. Instead, it depends on the design elements of the currency, such as those described above. In other words, unlike cash, CBDCs can be designed in various ways at both the institutional and monetary object level.
2 This piece confines itself to the means-of-payment function of central bank money. Other use cases for a CBDC could include its function as a store of value, for fiscal transfers, or other money functions.
3 Central banks will thus not have to rely on commercial banks who may not pass on the interest rates to the economy. For example, during the pandemic, risk-averse Indian banks that were hampered by weak balance sheets failed to pass on the policy rate cuts intended to fuel economic activity. The flipside is, if CBDCs can also bear interest like bank deposits, consumers might find them more attractive and move their bank deposits to CBDC accounts with central banks, especially since central bank money is considered the safest form of money due to low credit risk. If this happens, it could lead to a disruption in the banking sector’s role in intermediating savings toward credit provision in the economy, potentially impacting its growth.
4 A recent survey of central banks by the Bank for International Settlements also found varying motivations between advanced economies and emerging and developing economies (EMDEs). EMDEs were found to have stronger motivations for examining the issuance of CBDCs as a replacement or complement to cash—meaning, for a retail or general purpose, for payment efficiency and safety, and for financial inclusion. For advanced economies, the motivation for retail or general purpose CBDCs was found to be primarily payments safety and future preparedness.
5 The eNaira can be accessed by individuals and businesses through wallets. Two types of wallets have been made available—the eNaira speed wallet, for individuals, and the eNaira speed merchant wallet, for merchants. The commercial banks have been made responsible for verifying and onboarding their customers on to the wallets.
6 The International Monetary Fund Staff Discussion Note also mentions that the relative weights attached to the various private benefits and costs will differ by user and countries.