Embracing the wave of digital currency: the People's Bank of China's "regular army" is accelerating

Source: Bloomberg News

Imagine that in the near future, the cash withdrawal prompt voice of China's commercial bank ATMs may become, "Dear depositor, please press 1 to withdraw paper money, press 2 to withdraw digital currency and enter your digital wallet code."

With the development and promotion of electronic payment, digital currency is coming with unstoppable momentum. As a global leader in electronic payment, China is likely to become the first major economy to launch an official digital currency.

Mu Changchun, deputy director of the Payment and Settlement Department of the People's Bank of China, publicly stated in August that "the research on the central bank's digital currency has been going on for five years from 2014 to now. Since last year, relevant personnel of the Digital Currency Research Institute have been working '996' (from 9 am to 9 pm every day, 6 days a week) to develop related systems. The central bank's digital currency can now be said to be on the verge of being released."

In order to avoid being at a loss in front of the ATM after the launch of digital currency, it is necessary for us to understand the ins and outs of China's digital currency.

1. China’s central bank’s plan

The People's Bank of China has not yet released a specific digital currency white paper or related plans, but the central bank has actually started researching related topics since 2014. Bloomberg's comprehensive remarks by Mu Changchun, deputy governor of the central bank, and Fan Yifei show that for a society like China that has already gone highly cashless, the initial central bank digital currency design focuses on replacing M0, rather than M1 and M2, that is, it is limited to replacing cash and allowing residents to use it for various payments. M1 and M2 are based on commercial bank accounts and have been electronicized or digitized, so there is no need to digitize them again with digital currency.

Like the current currency issuance system, the People's Bank of China will first exchange digital currency to banks or other operating institutions, which will then exchange it to the public. In addition, commercial institutions will pay full and 100% reserve requirements to the central bank, thus ensuring that digital currency remains a liability of the central bank, guaranteed by the credit of the central bank, and has unlimited legal currency.

2. Differences from Pioneers

Bitcoin is the most famous digital currency. There are hundreds of cryptocurrencies besides Bitcoin. The latest one that has caused regulators more concern is Facebook's proposal to create a digital currency Libra in June this year. Regulators are concerned that Facebook has the ability to use its advanced technology and large customer base to create a currency that will challenge national sovereignty. Facebook Inc. previously told U.S. senators that the initial basket of currencies supporting its cryptocurrency Libra may include the U.S. dollar, euro, yen, pound and Singapore dollar.

There are still only a handful of official digital currencies launched by governments, including e-Peso issued by Uruguay and Sweden's plan to launch a pilot program for issuing electronic currency e-Krona this year.

Compared with digital currencies such as Bitcoin, the digital currency of the People's Bank of China will be centralized, which is fundamentally different from the "decentralization" of blockchain and Bitcoin. That is, the central bank has the sole right to issue digital currency, and the central bank can know the circulation of its own currency in terms of capital flow, while Bitcoin can be minted by machines and is anonymous.

3. How to use digital currency?

The People's Bank of China has not yet announced specific digital currency standards and usage methods, but from the life experience of using paper money and coins, we first need a wallet to store "money". A wallet that can store digital currency must also be a virtual wallet. We need to be able to identify its identity, that is, we need to register or create a digital wallet of our own, and the exchanged digital currency will enter this wallet.

Mu Changchun's speech in August emphasized that the central bank's digital currency is mainly used in small retail high-frequency business scenarios. He said, "In order to guide the central bank's digital currency to be used in small retail scenarios, not to have a crowding-out effect on deposits, and to avoid arbitrage and procyclical effects under pressure, we can set transaction limits and balance limits for different levels of wallets. In addition, we can add some exchange costs and frictions to avoid procyclical situations under pressure."

4. Why does China need digital currency?

Even in China, where electronic payment is very developed, people still rely heavily on cash in areas with poor account services and communication network coverage. Digital currencies targeting M0 are naturally aimed at the defects of paper money and coins in the circulation process, such as the high costs of issuing, printing, recycling and storage, the multi-level circulation system, the inconvenience of carrying, the ease of counterfeiting, the anonymity and uncontrollability, and the risk of being used for illegal activities such as money laundering.

