Take on Digital Currency in India by Gurneet Kaur

Introduction:

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The article below talks about the hot topic prevalent among many central banks and governments worldwide: Introduction of the sovereign backed Digital Currency. It describes the many variations money has gone through the decades and what led to the ideation of such a radical form of money. It further includes the many reasons why other countries, both developed & developing, are already in their testing stages to check the viability of this new form of e-money. The major highlight of this paper is to explore the consumer behaviour concept of 'pain of payment' and using it to strengthen the case for CBDC. The article concludes with the impact CBDC will have in India and the many challenges that are needed to be addressed before moving to the pilot stage of RBI's digital currency.

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Evolution of E-Money[1]-[2]:

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The digital payment mechanism that we use now for transactions, especially in the ongoing covid-19 pandemic, was not in place until decades ago. As the Wallstreet American movie rightly puts it- 'money never sleeps', it apparently does not considering how much it has evolved over the years. Initially, people made transactions through commodities, i.e. exchanged goods for goods, and these goods transacted for another ‘with consent’ was considered money. This is popularly known as the barter exchange. But the concept didn't work for the following reasons[3] (1) it required the two parties to have goods and services that each other wanted, which was not practical, (2) not all goods could be measured in the same unit, (3) making deferred payments was not an option, and finally (4) most of the commodities could not be stored for a long duration.

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Due to the reasons mentioned above, communities started using precious metals such as gold and silver, which had some intrinsic value. It was used both as pieces of jewellery and for transactions. This new form of money functioned better than the barter regime as a medium of exchange because (1) it was accepted in most societies, (2) it was relatively easier to carry and (3) it lasted longer. It could also be easily divided into smaller units, and future payments were feasible. (Mankiw, 1999, pp.156-157).

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Gold was used as a medium of exchange throughout the centuries. When this was prevalent, some countries allowed gold to be traded for goods and services. Many times, the paper and coins were considered equivalent to gold at an agreed-upon exchange rate. However, the rising inflation and eroding of US gold stockpiles made the US decouple dollars from gold in 1976, thus marking the end of the gold standard.

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Although many problems with the acceptance of metal as money were solved, there still existed some difficulties as they were cumbersome to carry, and were prone to theft and adulteration. Furthermore, only a few countries had the required availability of metals, so it could not be used as a standard of money.

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In ancient Rome, gold and silver were money to people. When Emperors in the 2nd and 3rd centuries needed more money, they regularly reduced the concentration of gold and silver in their coinage, resulting in these coins containing no precious metal at all towards the end of the 3rd century, and the Roman Empire experienced severe inflation as a result of the production of only worthless coins. This led to the evolution of banks in the 16th and 17th centuries in England and merchants deposited their gold there and obtained a statement/certificate detailing how much they had deposited. When the merchants wished to buy something, they could easily sign this statement over to other people. (Schenk, 1997- 8).

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Consequently, paper currency (i.e., pieces of paper that serve as a medium of exchange) grew popular. Unlike the certificate of gold, this paper money is guaranteed by the government and is recognized as legal tender. Because its face value surpassed its intrinsic value, it is referred to as fiat money. In today's world, most societies use fiat money. The central bank's fiat is used to issue and manage national currencies. Fiat currencies are stable, trustworthy, and efficient, assuming monetary authorities are competent and honest.

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Even with the wide acceptance of paper currency, payment mechanisms evolved due to advances in technology. Technology helped (1) streamline financial infrastructure, (2) reflect all transactions in one dashboard, (3) facilitate cheaper and faster exchange. With the invention of the electronic fund transfer system (EFTS), money was transferred to other accounts simply through devices facilitating an easy exchange of large sums of money and maintaining transaction records.Then evolved debit and credit cards , which popularly became known as plastic money. However, digital payments also come with few disadvantages that still need addressal such as service charges by payment processors, cyber theft, lack of infrastructure and technical problems.

