The CBDC Frontier for Payment Systems

Abhisek Mohanty is a fintech advisor and in-house counsel at a financial services company. Shatakratu Sahu is a lawyer practicing in New Delhi.

The Union Budget 2022-23 shed light on the central government’s approach to cryptocurrency. Although the budget recognized these digital assets, a heavy tax structure is proposed. In addition, Union Finance Minister Nirmala Sitharaman has floated the idea of ​​a digital rupee, India’s central bank (CBDC) own digital currency.

Does the introduction of such a CBDC make sense in light of technological advances in payments in India?

Why RBI is cautious about cryptocurrency

RBI Deputy Governor T. Rabi Sankar’s keynote address to an Association of Indian Banks conclave makes a scathing assessment of the place of cryptocurrency in India’s monetary and economic framework. India. While noting that cryptocurrencies are neither currencies nor financial or physical assets, Sankar believes that they are just a speculative asset operating as a Ponzi scheme. These views were quickly echoed by RBI Governor Shaktikanta Das who warned against private cryptocurrencies. He pointed out that these cryptocurrencies threaten macroeconomic and financial stability and undermine its ability to face challenges on both fronts.

These comments reflect the fears of the central bank (also the monetary policy regulator) regarding cryptocurrencies. It is pertinent to mention that the Supreme Court scuttled previous attempts by the RBI to ban cryptocurrency transactions outright in 2020.


Digital rupee: an idea whose time has come?

The Cryptocurrency and Official Digital Currency Regulation Bill, 2021 was due to be tabled for consideration during the last winter session of Parliament. The purpose of the bill was two-fold: to create a framework to facilitate the creation of an official digital currency and the probation of all private cryptocurrencies in India. The government has also received a proposal from the RBI to expand the definition of “banknote” to include currency in digital form.

Historically, currency is usually issued by a sovereign. Although private currencies have existed, they have given priority to sovereign currency since a public currency backed by a sovereign has better creditworthiness and is therefore more stable. A CBDC should be understood in this context as legal tender issued by a central bank in digital form and exchangeable for fiat currency (although in a different form).

Obviously, the RBI and the government are looking to leverage the benefits of the underlying technology, also known as Blockchain or Distributed Ledger Technology. A 2021 survey by the Bank for International Settlements found that 86% of central banks were reviewing the outlines of launching CBDCs. It is also likely that the rise of private cryptocurrencies and the associated risks of anonymity and threat to monetary stability have sparked central bank interest in exploring CBDCs.

Currency issued by the central bank exists in two dimensions: the paper money used in day-to-day transactions, i.e. retail, and the reserves held by commercial banks with the central bank to manage the interbank settlements, i.e. wholesale. The retail segment where paper money is primarily used would provide the platform for various interesting innovations and prompt central banks to rethink traditional ideas around monetary policy. This would require a single ecosystem with a central bank running the centralized payment system through electronic wallets from which payment can be made.

How does CBDC compare to UPI?

The wallet ecosystem is prevalent on the Unified Payment Interface (UPI) network, which Indians are familiar with. However, the CBDC stands out because the central bank runs the infrastructure and payment is made directly through currency issued by a central bank (not commercial bank reserves).

A centralized payment system would avoid the risk of any payment system being concentrated on a private player. Furthermore, such a system would minimize settlement risk since the entire system would be backed by the state. Today’s payment systems involve multiple controllers and jurisdiction-specific sets of regulations. Current systems have often been slow, expensive and even unreliable (the most recent example is Russia’s shutdown of the SWIFT ecosystem as part of the sanctions for invading Ukraine). A CBDC-based network can drive real-time transactions and establish a globalized payment system with minimal transaction costs, increasing transparency and creating trust in the business environment.


A digital currency would also enable a programmable currency, which could herald innovations in social welfare system and financial inclusion when combined with India’s JAM trinity (linking of Jan Dhan, Aadhaar and mobile phone accounts) . For example, the government could set an expiration date for spending the grants it gives and minimize any leakage or corruption by regulating where the grants could be spent (such as education or housing). Digital currencies would also reduce logistics costs for the central bank, which are spent to print, transport, store and distribute money.

What are the risks ?

While digital currencies solve many problems, they also create many others. The disintermediation of banks in the payment system would have secondary consequences that need to be carefully considered when designing such a CBDC.

There are fears that the CBDC’s sovereign support could incentivize people to withdraw balances from banks, leading to bank runs whenever they perceive the banks’ health to be fragile. The loss of low-cost deposits would hamper credit creation, affecting margins and increasing the cost of credit, ultimately affecting the country’s macroeconomic stability.

Technological readiness would determine the proliferation of digital currencies. Payment systems must manage the volume of transactions to be considered a valid alternative to the current UPI ecosystem. In addition, there is also a need to ensure high cybersecurity standards and increase knowledge about cyber risks.


So, the idea behind the CBDC is to provide legal tender that has some of the advantages of cryptocurrencies, such as programmable money, increased transparency, reduced logistics costs, without the drawbacks, including anonymity and the lack of control. At the same time, careful thought must be given to the design of this digital currency architecture.

(Disclaimer: The views expressed are those of the author and Outlook Money does not necessarily endorse them. Outlook Money will not be liable for any damages caused to any person/organization directly or indirectly.)

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