Expert opinion: DC/EP is a new currency in the digital economy era and may give rise to a new economic form in China

Author: Gao Caixia

Source: Tsinghua University Internet Industry Research Institute

Editor’s Note: The original title is “The Significance and Impact of DC/EP Issuance”

Recently, news about the digital currency of my country's central bank (Digital Currency Electronic Payment, referred to as DC/EP) has been released intensively, sparking heated discussions in society. At present, the central bank has basically completed the top-level design, standard setting, function development, joint debugging and testing. In accordance with the principles of stability, safety and controllability, internal closed pilot tests have been carried out in Shenzhen, Xiong'an, Chengdu and Suzhou since the end of 2019. The first batch of DC/EP pilot institutions include the four state-owned banks of Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and Construction Bank of China, and the three major operators of China Mobile, China Telecom and China Unicom. The pilot scenarios include transportation, education, medical care, consumption and other fields. In the future, the functions of DC/EP will be continuously optimized, and the issuance and application of digital legal currency will be steadily promoted. The significance of digital currency as the infrastructure of the digital economy has been increasingly recognized by the public.

In fact, the research of the People's Bank of my country on digital currency can be traced back to 2014. Under the leadership of Zhou Xiaochuan, the then governor of the central bank, the People's Bank of China established a special research group on legal digital currency to demonstrate the feasibility of the central bank issuing legal digital currency. In September 2016, based on the original group, with the approval of the Central Organization Department, the People's Bank of China established a directly affiliated institution, namely the Digital Currency Research Institute of the People's Bank of China. On June 15, 2018, Shenzhen Financial Technology Co., Ltd. was established, which is 100% controlled by the Digital Currency Research Institute of the People's Bank of China. In September 2018, the "Nanjing Financial Technology Research and Innovation Center" and the "Application Demonstration Base of the Digital Currency Research Institute of the People's Bank of China (Nanjing)" were officially unveiled. In August of the same year, the central government issued a document to carry out digital currency research and mobile payment pilot projects in Shenzhen. Since then, the institute has actively deployed research and development institutions in various places.

So far, the Digital Currency Research Institute of the Central Bank has applied for more than 80 patents involving digital currency. The content covers solutions such as digital currency generation, issuance, circulation, verification, exchange, and recycling; methods and systems for opening, upgrading, key replacement, depositing, payment, inquiry, currency exchange, and cancellation of digital wallets. From the perspective of patent applications, it can realize the process of digital currency issuance, trading, and withdrawal from the central bank to commercial banks, realize the use of DC/EP by end users, and help realize the circulation of DC/EP in the market.

Digital currency is the inherent requirement and inevitable result of the evolution of payment system, innovation of information technology and encryption technology, development of network economy and financial reform and innovation. Among them, the most noteworthy is blockchain technology. Blockchain is a new application mode of computer technology such as distributed data storage, point-to-point transmission, consensus mechanism, encryption algorithm, etc. It has the characteristics of "unforgeable", "full trace", "traceable", "open and transparent", and "collective maintenance". Relying on blockchain technology and smart contract technology and distributed concepts, such as Ethereum extending Bitcoin's programmable script technology, it is committed to developing a decentralized smart contract platform that cannot be stopped, shielded and self-sustaining.

At present, there are more than 5,000 digital virtual currencies in the world, with a market value of about 1.5 trillion US dollars. However, since it is a decentralized virtual currency that is separated from national credit, it is separated from sovereign credit, the issuance basis cannot be guaranteed, the currency value fluctuates greatly, and speculation is serious. Most countries have a conservative attitude towards digital virtual currencies. In order to prevent systemic financial risks, my country has adopted a high-pressure stance on illegal digital virtual currencies, prohibiting ICO, prohibiting the transaction of RMB and digital virtual currencies, guiding mining companies to withdraw, and prohibiting access to websites involving cryptocurrency transactions nationwide. For sovereign states, the best way to practice is for the government and the central bank to issue sovereign digital currencies. DC/EP is a legal sovereign state currency issued by the central bank with national credit as endorsement. Although DC/EP draws on the concepts and key technologies of blockchain technology, such as asymmetric encryption, traceability, non-forgeability, and peer-to-peer payment, the issuance of central bank digital currency at this stage does not directly adopt blockchain technology. The central bank said that the research and development of DC/EP does not preset a technical route, leaving more optional means for future DC/EP market circulation innovation and business model innovation.