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Electronic payment systems began with EFTS, debit cards, and credit cards and moved to digital wallets, UPIs, cryptocurrency and paved the way for central banks contemplating issuing digital currency in the economy.

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Digital Wallets[4], UPIs and Private Currencies

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Digital wallets require the users to add money from their bank accounts and make transactions with enticing discounts & offers. The history of digital wallets in India goes back to July 2004 when oxigen wallet was launched, which was India's first-ever e-wallet/mobile wallet. Later in 2006, wallet365.com was found, but both of them failed to attract users. The digital payment concept was actualized in India only when MobiKwik was debuted in 2009, followed by Paytm, airtel money, amazon pay etc.?

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The National Payment Corporation of India was established in April 2009 to integrate all of the country's payment mechanisms and make them consistent for retail payments. By March 2011, RBI discovered that each Indian resident only engages in six non-cash transactions per year, even though 10 million merchants accepted card payments. Owing to this fact, RBI issued a four-year vision statement in 2012, indicating its commitment to developing a secure, efficient, accessible, inclusive, interoperable, and authorized payment and settlement system in India. It's part of the Green Initiative, which aims to reduce paper usage in the domestic payments sector. Consequently, UPI was launched for the first time in 2016 for public use.

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UPI is based on a four-pillar, interoperable push-pull approach, with a remitter/beneficiary front end PSP (payment service provider) and a remitter/beneficiary back end bank that settles monetary transactions for users. According to Netmagic Solutions' CEO, UPI has become one of India's most successful deep tech innovations.

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The success of digital payment[5] systems was foreshadowed by the 2016 demonetization, and? consequent increase in technological adoption, massive e-commerce growth and negligible transaction costs associated with their use—the latter being a major thrust. However, it is not going to be long before they start charging Indian users. As per the article in the Times on India, Google pay, the most widely used payment medium, has started charging its users in the U.S.[6]. In the capitalist economy as it exists today, no business intends to give free services to their customers for a lifetime. Jio offering free internet services to capture market share is a prime testimony to this phenomenon.

Around the time when original digital wallets were failing, another currency was under development which even concerns the government and monetary authority even today- Cryptocurrency[7][8]. In 2009, the first decentralized payment medium, bitcoin, was created, and now it has a USD 2 trillion market capitalization which is as much as India's GDP. The major concern with cyptocurrency transaction was to ensure that the currency is spent only once. This issue does not occur with cash transactions because the cash once spent cannot be used to purchase another good or service. Nevertheless, this problem of ‘double payment’ was tackled with the implementation of blockchain technology. Blockchain, simply put, is a decentralised ledger which makes hacking or changing data stored in it impossible. This technology checks whether the same bitcoin was spent before and maintains the centralised records. It received so much attention because it solved the 'double payment problem' without involving an intermediary like Visa or Mastercard, i.e., no third party was needed to record a transaction in both parties' accounts with the help of blockchain technology. The point to note here is that this virtual currency is not backed by any gold or fiat but only by the value that people assign to it. And that's why the government is afraid of this, as they are losing power to the ordinary citizens.

But the question comes in- how do they derive their value? The answer is it's the miners who solve some mathematical problems using their processing energy for which they get rewarded with bitcoin, thus adding the supply of bitcoin to the economy. Bitcoin has enormous benefits like anonymity, decentralization and lower transaction cost due to the elimination of intermediary but at the same time, it raises some issues such as (1) it provides an opportunity for crime such as transactions over the dark net, ?(2) avenue for theft if the bitcoin wallet is not encrypted, (3) it is not accessible to all, and most importantly, (4) it is not accepted widely.

RBI made its stance clear on the circular issued in April 1, 2018 that it is not against investors trading in cryptocurrencies, its up to their discretion; however, the banks are prohibited from dealing in virtual currency or offering any related service to its customers. The government has strictly referred cryptocurrency as not legal tender but may soon be accepted as an asset[9] under SEBI supervision in India.

