Why are central banks around the world issuing CBDCs amid global monetary easing?

Arrangement: Roxe

Central bank digital currencies (CBDCs) have officially entered the international financial market, and many experts have identified CBDCs as one of the most important trends shaping currency in the next decade. According to survey data released by the Bank for International Settlements, 80% of the world's 66 central banks said they are researching digital currency technology, and about 20% said they may issue digital currencies in the next six years.

At present, the Bahamas, Uruguay, Ecuador, Venezuela, Thailand, and Cambodia have issued CBDCs, and the central bank digital currencies of emerging market countries such as China have entered the actual testing stage. The development of CBDCs in the world has entered the fast lane. What impact will the development and implementation of CBDCs have on central banks? Can it effectively cope with inflation? What opportunities and challenges will it face? To this end, on April 21, Roxe Payment Network invited Li Hui, Executive Dean of Huolian Technology Research Institute, Gu Yanxi, founder of American Liyan Consulting Company, and Cao Jing, co-founder and CEO of AscendEX (formerly BitMax), to conduct an in-depth discussion on the development trend of CBDCs. Haohan, CEO of Roxe Payment Network, served as the moderator of the meeting.

Impact of CBDC on central banks

CBDC usually refers to digital currencies directly issued by central banks. "Although it is still unclear what underlying technology central banks will use to support the issuance of CBDC, the development of encrypted digital currencies and Libra (now renamed Diem) is an important reason for the popularity of CBDC," said Gu Yanxi, founder of the US Lijian Consulting Company.

Initially, the Libra Association planned to issue a single stablecoin based on a basket of fiat currencies. This plan caused a sensation worldwide and also stimulated central banks in various countries to create their own CBDC solutions. However, central banks in various countries are currently in the exploratory stage, and the research on CBDC mainly depends on what problems it can solve. Gu Yanxi believes that CBDC is mainly to solve two problems: First, how to improve the efficiency of cross-border transactions? At present, the high cost and low efficiency of cross-border payments have seriously hindered the development of cross-border trade. This is the primary problem that CBDC should solve at present. For example, the Libra stablecoin is not only universal in various countries, but also can basically achieve real-time payment. This is the advantage of Libra. Secondly, how to deal with the opportunities brought by the emergence of digital assets? At present, digital assets are all generated on the blockchain. If you want to circulate globally, you need a native digital currency that can support docking with digital assets in terms of programming. Ethereum, which everyone is familiar with, uses smart contracts for transactions. Especially with the development of DeFi, many problems can be solved based on stablecoins.

"I think a single central bank issuing CBDC alone cannot solve these two major problems. If major central banks cooperate and issue CBDC while maintaining the independence of their respective monetary policies and reaching consensus on technology and issuance mechanisms, the above problems can be effectively solved, especially in terms of the performance of cross-border payments," added Gu Yanxi.

In this regard, Cao Jing, co-founder and CEO of AscendEX (formerly BitMax), holds a different view from Gu Yanxi. He believes that the real problem that digital currency needs to solve is not necessarily cross-border payment, but the problem of people in remote areas without bank accounts. "At the same time, I don't think that central banks of various countries will take unified measures to issue digital currencies, just like the EU will cause great problems if it adopts the same currency. Therefore, in the initial pilot implementation, central banks of various countries should issue their own CBDCs independently, which will help major countries observe the effects of CBDC issuance and then decide whether to follow up." Cao Jing added.

Cao Jing analyzed that CBDC is not necessarily a cryptocurrency. The core of blockchain is distributed accounting. From the current development situation, there is no clear regulation that the digital currency issued by the central bank is a cryptocurrency based on blockchain. It may also be an electronic currency in the form of storage designed by the central bank. Whether CBDC is a blockchain cryptocurrency, including whether Libra is a digital currency, and what form the central banks of various countries will take, there is no conclusion yet.

