Wang Yongli: Challenges of the implementation of central bank digital currency

Editor's note: This article is reproduced from Economic Observer, author: Wang Yongli.

On one hand, stablecoins or encrypted digital currencies such as Libra are heating up and "provoking", and on the other hand, central banks that are unwilling to see the legal currency system overturned have been or are gearing up for "digital currencies"...

Now, the regular army is about to "take action" - the digital currency of the People's Bank of China seems to be on the verge of being released.

However, the central bank has not yet released a complete white paper on digital currency, and many practical issues are still unclear. If we analyze the specific details such as "digital currency exchange mechanism", "digital currency storage and use", "digital currency and electronic currency coordinated operation", etc., it may be It will be found that there are still great challenges in the implementation of the central bank's digital currency.

Is it imminent or too early? This is a realistic question.

Is the central bank's digital currency about to be released?

It seems that the release of the Libra white paper has accelerated the process of central bank digital currency.

On June 18, 2019, Facebook held a press conference to launch its encrypted digital currency Libra, claiming that it would launch a "borderless currency" pegged to a basket of currencies, which attracted great attention around the world, especially in China.

On July 9, Wang Xin, director of the Research Department of the People's Bank of China, revealed that the State Council has officially approved the research and development of the central bank's digital currency. The central bank is currently organizing market institutions to carry out corresponding work and will launch the central bank's digital currency as soon as possible.

On August 10, Mu Changchun, deputy director of the Payment and Settlement Department of the People's Bank of China, said: "From 2014 to now, the research on the central bank's digital currency DC/EP (DC: Digital Currency, digital currency; EP: Electronic Payment) has been carried out for five years. 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."

Shortly afterwards, Deputy Governor Fan Yifei of the People's Bank of China also gave a relatively comprehensive explanation of the central bank's digital currency in writing.

China's central bank digital currency is "on the verge of being released" and may become the first country in the world to launch a legal digital currency (Venezuela claimed to have launched the world's first legal digital currency, "Petro" in 2018, but it had no actual impact at all). This has attracted widespread attention from the whole society, and even the international community.

So, what is the basic model of the central bank’s digital currency?

The information disclosed by central bank officials mainly includes:

The current design of the central bank's digital currency adheres to a centralized management model and focuses on replacing M0 rather than M1 and M2. The central bank's digital currency will adopt a two-tier operating system, that is, the People's Bank of China will first exchange digital currency to banks or other operating institutions, and then these institutions will exchange it to the public. The two-tier operating design can avoid excessive concentration of risks in a single institution (central bank), avoid crowding out bank deposits and affect the bank's loan issuance capacity.

To ensure that the central bank's digital currency is not over-issued, commercial institutions pay full and 100% reserve to the central bank. The central bank's digital currency is still a liability of the central bank, guaranteed by the central bank's credit, and has unlimited legal compensation. In addition, the two-tier operating system will not change the existing currency issuance system and binary account structure, avoid the "deposit migration" that may be caused by the public directly registering on the central bank's digital currency platform, and will not form competition with commercial banks and payment institutions' deposit currencies. Since it does not affect the existing monetary policy transmission mechanism, it will not strengthen the procyclical effect under pressure, so it will not have a negative impact on the real economy.

The central bank does not pre-set a technical route, and it does not necessarily have to be blockchain. Any technical route is acceptable. Several designated operating institutions take different technical routes to develop DC/EP. Whoever has a better route will eventually be accepted by the people and the market, and will eventually win the game. In other words, the central bank is technology-neutral. Whether it is blockchain or a centralized account system, electronic payment or so-called mobile currency, the central bank can adapt to any technical route. Of course, the functions must meet the central bank's threshold. For example, because it is aimed at retail, it must at least meet high concurrency requirements, at least 300,000 transactions per second.

At this point, the market will ask: Why should the central bank digital currency be launched as soon as possible?

On January 20, 2016, the central bank published an announcement on its website saying: "Strive to launch the central bank-led digital currency as soon as possible." As early as 2014, the network encrypted digital currencies launched using blockchain technology such as Bitcoin and Ethereum began to heat up. Many people believed that this network encrypted digital currency would subvert the traditional legal currency system and bring a huge impact on central banks and commercial banks. Therefore, some central banks and even the IMF claimed to develop their own digital currencies to ensure their own monetary authority. The People's Bank of China also set up a digital currency research team to carry out work.