Central bank digital currency[10]:

The incredible rise in digital payments and trading in virtual currencies in India with the vision to go into a cashless[11] economy, especially after covid has provoked the RBI to issue digital currency which will be accepted as legal tender, unlike the virtual currency we have today. One reason why virtual currency or digital payments has tracked attention is its independence from the banks for cash. And hence, moving to a cashless economy can provide stability and convenience if cyber threats are taken care of. CBDC is the digital form of legal tender money issued by a central bank per RBI. It will have the exact authenticity as fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different. In simple words, CBDC is the same money that we have today, only that its form is not paper. It is the sovereign currency in digital form. It would appear as a liability (money supply) on a central bank's balance sheet, the same as that of paper currency currently issued[12].

Other than India, other countries[13] diligently test the introduction of CBDC as legal tender; the list includes China, Sweden, The Bahamas, France, The Philippines, Japan, Turkey, Switzerland, amongst many others. Progress and motive behind issuing digital currency by some countries are mentioned below:

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China[14]:?

The People's Bank of China (PBoC) was one of the first central banks to concentrate on establishing a CBDC, organizing a dedicated task force in 2014. The idea gained traction in April 2020 when the testing of a CBDC prototype was disclosed. The Chinese CBDC prototype, known as DC/EP (digital currency/electronic payment), is now being tested in both the private and public sectors.

The main motive behind this introduction is that the PBoC wants to defend its monetary sovereignty by limiting demand for private cryptocurrencies (Wilmoth 2018) and preventing Libra, a Facebook-backed digital currency, from gaining traction in China. Because Libra would not be backed by the Renminbi (RMB), widespread acceptance by Chinese citizens could jeopardize the PBoC's sovereignty (Bartz 2019). And at the same time, they wish to internationalize yuan by promoting cross-border RMB payments (Bloomberg 2020).

Sweden[15]:?

According to the Riksbank, one of the main goals of issuing an official e-krona (Digital currency of Sweden), is to create a public alternative to future commercial currencies created by Big Tech and to ensure that confidence in the monetary system is maintained. Moreover, the deputy governor of the Riksbank, Cecilia Skingsley, predicts that Sweden will be cashless by 2023. (Jones 2018) as cash accounts for only 20% of all payments in Sweden (Statista 2019), and an increasing number of retailers are projected to discontinue accepting cash in the future.

The pilot test on t e-krona is expected to use blockchain technology, and the Riksbank will manage it alongside the tech giant Accenture. Even while Sweden population use less cash than any other country, some segments of the population still struggles with technological advancements and depend on cash for transactions. If cash acceptance continues to drop, those people will become increasingly marginalized. The e-krona is introduced to target persons who avoid making digital payments in order to compensate for their financial marginalization. Such an endeavour, to increase financial inclusivity, can only come from the public sector than the (profit-driven) private sector as there is very less likelihood of any profitability.

The Bahamas:?

The Bahamian CBDC initiative is known as "Sand Dollar," and its prototype was launched in December 2019 in the district of Exuma and two months later in the Abaco Islands.

The primary motive behind sand dollars is that opening bank branches on distant islands is not so cost-effective for banks. Furthermore, more robust anti-money laundering (AML) and counter-financing of terrorism (CFT) regulations increased the cost of banking services, resulting in a further reduction in bank branches (Island Crypto 2019). Surprisingly, the drop of bank branches did not result in a greater acceptance of electronic payments but rather a greater use of cash. As a result, Sand Dollars is expected to make digital payment services more appealing by boosting confidence in the e-payment system (CBoB 2019, p. 4).

The government has said that the private use of Sand Dollars will not require a bank account to reach unbanked portions of the population. Sand Dollars can also be used without a mobile device owing to a card-based version that can be updated using POS devices, thus promoting financial inclusion, which is another important goal of sand dollars.

England[16]-[17]:

The Bank of England and the Treasury together have launched a joint task force to explore a potential central bank digital currency—Digital Euro. As per the discussion paper issued by the Bank of England, if CBDC were to be introduced in England, it would work under the mechanism of the central bank having access to the core ledger, and API (Application programming interface) access to banks who would further provide a user-friendly interface to users to transact through CBDC.