In terms of operation mode, a two-tier operation structure will be adopted, that is, the central bank will first exchange DC/EP to banks or other operating institutions, and then these institutions will exchange it to the public. DC/EP is positioned as an electronic substitute for physical cash, belongs to M0, is equivalent to cash, and does not bear interest. The two-tier operation system retains the system and interest structure of the existing monetary system, does not harm the existing business model of commercial banks, will not cause financial disintermediation, and is also conducive to mobilizing commercial banks to actively promote DC/EP. In terms of technical architecture, appropriate adjustments are made on the basis of the existing currency operation structure to form a "one currency, two vaults, and three centers" structure. The so-called "one currency" refers to an encrypted digital string representing a specific amount of money that is guaranteed and signed by the central bank. "Two vaults" refer to the central bank's issuance vault and the commercial bank's bank vault, and "three centers" refer to the authentication center, registration center, and big data analysis center. The construction of the prototype system is carried out in multiple phases.

Compared with the existing RMB, it has the advantages of portability and security, supports dual offline payment, reduces issuance and storage costs, supports controllable anonymity, and is conducive to achieving the goals of anti-money laundering, anti-terrorism, and anti-corruption.

01 The significance of DC/EP issuance

1. DC/EP provides a more convenient means of payment for the internationalization of RMB

On June 18, 2019, Facebook released the white paper of the encrypted digital currency project Libra, intending to anchor multiple national currencies to form a "basket of currencies" to establish a "borderless national currency". Libra's advantage is that it can use Facebook's 2.7 billion platform users to create a low-cost, zero-friction payment system, providing the possibility for Facebook to realize its value in various scenarios such as games, e-commerce, and news, forming a complete closed-loop ecosystem. The Libra white paper has sparked heated discussions in the financial, academic, and business communities.

However, Libra is still in the white paper discussion stage. On the one hand, the Libra project has been questioned by the US Senate and Congress, and has been boycotted to varying degrees in other countries, and its compliance is questionable. On the other hand, eight members of the Libra Alliance have withdrawn, and most of them are influential payment institutions. If Libra is issued and popularized and applied in countries around the world, it will strengthen the international status of the US dollar, impact the sovereign currencies of other countries, erode the status of weak currencies, and also affect the future international development space of the RMB.

Faced with the pressure from Libra, the People's Bank of China re-examined the development of digital currency and began to accelerate it. In early August 2019, the central bank held a video conference on the work in the second half of 2019. The meeting called for accelerating the pace of research and development of my country's legal digital currency (DC/EP). Mu Changchun, deputy director of the Payment and Settlement Department, said that the central bank's digital currency can be said to be "on the verge of being released", which has raised market expectations. In November 2019, the first batch of DC/EP pilot institutions included the four state-owned commercial banks of Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and China Construction Bank, and the three major operators of China Mobile, China Telecom, and China Unicom in Suzhou, Xiong'an, Chengdu, and Shenzhen to carry out pilot projects. In April 2020, the pilot scenarios were announced one after another, and the application scenarios involved salary payment, transportation subsidies, retail and catering, etc., which are closely related to people's lives. The issuance of DC/EP has entered the countdown era.

At the same time, on April 16, 2020, Libra released an updated version of the white paper and made major revisions, mainly including providing a stablecoin anchored to a single fiat currency, improving the security of the Libra payment system through a strong compliance framework, abandoning the transition plan to a permissionless public chain system, and establishing strong protection measures for Libra's asset reserves. Libra2.0 greatly alleviates the regulatory and commercial resistance faced by the Libra project. During this period, new members continued to join the Libra Association, even including virtual asset service providers (VASPs). Since Libra's credit is significantly higher than other stablecoins, once Libra's stablecoin is issued, it will have a huge impact on the existing stablecoin market in the native blockchain ecosystem.

