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Opinion | CBDC is the UPI Moment for Fintechs: Rise of CBDC and Death of Crypto

By: K Yatish Rajawat

Last Updated: December 09, 2022, 16:52 IST

New Delhi, India

Digital Rupee is India's first central bank digital currency.

Digital Rupee is India's first central bank digital currency.

CBDC opens up a new world for Fintechs for international transactions to be part of international trade and reduce the cost of transactions for global trade

The fall of fraudulent and failing crypto exchanges is coinciding with the rise of CBDC (central bank digital currency) across the world. India has also successfully completed its launch and trials with the CBDC. What is important to understand is that this ushers in a new way of doing not just transactions but trade. It will revolutionise the structure of trade and business contracts and fulfill the potential that decentralised finance promised but was hijacked by many rogue elements styling themselves as crypto-entrepreneurs. CBDC opens up a new world for Fintechs for international transactions to be part of international trade and reduce the cost of transactions for global trade.

Cryptocurrency did promise international transactions but the underlying asset had no inherent value. Every dime n crypto entrepreneur was issuing his currency and acting like a central bank. Crypto-entrepreneurs hijacked the best intentions of decentralised finance (DeFi) technology and used it to create fake currency, misleading and diverting Defi’s true purpose. The purpose of decentralised finance was to liberate finance from the clutches of a few banks, but crypto entrepreneurs have created such a havoc of distrust that now the pendulum has swung the other way.

Now, the irony is decentralised promise will only work with centralised digital currencies. In social media times this has created extreme reactions. Just a few months back I had a major social media flare out with an advocacy firm that wanted another consultation for cryptocurrency in India. It was an acrimonious affair and I had to call out their stance publicly. Unfortunately, I had to delete some of those posts as they launched legal and personal attacks. But it brought out an important facet of crypto lobbying across the world — that the lobby is still throwing money to attack governments and policymakers to prevent a full and permanent ban.

In spite of cases of money laundering, fraud and illicit drug trade, a set of lawyers, legislators, parliamentarians and advocacy firms continues to push the Crypto agenda in India. Preventing legislation to ban this virtual asset. Crypto may die a slow death and foolish money will still back it, but the rise of CBDC is sure.

The advantage of CBDC over other forms of currency is its intelligence. It’s a leap in paradigm from currency being just a storage/transfer of value to intelligent money. If digital currency is issued by a central bank it has inherent value along with the fact that it can be programmed to be smart, intelligent, and be capable of decision-making. Almost every central bank in the world is planning a CBDC — this will fulfill the potential that decentralised finance once promised.

The Atlantic Council has prepared a CBDC tracker. It gives the details of CBDC rolled out by different banks. For instance, 19 of the G20 countries are preparing to launch a CBDC.

Currently, CBDC is only seen as a digital replacement of existing national currency or a response to cryptocurrency. I have for a long time argued that the CBDC has a role beyond this and that it is important for countries to develop not just a currency but a ‘smarter’ way of commerce. The end use of the CBDC cannot be limited only to the role that currency has played in the past, as it will be used to program smart contracts and increase trust in commerce. Ensuring trust by creating deliverable contracts of goods and payments facilitates transactions and in turn economic growth.

Two unknown entities transact with each other when they know that the goods promised will be delivered and payment made. Building this trust boosts trade and commerce — this is the role that CBDC will play. Till now in global trade the delivery of goods and payment was being managed by a series of global banks, multitude of contracts, inspection agencies and checks. CBDC, when programmed to be part of a smart contract, will reduce these layers of paper contracts and checks thus reducing the cost of trade or transactions both local and international. This reduction in cost is not nominal. According to a study by Corpay, only the foreign exchange conversion cost could be as high as 4 percent and there are many hidden charges that remitters and even receivers have to pay. This makes many trade transactions unviable.

The promise of lower cost and reducing the global banks hegemony in transactions that decentralised finance offered with crypto assets can now be realised in a legitimate manner with CBDC. It is thanks to the rapid expansion of cryptocurrency and the existential threat it posed to central banks and currency that CBDC is being rolled out.

Till now currency itself did not carry any intelligence of its own — it was a piece of paper, metal or leather but a digital currency can carry data. This data element can impart intelligence to make sure where CBDC can be used, how it can be used, or even what can be purchased with it. Even the way the digital ledger is kept for storing this currency can be used to create smart contracts. This is the true digitisation of the economy because fundamentally the unit of currency will have an intelligence of its own.

To give you an example, a very broad one with some assumptions, it is now possible to structure a payment between a large company and small vendor which ensures parity of payment. The biggest pain point for all MSMEs dealing with large companies is that they are not paid on time. Moreover, for any small or micro vendor to extract payment from a large company is almost impossible. I know it for a fact because as an independent consultant it’s almost impossible to get large companies to pay you on time. Their financial teams are not equipped to handle small vendors; so the smaller or even a medium-sized vendor gets squeezed and played around. If there was a smart contract based on CBDC, money would automatically get debited from these companies’ accounts on the delivery or completion of a contract and credited into the small vendor account. It would make several MSMEs viable. Moreover, if the CBDC is in the central bank blockchain-based ledger, it will not even go through the traditional banking layers or high cost system.

The delay of payment to MSME vendors can create liquidity pressure and even threaten their survival. In a smart CBDC world, if it’s distributed ledger-based, it would be possible to create a smart contract that can ensure satisfactory delivery of services and automatic debit and credit. If the CBDCs are being managed by the central bank it may not need to go through a banking system. These smart contracts can also reduce the cost of transactions, increase trust in domestic and even international commerce. If vendors know that they would get paid in every interaction, it would ensure that they would be able to transact with complete strangers even across multiple borders. A currency’s primary role in developed societies was to build trust in a monetary system so commerce could be enabled. This can be taken to the next level now with a smart CBDC enabling quicker and better commercial transactions.

Obviously, when CBDC is applied to the area of digital global commerce it, will have a ramification for wholesale and global banking. This is an area where even the most well-funded fintech have not been able to breach. And this is because, while fintechs may pride themselves on innovation, their area of operations has been limited to state borders. This is where CBDC can unleash innovation at a global scale if it is built with multi-country exchange in mind.

This is what the Bank of International Settlements (BIS) should insist that the CBDC should do, it should not remain as islands of innovation in their own countries. BIS has been trying to standardise some of the operational aspects of CBDC. An example of wholesale CBDC involving different currencies is the BIS innovation hub project, with the central banks of China, Hong Kong, United Arab Emirates and Thailand collaborating on the Multiple Central Bank Digital Currency (mCBDC) Bridge Project. This project aims to develop an international settlement platform through which central banks can utilise CBDC for transactions by financial institutions. The mCBDC project would enable cross-border payments that can be done in real-time between the four jurisdictions 24×7, with the foreign exchange leg settled in real time.

While currently the mCBDC bridge project is created by BIS and central banks, once the digital asset is created it will sooner or later become fungible across multiple digital networks. Moreover, forward-looking central banks will realise that the adoption of CBDC will depend upon its promotion by fintechs. Traditional banks may or may not promote CBDC as it will cannibalise some of the highly profitable transactions. Fintechs that get onto the CBDC bandwagon or create solutions will become future proof.

K Yatish Rajawat is a policy researcher working at Centre for Innovation in Public Policy. Views expressed are personal.

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first published:December 09, 2022, 16:52 IST
last updated:December 09, 2022, 16:52 IST
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