Serious consideration to CBDC is given because of its many advantages, such as eliminating private money creation, creating a digital economy, better cross border payments etc.

Japan[18]:

The Bank of Japan started testing the Proof of Concept (POC) of its central Bank digital currency on April 5, 2021, to see if the main functions and features required for CBDC are technically feasible. The bank intends to establish a test environment for the CBDC system and perform experiments on the essential operations that are core to CBDC as a payment instrument, such as issuance, distribution, and redemption, in Phase 1 of the PoC. This phase is expected to last till March 2023, totalling a period of one year. They are considering making payment mechanisms efficient and risk-free for a digital society.

Theoretical background: Can CBDC increase consumption?

Making payments for purchasing goods or services is a widespread practice in modern society yet, this act of exchange is far from being a dispassionate affair. Recent behavioural economic theories of purchases have found an emotion in the paying process: the experience of "direct and immediate displeasure" among people (Zellermayer 1996, p. 2), establishing the concept of "pain of paying." The idea that individuals consider an emotional experience when deciding whether to purchase a product directly contrasts to the basic economic assumption, which traditionally regards paying as simply a rational act and not an emotional one.

Mazar & Plassmann found that paying money indeed stimulated pain-processing brain regions, the emotive components of feeling pain through their experiments. Furthermore, they discovered that the giving up behaviour triggered when the participants paid through cash, causing them pain. Hence, cash was concluded to be more painful than credit cards. (Pain of Paying by Mazar & Plassmann, 2017).

Through their experiments, Als, Prelec and Simester found that participants who were told they would be paying with a credit card in an experimental auction setting bid considerably more for a pair of sporting event tickets than those who were told they would be paying with cash. Hirschman (1979) used actual consumer transaction data and discovered that consumers who bought with credit cards spent more than those who paid with cash or cheques after controlling for other circumstances. Hence, it can be clearly observed that how customers paid seemed to impact how much they paid. (Soman, D., 2003, P.173-183).

The question now arises: Why is cash more painful than any other method?

A series of interviews were conducted, and it was found that cash is the most transparent payment method since it allows you to see exactly what you're paying for. Other payment methods like plastic cards, e-wallets etc., are not as transparent as cash, which establishes a direct relationship between transparency of the payment system and pain associated with payment (higher the transparency, higher the pain). (Soman, D., 2003, P.173-183).

Furthermore, research has been undertaken to prove that consumers experience less discomfort while paying with mobile phones and watches than when using credit cards because the consumer's attachment mitigates the pain to the payment tool. When an object is lost, attachment can cause "feelings of self-loss". As attachment grows, so does the pain of paying, which is why cash is the most painful payment method. ?(Ball and Tasaki, 1992).?

The findings imply that using new payment tools such as mobile phones or watches may actually improve the customer experience by reducing the agony of paying. (Francesco Pisani and Selin Atalay , 2018)

Hence the above content establishes these two points:

The direct relationship of transparency & pain of payment
Possession of an object creates an emotional attachment to that very object.

These findings can be linked with the consumption of an individual. If the payment system is non-transparent, the spending by consumers can be increased. Many people even utilize this concept and pay through cash to manage their budget & expenses. Suppose the central bank wishes to increase consumption, they have to make citizens use less transparent methods such as digital payments will be beneficial to the economy as a whole, especially at the time of recession (such as the time of the pandemic, when people are less willing to consume), thus strengthening the case of introducing regulated digital payments (CBDC) in developing countries such as India.

Impact in India:

As per statista[19] data published by Sandhya Keelery, August 24, 2021, India had the world's second-largest population using internet services at over 749 million users in 2020. This figure is estimated to reach over 1.5 billion by 2040, where 73% of India's total web traffic comes from using mobile phones.? Also, Digital payments have grown at an impressive CAGR of 55 per cent. This massive growth in digital payments shows that there is a possibility that Indians might comfortably accept this new form of fiat money.

