Central Bank CryptoCurrency (CBCC):

Digital currency is currently in news.  Russia and China is reported to be on the verge of issuing official cryptocurrency.  CME, the world’s largest exchange, is planning to introduce future on Bitcoin by the end of this year.Here Here  In my last post I have explained why Bitcoin can be considered at best a currency of a community- a virtual country, so to say-  of Bitcoin users. So a future on a foreign exchange of an unknown country without any verifiable foreign  trade activities  is definitely problematic.  Be that as it may; the possibility of introducing digital currency by central banks is now a hot topic. The head of the Secretariat of the Committee on Payments and Market Infrastructure of BIS along with a colleague has recently published a paper on the Central Bank Cryptocurrencies.  In this paper the authors have identified four key properties of Money- issuer (central bank or other); form (electronic or physical); accessibility (universal or limited); and transfer mechanism (centralised or decentralised). It is interesting to see that the authors have failed to identify the most important property of money- unit of account. A medium of payment is not a currency unless it is also a unit of account. That is why  a credit card, a bank debit card or a prepaid cash card  is not money, despite each being a digital medium of payment.   In fact, in terms of volumes as well values, the medium of payments even in a developing country like India is largely electronic. The following table shows that money in India exists mostly in the digital form, as most of the bank money is. Even after exclusion of  time deposit from the ambit of  payment system, the digital money ( bank money)  dominates the physical money or cash.

Composition of Broad Money (M3) in India

So issuance of central bank currency would only digitalize the cash component of money as other medium of payments are already in digital form. So  CBCC  should be considered only as a replacement of physical cash issued by a central bank.  The champions of cryptocurrency, however,  would like it to be the sole medium of payments, at least of the online variant. It is difficult to understand why anybody would like to replace a part of the system that is working fine with another only because of its compatibility with a particular ideology about issuance of money.  In fact, instead of reducing the cost, a decentralized transfer mechanism like bitcoin would increase the social cost of running a payment system.  Leaving aside these ideological issues about money for now, let us consider the possibilities of issuing cryptocurrency by a central bank. I intend to outline a protocol that can be adopted in the specific case of India. In this post I enumerate the essential features that a Central Bank Cryptocurrency Currency(CBCC) should possess with specific reference to India.

The Reserve Bank of India (RBI) spent on average 35 billion of rupees in printing notes in last 3 years, ignoring the spike of 2016-17 due to demonetization. This amounts to more than 500 million dollars- not a small sum.  The commercial banks also have to incur huge cost  over and above the printing cost incurred by RBI to manage the last mile of the currency supply chain.  If we can replace printing of notes by creating digital strings of binary numbers in computers, the total cost could be easily reduced significantly.  It is not necessary to eliminate physical cash completely. Digital and physical cash could coexist for a long time to come. When every citizen is connected to the digital space we can think of complete elimination of physical form of cash.

Let us first understand how the paper currency system works in India. Before that, we need to consider the enormity of logistics involved in cash management system in a country like India. As on end March 2016, 90 billion pieces of notes and 89 billion pieces of coins were in circulation in India. The number of currency chests and coin depot/sub-depot were 4211 and 4008 respectively at the end of 2012. There were around 222 thousand ATMs in India. The details of the currency supply chain is given below.

1. Note printing presses print notes as per indents placed by Currency Management department of RBI.One characteristic of the paper note is worth noting here; every note has a distinct identity.
2. RBI receives the currencies in their vaults
3. RBI remits the currencies so received to various currency chests maintained at bank branches.
4. The commercial banks run the currency chests as an agent of RBI, while the treasure in it is the property of RBI. Any withdrawal or deposit into the currency chest is recorded as debit or credit respectively in the bank’s account maintained with RBI.
5. Transport of currencies from currency chests to other bank branches  is the responsibility of banks.
6. General public can obtain cash from banks either over the counter of bank branches or from ATMs. Government departments having accounts with RBI  withdraw cash from RBI counters to meet their cash needs, and thereby inject cash into the economy.
7. When general public or government departments deposit cash into their bank accounts, the banks or RBI examine the circulation worthiness of deposited notes. The soiled notes are then withdrawn from circulation and briquetted by RBI.

