?? Special Edition: India’s 51-page CBDC report

Gm! This is the doodhwala, the only crypto newsletter that comes to you not once but six times a week. That’s right we stick to the doodhwala name ??

Today’s post is a wooozay!

It’s about a ?? HOT TOPIC ?? that everyone is talking about.

The thing is, everyone is wrong!

Including us.

So, we’re not going to talk about it.

Instead, we’re getting a guest to talk about it!

This dude is:

• a crypto builder ??
• ex-coFounder of?Dehidden???
• the OG-iest ???? OG, you’ll eva meet

This guest post is written by ??? Dhruva Chakravarthi

And it’s about ???India’s CBDC

LFG ??

Wait, why is this important? ??

The RBI recently released a report on their studies and plans for CBDCs in India.

I’m not sure when was the last time any of you read a 51-page report, but no fear, the Doodh is here.

We’ve done the reading, research, and even a peer review for you, so you’re all up to speed about the topic while sipping your morning doodh. ??

To set context, let’s explain what a CBDC is.

The Central Board Digital Currency is a digital form of a country’s fiat currency. Many countries are exploring and working on their implementation to help transition to a digital economy, enabled by the technology we have today - the internet, databases, and cryptography.

TL;DR

The Indian CBDC proposal can be best comprehended as a better form of cash, than a worse form of crypto, aiming to solve infrastructural problems around the cash economy in ????.

Here’s some of the key features:

• CBDC is a sovereign currency issued by Central Banks in alignment with monetary policy
• Appears as a liability on the central bank’s balance sheet
• Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
• Freely convertible against commercial bank money + cash
• Fungible legal tender for which holders need not have a bank account
• Expected to lower the cost of issuance of money and transactions

Here the probs ??

In the 70+ years since independence, India’s cash-heavy economy has served us well.

But technology can help us revamp this system, and that’s the motivation of the RBI as per the report.

Is it the best technology or the best solution?

Arguable. ?? ♂?

While the CBDC proposal aims to solve multiple key problems of the cash economy.

But here are the 3?? main issues to understand:

1. Cash Finality: Cash finality means creating a data layer that banking institutions, central or intermediary, would finalize the cash settlement onto. It would be one reliable source of information to account for all the money transacted with and within the country. ??
2. Infrastructure Costs: The cost of running our current economy is quite high, relative to the technology solutions we have today. From printing money, to building brick-and-mortar banks, multiple accounting systems, and all the people who work jobs every single day to run all of this. Just ensuring the stability of our monetary system is resource and cost-intensive. ??
3. Cross-Border Payments: The hassle of moving cash while traveling across borders adds friction to the common man. We’re restricted in many ways, not because we aren’t free to move money across borders, but because it is the only way governments can enforce anti-money laundering across borders. ??? ♂?

How tf will this system be built? ??

Now, this is where it starts getting interesting (or boring, depending on who’s reading).

You might not have to worry about a lot of this because this is infrastructural stuff, that if done right, should go unnoticeable to us all.

But it’s good to know how our system will be built, especially if we don’t know how it currently works:

1. CBDC-W and CBDC-R: Yep, there would be two different types of CBDCs. ???CBDC-W will handle the wholesale economy between financial institutions, which should make interbank payments and security settlements faster. ???CBDC-R is for the retail market, to set the foundation for all private sector, non-financial consumers, businesses, etc.
2. Administration models: The CBDC can very simply be centrally administered by the RBI in a ‘Single Tier Model’ or ‘Direct CBDC Model’. This would make the Central Bank the single source of issuance and distribution of digital currency.

Or it can bring in a degree of decentralization by adopting a ‘Two Tier Model’ which could work in 2?? ways:

• An ‘Indirect Model’ where some power is provided to intermediary banks to provide the CBDC to the consumers on demand, and only settle the wholesale bank balances with the central bank.
• A ‘Hybrid Model’ where a messaging layer allows the Central Bank to issue CBDCs to intermediary banks, giving them the responsibility and liability of handling customer-associated activities.

