Do we need CBDC in India?

With a massively successful Unified Payment Stack (UPI) why do we need CBDC in India. Let's find out.

India has witnessed monumental changes in how payments have evolved over the past decade. Not only has the payment infrastructure transformed, but customer behavior and trust in digital payments have also seen a massive spike. Compared to the total volume handled by the Unified Payments Interface (UPI) in January 2022, which was 461 crore, it skyrocketed to over 21,61,000 crore in August 2024, marking a growth of over 4,500 times in just two years.

However, UPI, though appearing real-time for end-users, is not actually so. UPI serves as a messaging layer between partner banks and conducts settlements between them every two hours, 24/7. As the number of transactions increases, so does the load on the overall infrastructure.

Despite this, UPI remains one of the best systems available. It processes an average of 2,500 transactions per second and is deeply integrated into the Indian payment ecosystem.

So, when the system works so flawlessly, what could possibly justify further advancements in this space? And why is the NPCI (National Payments Corporation of India) building the Central Bank Digital Currency (CBDC)?

The answer is simple: “To unify the payments and messaging layers into one.”

While the answer may be simple, achieving a unified layer is a monumental task, and it raises several important questions:

• Do we need a Unified Layer?

• Would this Unified Layer (CBDC) replace UPI?

• Can this Unified Layer (CBDC) scale as much as UPI?

• What problems does it solve that the current UPI ecosystem cannot?

• What are the benefits for end users?

• With CBDC accruing no interest and having very limited use in its current format, why should an end user even consider using it?

The list of questions could go on, but the most crucial one to consider is: “What value does this new system add?”

The most prominent answer is that, as a Unified Layer, it could significantly reduce intermediaries, eliminate the need for reconciliations, and cut costs—provided that we achieve the necessary scale.

Let’s explore how all of this can be achieved on the Unified Layer. One of the biggest benefits of leveraging distributed ledgers is the Asset vs. Delivery mechanism.

When we use UPI, payments are made via one layer, while goods and services are delivered through another layer (or means). However, on distributed ledgers, this can be done simultaneously in one seamless process.

To better understand the Asset vs. Delivery system, let’s consider a scenario:

Suppose you’re planning a business trip to the US from India, and you’ll need some USD for your expenses during the trip.

How would you acquire the USD? Typically, you would go to a Forex dealer and exchange your INR for USD. Let’s set aside the fees for a moment and focus on the transaction itself, which happens in two steps.

• Step One: You deposit your money into the Forex dealer’s account. Once they receive the funds.

• Step Two: They release the USD to you.

But what if you make the payment in INR and never receive the USD in return? Yes, you could take legal action to recover your money, but this process highlights several inefficiencies in the current transactional system:

• Trust: You need to trust the Forex dealer to honor the payment.

• Time: The process can be time-consuming, involving multiple steps.

• Cost: You often pay a premium for this service because the Forex dealer, acting as an intermediary, needs to make a profit.

In short, you end up spending more time, relying on a third party, and paying extra.

However, when done on a unified ledger, everything can be executed in a single, instant transaction. This process is not only more convenient and cheaper but also eliminates the need to trust a third party.

Let me take another example here: 

Uniswap: Uniswap is a decentralized exchange (DEX) that enables users to swap assets without relying on a centralized third party. It operates using smart contracts, liquidity pools, and automated market makers (AMMs) to facilitate peer-to-peer trading. Uniswap is hosted on the Ethereum blockchain and six other distributed ledger platforms, making it one of the largest DEXs by transaction volume.

        A PvP transaction for asset delivery on Uniswap between USD <> EURO

USDC and EUROC are synthetic assets, each backed 1:1 by their respective fiat currencies, the US dollar and the euro. In the scenario described above, if I need to receive euros and pay in USD, the transaction can be completed in a single step. This eliminates the need for insurance or concerns about failed deliveries, as the transaction is secure and instantaneous.

Back to CBDC’s:

If Unified Ledgers are so efficient, does that mean CBDC is better than UPI? Technically, yes, but there are still many challenges to overcome before it becomes the de facto choice. Progress will need to be gradual.

Currently, some of the areas where CBDC has been utilized include:

• Direct Benefit Transfers (DBT) under various government schemes.

• Bonuses for bank employees.

• Food vouchers for employees.

However, the potential for CBDC is much larger, with possibilities for it to make significant inroads into other areas. On the other hand, UPI is being used for almost everything today. But does the success of CBDC mean it will take over the current use cases of UPI and scale? That remains to be seen.

In my opinion, the answer is no. Both systems can coexist, each offering distinct advantages and use cases. While UPI remains the best way to make payments today, the additional benefits provided by Unified Ledgers, leveraging distributed ledgers, open up new avenues for business.

But what are the use cases where CBDC might become more prominent?

1. Vertical Scaling: Since the CBDC stack is built on a distributed ledger, enabling Asset vs. Delivery on the same stack requires the development of programmable CBDC (pCBDC). This enhancement allows programmability on top of the CBDC stack. For instance, the Direct Benefit Transfer (DBT) scheme leverages pCBDC to ensure that agricultural benefits are used exclusively for agricultural purposes. Implementing this mechanism requires significant development efforts from the CBDC team, including bringing more assets onto the CBDC platform.
   

2. Horizontal Scaling: Horizontal scaling offers another approach to accelerating the adoption of CBDC. This strategy involves enabling CBDC as a mechanism that can be integrated with other distributed ledgers where assets already exist. In this way, CBDC can serve as the payment mechanism, completing the Asset vs. Delivery process across different platforms.

While horizontal scaling is a unique approach that has not yet been widely tested, several pilot projects are underway to explore its potential. These pilots aim to expand the adoption of CBDC in a regulated manner, unlocking the vast potential of distributed ledgers in India.

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