Digital RMB attempts to solve three problems: What is the role of smart contracts?

Wu Shuo Author | Tan Shu

Editor of this issue | Colin Wu

On July 16, the central bank released a white paper on the development of the digital RMB e-CNY (1), which gave a very detailed introduction to the e-CNY, which is already in the testing phase. Although other countries have launched digital currencies issued by central banks around the world, such as the [Sand Dollar] (2) launched by the Bahamas last year, China's e-CNY is at the forefront of the world in terms of economic strength and national influence. At present, the digital currency launched by the People's Bank of China can solve the following problems:

1. Fund security issues

On June 28, Federal Reserve Vice Chairman Randall Qualls spoke at the Utah Bankers Association meeting, saying that it was not necessary for the Federal Reserve to issue CBDC, and that existing stablecoins on the market could already meet the requirements well.

Qualls said that the existing payment system in the United States is already working very well. For example, the Federal Reserve's large-value payment service Fedwire Funds Service processes 4 trillion payments every day, while the private institution "The Clearing House" processes 2 trillion payments every day.

However, in the area of ​​daily payments, the US payment system is not yet well developed. The instant transfer service between banks that is already commonplace in China does not exist in the US. Currently, the fastest interbank transfer service available to US users is ACH (Automated Clearing House), which is developed by the clearing house and can be transferred on the same day. The instant transfer system [FedNow](3) developed by the Federal Reserve will not be ready until 2023 or 2024.

In contrast, in the field of daily transfers, the system of the People's Bank of China is far ahead of the Federal Reserve's system. Under this circumstance, the senior officials of the Federal Reserve are still conservative about the development of CBDC, and China's e-CNY is very ambitious. Of course, the US dollar currently bears the functions of the world's reserve and clearing currency. From the perspective of promotion, there are many issues that need to be considered, so the conservative attitude of the Federal Reserve is understandable.

Although China's daily payment experience is already very convenient, there are still certain risks. After all, whether it is a commercial bank or a third-party payment institution such as Alipay, the balance of people's accounts may not represent the same amount of RMB. For example, if a bank goes bankrupt, the Federal Reserve provides depositors with insurance up to $250,000, and the People's Bank of China provides depositors with insurance up to 500,000 RMB. Considering that the deposit amount of most depositors does not exceed the above figures, in daily life, people can safely treat the balance in the bank as 1:1 legal currency.

The CBDC issued by the central bank helps users eliminate third-party risks. Since e-CNY is equivalent to cash, if users hold large amounts of e-CNY, it is safer than depositing it in a bank.

2. Internationalization of RMB

Regarding the internationalization of the RMB, the white paper mentioned that although technically speaking, e-CNY can be used across borders, at this stage e-CNY is designed mainly for domestic use. In the future, the central bank will explore the possibility of cross-border use of e-CNY through the G20 or other international organizations.

The white paper is very low-key about the internationalization of the RMB. However, with the development of China's economy and the launch of some international multilateral trade, it should be said that e-CNY has considerable potential in the internationalization of the RMB.

Currently, bankers around the world use the Society for Worldwide Interbank Financial Telecommunication (SWIFT) to conduct transactions, and the system is dominated by the United States. In theory, the United States can use this influence to weaken other countries' access to the global financial system. In March this year, Russian Foreign Minister Lavrov called on Russia and China to reduce their dependence on the US dollar and Western payment systems when he began his visit to China this week.

To this end, China has developed the Cross-Border Interbank Payment System (CIPS), an alternative to SWIFT. However, since the RMB is not popular internationally, most cross-border transactions in China are still settled in US dollars through the SWIFT system. e-CNY can obviously play a big role in the popularization of the RMB worldwide, and then be used for international settlement and even international reserves.

3 Effective implementation of monetary policy

Central banks of various countries have long faced a problem, that is, monetary policy may not be well implemented. Since the COVID-19 pandemic, central banks of various countries have been stimulating the economy by printing money, but the effect of printing money is difficult to control. From the perspective of stimulating consumption, the central bank generally hopes that people will spend the extra money it prints. If people who receive subsidies use the money to buy stocks, speculate in real estate, or speculate in cryptocurrencies, this is exactly what the central bank does not want to see.

In recent years, the State Council has proposed to stimulate the economy not by "flooding" but by "precision drip irrigation", but if there is a lack of effective tools, "precision drip irrigation" may not achieve the expected results. Take business loans as an example. Since last year, in order to alleviate the impact of the COVID-19 epidemic on the economy, the government has increased its financing support for small and micro enterprises and private enterprises. Major banks have offered low-interest business loans, and even directly subsidized the interest on business loans. Under the special policies during the epidemic prevention and control period, the cycle of business loans has become longer and longer, and can be as long as 20 years. The original intention of the business loan business was good, but some people took the opportunity to exploit the loopholes and used the money from business loans to buy houses, enjoying lower interest rates and longer repayment periods.

If the smart contract function of e-CNY is used, monetary policy will have a better effect. For e-CNY, the time limit and destination of spending can be restricted, and the flow of funds can also be accurately tracked, thus solving the problem of currency "decoupling from reality and moving towards virtuality" to a certain extent.

e-CNY can solve many problems, but it also faces certain challenges. For example, Qualls once said that one of the difficulties in developing CBDC is that it will provide more opportunities for cyber attackers. Considering that the Internet eliminates the boundaries of attacks, it is likely to encounter more attacks, which is one of the reasons why he opposes CBDC. Threats from the technical security level obviously also exist for e-CNY, and this must be tested for a sufficient period of time to ensure the security and stability of the system. Therefore, before large-scale application, e-CNY should have a long testing process.

[1]:http://www.pbc.gov.cn/en/3688110/3688172/4157443/4293696/2021071614584691871.pdf

[2]:https://www.sanddollar.bs

[3]:https://www.frbservices.org/financial-services/fednow