Viewpoint | Central bank digital currency has advantages that traditional currency cannot match

Source: China Money Market, original title: "Some Thoughts on the Development of Central Bank Digital Currency"

Author: Feng Mengting, Graduate School of Chinese Academy of Social Sciences

Key points

In recent years, central banks and monetary authorities in major countries and regions have been conducting research on issuing legal digital currencies, and discussions on the pros and cons of central bank digital currencies are also heating up in the market. Central bank digital currencies have advantages that traditional currencies cannot match, but risks cannot be ignored. At present, the research and development of digital RMB is at the forefront of the world and has received high attention at home and abroad. In the context of complex international relations, my country should pay close attention to its potential risks and strategically promote the research and development of digital RMB.

Central bank digital currency (CBDC) is a digital form of legal tender issued by the central bank. With the vigorous development of the global digital economy, central banks and monetary authorities in major countries and regions have been conducting research on issuing legal digital currencies in recent years, and discussions on the pros and cons of central bank digital currencies are also heating up in the market.

1. Central banks of various countries have accelerated the development of legal digital currencies

Before the central bank's digital currency entered the public eye, there was a stable "currency" issued by the private sector on the market, but it was completely different from the currency that people traditionally carried. It allows two people anywhere in the world to complete transactions over the Internet in a few minutes, but most retailers do not allow this encrypted "currency" to be used as a payment method for purchasing goods because its price fluctuates greatly. Ultimately, it comes from the fact that it is not issued by the country or the central bank, and there is no guarantee that it can be exchanged with traditional currencies at a predictable price. This kind of stable currency issued by the private sector is often regarded as a financial asset rather than a currency for payment. At the same time, the anonymity of stable coins also makes it more challenging for regulators to track, trace and combat economic and financial crimes.

Against this backdrop, central bank digital currencies have begun to enter people's horizons. However, if other central banks issue their own digital currencies and allow cross-border use, it may erode the use of traditional currencies issued by their own central banks and threaten the ability of decision makers to transmit monetary policy. So far, at least 36 central banks are conducting research and development of central bank digital currencies, but overall they are still in the research and experimental stage. Among them, 18 central banks have announced research plans on retail legal digital currencies. Retail pilots of legal digital currencies such as China, the Bahamas, Cambodia, the Eastern Caribbean Currency Union, South Korea and Sweden are underway. Ecuador, Ukraine and Uruguay have completed retail pilots of legal digital currencies, and Venezuela has launched the legal digital currency "Petro". In addition, the COVID-19 pandemic has accelerated the transformation of payment methods from physical cash to contactless payment methods, and major central banks in Western countries such as Europe and the United States have stepped up their research and development of digital currencies. The Federal Reserve's long-standing cold attitude towards legal digital currencies has changed. The Central Bank of Russia announced that it will study the feasibility of issuing digital rubles, and the European Central Bank also stated that it will study the application for the "digital euro" trademark.

Among the major central banks in the world, the People's Bank of China is at the forefront of the research and development and testing of legal digital currency. In 2016, the People's Bank of China proposed to build a concise, efficient and nationally appropriate Chinese legal digital currency issuance and circulation system that is both secure and flexible. The digital RMB currency is planned to adopt a central bank-commercial bank "two-tier operation" structure, and is positioned to achieve cash (M0) substitution. So far, the research and development test of the legal digital currency of the People's Bank of China has basically completed the top-level design, functional development, and system debugging. At present, small-scale internal closed pilot tests in different scenarios have been carried out in Shenzhen, Suzhou, Xiong'an, Chengdu and other places.

2. Central bank digital currency has advantages that traditional currency cannot match

As an alternative and supplement to traditional currency, the central bank's legal digital currency has the following main advantages.

First, the universal availability and no transaction intermediary fees of the central bank's digital currency provide users with a digital payment method for small-amount, high-frequency transactions, with high transparency and low cost. Compared with private electronic payment methods, cash is more widely available, and the central bank's digital currency is a form of cash. The central bank's digital currency can not only reduce the cost of cash issuance, but also make payments independent of commercial banks and the Internet, achieving more convenient and faster transactions.

Second, the central bank's digital currency helps improve the effectiveness of monetary policy. Information on the public's holding and use of digital currency can be directly fed back to the central bank. The central bank's digital currency supported by big data can capture effective information on currency circulation more timely and accurately, providing a precise basis for monetary policy regulation. At the same time, the central bank can bypass financial market intermediaries and directly affect the interest rate of digital currency, which can improve the effectiveness of monetary policy transmission.

Third, it helps to support public privacy and combat illegal and criminal activities. Central bank digital currency can use technical means to improve the anonymity of electronic payments, and can also allow the central bank to have a deeper understanding of the flow of funds in the economy. Payment data managed by the state can help protect public privacy on the one hand, and on the other hand, it can also help combat money laundering and terrorist financing activities, and combat illegal activities such as tax evasion.

3. The risks of central bank digital currency cannot be ignored

Security is fundamental to the long-term development of digital currency. The most critical issue in the research of digital currency by central banks of various countries is security, which is reflected in reality in how to more effectively avoid or reduce the adverse effects of digital currency on economic and financial stability.