Also, RBI's recent initiative[20] to locate the areas where online transaction is very low through geotagging and developing infrastructure to improve it is another step in moving towards a cashless economy.?Under this trial scheme, the RBI is allowing small value offline payments with built-in safeguards such as user security & liability protection. Authorized Payment System Operators (PSOs) — banks and non-banks – will be able to provide offline payment solutions for remote or proximity payments using cards, wallets, or mobile devices. When using cards in offline mode, the card data and transaction information are retained at the terminal, generating a transaction response with data that can be used to generate a receipt. The stored payment data is sent to the payments platform for processing when the internet connection is restored.

Suggested Working Model:

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CBDC can be established through blockchain technology where the RBI will have a master ledger of all transactions. Banks can help in assistance to check for 'double spending'; in this case, the end-users will manage digital currencies through their digital currency wallets. A major advantage in this model is that International payment will be possible, but internet connection will be required, which might be a massive challenge in remote locations. However, to assist in this regard, IoT can be put to use. Through IoT, transactions can be facilitated offline without an internet connection. And later, the payments can be reflected in the ledgers once the internet is connected. This will be more feasible for India, where the internet is not very stable and not readily available in remote locations. However, this technology will only facilitate domestic payments because on-point payment contact is required. The diagram below reflect how this shall work:

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Diagram reflecting the suggested working model of CBDC

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CBDC Advantages[21]:

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Help in increasing consumption

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The discovery that the payment process has a significant impact on the desire to pay has essential implications for the government. If the government wants to boost up spending in order to boost GDP, encouraging customers to use a stored value smart card or credit card instead of cash might be a viable option. Furthermore, because payment mechanisms have been shown to impact consumer buying behaviour significantly, the government may consider increasing its investment in payment technologies. The new payment technology, in particular, should not require a signature or a password to ease its complicated design and it should be designed to eliminate cash transactions.

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The overall volume of digital payments in the country has increased from 1459.02 crores in F.Y. 2017-18 to 4371.18 crore in F.Y. 2020-21 as a result of further efforts towards digitization. Some measures have already been taken to encourage digital payments, such as FASTag and DigiVaarta, as well as to increase the popularity of BHIM's barcode-based merchant payment mode among merchants and traders in general.

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Also, Telangana became the country's first state to launch an official e-wallet. The state created the T-Wallet, the state's official digital wallet, which provides people with a 24/7, anywhere platform for digital payments at no additional cost. To raise awareness about digital payments, the Digi Dhan Abhiyan and Vittiya Saksharta Abhiyan initiatives were undertaken[22].

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2.????????????????? Reducing Transaction Cost[23]

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The most widely used payment mechanism like cash, digital wallets, UPI, NEFT transfers, etc., incurs transaction fees that could be eradicated/ limited through digital currency issued directly by banks through RBI.

Banks charge a fee for UPI transfers, which are the most extensively utilized payment method today[24].?

On person-to-person UPI payments[25] beyond 20 transactions per month, Axis Bank, ICICI Bank, and Kotak Mahindra Bank, for example, charge Rs 2.50 for amounts up to Rs 1,000 and Rs 5 for transfers exceeding Rs 1,000. HDFC Bank charges Rs 2.75 and Rs 5 for the above limits, respectively.?

Similarly, NEFT, RTGS, and IMPS charge a flat 4% for transferring money from your wallet to any bank account after a specific limit (avg. Rs 1000) and Paytm charges a flat 4% for sending money from your wallet to any bank account.?And, Mobikwik costs 2.95 per cent of the transfer amount, according to the website's rates[26].

CBDC will reduce such costs because it won't require any account maintenance or minimum balance fees, no overdraft charges, and no returned deposit fees, among many others.

Moreover, Fees and currency expenses are common in standard wire transfers and international transactions[27]. Because there would be no intermediary entities in digital currency transactions, transaction costs will be lower than for bank transfers. This can be a very beneficial for travellers. Furthermore, the transfer will be quick, removing the hassle of customary authorization formalities and wait times.

