Last year, when the Bank of Russia issued a paper proposing a central bank digital currency (CBDC), there was considerable pushback from the banking sector. Following consultations, there has been some compromise on the digital ruble. However, an updated paper published yesterday still shows little concern about the potential migration of bank balances to the central bank. And several other features give the central bank considerable control.
There are plans to introduce laws to allow the central bank to ban certain institutions, companies or individuals from accessing the digital ruble. That’s in marked contrast to physical cash, which is open to all and will likely decline in use once there’s a digital version.
Even if a ban aims to censor fraudsters or tax evaders, once the law is on the books, there’s the possibility of using it for other purposes to exclude people from the economy. If the law is too widely applied, it could encourage greater black market use of cryptocurrencies.
Physical cash is also anonymous. In contrast, the Russian digital ruble will have confidentiality at a level that’s not less than current non-cash payments. In other words, the anonymity of cash will eventually disappear as physical cash declines.
Migration of bank balances to digital ruble
But the first point, the migration of bank account balances to the central bank, is the biggest one. Given the digital ruble comes with the central bank’s backing, many people might convert their bank deposits to digital ruble balances.
Most other central bank CBDC plans include limits in CBDC balances. In Germany, it has been argued that a CBDC is a central bank power grab implying that eventually, central banks will remove limits. Perhaps the Bank of Russia is just being open?
However, the Bank of Russia plans to introduce the digital currency in phases. This gives commercial banks the chance to restructure their balance sheets. The central bank intends to take up the slack so banks can borrow more from the Bank of Russia if customer deposits decline. Any additional borrowing costs will be passed on to customers. To prevent rates from getting too high, the central bank can choose to lower rates.
A one-liner in the report says the bank might consider the possibility of digital ruble limits.
The government’s ability to lock out people from the digital ruble system might put a brake on the demand for the CBDC and hence the migration of bank deposits. The digital ruble will also not be interest bearing. However, without any balance limits, if a bank gets into trouble, a bank run could happen incredibly fast.
In the first CBDC paper, the central bank outlined a number of potential models, including a fully centralized digital ruble.
After feedback, the current version proposes relying heavily on banks as intermediaries with a decentralized two-tier model, favored by the vast majority of people who provided input on the CBDC. So the digital currency will be issued to banks, and the banks will issue it to the end-users.
At a technical level, the central bank envisages a hybrid model with centralized settlement and some use of distributed ledgers, where the Bank of Russia will control any validating nodes.
It’s envisaged that smart contracts will be used to enable conditional payments and potentially for money only to be used for certain purposes. That could be especially useful for government grants.
The Bank of Russia will issue the cryptographic keys used by everyone. It already has a key issuance system for all Russian corporates that is used to submit tax returns and digitally sign contracts.
Plans also include an offline payment mode requested by 88% of those that provided feedback. For now, the aim is to have an offline and online wallet where online balances can be moved to the offline wallet. This might help with regular usage, but what if there’s some disaster knocking out electricity and people didn’t anticipate needing to use money offline?
The Bank of Russia plans to launch a prototype in Q1 2022 and following that, a roadmap will be drawn up. The initial phase will focus on mainstream use of the currency outside of wholesale banking use. The second phase will aim to connect financial intermediaries, enable offline usage, and use it for foreign currency exchange.