Why the shape of digital rupee will be determined by its use-cases

Experts agree a CBDC will help create a better financial ecosystem, but differ on its design

A day after the budget announcement that the Indian central bank will launch a digital rupee this year, the speculation started pouring in. One report said that India’s central bank digital currency (CBDC) may not be based principally on blockchain technology; another claimed that it might turn out more like a digital payments wallet than digital money.

Everyone agrees that a CBDC will help create a better financial services infrastructure, but there seems to be no single right answer to how it should be designed.

Around the world, some of the biggest criticisms of blockchain-based cryptocurrencies are that they are anonymous, entail high transaction fees and transactions take longer to go through than in current digital payments systems.

“Things like security, transaction times and fees depend on the architecture of a blockchain. Each of these are like individual knobs that can be turned by varying degrees while creating a virtual currency,” says Sanjay Phadke, a fintech expert who works with iSPIRT, a technology think-tank.

A key difference between a private crypto and a CBDC is that while the former runs on a blockchain, the latter may be run through a distributed ledger technology (DLT) system. While a DLT system gives a central authority more power of decision making on who can access and edit the database, a blockchain — a subset of DLT systems — is far more democratic, as all “peers” in the system take collective decisions.

“Blockchain is a very loosely defined term and can mean different things to different people. Also, in designing a system of ledgers, one can choose to make it faster, cheaper or more secure, but everything cannot be optimised all  at once,” explains Phadke.

This effectively means that the use-cases for a CBDC will determine which of these factors is given primacy. As such, zeroing on the use-cases is the first step towards creating a CBDC, and not the other way round. “RBI has been examining use-cases and working out a phased implementation strategy for introduction of CBDC with little or no disruption,” the government had said in November last year.

“For instance, one use-case can be to disburse government subsidies through the digital rupee.  Theoretically, this will mean that only a person’s Aadhaar number would be enough to transfer money directly to the beneficiary and thus put the banks out of the equation completely,” says a fintech industry executive who does not wish to be named.

“Although this could be a more efficient transfer of funds, the cost of doing so might also fall squarely on the government or central bank. Are they ready to bear that burden?” he asks.

Fillip to fintech?

Vishwas Patel, chairman, Payments Council of India, and director, Infibeam Avenues, reckons that since the CBDC is a liability of the central bank, it will minimise depositors’ exposure to their bank. The idea that a central bank will default on its obligation to honour a payment or settle a transaction is currently unthinkable. A CBDC is, therefore, a risk-free settlement asset.

CBDCs would also potentially enable a more cost-effective globalisation of payment systems. An Indian importer could pay an American exporter on a real-time basis without the need for an intermediary. The time-zone difference would no longer matter in currency settlements.

“We do a T+2 settlement for merchants, but with CBDCs we can do instant settlements. CBDCs have the potential to bring down the costs of making cross-border payments, as they potentially dispense with correspondent banks,” says Patel.

Prime Minister Narendra Modi said last week that India will revolutionise the fintech sector by creating new opportunities and lessen the burden of handling, printing and logistics management of cash, apart from making digital payments and online transfers of funds more secure.

Race against time

While the underlying technology and use-cases of a digital rupee are debated, one factor to consider is that private cryptos are getting bigger by the day. Several estimates already peg India’s crypto asset market at around $6 billion, with 15-20 million people holding them.

However, the bigger concern according to experts is that China’s digital currency has already seen mass adoption inside that country, and Beijing will hard-sell its use internationally. According to a report by Al Jazeera, the digital yuan is one of only three payment options for foreign athletes and visitors, along with cash and Visa cards, at the ongoing Winter Olympics. In January, the Chinese central bank announced that more than 261 million individual users nationwide had registered a digital yuan wallet, an app for using e-CNY.

Moreover, 90 countries representing 90 per cent of global GDP are currently exploring digital currencies. Of these, 16 are now in various stages of pilot programmes while nine, mostly small Caribbean nations, have already launched a digital currency.

“It is not like a lot of major countries have already launched a CBDC and India will be one of the first of the lot if we can do it this year. This will also give a strong brand proposition to the rupee,” says R Vivekanand, global head of Quartz, a startup incubated by Tata Consultancy Services that builds DLT systems for industry.

While CBDCs may ultimately overpower cryptos like bitcoin and ethereum because of their legitimacy, they are also expected to be “greener”, as no proof of work is required — and so the energy-intensive process of mining goes out of the window.

Mining is the process by which crypto transactions on a blockchain are verified by a computer or participant in the blockchain. As this requires massive computing power, the miner is rewarded for his service with crypto by the blockchain.

“In a CBDC, there is no need to go through mining, like in the case of bitcoin, as there is no need to solve computational problems for verifying transactions and consensus. Blockchains inherently don’t consume more power than other types of networks,” explains Vivekanand.