However, in the actual operation of network encrypted digital currencies such as Bitcoin, people are increasingly finding that since there is no corresponding social wealth that can be protected by law and they are completely network virtual assets, their prices are very prone to fluctuations, and many of them even disappear like smoke and cloud. They cannot be used as currency at all, and it is impossible for them to subvert or replace legal tender. It is also impossible for central banks to imitate decentralized network encrypted currencies such as Bitcoin to design and operate legal digital currencies led by the central bank. Therefore, the research and design of digital currencies by central banks of various countries have fallen silent for a time, and some countries have even announced the suspension of related research plans.

As a result, some networks and financial institutions began to launch "stablecoins" backed by fiat currencies as reserves, including stablecoins that are pegged 1:1 to a single fiat currency and stablecoins pegged to a basket of currencies.

Among them, stablecoins that are only pegged to a single legal currency, such as USDT, GUSD, and JPMCoin that JPMorgan Chase plans to launch, although they may use technologies such as blockchain to form cryptocurrencies, their "token" characteristics as pegged currencies are very obvious, and it is difficult to replace the legal currency they are pegged to, and it is difficult to achieve major breakthroughs in monetary attributes and enhance social appeal and market hype.

Therefore, Facebook, the world's largest social networking site operator, took the lead and joined 27 other large e-commerce and payment companies to release the white paper of Libra, a blockchain digital currency that is backed by the legal currencies of several major countries, on June 18 this year, claiming that Libra will "establish a simple, borderless currency that serves the financial infrastructure of dozens of people." Once the white paper was released, it immediately had a huge impact on the world. Many people believe that relying on Facebook and its hundreds of large companies as initial members with a huge user base of about 3 billion people, Libra will become a super-sovereign world currency with huge and far-reaching influence.

Considering that the basket of currencies to which Libra is pegged may not include the RMB, this has made many Chinese people deeply anxious. They believe that this will further enhance the international influence of the US dollar and inhibit the internationalization of the RMB. China must speed up the research and development and implementation of digital currency to seize the leading position in digital currency.

It may be in this situation that the People's Bank of China has significantly accelerated the pace and disclosure of digital currency work, especially considering that the organizational structure of Libra is actually the same as the organizational structure adopted by the central bank's DC/EP, which has further enhanced the central bank's confidence and sense of urgency to launch digital currency as soon as possible.

Challenges of implementation

However, ideals are full and reality is skinny, and the implementation of the central bank's digital currency still faces great challenges.

Although central bank officials announced that the central bank’s digital currency is about to be launched, they have not actually released a complete white paper on the operation plan, and many technical details have not been clearly disclosed. From the information currently released, the central bank’s digital currency still faces many challenges in its implementation, involving at least three major issues that need to be clarified:

First, how to exchange central bank digital currency

According to what has been disclosed so far, the central bank's digital currency focuses on replacing M0 (cash) rather than M1 and M2 (deposits therein); it will adopt a two-tier operating system, that is, the People's Bank of China will first exchange the digital currency to banks or other operating institutions, and then these institutions will exchange it to the public.

That is to say, the central bank's digital currency is just the digitization of RMB cash, so it should be more appropriate to call it "central bank digital cash". Correspondingly, members of society should only be able to give RMB cash to banks or other operating institutions to exchange for RMB digital currency. Banks or other operating institutions can only exchange RMB cash with the central bank for RMB digital currency at a 1:1 ratio. In this way, the central bank will replace RMB cash with RMB digital currency, forming a digital currency to replace M0. Among them, bank deposits should not be exchanged for digital currency to avoid replacing M1 and M2 (deposits). This means that after the central bank launches digital currency, China will maintain a monetary system in which electronic currency and digital currency coexist.

But the question is, in this case, how to control the scale of the central bank's digital currency?

If the operating efficiency and cost of digital currency are indeed better than electronic currency (bank deposits), people are willing to hold more digital currency, but what if they don’t have enough cash? Are they allowed to convert bank deposits into digital currency? If people are allowed to exchange bank deposits for digital currency, there will be a substitution for deposits in M1 and M2. But if it is not allowed, and it is strictly limited to cash exchange for digital currency, considering that cash in circulation has been increasingly replaced by electronic currency (digitalization of currency), its proportion in the total amount of currency is already quite low and is still decreasing, and even if the central bank launches digital currency, it is impossible to completely cancel cash in circulation in a short period of time. So, in addition to the existing electronic currency system, how much sense does it make to invest huge manpower and material resources to create a new digital currency system and rush to launch and operate digital currency that only replaces cash?

Second, how to store and use digital currency

The monetary unit of digital currency is fixed (such as RMB), there is no longer a physical carrier (such as banknotes) and carrier number, and there is no longer a distinction between different denominations. Digital currency represents the number of monetary units (which can be infinite or to a certain number of decimal places) and needs to exist in the form of account records.