Both DC/EP and Libra have borrowed or directly adopted the ideas and technical features of blockchain technology, and are likely to meet in the international market. Due to the winner-takes-all problem that may arise from network effects, judging from the series of information released, the two sides have entered a situation of chasing each other to gain first-mover advantage.

DC/EP is a new form of RMB development in the digital economy era. In different historical periods, there have been physical currencies represented by shells, metal currencies represented by metals, and substitute currencies represented by paper money. Credit currencies represented by national sovereign credit have further developed, and now electronic currencies have entered the information age.

At present, my country has entered the era of digital economy represented by big data, cloud computing, artificial intelligence, the Internet of Things and 5G. Since currency carries business information, logistics information and personnel flow information, it actually links the relationship between enterprises, enterprises and individuals, and individuals and individuals. It is the expression and carrier of production relations. DC/EP can meet the demands of lower cost, zero friction, infinite divisibility, security and privacy protection of the people in the digital age. When expressing the prototype design goals of DC/EP, Yao Qian said that legal digital currency is credit currency in value, cryptocurrency in technology, algorithmic currency in implementation, and smart currency in application scenarios. DC/EP can be said to be the product of the highly developed modern commodity economy and the continuous advancement of technologies such as cryptography. It is the manifestation of the continuous evolution of currency as a means of payment, and represents the development direction of modern credit currency.

3. DC/EP is the key hub for the development of the future digital economy

On April 9, 2020, the "Opinions of the CPC Central Committee and the State Council on Building a More Perfect System and Mechanism for Market-based Allocation of Factors" was released, which for the first time listed data as one of the five major factor markets, along with land, labor, capital, and technology. In the era of digital economy, data will replace oil as the driving force for social development. Compared with oil, data resources are inexhaustible and have the characteristics of massive, real-time, and continuous. Data has no boundaries and can be combined with various industries, penetrate into all areas of production and life, and will be abstracted into assets of the digital era economy, derive new business forms, and drive economic development. In the future, with the advent of the digital twin era, physical assets will continue to be mapped to the virtual world, cross-border collaboration and smart contracts will be widely used, and the digital world and the physical world will achieve division of labor, mutual care, deep interaction, and integrated development. DC/EP will build a bridge between the physical world and the digital world, and will bear the functions of pricing, trading, and value transfer, playing a hub role. DC/EP will become a tool for governing the digital world, reflecting the logic and laws of the world's operation, and outlining the appearance of the future world. Under the influence of the emerging industrial ecology with DC/EP as the core, it is expected to reshape the laws of economic development, form a new world pattern, and produce irreversible results.

02 Impact of DC/EP issuance

1. Impact on the economy and finance

At present, blockchain has been included in the scope of new infrastructure. As a public product, DC/EP can integrate into the operation of information infrastructure with digital features such as fast, efficient, and infinitely divisible, so as to achieve the purpose of reducing costs, increasing efficiency, and realizing multi-party collaboration. In particular, with the construction of basic network facilities such as the National Blockchain Platform (BSN) and regional vertical industrial chain clusters, DC/EP is likely to be integrated into the platform and ecology and will promote mutual cooperation and integration among members, giving birth to a new value chain and a new economic form.

In the financial system, the emergence of DC/EP may trigger new financial system and product innovation, enhance the integration of the real economy and the financial system, and strengthen the governance capabilities of the central bank.

The legal compensation and traceability of DC/EP undoubtedly strengthen the country's governance capacity. Every enterprise and individual has a close relationship with the national administrative department, such as paying taxes, paying social security, issuing loans and wages, and targeted poverty alleviation. On the one hand, within the scope of relevant national administrative functions, it is likely to be issued and promoted in the form of DC/EP. For example, if there is tax evasion or large-scale abnormal consumption of the legal income of civil servants and state-owned enterprise employees, there will be an early warning in the big data of the central bank. Unlike the irreversible losses caused by traditional post-event supervision, one of the advanced features of the central bank's digital currency is that it can warn in advance and intervene in advance to stop criminal behavior. On the other hand, for small and micro enterprises and poor families, specific interest rates or subsidies can be accurately implemented to prevent the phenomenon of idle funds and misappropriation of charity funds. Through precise financial and financial policies, both kindness and severity will deter economic crimes and corruption, encourage charity, and thus help establish fair and reasonable business transactions and shape a credible social atmosphere.