"I think the main pain point that central banks want to solve by launching digital currencies is the problem of most people in developing countries not having bank accounts, rather than cross-border payments." Cao Jing further analyzed that due to the high maintenance costs of branches, there are no bank branches in many countries, especially in remote rural areas of developing countries, and it is very inconvenient for people to deposit and withdraw money. Digital currency can largely solve the problem of no bank accounts, and many services can be solved online. In addition, if the US dollar is replaced by digital currency, it will have a significant impact on the world, so large economies including the US dollar and the euro are unlikely to start pilot projects from the early stage. Instead, some small countries with relatively simple economic structures are developing faster in the digital currency track. Of course, there are also major countries like Japan, but most of the pioneers of CBDC are small countries such as Iran and Venezuela, because for countries that cannot freely convert foreign exchange, digital currency can help them break through some real obstacles.

“Indeed, it is cheaper for small countries to try out digital currencies to replace the original systems, just like China’s mobile payments replaced cash payments. If the United States replaces credit card payments, it will not actually bring much benefit, and the education cost of replacing the original system is also very high.” Haohan, CEO of Roxe Payment Network, also said.

Li Hui, executive director of Huolian Technology Research Institute, believes that CBDC is a trend of historical development. In the future digital world, whether to build a financial infrastructure that is more compatible with the digital world on the existing system is the key consideration for many central banks to design CBDC. The purpose is to better control the flow of funds, and then better conduct macroeconomic regulation, implement some fiscal and monetary policies, including increasing the payment elasticity of currency, and reducing many unnecessary intermediate links. Last March, the US economic stimulus plan was a good example. The reason why the digital dollar plan was proposed at that time was because digital currency payment was more efficient. Through the digital dollar, the US government can more efficiently distribute relief funds directly to the American people without going through banks or payment companies. Not only the United States, but many countries have this demand.

As a new thing, central banks of various countries are in the exploratory stage. As for whether the underlying technology will adopt blockchain technology, whether to make retail CBDC or wholesale CBDC, different countries have different practices. Although some countries have launched CBDC, in fact, it has not really been implemented. The reason is that the CBDC system has not been fully utilized. The development of CBDC will have a certain impact on the existing banking system. A successful CBDC design will not undermine the stability of the existing financial system, otherwise it will bring financial risks.

“As Dr. Cao said, the countries that have previously tried CBDC are actually those with underdeveloped economies or severe inflation. This is because they are worried that if China’s DCEP or the US digital dollar is developed, it may replace their domestic legal tender, causing their own sovereign currencies to be severely impacted and affected. In addition, CBDC is a technology-based digital system, which will have some technical risks and require continuous testing and iteration,” Li Hui added.

Can CBDC alleviate the inflation dilemma?

"CBDC may bring certain risks if it is not designed properly. In a financial crisis, depositors may transfer their deposits to CBDC. The reliable deposit insurance can continue to play a role in preventing bank runs, but CBDC makes it easier to transfer money, thus triggering bank runs." Haohan said: "In the digital world, legal tender cannot circulate better, because almost every country's legal tender needs to go through its own clearing and settlement system. For example, the United States uses FED-WIRE for local clearing and settlement, and China has two clearing and settlement systems, domestic and international, which are isolated from each other and have great friction. For some countries with severe domestic inflation and international sanctions, issuing CBDC may be a possible solution as a currency substitute to alleviate inflation, such as Türkiye."

Li Hui believes that CBDC is a payment method that cannot directly solve economic problems such as domestic inflation. The United States has previously printed a lot of money, and mentioned in the report that it can use CBDC or digital dollars to distribute these funds to the public and businesses, which will accelerate everyone's expectations of inflation.

Cao Jing and Li Hui share the same view on the relationship between CBDC and inflation. He said that digital currency itself will not solve the problem of inflation, but if digital currency is adopted on a large scale, it can help decision-makers in various governments to formulate more refined monetary policies. From this point of view, CBDC can help alleviate inflation to a certain extent.