In 2018, the Bank for International Settlements (BIS) first proposed that there are two basic paradigms for currency, namely the "account paradigm" and the "cryptocurrency paradigm". The so-called "account paradigm" refers to the currency that the currency owner deposits in the deposit account of the payment and clearing institution, such as electronic currency; the "cryptocurrency paradigm" refers to the currency owner using his own private key password (Token) as the control right, and the currency can only be paid and used after being recorded and mutually verified by the distributed ledger system, such as cryptocurrency.

This statement seems to help distinguish between electronic currency and cryptocurrency, and has been frequently cited by Chinese authorities recently, but this division is not accurate.

In fact, from the perspective of its form, money can be divided into only "cash" and "non-cash". Correspondingly, the methods of collecting, paying and settling money mainly include two categories: "cash settlement" and "book settlement", and non-cash money can only be established on the basis of accounts.

Cash settlement is a method of clearing transactions directly by cash (buyer pays, seller receives). Since cash itself is universal in society and does not carry out owner marks, it is anonymous and basically controlled by whoever holds it. The two parties do not need to know each other, but only need to recognize the quality and price of the goods or services being traded. The two parties directly exchange money and goods, and neither party owes the other anything. However, in order to prevent counterfeiting of currency, the recipient often needs to conduct currency inspection.

Bookkeeping settlement is a method of currency (fund) settlement by a clearing institution with deposit accounts opened by both parties to the transaction by reducing the balance of the payee's account and increasing the balance of the payee's account. To carry out bookkeeping settlement, first of all, both the payee and the payee need to open a deposit (reserve) account in the clearing institution (clearing institutions also need to open deposit accounts with each other to handle collection and payment settlement, or jointly open deposit accounts in a centralized clearing institution to establish an account connection relationship), and obtain a deposit account certificate or encryption tools for use. The account needs to maintain a sufficient deposit balance for external payments, or within the overdraft limit allowed by the clearing institution; secondly, there needs to be a payment and collection information transmission system between the payee and the clearing institution; thirdly, in order to avoid errors and protect the interests of all parties, bookkeeping settlement can generally only be initiated by the payee, notifying its clearing institution to deduct its deposit and transfer it to the payee's deposit account. At the same time, each payment settlement often requires verification of the account name, deposit voucher or password, account balance, etc. involved in the deposit account, collection and payment information, etc. To this end, a set of clear operating rules needs to be established and strictly enforced.

In the bookkeeping and clearing method, the deposit account is the core and foundation, and the information transmission and verification system is the support and condition. The essence of the deposit account will not change, but the form of the account and the way of information transmission and verification will continue to improve with the advancement of technology, thereby continuously improving the efficiency of currency (fund) clearing, reducing clearing costs, and strictly monitoring various risks. Of course, under certain technical conditions and operating environments, the security of payment and clearing and the strictness of risk supervision will also conflict with the efficiency and cost of clearing, which requires effective evaluation and reasonable trade-offs.

With the development of information technology, bookkeeping and clearing have been continuously enhanced, greatly reducing the cost of the entire process of currency printing, escorting, collection, verification, storage, withdrawal, and destruction, and continuously improving the efficiency of currency collection and payment and clearing, strengthening anti-money laundering, anti-terrorist transmission, anti-tax evasion and bribery, etc. At the same time, it is also conducive to concentrating more idle money in the society into banks, and allocating it to places where the society needs it through bank loans, etc., improving the efficiency of capital utilization and creating greater social wealth. Therefore, bookkeeping and clearing are increasingly becoming the most important clearing method in the world. Correspondingly, the degree of currency digitization is continuously improved, and the proportion of cash in the total amount of currency is continuously reduced.

Among them, the establishment and management of deposit accounts can be divided into a "centralized" model that is centrally carried out by a clearing institution and a "distributed" model that is managed by all participants on the clearing platform or a selected number of representative participants. In other words, all non-cash currencies can only exist in the form of deposit accounts, that is, they can only be "account paradigms" and there is no non-account paradigm. Even in a distributed account system, the password directly overlaps with the account name, and there is no longer a real-name system for accounts. It is only a change in the form and processing of accounts, and the essence of accounts is no different. Distributed accounting will not subvert the double-entry bookkeeping method, because for each transaction, the record of each node must still simultaneously reduce the account balance of the payee and increase the account balance of the payee, that is, it is still double-entry bookkeeping, but the record of a transaction is recorded simultaneously in multiple sets of mutually backed-up account systems.

Therefore, holders of the central bank's digital currency must also open a deposit account, and its use also requires a supporting information transmission and processing system.

So, how to open a digital currency account and how to use it?