3. Impact on life and culture

In the short term, the promotion scope of DC/EP will start from the pilot and will gradually be open to the general public. However, DC/EP needs to face many challenges to achieve popularization. On the one hand, the convenience and efficiency brought by mobile payment can already meet the needs of modern life; on the other hand, since DC/EP does not bear interest, it cannot bring asset returns to the holders/institutions. How to cultivate users' usage habits and satisfy users' experience is a huge challenge for DC/EP. Furthermore, DC/EP also involves operations such as downloading digital wallets, which may increase the user's operational burden. Of course, for foreigners who do not have easy access to bank accounts, as well as the elderly and minors who do not have accounts, DC/EP will be of great attraction. In short, at this stage, even if DC/EP is promoted and used, it will be a long-term supplement to the current RMB and will not affect life.

In the long run, the technical design of DC/EP reserves the possibility for smart contracts, and this part of the function exists for private enterprises to build commercial scenarios. New business opportunities may arise in different regional clusters, merchant clusters, and organizational association clusters, on this basis, promoting the development of the sharing economy and promoting the development and growth of community exchanges and community culture.

Under the influence of DC/EP, the theoretical research foundation of the academic community will undergo tremendous changes, the academic preface theory and the economic and econometric models it cites will be distorted, and the forward-looking predictions of the real world will be biased. The emergence of a new digital financial system, with its cross-border and cross-border characteristics, will pose a huge challenge to the current economics, finance, statistics, and econometrics.

The basic monetary structure of financial institutions and the accounting items of enterprises will also face adjustments. New financial and accounting theories will be innovated to empower corporate practices. The Ministry of Finance should speed up the research and reform of relevant systems.

03 DC/EP issuance and operation timeline

Looking back on the development history of electronic currency in my country, it has gone through a stage from nothing to something, slowly crawling up to an accelerated growth stage. Now, with the help of highly developed third-party payment and mobile payment, M1 and M2 have basically been realized in electronic form, showing strong vitality and superiority.

Referring to the above development path, it is predicted that DC/EP will also be a process from scratch. The history of DC/EP is also inevitable. The specific evolution is shown in the following figure:

DC/EP historical evolution diagram

DC/EP is not limited to a specific technology. It is expected to form a new value ecosystem in the future with the central bank, banking institutions, local government agencies, payment institutions and social commercial institutions as the main body and the public participating together. We predict the timetable for the issuance and operation of DC/EP as follows:

November 2019

The first batch of DC/EP pilot institutions include the four state-owned banks of Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank, and the three major operators of China Mobile, China Telecom and China Unicom. The pilot scenarios include transportation, education, medical care, consumption and other fields. Internal closed pilot tests will be carried out in Shenzhen, Xiong'an, Chengdu and Suzhou for a period of 1 year.

From October 2020 to December 2021, a complete closed-loop payment scenario will be announced, and a sample project will be implemented, including network environment, hardware environment, software environment, clearing and settlement system, and e-wallet terminal usage plan. The second batch of pilot projects will be announced, and the scope of the pilot projects will be expanded.

2022-2023

Announce the scope of the third batch of pilot projects, expand the functions of DC/EP, encourage the use of DC/EP, and allow it to run alongside current currencies. Open up the use of electronic wallets and introduce policies for the use of DC/EP currencies.

2023-2025

Taking the new infrastructure as an opportunity, the DC/EP ecosystem is improving at a faster pace. With the help of the blockchain system and ecosystem, DC/EP exists independently and is deeply integrated with the industry.

2025-2030

DC/EP gives birth to new business models and empowers the value ecosystem.

future

Assisting the internationalization of the RMB

DC/EP is a new financial infrastructure solution proposed by the central bank under the new international situation and the background of the times. It demonstrates my country's openness and inclusiveness in the financial field. Its promotion process will also continue to evolve with technological innovation and will create a new economic ecology in the digital economy era.

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