The fintech world is on the cusp of a major transformation, with central bank digital currencies (CBDCs) occupying the central space.
Throughout human history, money and payment systems have constantly been reinventing themselves. From a simple barter system to precious metal-based trading to ruler-issued stamped coins to central bank-issued promissory notes – all have been avatars of money and payment systems. From banknotes today, we have come to the era of virtual currencies or cryptocurrencies.
These are essentially alphanumerical strings or are technically called hashes; interestingly enough, they represent value in the real world. Despite the massive crash in the crypto world, Bitcoin, the classic and the oldest crypto coin is trading at about USD 20,000 each. Once the money becomes a string of alphanumeric numbers and independent of an intermediary such as a bank (to certify the account balance before transacting) to transmit, it becomes electronically mobile and can be sent to any corner of the world almost instantaneously.
There are thousands of cryptocurrencies in existence today. Cryptocurrencies being "external" money created by players beyond the jurisdiction of the financial regulators, have been watched with a degree of caution by central banks around the world. Cryptos are money as they meet all three criteria of being money – a store of value, a medium of exchange, and an accounting unit. However, they have one major problem for the users: the wild price swings. An innovation called stablecoin has solved this problem making the value more stable within an acceptable narrow band. It has accelerated crypto adoption as it takes away the uncertainties around prices to a large extent. While this is the external environment of money, it is illustrative to examine the rapid changes in the Indian financial sector in the recent past.
UPI – The Transformation Agent
UPI (Unified Payments Interface) introduction in 2016, post-de-monetization, has been a watershed moment in the history of the Indian financial system. From a humble beginning of 2.6 million transactions worth 893 crore in 2016, the UPI has clocked 6.78 billion transactions worth Rs 11,16,000 crore in September 2022, in one month alone. Today, UPI-based payments account for over 40 per cent of total global real-time payments (ACI report). The country has taken a giant stride in modernising its payment systems and, by some estimates, has realised a GDP (gross domestic product) efficiency gain between 0.5 per cent and 1 per cent. UPI platform is expected to handle about 70 billion transactions worth over 1.5 trillion USD in FY22-23.
UPI has also been a significant contributor to financial inclusion in India. Bank account ownership has dramatically risen from 40 per cent in 2011 to about 80 per cent in 2021 (World Bank Global Findex Database 2021). A whopping 470 million new Jan Dhan accounts have been opened so far. The icing on the cake is that there is no significant urban-rural divide in account ownership, indicating that many new accounts are from rural areas.
Behind the roaring success of UPI lie the enabling infrastructure and a few brilliant design choices. Near universal biometric identity, Aadhar, and extensive mobile access form the backbone of UPI. UPI, backed by the non-profit National Payments Corporation of India (NPCI) and the Reserve Bank of India (RBI), has been made a public good. NPCI has set the standards and allowed API-based (Application Programming Interface) access to all stakeholders inviting a slew of innovations in the fintech space. Today, nearly 350 plus banks are on board the UPI platform. Providing freedom to users from memorising 16-digit bank account numbers and complicated IFSC codes through easy-to-remember virtual UPI addresses, like abc@oksbi and QR codes, has accelerated its adoption. Perpetual struggle with finding the right amount of change after every customer transaction has sent the smallest merchants hurtling towards UPI.
In 2013, NPCI introduced RuPay, an indigenous card payment system offering lower costs to banks and merchants. What started with a market share of about 0.6 per cent is now around 60 per cent and has got or is in the process of obtaining international acceptance in countries like Singapore, Bhutan, Nepal, the Maldives, the UAE, Bahrain, France, the UK, Europe, and South Korea. RuPay payment network provides an alternate set of card payment rails to the Indian market and de-risks the impact of any sanctions or embargos if they were ever to be imposed against India. It also provides a credible low-cost solution to countries wanting alternatives to card payment network duopoly.
As discussed earlier, central banks were always concerned about the rapid proliferation of this 'external' money called crypto. Cross-border remittances were hard to track and measure accurately, and the final beneficiary of a transaction was harder to map. The preferred currency of cyber ransom is crypto. Stablecoins are recognised as a direct competition to the central bank money (ECB paper on CBDC, Dec 2021). Against this backdrop, the central banks have been re-evaluating their digital strategies and have zeroed in on a solution called Central Bank Digital Currency (CBDC). CBDC is essentially a digital version of the fiat (banknote) currency.
The European Central Bank Digital Euro report 2020 lists five scenarios where a CBDC launch becomes imperative. One of them is the emergence of a credible alternative to central bank money. The steady rise of stablecoins seems to have triggered the scenario supporting the case for a digital Euro. Today, about 100 central banks worldwide are planning on issuing digital currency. Notable amongst these are China, the US, the UK, Europe, and India. China's e-CNY project is already in the pilot phase. Last month, the US released its executive order on digital assets laying the ground rules for building a digital dollar.
In India, in her last budget speech, the finance minister (Nirmala Sitharaman) committed to the launch of blockchain-based CBDC. In a recently released concept note on CBDC, RBI has given a clear view of its thinking on the digital rupee. It has advocated the launching of a non-interest-bearing wholesale as well as a retail digital rupee. In addition, it has supported a mix of DLT (Distributed ledger technology) and centralized architecture for the launch of its CBDC.
The Prime minister's launch of the e-Rupi in 2021 for a cashless vaccination program gives a glimpse into the capability of a digital rupee. This could be thought of as programmable money. Built into the digital token (a unique alphanumeric string) can be the purpose for which this money can be spent, and it can even be programmed to expire. Many government social security and subsidy programs can benefit from this programmable feature. For example, a subsidy intended to pay for a child's tuition fee or school uniform cannot be diverted for any other expenditure by the parents. Moreover, the e-Rupi is compatible with feature phones (non-smartphones) and can be transacted offline. Thus, it promises to enable a UPI-like experience for roughly 60 per cent of mobile users for their payment needs.
Well-designed interoperable CBDCs can significantly reduce the transaction cost of cross-border payment. BIS (Bank of International settlement) has been working on an m-Bridge technology which, if adopted, could see money transfers on the banking channels as efficiently as crypto transfers. The fintech world is on the cusp of a major transformation, with CBDCs occupying the central space.
Santosh K Misra is a former IAS officer. Views expressed in the article belong solely to the author.