How CBDCs are Reshaping Digital Payments in the Fintech Sector
Central banks are key to our financial system. Historically, they’ve ensured quick, stable, and smooth financial operations, handling payment systems and currency issuance. But they’re updating their roles with new technology and global economic shifts. Enter central bank digital currencies (CBDCs), a game-changer led by fintech innovators.
What is CBDC?
The Reserve Bank of India (RBI) describes Central Bank Digital Currency (CBDC) as a digital legal tender issued directly by the central bank. It holds the same value as traditional fiat currency and can be exchanged one-to-one with it, maintaining parity and stability in its digital representation.
Types of CBDC:
Central Bank Digital Currencies (CBDCs) are divided into two primary categories:
Used for transactions between the Central Banks and banks, wholesale CBDC improves the efficiency and safety of financial systems. It enhances real-time gross settlement processes and can streamline cross-border settlements via a corridor network, enabling quicker and more secure international transactions.
Aimed at the general public for everyday transactions, retail CBDC, often based on Distributed Ledger Technology (DLT), ensures transaction traceability and anonymity. It may be issued by the Central Bank or through intermediaries, with various models like direct, indirect, or hybrid.
The Role of Fintech in CBDC Development
Fintech is crucial in making CBDCs user-friendly and secure. With the help of modern technologies such as blockchain, fintech companies are creating a solid security infrastructure to support CBDCs.
In the domain of CBDC development, fintech is not just focusing on efficiency and security but also championing inclusivity. The sector is thoughtfully building digital solutions that extend the accessibility of CBDCs by targeting those traditionally marginalised in the financial system.
Modernising Banking Services
Banks are embracing CBDCs as a vital part of digital payment transformation. This adoption is a strategic move towards more efficient and effective banking services. By aligning with financial technology trends, banks are reshaping their services to meet the dynamic needs of the digital age.
CBDCs could significantly alter the traditional banking landscape in India, where the Reserve Bank of India remains the primary owner of digital currency, with banks playing a crucial role in its distribution. This change allows consumers to hold digital currencies via banks, potentially modifying the banks’ functions in payment systems and impacting their revenue from conventional services. However, it also opens up opportunities for Indian banks to provide new services, such as quicker, more secure payment options, digital wallets, and innovative investment products, in line with the RBI-led digital currency initiative.
India’s Exploration of CBDCs
In 2022, the RBI launched its digital rupee, e-rupee, leveraging blockchain technology. It initiated two pilot programs: CBDC-W with nine banks in November and CBDC-R in December across Mumbai, New Delhi, Bengaluru, and Bhubaneswar, initially involving four banks. This retail pilot expanded to over 15 cities, engaging 50,000 customers and 10,000 merchants, including many key players. Presently CBDC is offered by 13 banks and has hit the 1 million mark per day in December 2023 and has since then sustained a whopping of over 2 million transactions per day.
While the wholesale CBDC enhances interbank payments, the retail version targets the private sector and citizens, aiming to modernise the physical currency system.
Enhancements in CBDC Capabilities
To boost CBDC adoption, interoperability of CBDC and UPI was launched in June 2023, which gave further impetus to CBDC growth.
The RBI is reportedly boosting CBDC transactions with features like offline capabilities, as per Reuters. Leading banks are developing these for feature phones, allowing transactions without network connectivity. Another element being explored is programmable CBDC, ‘fit-for-purpose’ money, particularly for social benefits and targeted payments.
For instance, pre-programmed CBDC for LPG subsidies could be issued as a direct benefit transfer, usable only at authorised LPG agencies. These agencies can convert the CBDC to general-purpose CBDC or fiat currency at commercial banks.
Similarly, in agriculture, CBDC could transfer fertiliser subsidies, accepted only at designated outlets, ensuring efficiency in the subsidy program. Programmable payments extend further to employee expenses in various organisations and are applicable in industrial supply chains for specific expenses like fuel and state border taxes.
The rising interest in CBDCs stems from their potential to meet public policy goals, enhance economic stability, and provide a secure, efficient payment system. Countries are adopting diverse approaches to CBDCs: some are methodically researching and testing, planning gradual rollouts, while others are rapidly moving towards full deployment.
In India, discussions and analyses are underway to determine the optimal implementation strategy for CBDCs. This exploration opens up considerable prospects for various players in the ecosystem to develop services that simplify digital transactions, catering to a wide range of needs and applications.
What is CBDC, and how does it differ from traditional digital currencies?
CBDCs are digital currencies issued by central banks, akin to digital forms of paper money, thus more stable than non-government-backed cryptocurrencies like Bitcoin. CBDCs are inherently digital and designed for digital environments, unlike typical digital transactions that transfer traditional money online.
What impact do CBDCs have on financial inclusion?
CBDCs could significantly enhance financial inclusion. They’re designed for easy use and accessible through digital platforms, even to those without bank accounts. Particularly beneficial where banking services are limited, CBDCs help bridge financial inequality by enabling broader participation in the digital economy.
What challenges and concerns surround the adoption of CBDCs in the fintech sector?
CBDCs are gaining global traction, with countries adopting them at various paces and methods. Some are in pilot phases, others in larger trials, exploring integration into their unique financial systems. There’s no universal approach; each country tailors its CBDCs to meet its economic needs and citizen requirements.