There is another reason that has not been revealed, that is, when there is no unified standard for digital currency and the whole world is vigorously researching it, the trial and error of the People's Bank of China may leave its mark on the unified standard and prevent the RMB from being controlled by others in the future world monetary system. As Wang Xin, director of the Research Department of the People's Bank of China, said, "Behind the currency are interests, power, politics, international politics, and diplomacy." Zhou Xiaochuan, former governor of the People's Bank of China, predicted that a more international and globalized currency may emerge in the future, a strong currency that will lead to an exchange relationship between major currencies and it.

5. Will people choose to use it?

It's hard to say. At least for now, the digital wallet of the People's Bank of China is just a wallet, while the most common electronic payment methods in China - Alipay and WeChat Pay also have additional functions such as social networking, e-commerce, taxi-hailing, checkout and investment. Although users do not have interest income, they can make various investments. The digital wallet of the central bank may find it difficult to provide similar functions; the central bank report shows that in the first quarter of 2019, non-bank payment institutions processed 58.00 trillion yuan in online payment business, a year-on-year increase of 13%.

6. Why not use blockchain architecture?

The central bank tried to adopt blockchain architecture during the initial development, but blockchain technology obviously cannot meet the needs of large-scale transactions at the same time. Mu Changchun pointed out, "During the Double Eleven last year, the transaction peak of China UnionPay reached 92,771 transactions per second. In comparison, Bitcoin is 7 transactions per second. Ethereum is 10 to 20 transactions per second. According to the white paper just released by Libra, it can handle 1,000 transactions per second."

Since the technology failed to meet the standards, the central bank decided to be technology neutral, not pre-set the technical route, and not exclude any technical route to achieve the goal. It was completely handed over to several designated operating institutions to take different technical routes for research and development, and the functions only needed to meet the high concurrency demand threshold. "For example, because it is aimed at retail, it must reach at least 300,000 transactions per second."

In addition, the central bank's digital currency can be loaded with smart contracts, but in order to avoid it becoming a valuable ticket, the central bank will only load smart contracts that are conducive to the functions of currency such as medium of transaction, store of value, and unit of account, and will remain cautious about smart contracts that exceed the above functions.

7. Privacy issues

Compared with the anonymity of Bitcoin, the central bank's digital currency hopes to be as easy to circulate as cash while also achieving controllable anonymity. How to protect the privacy of users has become a matter of concern to all. As Mu Changchun pointed out, the central bank's digital currency must ensure the anonymity of both parties to the transaction while ensuring the three anti-money laundering, anti-terrorist financing, and anti-tax evasion. A balance must be struck between the two. Fan Yifei, deputy governor of the central bank, previously stated in an article that the central bank can require relevant institutions to report large and suspicious transactions, and the central bank can also set daily and annual cumulative transaction limits for them, and stipulate large-amount reservation exchanges; even if necessary, it can consider implementing tiered charges for the exchange of central bank digital currency.

Fan Yifei is also cautious about the central bank's digital currency loading smart contracts. Loading smart contracts in addition to the functions of legal tender itself may also infringe on citizens' privacy rights and is not conducive to the protection of personal rights and interests.

8. What other challenges does the People’s Bank of China face?

According to information disclosed by officials of the People's Bank of China, the digital currency to be issued in the future will be strictly limited to cash exchange, rather than a digital currency that replaces all currencies. Wang Yongli, former vice president of the Bank of China, wrote that cash in circulation has been increasingly replaced by electronic currency (digital currency), and its proportion in the total amount of currency is still decreasing. In addition to the existing electronic currency system, investing huge manpower and material resources to create a new digital currency system, how much actual role and value will it have?

In the vast territory of China, especially in remote and backward areas, the time and cost of implementation are also a problem. If the digital currency promoted by the People's Bank of China only replaces cash but not deposits, its internationalization space may be very limited.

What is the relationship between the digital currency operating system and the electronic currency operating system? Can the current electronic currency system play a similar role with a slight improvement? How to coordinate and manage the two monetary systems? Among them, the most prominent question is how to control the scope of use and total scale of the central bank's digital currency so as not to impact deposits and fully play its role? At a time when the digital currency of the central bank of China is "about to be released", these questions raised by Wang Yongli seem to have no clear answers. Written by Bloomberg News