The first is the potential risk of bank disintermediation. The central bank's digital currency is a substitute for traditional cash. Large-scale cash digitization and disintermediation may disintermediate banks and may also lead to a "digital run" on the central bank by the public. Therefore, the design of the current central bank's digital currency issuance has become the primary issue for researchers and developers to consider. Major central banks have stated that digital currency issuance will only replace part of the cash. In addition, the circulation speed of the central bank's digital currency may be faster than that of traditional currency. In the absence of commercial bank participation, the uncertainty of the accumulation and spread of traditional financial risks will also increase.

The second is the risk of weakened monetary sovereignty. Considering the many advantages brought by the digitization of legal tender, if all major central banks issue digital currencies and use them for cross-border payments, it may strengthen the international use of strong currencies such as the US dollar, which will not only fail to improve the existing international monetary system, but will strengthen the current position of the US dollar in the international monetary system. In extreme cases, many other currencies may be replaced by the "digital dollar", resulting in the loss of national monetary sovereignty.

The third is the system, network and password security risks. The real-time nature of the central bank's digital currency requires the central bank to have sufficient technical resources, a fast decision-making structure and response capabilities to ensure business continuity and operational resilience. System technical failures, network attacks and cryptographic technology defects will quickly affect a large number of users, threatening not only the security of personal information, but also the stability of the financial system and affecting the public's confidence in the central bank and legal tender.

Fourth, there are systemic risks outside the financial sector. Currency is a necessity for a country's social production and life, involving all aspects of the economy and society. The central bank's digital currency will not only reconstruct the rights and obligations between financial regulatory authorities, commercial banks, market institutions and users, as well as regulatory responsibilities, but will also involve many fields such as finance, taxation, justice, education, transportation and logistics. While the digitization of legal tender improves payment efficiency, it also increases the risk of financial risks spreading to external fields.

4. The research and development of digital RMB should be actively, steadily and prudently promoted

my country's electronic payment system has taken a leading position in the world, and the development of digital RMB is also at the forefront of the world and has attracted great attention at home and abroad. In the current complex international relations, my country should pay close attention to its potential risks and strategically promote the development of digital RMB.

First, actively promote the research and development of digital RMB and risk testing. In view of the complexity of legal digital currency itself and its wide range of involvement, it is advisable to carefully judge the timing of its issuance and the possible impact on the stability of the economy and financial markets. First of all, it is necessary to closely combine China's national conditions and actual needs, comprehensively evaluate the cost-benefit, fully predict its potential risks and have a complete response plan. Secondly, improve the use process of digital RMB, enrich the scene application, and expand from the current small retail scene to a wider range of merchant-side scenes as soon as possible, so that digital RMB can better serve the high-quality development of the industrial Internet. Thirdly, explore the construction of a regulatory framework that is compatible with the characteristics of digital RMB, do a good job in the construction of the circulation environment of digital RMB, and ensure flexibility and scalability.

Second, we should attach great importance to the construction of infrastructure related to the issuance of digital currency by the central bank. The relevant infrastructure mainly includes two aspects. On the one hand, it is necessary to build IT systems and networks with security, immediacy and operational flexibility, improve the security management system of the digital RMB operation system, formulate relevant systems and standards, and organize all-round system security testing and evaluation from the aspects of cryptographic application security, financial information security, business continuity, etc., to ensure that we have the ability to fully respond to operational failures, network terminals, natural disasters, power failures and other problems. On the other hand, based on the existing citizen identity information system, we should accelerate the construction of a unified national digital identity information system, explore the development of an inclusive account system based on digital identity, include citizens' biometric features in the collection scope, and study and formulate unified standards from a technical level to ensure the security and robustness of databases, network access and authentication.

Third, properly publicize the progress of digital RMB research and development, and improve the laws, regulations and systems related to digital RMB as soon as possible. China's electronic payment system development is already at the forefront of the world, and the current digital RMB research and development has attracted great attention at home and abroad, which may prompt Western countries such as Europe and the United States to step up their efforts to formulate preventive measures that are unfavorable to us. China should keep a low profile and avoid too much "showing". In addition, the application of digital RMB also involves many legal and regulatory obstacles. For example, the current cross-border payment, cash management and other systems may not be applicable in some scenarios of digital RMB. China should seize the current opportunities of the "People's Bank of China Law of the People's Republic of China" and "Commercial Bank Law of the People's Republic of China" to remove legal and regulatory obstacles such as cross-border payment and cash management related to the development of digital RMB, and continuously improve regulatory policies in pilot tests.

Fourth, while promoting the pilot in an orderly manner, fully dispel doubts and confusions for the public. The early testing work has accumulated preliminary experience for the future promotion and application of digital RMB, and has also triggered various speculations at home and abroad. Therefore, while promoting the pilot test of digital RMB in an orderly and steady manner, it is necessary to strengthen the guidance of the public, fully dispel doubts and confusions on issues of general concern to the society, such as the relationship with existing payment tools, the use of middle-aged and elderly people, and personal privacy protection, and improve various measures to protect relevant vulnerable groups in view of the "digital divide", so as to create a better social public opinion environment for the promotion and application of RMB digital currency.