Why ‘NUE’ should harness blockchain to reinvent payments in India

The evolution of payments systems was extremely gradual over the course of early commercial history as trade systems moved from one of barter to a monetary based system. This was before the payments sector underwent rapid transformation in the decades since the 1960s, made possible in part by central banks and private sector actors—who today continue to drive developments in the payments space.

The role of the private and public sector in driving the growth of the payments sector in India

Broadly speaking, the evolution of the payments space from the 1960s can be easily classified into two phases. From the 1970s to the 1990s, central banks played a pivotal role in standardising the payments process through the creation of centralised systems such as the Automated Clearing House (ACH) in the US, and the Real Time Gross Settlements (RTGS) in India. With such platforms, financial institutions, organisations, and individuals were able to enjoy the automated settlement of high-volume transactions—completely revolutionising the way payments were carried out. Specific to India, the RTGS has been in operation for close to two decades and has undergone multiple refinements, led by the Reserve Bank of India, to ensure that the system is secure and cost effective.

Since the 1990s, private corporations and national payment networks have increasingly led efforts to improve the cost, speed, and reliability of automated payments. This paved the way for greater innovation and the use of cutting-edge technology across the payments sector, which enabled India to leapfrog countries around the world. In 2016, the National Payments Corporation of India (NPCI) unveiled the Unified Payments Interface (UPI). Designed as a public good, the interface was built to handle the instantaneous transfer of value between two parties who have a UPI address.

In just three years, UPI has attained 955 million transactions amounting to 1.61 trillion rupees, 100 million active users in 2019, and is processing an equivalent of 15% of India’s GDP (₹31 lakh crore) in 2020; a testament of the impact of real-time payments systems on Indian consumers.

As this came at a time where most consumers were reliant on card-based transitions, one could say that the UPI paved the way for an outright explosion in the fintech space, with countless apps being developed to provide customers with real-time payments.

Today, India continues to be at the forefront of change. Amidst UPI’s success, the RBI made several announcements in 2020 on its plans to create a New Umbrella Entity (NUE) in the retail payments space—setting the stage to provide public and businesses with multiple alternatives for safe and efficient payments. This new NUE was created with the intention of boosting the retail payments system in India by offering an interoperable nation-wide payments network. NPCI will remain relevant even with incoming competition from the new NUE, however, and the UPI ecosystem and framework and other existing systems can be seamlessly integrated with the NUE.

The new NUE—returning profitability to a traditionally low margin industry

At first glance, it might seem like the impact of the new NUE is limited to improving transaction speed and introducing an interface that is consistent and unified in the payments space. However, with payments being a notoriously low margin business, the fundamental question that arises for new players is how to distinguish themselves from incumbents while ensuring that they drive up their profits, especially given that NPCI’s systems work so well?

The solution lies in a threefold strategy. First, change the rules of the game by being more than ‘just’ a payments platform. Second, design your systems from Day 1 to operate at the lowest costs and third, design the tech systems to be hyper scalable from the start.

To offer more than ‘just payments’ the opportunity for the NUE lies in creating new products where payments are seamless and deeply embedded in the business flows. This enables a convenient and entirely frictionless payment experience for customers.

Similar to most industries, value creation has begun to move up the stack, and there lies an opportunity for businesses to generate profits by differentiating themselves in the areas of cost and performance. This concept has been utilised by ride hailing giant Uber, who pioneered new technologies that allowed individuals to complete their rides without paying—cash does not change hands, once the car comes to a halt, the passenger will receive a receipt in their email notifying them that the payment has been deducted from their card.

Imagine how seamless embedded payments like this can be replicated in complex workflows such as Letter of Credit, tax payments, invoice financing, and even corporate debentures. Herein lies the opportunity for the friction in business transactions to be significantly reduced, and unprecedented efficiency gains to be achieved, which will in turn translate into colossal positive gains for the economy.

Successful payment networks must execute billions of transactions with precision to keep operating costs low. To reduce transactional friction, the payments network needs to be built with technology that enables it to achieve that. Even with major innovations in place, financial institutions today still find themselves having an army of 40-50 people vetting and reconciling their systems. The big opportunity for the NUE is to make technology choices that eliminate such wasteful legacy systems.

Lastly, as the digital payments space continues to grow rapidly in India, the stress placed on financial institutions’ legacy centralised infrastructures is immense—resulting in notable failures in recent years. The NUEs have to address this challenge head on by selecting distributed, scalable systems that are able to keep up with the explosion of payments in India.

Why is blockchain best suited to disrupt the payments space?

Integrating new technologies into legacy payments stacks has always been a near-impossible task, with payments often viewed as parallel to and independent from the business workflow. Blockchain, however, serves as a viable alternative to other emerging technologies when it comes to deployment in the payments sector—with the ability to scale and handle complex processes, and address the three challenges mentioned above.

Distributed Ledger Technology (DLT) based smart contracts are able to process complex business logic, allowing businesses to transact directly and in strict privacy with one another, while driving down transaction and record-keeping costs. Imagine an NUE built on such a platform—one which can handle complex processes such as asset issuance of trade settlements, imagine the power of a payment platform built on blockchain that allows SMEs to calculate taxes, issue complex corporate bonds, submit invoices for discounting, and make and receive payments all within the same workflow. Furthermore, each of these independent processes are able to communicate with each other seamlessly. Offering these value-added workflows embedded in the payments infrastructure can create new pockets of value that can be captured by the NUE.

DLT is also known for its promise of scalability and accuracy, which can drive the reconciliation and settlement costs of NUE to near zero. A robust blockchain system will only commit transactions to the ledger that participants are on—which is essentially where there is ‘consensus’ between parties.  This ensures that the ledger automatically maintains and shares a verifiable record seamlessly amongst all parties. An example that demonstrates the potential of blockchain technology is the Spunta Project in Italy, built on R3’s Corda. Today, over 100 Italian banks use the blockchain platform to perform interbank transfers and settlements.

Finally, the fact that DLT networks are able to provide a seamless audit trail helps to significantly lower the regulatory burden for new entrants. Blockchain’s finality and immutability leaves a permanent, time-stamped audit trail for every stage of a business transaction and process, making it easy for entities to isolate and extract relevant information where required.

The future of payments is blockchain

Blockchain detractors might be skeptical about the maturity level or throughput of the technology. But in 2021, as the blockchain sector becomes increasingly mature, these fears no longer hold true. Strong use cases across industries such as the Spunta Project outlined above, and DTCC’s Project Ion have clearly demonstrated that DLT is ready for prime-time, and able to handle high volume, high resiliency projects at a national scale.

The future of the payments space is bright and brimming with potential—DLT will play a pivotal role in enabling the new NUE to gain a sustainable advantage over their competition and leapfrog the world once again by ushering in an era of embedded, seamless, invisible payments that are natively integrated with business workflows.

The article is by Vivekdeep Gupta, Country Head, India at R3.