Under the two-tier operating system, individuals or organizations that obtain digital currency can still only open deposit accounts in banks or other operating institutions, and banks or other operating institutions open deposit accounts in the central bank.

This involves a question: the current systems of the central bank, commercial banks and other clearing institutions are not unified, but basically independent. To operate digital currency, the central bank has been researching and developing for a long time, and it seems that a new operating system has been formed. So, do commercial banks and other operating institutions need to establish a corresponding operating system and connect it to the central bank system, or can the existing electronic currency operating system be used for the operation of digital currency? Or can commercial banks and other operating institutions also open accounts on the central bank's digital currency operating platform and operate uniformly on the central bank's platform?

At the same time, when individuals or units actually use digital currency, they also need specific information carriers of digital currency (such as mobile phone QR codes and scanners, facial scanning and recognition, etc.). So, does digital currency need to develop new information carriers, or can it use bank cards or mobile phones or facial recognition like Alipay and WeChat Pay? If the operating system and information carriers are basically unchanged, then how much improvement will it have over the current electronic currency system if a new digital currency system is specially developed? Where exactly is the superiority of its input-output efficiency?

The central bank officials explained that the current electronic currency uses electronic payment tools, such as bank cards and Internet mobile payments. Funds transfers must be completed through traditional bank accounts, which adopts a "tightly coupled account" approach. The public's demand for anonymous payments cannot be fully met, so it cannot completely replace M0. The central bank's digital currency is "loosely coupled with accounts", which means that it can realize value transfer without traditional bank accounts, greatly reducing the dependence of transactions on accounts. The central bank's digital currency can be as easy to circulate as cash, which is conducive to the circulation and internationalization of the RMB, and can also achieve controllable anonymity.

Many details here are not clear, and the use of the need for anonymous payment as an important reason is itself questionable: in fact, an important direction for the development of currency and payment technology is to continuously enhance compliance monitoring of fund collection and payment, rather than protecting anonymous accounts and payments. Of course, not protecting anonymous accounts and payments does not mean not protecting the public's information security. The public's identity and payment information cannot be disclosed or used illegally by any unit without legal permission.

In addition, if digital currency only replaces cash but not deposits, its internationalization space is very limited. Even if it can be circulated as easily as cash, it is not necessarily more conducive to the internationalization of the RMB than using bookkeeping and settlement!

Third, how does digital currency coordinate with electronic currency?

According to the central bank's explanation of digital currency, it is mainly a substitute for M0, intended to reduce the printing and circulation of cash, and does not bear interest, nor can it be used to issue loans, and needs to be managed separately. This means that more than 95% of the total currency is still bank deposits, and the current electronic currency model is still maintained, that is, after the central bank launches digital currency, digital currency and electronic currency will run in parallel.

So, what is the relationship between the digital currency operating system and the electronic currency operating system? Why must the central bank's digital currency be launched as soon as possible? What is the actual role and value of a digital currency that only replaces cash, not all currencies? What are the advantages of input and output? Can the current electronic currency system play a similar role with a slight improvement? How can the two monetary systems be coordinated and managed? Among them, the most prominent issue 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?

In fact, if the central bank's digital currency is strictly controlled within the range of M0, it will not have much impact on the deposits and payment services of banks and payment institutions. In this case, there seems to be no need to emphasize the two-tier operating system. It is entirely possible to consider implementing a one-tier operating system of the central bank, allowing social entities to register and handle payments directly on the central bank's digital currency platform.

In short, the impact of the change in the monetary system is extremely wide and profound. We must be very cautious, carefully demonstrate and compare and analyze it. We should not rush to launch the central bank's digital currency just because there are encrypted digital currencies or digital stablecoins in society. In fact, there is also competition between different digital currencies. The most fundamental factor in their international influence is their own application scope and actual effectiveness (just like the sovereign currencies of various countries, whether they can become international central currencies depends on the comprehensive national strength and international influence of the currency issuing country). It is not that whoever launches digital currency first will definitely lead the development path and standards of digital currency, and will definitely seize the international control of digital currency.

Considering that online cryptocurrencies such as Bitcoin have been proven to be difficult to become real currencies; "stablecoins" pegged to a single legal tender at a 1:1 ratio can only be tokens and cannot subvert and replace legal tender; Libra, which is pegged to a basket of currencies, itself has many difficult problems that are difficult to solve, and whether it can be launched and effectively operated is full of uncertainty; the application of blockchain technology also has the "triangle problem" of "decentralization, security, and high performance" that is difficult to achieve at the same time, etc., we must attach great importance to and actively research digital currencies, but we must also remain sufficiently calm and rational.