“Whether it is CBDC or the existing economic system, the key to curbing inflation lies in monetary policy, that is, whether the money supply can be truly controlled to be consistent with the GDP supply. If the total amount of money is constant, a deflationary economy will not lead to inflation.” Gu Yanxi said: “The CBDC carrier itself will not have an impact on inflation. The key still depends on the central bank’s monetary policy. Under the current circumstances, I think Bitcoin is the best tool to curb inflation worldwide.”

Can CBDCs of different countries be interconnected?

"At present, the development of CBDC is still in its early stages. It is difficult to truly achieve the unification of global digital currencies both from a technical and political perspective. There is a high probability that a public interface will be established by the major currencies of several major countries. The future development of CBDC is more of a political and commercial issue than a technical issue. It is too early to discuss whether integration is needed and how to integrate it during the trial stage," said Cao Jing.

Gu Yanxi believes that it is very likely that a unified standard will be reached in terms of technology, and then each country can achieve interoperability after issuing according to its own monetary policy. Specifically, whether the central bank will adopt a "distributed" or "centralized" system and standard depends mainly on what kind of agreement will be reached between central banks. Although the investment cost is high, a unified technical standard is definitely feasible and operability can be achieved.

"I agree with Mr. Gu's point of view. In the future, a set of global common unified standards will definitely be established to achieve the interconnection and interoperability between CBDCs of various countries." Li Hui said: "This standard is not only technical, but also includes many business aspects. On the basis of unified standards, currency exchange can be carried out more smoothly between each other, including the realization of payment and other functions." In fact, international organizations such as the G7 Group, G20, Bank for International Settlements, Financial Stability Board FSB and Financial Action Task Force on Money Laundering FATF have been discussing the future standards of CBDC very intensively. Just like the current cross-border payments are based on the SWIFT standard, in the future, digital currencies will also have such an institution or organization to specify a set of standards. In addition, the current cross-border remittances are bank-to-bank transactions. There are many banks in each country, which is an N-to-N relationship. In the future, if each country has its own CBDC central bank digital currency system, it will become a one-to-one relationship. Therefore, for future cross-border payments, CBDC can reduce many intermediate redundant links in business and improve remittance efficiency.

The positive effects of China's issuance of DCEP

At present, China's share in the world economy is disproportionate to the share of RMB in foreign exchange reserves of various countries. Although the internationalization of RMB has made great progress, as a non-freely convertible currency, it still restricts many countries from adopting RMB. The development of digital currency can enhance the international status of RMB. In addition, the promotion of RMB digital currency is also good for people without bank accounts in many parts of China, allowing more people to enjoy financial services.

"As for the defense of the US dollar, China, as the world's second largest economy, has a GDP of about 75% of that of the United States. It has a very strong ability to resist the inflation output of the US dollar. Therefore, the launch of the digital RMB has laid a good foundation for China's international economic influence and the popularization of the RMB," Cao Jing added.

"I agree very much with Dr. Cao's views on monetary policy." Gu Yanxi said: "As a new RMB carrier, DCEP will definitely reach more users and application scenarios that the existing RMB circulation system cannot reach, such as the unbanked population mentioned by Dr. Cao. This is indeed good for them. As for whether DCEP can fight against the expansion of the US dollar, in addition to monetary policy, it also depends on factors such as the degree of promotion of DCEP and the degree of market acceptance worldwide."

"The international status of the RMB mainly depends on monetary policy and economic strength, and of course it is inseparable from some diplomatic policies. DCEP, which is based on payment, circulation efficiency and diversity, can accelerate this process, but DCEP is currently only being piloted domestically, and it will take a long time before it can be truly used on a large scale and invested internationally. Therefore, in the short term, DCEP may not have any essential resistance to the current situation and can only play a mitigating role. But in the long run, it can indeed accelerate the improvement of the international status of the RMB." Li Hui said.

At present, all countries are rushing to promote CBDC. Under the trend of digitalization, CBDC, as an important supplement to the current underdeveloped payment and settlement system, can not only solve the existing cash management cost problem, but also promote the realization of inclusive finance, allowing more people to enjoy more convenient, safe and low-cost financial services.