Step 1: Use the condition of touching both coordinate axes.
If a circle touches both coordinate axes, then the absolute values of the coordinates of its centre are equal to the radius.
So, the centre must be of the form
\[
(r,r),\quad (r,-r),\quad (-r,r),\quad \text{or} \quad (-r,-r)
\]
Step 2: Check option (1).
The given circle in option (1) is
\[
x^2+y^2-2x+2y+1=0
\]
Compare with the general equation
\[
x^2+y^2+2gx+2fy+c=0
\]
Here,
\[
2g=-2,\quad 2f=2,\quad c=1
\]
So,
\[
g=-1,\quad f=1
\]
The centre is
\[
(-g,-f)=(1,-1)
\]
The radius is
\[
\sqrt{g^2+f^2-c}
\]
\[
=\sqrt{(-1)^2+(1)^2-1}
\]
\[
=\sqrt{1}
\]
\[
=1
\]
Thus, the centre is
\[
(1,-1)
\]
and radius is
\[
1
\]
Since the distances of \((1,-1)\) from both coordinate axes are \(1\), the circle touches both coordinate axes.
Step 3: Check whether the centre lies on the given line.
The given line is
\[
x-2y-3=0
\]
Substitute the centre
\[
(1,-1)
\]
\[
1-2(-1)-3=0
\]
\[
1+2-3=0
\]
\[
0=0
\]
Hence, the centre lies on
\[
x-2y-3=0
\]
Step 4: Final conclusion.
Therefore, the required circle is
\[
\boxed{x^2+y^2-2x+2y+1=0}
\]