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Busting Myths: CBDC vs. Cryptocurrencies vs. UPI

Experts believe that the risk-free nature of a CBDC lowers the possibility of settlement default for institutions as well

Busting Myths: CBDC vs. Cryptocurrencies vs. UPI

By Dileep Seinberg

The financial landscape around the world is changing quickly due to the reinvention of money and innovations in payments. The transition from paper money to account-based electronic money and, most recently, the rapidly spreading programmable tokenized money has prompted central banks to introduce CBDCs (Central Bank Digital Currencies), which are new central bank currencies backed by sovereigns.

Features & Use Cases of the Digital Rupee

The affordable and quick settlement of payment transactions is CBDCs’ key differentiator worldwide. In India, a CBDC will first be useful to people making deposits at banks. Because the CBDC is a liability of the central bank, depositors are less likely to lose money to their bank. It is currently inconceivable that a central bank would default on its obligation to honour a payment or settle a transaction. Therefore, a CBDC is a safe asset to use in a settlement. The risk-free nature of a CBDC lowers the possibility of settlement default for institutions as well. Banks and other financial institutions currently settle their debts using reserves held with the RBI. By allowing CBDCs to settle interbank transactions, the counterparty banks, financial institutions, and the RBI would be exposed to fewer liquidity and solvency risks.

Cross-border payments are the second application for an RBI-issued CBDC. Cross-border payments cost more than domestic payments because multiple banks are involved, sometimes even from the same country. Cross-border remittance settlement takes longer and costs more money than domestic payment transactions because foreign banks typically operate through “correspondent banks” that have their settlement accounts with the central bank. Cross-border remittance settlement times may also differ based on the payee’s status as a regular importer or exporter, a small or large business, a retail consumer, the type of bank involved in the remittance chain, and other factors.

Due to their potential ability to do without correspondent banks, CBDCs have the potential to reduce the costs associated with sending money internationally. A CBDC can be settled in the central bank’s digital ledger directly since it was issued by the institution, bypassing the chain of banks that would normally be involved in a cross-border transaction.

CBDC vs Crypto?

Digital currencies, CBDC, and cryptocurrencies have generated a lot of buzz. A cryptocurrency is a type of digital currency that, with its encryption algorithms, serves as an alternative payment method. A central bank digital currency can be thought of as the digital version of a nation’s fiat currency, whereas cryptos are digital assets on a distributed network. 

A decentralized network infrastructure is used to store cryptocurrencies, enabling transactions to be carried out, verified, and added to the public ledger without the interference of a third party. CBDs are legal tender; they cannot be used as stock or security tokens in the same way that Crypto does. Digital Rupee does not offer DAPPS, metaverse, or NFT-level solutions. CBDC, being a legal tender, does not work as a specific utility token. CBDCs are centrally controlled, and most central banks around the world are adopting Hyperledger, which is controlled by corporations like any other technology, whereas Crypto was developed decentralized.

Furthermore, no other government entity has control over digital currencies. Owners of cryptocurrencies can access their money directly. These are encrypted for security. The nature of cryptocurrencies is highly volatile. A wallet address is necessary when using one of the most well-known cryptocurrencies. This means you are not required to reveal any personal information there.

CBDC vs UPI Payments?

The digital rupee will be the underlying payment mode that can be used for digital payments instead of currency/cash. To transfer funds, payment rails such as UPI, IMPS, and others use the underlying currency or cash. In this case, when payment rails and the digital rupee work together, a smooth payment transaction is expected to be possible. Currently, digital versions of physical currency notes are used to make UPI payments. 

In other words, every rupee transferred through UPI is backed by physical money. The virtual rupee won’t have to be backed by real money because it will be accepted as legal tender on its own. Additionally, while each bank has a separate handler for traditional online transactions, the Reserve Bank of India (RBI) will operate the digital currency, allowing for direct and immediate settlement of all transactions.

Conclusion

The use cases for CBDCs are primarily focused on providing three critical functions. To begin with, CBDCs and their applications seek to provide a dependable alternative to cash rather than replace it. The next important feature of CBDCs that can be seen in their use cases is their support for digitization. Due to digitalization, CBDCs can offer many benefits, such as peer-to-peer transactions, open and competitive ecosystems, programmable payments with smart contract support, and more. Interoperability with international CBDCs or multi-CBDC platforms could also be used for international payments by central banks that use virtual currencies. 

Based on the overview of CBDC use cases and features, it is fair to postulate that CBDCs have considerable potential. They could eventually become the most popular way for people and businesses to do business financially. The CBDCs would also keep changing the established precedents in the financial sector. CBDC use cases could have a real impact on how people and institutions think about digital money.

The author is founder and CEO, MuffinPay

Also Read: How is technology changing as neo-banks and cryptocurrency plan to co-exist

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First published on: 03-12-2022 at 04:59:59 pm