CBDC: A simpler solution for digital payments?

A peek in to CBDC vs UPI debate purely from a technology standpoint

Central Bank Digital Currency (CBDC) is the digital version of physical cash, which includes paper bills and coins. Whereas UPI is a payment system that helps move money between bank accounts quickly.

Under the hood, UPI moves data across the servers of UPI Third-Party Apps (TPAP), Banks, and NPCI to facilitate payments. The banks maintain a silo ledger, and the UPI protocol helps post the ledger entries on a real-time basis. The actual fund transfer happens during the bank settlement cycle (which is not an instant process). As payment velocity increases yearly, these organisations must invest heavily in payment infrastructure. Technology and compliance costs make it almost unviable for smaller cooperative banks to participate in the network, and there is a constant dialogue between the industry operators and the government to charge a small transaction fee.

CBDC requires the RBI to mint digital rupee tokens and distribute them via the scheduled commercial banks. It maintains a distributed ledger, a shared database with user identities firewalled. A single entry on this ledger represents a payment transaction. The settlement is immediate, similar to handing over cash to someone. The shared database must be hosted only by a few industry consortiums to validate the transactions, and individual banks do not need to invest in the payment infrastructure. This approach makes it possible to reduce the cumulative technology and compliance costs at scale compared to UPI. Blockchain, the underlying technology behind CBDC, has not yet evolved to handle millions of transactions per second. But that’s likely to change this decade.

The icing on the cake with CBDCs is that RBI does not have to print physical money and deal with moving it out of circulation when necessary. It can mint digital rupee tokens and burn them according to monetary decisions. Some of these tokens can be minted for specific purposes using special smart contracts, which makes them very attractive for Direct Benefit Transfer (DBT) programmes.