The digital ruble is a step towards the evolution of wholesale and retail payment systems in the Russian Federation, however, the possible benefits depend on the final format of the new asset implementation. This is stated in the analytical report of the cryptocurrency exchange Binance and the company Mindsmith.
CBDCs provide clear advantages in the convenience, efficiency, stability, and affordability of retail payments.
With the fall in demand for cash and the lack of an alternative in the form of CBDC, citizens will lose access to central bank money. In this case, the credibility of the national currency will depend on the authority of financial intermediaries.
Experts name among the positive results from the introduction of the digital ruble:
- the provision of an efficient cash substitute, coupled with control over the illegal use of the asset;
- ensuring financial stability;
- reducing the negative consequences for banks by reducing their role in money creation.
Preferred digital ruble model
The digital ruble model described in the Bank of Russia report assumes that commercial banks will receive more powers in terms of managing users’ wallets. In a sense, this will limit the flexibility of the centralized model.
On the other hand, such a format will create favorable conditions for the active involvement of fintech companies in improving the convenience and efficiency of operations for end customers, and will also become the basis for the rapid development of market competition.
The account-based digital ruble is seen as a much simpler alternative to the proposed model and could help combat money laundering. This option is also able to provide a high level of security and control of CBDC emissions, without the need for solutions with complex architectures and expensive computations.
The impact of the digital ruble on other market participants
CBDC has the potential to lead to volatile financing of commercial bank deposits. Even if the digital currency project was created primarily as a means of payment, during periods of crisis, a large-scale flight of economic agents towards the central bank is possible.
With a stable financial system, commercial banks will be able to offer the population an effective alternative to the digital ruble: an increased interest rate that compensates for credit risk or another range of services.
However, in the face of an economic shock, an increase in the interest rate on deposits is unlikely to stop the transition to other banks, cash and central bank accounts, which will become available with the introduction of the digital ruble.
Due to the multifaceted nature of the risks, potential project participants must first agree on the role and legal responsibility of each.
The Bank of Russia can diversify risks and commission an independent third party to develop, integrate or support the operation of a digital currency. Or create an independent governing body to remove some of the workload and associated expertise requirements.
Confidentiality of the digital ruble
The desire to remain anonymous is not necessarily associated with illegal activity. Although even a stable, trusted and completely confidential digital currency can be suitable for illegal transactions.
If CBDC transactions become fully public, such a digital currency will likely not diminish the demand for private forms of money and raise fears of excessive control.
The anonymity of the digital ruble is not a binary characteristic. As part of the intermediate options, users can register with their IDs to create CBDC accounts. Data can be stored anonymously if, for example, transactions do not exceed a certain threshold or regulators have no reason to suspect that the account is associated with illegal activity.
The design of the digital ruble must be carefully balanced so as not to compete with bank deposits and reduce the risk of degradation of financial intermediation.
Important properties of the digital ruble
Existing retail and wholesale payment systems ensure stable functioning by restricting access. In cryptocurrency systems, barriers to participation are minimized, and operational stability is based on a system of economic incentives and technical measures to prevent attacks.
This does not mean that CBDCs should fully apply cryptocurrency approaches in order to create a completely open system. The Bank of Russia can benefit from models of cryptocurrencies such as Bitcoin.
- Using distributed ledgers
The choice of infrastructure for the implementation of various CBDC models is one of the key design issues for the digital ruble, since the requirements differ significantly in different implementation scenarios. The use of blockchain within the CBDC framework can go a long way towards creating a technology environment and expanding the use of financial technology.
In the context of the models considered by the Bank of Russia, decentralization can occur at two levels: the admission of new participants to the system (the level of opening wallets) and transactions (the level of settlements).
A token-based system is capable of providing universal access and confidentiality as any user can obtain a digital signature. One of the major drawbacks is the high risk of losing funds if end users do not keep their private key. Problems are possible in the development of an effective system for combating money laundering.
Even if the Central Bank of the Russian Federation decides to abandon the use of blockchain as a basic CBDC infrastructure, some features of this technology can still be useful.
