Digital Currency by People’s Bank of China Hold Huge Potential
June 16, 2020
Abstract: Under current circumstances, the development of digital currency by the People’s Bank of China is a new solution for financial stability.
Digital currency, blockchain, and other hot issues surrounding the “digital economy” attracted great attention from all sides during the Two Sessions this year. In an interview with the Financial Times, Yi Gang, Governor of the People’s Bank of China, said that “At present, research and development work into the digital RMB is proceeding according to the principles of stability, safety, controllability, innovation, and practicality. First, internal closed pilot tests are to be conducted in scenarios in Shenzhen, Suzhou, Xiong’an, Chengdu, and during the future Winter Olympics to verify theoretical reliability and system stability as well as performance, functional availability, process convenience, the applicability of the scenario, and the controllability of risks”. Before the Two Sessions, news spread about the internal test of China’s Digital Currency Electronic Payment (hereinafter referred to as “DC / EP”) being partially tested in the Bank of China, Agricultural Bank of China and other large state-owned commercial banks. This has led domestic and foreign media to believe that China may become the first country in the world to issue a legal digital currency, due to the high priority allocated by the Chinese government and the rapid development of related technologies. As the problems related to DC / EP involve political, economic, financial, scientific and technological, legal and other aspects, the constructions of such systems as technology, value and governance are still being continuously improved and optimized. To facilitate comprehension, this article will focus on developments and trends in DC / EP and briefly review other related issues.
I. Main development contexts of DC / EP in China
In 2016, the “13th Five-Year Plan for National Informatization” issued by the State Council of China listed blockchain technology as a “strategic frontier technology”, which has attracted capital from various layers and fields. This accelerated the R&D and innovation of the fundamental technology of the blockchain, and laid a solid technical foundation for the development of DC / EP. In 2017, the People’s Bank of China (hereinafter referred to as the Central Bank) formally established the Digital Monetary Research Institute (formerly known as the Special Research Group on Statutory Digital Currency established in 2014). After the establishment of the Institute, the Central Bank explored the financial innovation of blockchain technology in such fields as transaction settlement and trade finance based on fundamental research on blockchain technology and standardization. It has accumulated valuable experience in studying the development of legal digital currency. During this period, several financial institutions jointly established China’s first Fintech Digital Monetary Union, a communication platform for the smooth implementation of digital currency at the financial institution level. In 2018, the experimental production system for the digital bill trading platform developed by the Institute was successfully put into trial operation, and digital bill issuance, acceptance, discount and rediscount based on blockchain technology were successfully undertaken. In 2019, the State Council formally approved the R&D on Central Bank Digital Currency and the launch of the trade finance blockchain platform (PBCTFP) developed by the Institute. In mid-April 2020, the Central Bank led the testing of application scenarios, with the pilot focusing on the four state-owned commercial banks in Shenzhen and China’s three major telecommunication operators, namely China Mobile, China Telecom and China Unicom.
II. The attributes and features of DC / EP
In terms of its attributes, the function of DC / EP is not to issue a new currency, but to replace the existing paper money (i.e. M0 replacement). Therefore, its function and attributes in economic and financial activities are consistent with paper money but in a digital form. Second, DC / EP is a digital payment tool with value characteristics, which can realize value transfer without creating an account when making payments, so it can realize the function of controllable anonymous payment and the protection of consumer privacy, and also meet the requirements of countering money laundering and preventing tax evasion. Third, DC / EP is a Central Bank-sponsored digital currency, and belongs to the legal currency that is endorsed by central bank credit, so it has an unlimited legal tender.
In terms of its features, unlike traditional electronic payments, the DC / EP payment mode is consistent with that of traditional paper money, that is, the “double off-line payment” mode. Specifically, both income and expenditure are offline. In the condition of complete absence of networks, as long as mobile communication devices have power, they can also complete the payment. Another feature of DC / EP is the use of a two-tier operating system for R&D and conversion in the launch mode, and that is to say, the upper layer is the Central Bank which converts DC / EP to commercial banks or commercial institutions, and the lower layer is the conversion of DC / EP to the public by commercial banks or businesses. The establishment of a two-tier operation system will minimize the impact on the existing monetary system and interest structure without triggering financial disintermediation, and could also leverage the resources such as commercial banks and commercial institutions to develop more mature infrastructure, talent pools and service systems. The third notable feature of DC / EP is that no technical route is preset, mainly because, although DC / EP draws on the concepts and key technologies of blockchain, at present the Central Bank does not directly use this technology to issue digital currency. The Central Bank does not intervene in whether commercial institutions use blockchain or traditional accounts, electronic payment instruments or a mobile payment instrument when distributing digital currencies to the public.
