The Reserve Bank has conceptualised a Unified Markets Interface with the capability to tokenise financial assets and settlements using wholesale central bank digital currency (CBDC). Jayanth R. Varma explains how this digital platform can be the foundational pillar of India’s next-generation financial market infrastructure
What is digital money?
Almost all the money that we use in India today is digital money. When we scan a QR code and make a payment using UPI or net banking (NEFT/RTGS), we are using digital money. In this case, money exists only as a digital record in a bank’s computer and there is no paper work involved. Non-digital money (currency and cheques) are declining in importance.
What is smart money?
Since digital money lives in a computer, we can ask the computer to check a variety of conditions before allowing the money to be spent. Parents may, for example, want to give money to their children programmed in such a way that it can be spent only at the school canteen and only on weekdays. Or when paying an advance to a plumber, we may want to ensure that it can be spent only at specified hardware shops within one week.
More than a decade ago, cryptocurrencies like Bitcoin and Ethereum implemented programmable money. In recent years, mainstream payment systems are also trying to achieve programmability often using the same blockchain technology that underlies cryptocurrencies. The blockchain essentially provides a distributed (shared) data and computing resource accessible to all participants.
What are the advantages of using CBDC?
Central bank digital currency (CBDC) is digital programmable money issued by the RBI directly. Apart from programmability, a key advantage of CBDC is that it is backed by the government, and there is no risk of failure of any commercial bank. When we use netbanking or UPI, the money sits in the payer’s bank account shortly before making the payment, and in the recipient’s bank account shortly afterwards. If either bank fails during this short period, the payer or payee is exposed to risk of loss.
During the global financial crisis of 2008, some of the largest banks in the world failed or survived only because of government bailout. So, for large value payments (for example, paying crores of rupees to buy a house), we might want to avoid the risk of bank failure. CBDC solves this problem neatly.
What are tokenised assets?
Blockchain and similar technologies that make money programmable can also make other assets programmable. This process is called tokenisation. We can turn equity shares, mutual funds, bonds, mutual fund units and other financial assets into tokens that all live on a blockchain or similar distributed data and computing resource. The advantage is vastly enhanced programmability. We can program several different assets simultaneously imposing cross-asset conditions. For example, one could issue instructions like “sell 100 shares of Company X at a price at least 100 and use the proceeds to buy shares of Company Y at a price of not more than 25, but only if both transactions take place.” This means that if X is trading above 100, Y would not be bought; similarly if Y is trading below 25, X would not be sold.
Retail vs wholesale CBDC
Retail CBDCs are designed for ordinary individuals for making small denomination payments while wholesale CBDCs target large financial institutions making payments of hundreds or even thousands of crores. Many experts fear that large scale flight of deposits into retail CBDCs could threaten the banking system during times of crisis. This issue does not arise with wholesale CBDCs.
Wholesale CBDC & tokenised assets make financial markets more safe
Suppose a large mutual fund sells Government of India bonds worth Rs 1,000 crore to a large bank. Should the mutual fund deliver the bonds first or should the bank make the payment first? Neither. We want Delivery versus Payment (DVP) in which both legs happen simultaneously and irrevocably in a single atomic transaction. And we want the payment in central bank money. Tokenisation of the bonds and wholesale CBDCs make things like this very easy. This is what the RBI is envisaging. Thus, asset tokenisation offers new possibilities for Indian financial markets in expanding access, improving transparency, and enhancing settlement efficiency through smart contracts.
The writer is a former professor at IIM-Ahmedabad