- Smart contracts and programmability
The digital ruble must have sufficient functionality to improve the usability of central bank money, support innovation and interoperability with other payment systems. Therefore, experimenting with an asset should start with the minimum programmability required to implement the required functions.
At the same time, the digital ruble should be designed taking into account the scalability of the solution in the future.
Should the digital ruble be accepted everywhere?
At the stage of widespread industrial exploitation of the digital ruble, widespread acceptance by trade and service enterprises is a prerequisite for effective popularization.
The potential integration of the digital ruble with payment systems MIR, Visa, Mastercard, UnionPay and others has a strong mutual synergistic effect. They could become powerful partners in ensuring the massive diffusion of the digital ruble.
How to secure the digital ruble and users?
The digital ruble must meet high security standards in terms of technology and user properties.
The accelerated digitalization of the financial sector will open up new opportunities for cybercriminals. Decentralization through the introduction of blockchain will potentially increase the number of attacks, and the emergence of a fundamentally new level of automation based on smart contracts will create fertile ground for the emergence of threats.
For safety, you must ensure:
- The availability of the digital ruble is its ease of use, the ability of the system to withstand large-scale «classic» and blockchain-specific cyber attacks.
- Integrity – Protects against double spending, fraudulent charges, and unauthorized access to hardware devices.
- Confidentiality – characteristics that minimize both the amount of stored information and multi-level access to it.
What to do with offline payments?
To meet the key features of cash, the digital ruble must allow offline online payments, be easy to use, and provide an adequate level of privacy protection.
At the initial stages of development, CBDC can be implemented without the offline payment function. However, when switching to large-scale testing, this opportunity must be provided for all market participants on equal terms.
Why is the digital ruble needed?
The implementation of CBDC potentially answers a number of challenges, the relevance of which has increased significantly in recent years:
- decrease in the popularity of cash and an increase in the share of non-cash payments against the background of the development of financial technologies;
- increased competition for national currencies from cryptocurrencies, DeFi tokens, as well as projects like Diem (formerly Libra);
- achievement by a significant number of central banks of the effective lower bound of the interest rate and reduction of monetary instruments;
- the irrelevance of many payment infrastructures.
What should be the digital ruble and what will it give
The Central Bank of the Russian Federation has identified two models of ownership of the digital ruble. The first is based on deposit accounts at the central bank for all households and businesses. In terms of functions, they will be similar to regular bank deposits, including Internet solutions and mobile applications, and commercial banks can provide services for exchanging bank deposits for CBDC with a possible commission.
Alternatively, the Bank of Russia could offer a token-based digital currency with minimal regulatory influence. Such a concept could become popular among central banks due to the possible anonymity of the CBDC. In this case, the regulator will not know who is currently holding the issued tokens, as is the case with cash.
- Improving the efficiency of retail payments
There are a number of arguments that support the importance of CBDCs in supporting the efficiency of retail payments:
- decreased demand for banknotes;
- the low level of household access to the commercial banking system, which can occur both in the least developed countries with an undeveloped banking system and in countries with relatively high income inequality;
- unstable or overly concentrated retail payment infrastructure.
- Cash replacement and illegal use control
Some researchers analyzing the privacy of payments and anonymity of the CBDC fear that the lack of anonymity will significantly limit the freedom of citizens.
- Overcoming the lower bound of the interest rate
If CBDCs are used to completely replace cash, this would theoretically push interest rates down to the effective bottom. A CBDC-based economy will potentially enhance the effectiveness of monetary policy during the financial crisis.
Such a scenario would help both in the issue of overcoming recessions, rising unemployment or deflation, and in the need to resort to unconventional monetary policy measures.
- Development of monetary policy tools
CBDCs have the potential to expand the range of monetary policy options and improve its overall effectiveness through adjustable interest rates.
This position does not mean that the accrual of interest on the digital ruble is a necessary and sufficient condition for the effectiveness of this instrument. However, such a scenario should be considered at least as part of an experimental study of the concept of the digital ruble.
- Optimizing incentive measures
CBDC can be used as a tool to increase aggregate demand. For example, by direct distribution of the created digital money among the population, which in the long term will facilitate the achievement of price stability.