3. Bearing Interest: The CBDC could choose to pay positive interest to those ‘depositing’ them in banks. This would incentivise people to just lock up their cash and not use it in the economy while inflating the currency supply. The simpler option would be for these CBDCs to be non-interest bearing, which might not incentivise the users to switch to it, unless they value the other economic benefits of the CBDC.

4. Database Architecture:

• A ’Token-based’ CBDC system would store data at a transaction-first level. The core data would be every transaction of the token in the country, while wallets/accounts act as intermediaries. This is generally how any ledger-based system or transactional system is designed since it manages the high volumes of transactions effectively.
• An ‘Account-based’ CBDC system would treat each user account/wallet as the core data layer of the system, while transactions are managed as an offshoot. This is how most user base systems are designed, making it harder to handle the transactional volume, but simpler to migrate account data from legacy systems.

5. Anonymity: To digitally replicate cash transactions, anonymity would be important. The RBI intends for the CBDC to have user anonymity at a transaction level, universal acceptance of the transaction, as well as finality of said transaction.

6. Fixed Denomination vs Minimum value: The intuitive way of designing this system would be to have the CBDC reflect the value of the rupee in the cash economy by pegging each CBDC token to a minimum Rupee value (Re1 or 1p). The other method would be to have CBDC tokens reflecting cash denominations used like Rs. 500, 100, 50, etc which would be easier to convert cash economy to CBDC, but increase infrastructure costs to manage and account for more token types.

Damn, that was A LOT of words.

So, let’s take a break. Here’s a meme.

Okay, real talk ??

Now that you know the different design directions the RBI is considering, each with its own pros and cons, the current preference of the RBI is to ??

• CBDC-R and CDBC-W as the two fundamental token types
• Intermediary model to include banks
• Use non-remunerative (not interest bearing) CBDCs
• Treat CBDC-W as “Account-based”, and CBDC-R as “Token-based”
• Managed anonymity, similar to cash

Cool Specs ??

• Offline functionality → Enabling people to use the digital currency without always having to need the internet
• Limited programmability → Would enable more robust financial tooling to be developed, like credit systems to back agricultural industries and MSMEs
• Interoperable integrations → With existing payment systems like UPI, VISA/Mastercard, NEFT, PayPal, etc
• Cryptographic encryption → To make the system more resilient to cyber-attacks or data manipulation
• Recoverability → In case of breaches or exploitation

Alright, where do we go from here? ?? ♂?

The RBI intends to explore the pros and cons some more, but begin to implement the solution in a phased approach to mitigate risks at scale.

The phased implementation would begin with a prototype of the solution, followed by a controlled test implementation with intensive testing.

Link to some better studies:

1???PwC Report on CBDC compared across other countries

2???Doodhwala Twitter Spaces Peer Reviewing the paper

3???The entire CBDC Report by RBI (October 2022)

Here’s my hot take ??

• The proposed system shows that the RBI is actually doing its research and trying to fix complex infrastructural problems faced by a country. Kudos to the RBI! Hopefully, it’ll get better from here.
• There seems to be an extreme lapse in the centralization risk posed by the CBDC system. The C does stand for Central, after all.
• Centralization risks put too much economic power with policymakers (which is how it currently exists). But the problems scale with the system - even small chances of corruption, user monitoring, and system manipulation could create huge impacts on the economic and democratic stability of the nation.
• Having a public governance system overseeing the CBDC’s management might be a beneficial feature, this maintains the democratic trust of the nation with financial institutions.
• While it might be too early to depend on blockchain technology due to its nascency, the same can be said of the DLT systems of other countries. We might be inheriting risks unnoticed by these countries in a monkey-see-monkey-do fashion. It might be wise to wait + study these systems as they are implemented to the scale of blockchain systems.

But that’s just my two Sats. ??

Stay tuned for another crypto concept deep dive next Sunday!

Big ups to Dhruva for dropping some knowledge bombs on the doodhwala audience.

Give him a ?? on Twitter and let him know who sent ya.