We are interested in designing a supply chain that delivers digital currency to general public, maintaining the basic functionality and integrity of the existing supply chain.  We need not differentiate between notes and coins in the digital environment. .

The main characteristics of the proposed CBCC would be as follows:

1. Each note would have specific denomination- large denomination of 5000 and 10000 can also be introduced.
2. If Alice wants to pay 102 rupees to Bob and Alice has only one 100 rupees and one ten rupees in her wallet, the system would function exactly the way cash based transaction would function. Alice would pay one 100 and one ten rupees to bob. Bob would immediately pay back to eight rupees to Alice in denominations available to Bob.
3. Like Bitcoin there would be wallets as app in mobile or users can use hardware based wallet also. There is no question of having any exchange as custodian of wallet in dematerialized form.
4. A person without a bank account can download a wallet and can receive digital currency in this wallet.
5. There would be no connection with a wallet with wallet holder’s bank account. However, a wallet holder would be able to download cash from her bank account as currently she withdraws cash from her bank account. The only difference would be that the bank / ATM would give her digital cash and not physical cash
6. There would be no special KYC verification for downloading digital wallet apart from providing a unique identification number.
7. In case of loss of a wallet, the process would be the same as it happens if one losses one’s physical wallet containing physical cash. A First Information Report (FIR) has to be registered with a police station and the system would ensure that missing digital notes are blocked to the extent the digital money in the lost wallet has not been spent till that time. After completion of investigation the cash can be restored to the original owner.
8. The central bank may prescribe a limit to the value of digital currency a wallet can hold. For example, it may be stipulated that the wallet is designed to hold a maximum amount of 100 K rupees. A wallet holder would not be able to load cash to her wallet from a bank or from another payer more than amount.
9. It may be possible to take insurance for loss of a wallet with a sum insured to the extent of a pre-determined fraction of the amount lost. The wallet holder has to pay the insurance premium.
10. It would be issued by the central bank as it is done today.
11. It would retain the anonymity of cash to a large extent- but theoretically for a given transaction payer and recipient’s identity can be found out.
12. There would be almost instant authentication of any transaction without any third party verification. The central bank would take the responsibility of authentication without any manual intervention. The process would be almost instantaneous as it happened in the use of debit card today.
13. It would run parallel to paper currency till such time the share of paper currency becomes negligible
14. It would be a legal tender with the rider that if the recipient of a transaction is not ready to accept digital currency, the payer has to pay the former with paper currency.
15. All government agencies would have the infrastructure to receive digital currency. No government agency or a public utility would not be able to deny any digital currency transaction if the counterparty insists on that form of transaction. Thus a citizen would be able to buy a bus or metro ticket with digital currency. Taxes also can be paid by digital currency.
16. A bank account holder can go to a bank branch or an ATM and would be able to load digital currency in her wallet as if physical cash is being dispensed as it happens today.
17. With the consent of its employees, an employer can pay wages or salaries in the form of digital currencies. Government would prefer to give subsidies through digital currencies.
18. Digital currencies would not work outside the jurisdiction of the issuing central bank. Thus it is a legal tender within the country of issuing central bank.
19. A foreign citizen can exchange foreign currency with digital currency as long as he or she gets the wallet downloaded from the issuing central bank’s portal. The only restriction is that if the wallet is used for transaction outside the issuing central bank’s jurisdiction, it would not be authenticated. A money changer can exchange foreign currency (paper form) with domestic digital currency.
20. No transaction fee is to be paid for using digital currency
21. The central bank would be free to issue digital currency of any amount as it happens today.

Is it possible to have CBCC with all the above features? Surely it is possible using the same technology that Bitcoin uses, with some tweaking. In my next post I will outline a high level   design of such a system. I am confident that it should be possible to develop such a system which would not allow double spending and provide a very high level of anonymity to transactors and their transactions.

Other references: here here