- Ensuring financial stability
CBDC will enable the concept of sovereign money to be implemented – a system where banks will no longer create demand deposits and new funds.
Settlement in central bank money will potentially reduce credit risk in payment systems. This will reduce the relevance of large banks, the need for government deposit guarantees, and the negative externalities of financial destabilization.
CBDCs are capable of effectively replacing cash in the context of retail outlets with stable internet connections. However, the use of CBDC for autonomous peer-to-peer payments requiring a reliable and resilient network infrastructure is a controversial topic.
In the context of a “narrow” banking system, CBDCs are gaining importance as an alternative to deposits, combining zero credit risk and a digital format.
Benefits and negative consequences
Taking into account the non-obviousness of the consequences of the introduction of the digital ruble for commercial banks, a number of potential advantages and disadvantages are highlighted.
- optimization and acceleration of settlements for interbank transactions will lead to an increase in customer loyalty;
- lower barriers to entry into the status of a payment service provider due to the transition from a multi-tier banking system to a distributed system based on CBDC will increase competition in the payment services sector. In the long term, this will reduce transaction costs;
- the potential replacement of correspondent banks with a single transactional platform based on CBDC will increase the speed of transactions and transparency of payments;
- the introduction of a peer-to-peer direct interbank payment mechanism will reduce credit risk and counterparty settlement risk, freeing up significant amounts of collateral.
- the cost of implementing an interbank settlement system based on CBDC at the initial stages will exceed the cost of using existing gross settlement systems in real time. During the transition period, it is necessary to maintain the functioning of both traditional and new infrastructure;
- potential simplification or complete elimination of correspondent relations between banks and reduction of transaction costs, will reduce the profits of banks;
- lowering the barriers to entry into the status of a payment service provider and increased competition between banking organizations will result in a reduction in the income of traditional service providers.
The listed disadvantages are largely related to the very fact of the transition to a new system. However, increased competition and lower costs are a constant trend among existing payment systems, driven by technological and regulatory innovation.
If the digital currency is built on the basis of the blockchain, then the effect will be as follows:
- building confidence in the national monetary system by increasing the transparency and traceability of transactions, as well as the effectiveness of anti-money laundering procedures. In the context of CBDC, blockchain is able to solve potential problems of personal data vulnerability through reliable distributed storage and technology-associated cryptographic protection mechanisms;
- CBDC potentially acts as an alternative to instruments for absorbing excess liquidity (for example, reverse REPO operations or deposit auctions ), and expand the capabilities of the Central Bank in the context of controlling bank liquidity;
- modernization of the settlement system will lead to significant optimization in terms of flexibility, scalability and fault tolerance, since any verifier can confirm the validity of a transaction;
- a CBDC-based settlement system can function as an alternative to existing payment systems, which contributes to greater diversification of payment processes and currency systems.
- risks of compromising confidential payment data. Implementing a CBDC project will require significant effort in fine-tuning the transparency and traceability of transactions;
- an increase in legal risks due to additional difficulties associated with the harmonization of the regulatory rules for the work of these projects between different jurisdictions;
- the decline in income associated with the simplification of correspondent banking relations will potentially force commercial banks to compensate for it through more risky forms of lending.
The main functions of combating money laundering should be carried out by the banks and financial intermediaries themselves. However, such a model will increase the risks of unfair behavior of market participants. Therefore, the Bank of Russia should pay increased attention to standardization and the creation of unified centralized platforms and databases of KYC questionnaires.
One of the incentives for the development of the digital ruble project is to limit the demand for private types of money.
During the implementation phase, when the demand for CBDC in relation to bank deposits may still be reduced, the central bank needs to pay attention to the consequences of abandoning the intermediation of commercial banks. Regardless of the concern about the state of the bank, the ease of converting deposits into CBDCs can provoke an outflow of funds and affect financial stability.
Confidentiality of user information will also become a stumbling block in the choice of the final design of the digital ruble. The initial design of the digital ruble will need to include characteristics that minimize both the amount of stored information and multi-level access to it. The ultimate success of the digital ruble project depends on the anonymity provided.