III. Similarities and Differences between DC / EP and Other Digital Currencies
(1) Similarities and Differences between DC / EP and Decentralized Digital Currency (Unregulated Currency)
In comparison with bitcoins (BTC) and Ethereum (ETH), DC / EP is identical to them in terms of anonymity. No account is required to make a payment and the value is transferred online; DC / EP differs from them in that it is a legal currency, endorsed by national credit, while Bitcoin and Ethereum’s credit is based on algorithms and consensus. Second, DC / EP is RMB, stable currency, and its value is that of the RMB, while Bitcoin and Ether are not stable and their price volatility is high. Furthermore, DC / EP is a centralized currency created by the Central Bank, and its production and distribution are determined by the Central Bank, while Bitcoin and Ether are decentralized currencies whose production and distribution are determined by algorithms and miners.
(2) Similarities and Differences between DC / EP and Centering Digital Currency (Unregulated Currency)
Compared with LIBRA, DC / EP has in common with it in that they are both centering digital currencies, which reduces the cost of banknote issuance and improves the efficiency of payment and clearing. Second, in order to prevent over-issuance, both of them adopt 100% reserve support measures and a dual-tier operation mode at the time of issuance. Third, both DC / EP and LIBRA have enforceable anonymity, which can protect the legal privacy of the public.
There are four main differences between DC / EP and LIBRA. First, in terms of its technical routes, although both of them adopt a hybrid architecture, DC / EP’s using of blockchain technology depends on the technical route employed by commercial banks or commercial institutions, while the bottom layer of LIBRA is a centralized structure and the top-level settlement uses blockchain technology. Second, in terms of asset reserves, DC / EP uses the RMB as its asset reserve, and has no risk from exchange rate fluctuation, while LIBRA uses a basket of currencies as its asset reserve, which clearly risks exchange rate fluctuation. Third, in terms of functional orientation, DC / EP is an alternative to M0, which does not involve M1 and M2, but LIBRA is theoretically available for lending, so it will expand into the fields of M1 or M2. Fourth, in terms of debtor risk, DC / EP is issued by the Central Bank and backed up by national credit, while LIBRA has the Libra Money Association as its debtor, and the public will face the dual credit risk imposed by Libra Money Association and the issuing institution.
IV. The Development Trend of DC / EP
From a macro perspective, with the increasing frequency and complexity of social and economic activities, as well as the increasing number of financial innovation activities and the accelerating speed of payment technology processes, financial technology has profoundly changed the financial situation. In order to safeguard national financial security and build a modern central bank system, the development of a digital currency by the Central Bank is a newly-established financial solution put forward and implemented by the Central Bank in the new situation. This shows China’s openness and inclusiveness in the financial field, and its development process will continue to advance with the innovation of technology, especially blockchain technology. From a micro perspective, the issuance of DC / EP can not only reduce the costs incurred by the issuing and circulation of paper money, improve the efficiency and security of trading activities, and reduce the occurrence of illegal and criminal activities such as money laundering and tax evasion, but also boost inclusive finance and support high-quality economic development.
In the short term, on the one hand, because the underlying blockchain technology has issues in terms of performance, security, storage, interaction, operation and maintenance, compliance and intelligent contracts, more testing of application scenarios and more involvement of relevant institutions are needed before the formal implementation of DC / EP. On the other hand, due to trading habits, although DC / EP is an alternative to M0, it will not completely replace paper money in the short term, nor will it cause financial disintermediation, let alone have a big impact on the existing real economy.
In the long run, on the one hand, with the profound changes in trade, finance and other industries, a cashless society will accelerate, and Central Bank Digital Currencies such as DC / EP will completely replace paper money. Especially after the experience of the COVID-19 epidemic, countries around the world, including China, have a new understanding of the use of digital currency for transactions. On the other hand, as DC / EP is currently positioned as M0 without interest accrual, the Central Bank can gradually convert DC / EP into interest-bearing assets to the extent that is acceptable to the public, which can not only enrich the investment targets of domestic investors, but also use its borderless nature to free overseas investors from restrictions on cross-border payment trading systems, provide safe reserve assets for overseas investors, and facilitate RMB internationalization. Therefore, I expect that the replacement of paper money by digital currencies may be completed in the next 10-15 years at the earliest.
To sum up, the development of China’s digital currencies is a paperless currency reform driven by the Central Bank from the top down and in an orderly manner, with the support of the Central Government and the involvement of multi-level commercial institutions. Judging from the development process of DC / EP and given the statement without a clear timetable for the introduction of DC / EP by the Central Bank’s Governor Yi Gang, the Central Bank’s introduction of DC / EP will be a prudent and stable process. On the other hand, because it is difficult for commercial banks to promote the use of digital money in the real economy or to individuals, it will take time for the Central Bank to truly fully promote DC / EP. However, it’s certain that issuing a Central Bank Digital Currency has become an important means for comprehensively advancing the modernization of the national governance capacity and governance system, and safeguarding national financial security. The potential of the DC / EP issued by the Central Bank is huge, benefiting all parties, with a bright future.
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