?????????3. Economic surveillance

As per Arthakranti, a thinktank[28], 2-3 times of GDP of India is black money. GDP of India is $ 3 trillion or Rs 210 lakh crores, and black money is Rs 600 lakh crores. Of this, 15% or Rs 30 lakh crores held in cash in houses and other places have been removed due to demonetization, but the rest are yet to be discovered. Some of these are still in cash, some in the form of Benami properties, some stacked in Swiss banks. But if CBDC is introduced, all the transactions could be regulated and identified. If the money is tracked, tax collection will also improve and be easily calculated, forming the most considerable portion of the government's overall income.?

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????????4. Reduced use of private currencies[29]

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To reduce cryptocurrency transactions, the government needs to take steps to create awareness that these private currencies are not viable. And introducing sovereign backed virtual currency will help this and also prevent counterparty risk, which is the major drawback with virtual currencies we have today. CBDC could also protect the public from the abnormal level of volatility some of this virtual currency experience. The most recent example being a jump of of 50% in dodgecoin in a day just by a single tweet on February 2021 by Tesla CEO, Elon Musk.

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Even though the central bank digital currency has a huge potential to better the Indian economy, there are still various challenges that the government & RBI has to face to ensure its successful implementations. Some of these challenges are:

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·????????????? Around 72%[30] of the Indian population is based out of rural locations where the infrastructure is not as developed. Therefore, the introduction of digital currency might not ensure financial inclusivity. However, the recent geotagging initiative by RBI to improve infrastructure in rural locations might take care of this issue, but it will not be eradicated soon.

·????????????? Even if the transaction cost, cost of maintaining minimum balance etc., will be reduced, for management of CBDC infrastructure, the government will still charge some fixed cost.

·????????????? If the mobile phone is lost or the private key is lost/hacked, the end-users can lose all their money. However, this threat is already applicable to paper and digital wallets that we use today.

·????????????? There will be some decrease in the use of virtual currency with decrease in risk to a certain extent , but this cannot be said for sure as the main reason for this high transactions in VCs is anonymity, which will be lost if the government-regulated digital currency is introduced.

·????????????? CBDC can help identify, verify, and record each transaction made through it. But the question arises: What if the black money still exists due to existing cash supplies? It is not feasible to go completely cashless as long as 1.3 billion people have internet connections & mobile phones.

·????????????? Cash in Circulation is still rising despite the hike in UPI transactions. Cash held by Indians in 2017 was Rs 8 lakh crore, and today, it has been increased to Rs 28 lakh crore[31]. The pattern in UPI spending has revealed that people are still using cash for a large volume of transactions. The question now arises- Would CBDC be able to win the confidence of Indians to use digital mode of payment for high volume transactions as well?

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Future Scope:

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The article at present covers secondary research on the evolution of money from its commodity form to ideation of digital currency to be issued by RBI as legal tender to exchange goods & services. Their recent statement announced the pilot stage of testing CBDC in India by next year. To substantiate the advantages & disadvantages analysed, a lab experiment can be conducted and pain of payments concept can be actually tested. Furthermore, primary research in the form of exploratory interviews can be undertaken to expand on the suggested working model of CBDC & its execution in India.

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Bibliography

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K?nig, S. (1997). THE EVOLUTION OF MONEY. Retrieved from https://wustl.edu/: https://wueconb.wustl.edu/E1043S00/schenk/Money/Commodities.html Schenk, R.

Mankiw, N. G. (1999). Macroeconomics. In N. G. Mankiw, Macroeconomics. New York: Worth Publishers.

Raghubir, P. &. (2008). Monopoly money: The effect of payment coupling and form on spending behavior. Journal of Experimental Psychology. APA PsycArticles, 213–225.

Soman, D. (2003). The Effect of Payment Transparency on consumption: Quasi-Experiments from the Field. The Netherlands: Kluwer Academic Publishers.

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