Why Understanding Digital Wallets is Key for Central Banks Desiring Widespread CBDC Implementation

Central bank digital currency (CBDC) pilots have evolved into implementations in the past several months, with large-scale projects by the Eastern Caribbean Central Bank, Nigeria, and China leading the world in CBDC development. The value proposition of CBDCs is extremely significant and in-line with the principles of decentralized finance (defi), particularly given CBDCs’ access and placement to reach previously unbanked individuals.

However, one often-overlooked implementation point of CBDCs is at the point of connection from the banking system to the end-user: the wallet. Current technological, economic, and social infrastructures simply do not exist for many individuals that CBDCs have the potential to benefit. The best way to understand these factors while simultaneously considering a myriad of other topics is to look at successful examples of pre-CBDC digital payment frameworks. It will also be important for governments to solidify their wallet choices in policy considerations when developing CBDCs, with CBDCs being the gateway into the world of Web 3.0 and beyond.

The case of India’s push to digital payments

India is one example of a nation that may come out ahead in terms of long-term CBDC implementation, despite not having significant first-mover advance in the digital currency space. The announcement of India’s proposed digital rupee came in early February 2022, a complete reversal from talks just months prior in late 2021 that proposed India banning cryptocurrencies as a means of payment.

India has been able to implement a variety of different initiatives to help ease CBDC implementation dating back several years prior to the recently heightened interest in CBDCs by central banks around the world. Smartphone penetration in India continues to rise, with governments incentivizing increasing amounts of users, particularly in rural areas, to adopt smartphones. To this extent, smartphone penetration in rural India has risen from 9% in 2015, to 25% in 2018, with over 53% of all Indians having mobile access to the Internet as of 2020.  

This increased access to smartphones has enabled more accessibility to digital wallets and payments services. To further emphasize these newfound capabilities, the Indian government launched the Unified Payments Interface (UPI) system in April 2016, enabling inter-bank peer-to-peer (P2P) lending and person-to-merchant (P2M) services. During this time., entities like Paytm, Google Pay, and PhonePe established wallets based on UPI technology, with other services like BharatPe enabling cross-wallet transfers through a singular QR-code system, highlighting the need for public-private innovation and partnerships in developing digital payments aimed at mass adoption.

Compounding the move to utilize digital payments was India’s demonetization of currency on November 2016, which became yet another catalyst along India’s route to payments digitalization, with India effectively removing 86% of its currency from circulation overnight. Billed as a move to help fight corruption, this move had the tertiary effect of increasing enrollment in the country’s Aadhaar infrastructure, a digital unique identification number with some biometric qualities.

The example of India highlights how critical wallets are to ensuring the success of digital payments, paving the road for future implementations of CBDCs. Ensuring equitable access to smartphone devices through surging mobile penetration rates, providing Indians with digital identities, and creating payment rails to facilitate mobile wallets with interoperability remains critical in setting the stage for increased digital payments usage in India, with the digital rupee ostensibly able to capitalize on all these factors for implementation and use in the age of Web 3.0

Policy considerations

Many current debates around CBDCs speak specifically to CBDC design, ranging from how a CBDC is distributed and whether or not a CBDC is based on distributed ledger technology (DLT) or not. However, significant policy perspectives must be further incorporated into CBDC pilot testing, more specifically focusing on access to digital wallets.

Identify verification of wallets is one issue that is currently a hot-button issue for proponents and detractors of CBDCs alike. On one hand, India’s capabilities to issue the majority of Indians a unique identity number within the Aadhaar system has enabled real-time settlements and transfers, to include the effective distribution of coronavirus stimulus aid in 2020. This is also important from the perspective of Anti-Money Laundering (AML) and Know-Your-Customer (KYC) regulations. However, Aadhaar’s hope to integrate consumer biometrics into the Aadhaar system has come under intense scrutiny,  with many questions being raised by privacy advocates of Aadhaar’s protection and usage of collected data. This raises questions of how AML/KYC regulations can be followed without violating users’ rights to privacy, while still ensuring proper identification of consumers.

Additionally, the issue of wallets being able to work in cross-border scenarios is also a topic that necessitates further discussion. Different country-specific regulations present significant challenges for regulators, necessitating more investigation on how truly interoperable wallets can be developed for consumer use, with migrant workers, business travelers, and tourists being among the millions of consumers that would want a multi-functional and interoperable wallet. Offline transactions and capabilities are also of significant concern. Additionally, the growth of popularity in other digital assets like cryptocurrencies and non-fungible tokens (NFTs) also highlight the need for a wallet to incorporate these different asset types while providing consumers with the capability to transact globally.  

Conclusion

In today’s world, a typical consumer’s wallet might be filled with their identification, credit and debit cards, as well as cash in different denominations, with all these things fitting nicely into standardized pockets. Amidst central banks’ rush-to-market to implement CBDCs, governments must consider how consumers can access digital wallets to use CBDCs in the first place, calling upon public and private entities to work together to create the digital version of standardized pockets. Having interoperable wallets capable of holding different digital assets will be just some of the crucial design features that governments must solve, particularly if governments desire to have widespread adoption and use of CBDCs by their respective populations.