Yao Qian, Director of the Central Bank Digital Currency Research Institute: Technical Considerations of the Central Bank’s Digital Currency

On January 26, Vice Governor Fan Yifei published a signed article titled "Some Considerations on the Central Bank's Digital Currency" (hereinafter referred to as "Considerations") in the "China Business Daily", which attracted widespread attention from all walks of life. The article mentioned some important design concepts of the central bank's digital currency, which is of guiding significance for promoting the next step of the central bank's digital currency research and development. This article attempts to interpret these concepts from the perspective of technical implementation.

Yao Qian, Director of the Digital Currency Research Institute of the People's Bank of China

1. China’s current central bank digital currency design focuses on replacing M0 rather than M1 or M2

Central banks of various countries are actively exploring what central bank digital currency is. The motivation for the Swedish central bank to start digital currency research is to cope with the shrinking domestic cash circulation, so it is directly called "digital krona", that is, digital cash. The Bank of England defines it as a digital currency issued by the central bank through specific rules, which is equivalent to legal tender and bears interest, and grants the public a way to access the central bank's balance sheet electronically anytime, anywhere. The starting point of the Bank of Canada is to evaluate whether digital currency is more efficient and low-cost than the existing retail payment system, so the definition proposed emphasizes its payment medium function: "A digital value form issued by the central bank for payment". The ECB's term is digital base money, which has two characteristics: one is that like circulating paper money, it represents a debt claim against the central bank; the other is that unlike paper money, it is a digitized central bank liability.

At this stage, the primary starting point for my country to develop the central bank's digital currency is to supplement and replace traditional physical currency, which is defined as cash (M0). Some people may object to this, and their point of view is that if the central bank's digital currency is only positioned as digital M0, it will not be conducive to exploring the new qualities of this new currency. Today, when technology is a strong driving force, the central bank's digital currency must incorporate more new features on the basis of absorbing the advantages of cash. If it only simulates physical cash step by step, it is doubtful whether this goal can be achieved, and it may also affect the future competitiveness of the central bank's digital currency.

Obviously, the Considerations have fully considered this concern, so the cautious term "at this stage" is used. This term is close to the ECB's report on digital base currency. The ECB believes that "the intuitive approach of allowing non-bank entities to convert bank deposits into digital base currency at a 1:1 ratio seems more attractive, provided that the main purpose of non-bank entities using digital base currency is to replace cash rather than bank deposits. As long as the main purpose is to replace cash, the negative effects of digital base currency may be negligible. Therefore, at least in the initial stage, digital base currency is still positioned as a cash substitute until more experience is gained."

Therefore, in my personal opinion, the positioning of the central bank's digital currency at this stage in the "Considerations" not only takes into account risk prevention and control, but is also forward-looking.

2. Two-tier delivery system  

The term "two-tier issuance system" comes from a recent research report on central bank digital currency by the Bank for International Settlements (BIS). The report compares different issuance modes of central bank digital currency and proposes two methods: "non-tiered issuance" and "tiered issuance". In the case of non-tiered issuance, the central bank directly issues money to non-financial institutions or even individuals, which requires breaking through the current situation that only commercial banks can open accounts in the central bank. Tiered issuance is similar to cash issuance, where the central bank only issues money to commercial banks, and commercial banks are responsible for issuing money to existing individual or corporate customers.

The central bank's digital currency adopts a two-tier issuance system, which is a further deepening of the traditional "central bank-commercial bank" binary model. In the article "Theoretical Basis and Architecture Selection of China's Legal Digital Currency" (China Finance, 2016, No. 17), Vice President Fan Yifei once said: "The operating framework of legal digital currency is also a very critical issue. There are two models to choose from: one is that the central bank directly issues digital currency to the public; the other is to follow the traditional 'central bank-commercial bank' binary model. The first is also the common model of some digital currencies at present. In this case, the central bank directly provides legal digital currency issuance, circulation and maintenance services to the whole society. The second still adopts the current paper currency issuance and circulation model, that is, the central bank issues digital currency to the business library of commercial banks, and commercial banks are entrusted by the central bank to provide legal digital currency deposit and withdrawal services to the public, and work with the central bank to maintain the normal operation of the legal digital currency issuance and circulation system. We prefer the second model for a simple reason: first, it is easier to gradually replace paper currency with legal digital currency under the existing currency operation framework without subverting the existing currency issuance and circulation system; second, it can mobilize the enthusiasm of commercial banks to jointly participate in the issuance and circulation of legal digital currency, appropriately disperse risks, and accelerate service innovation to better serve the real economy and social livelihood."

It should be said that whether it is the dual model or the two-tier issuance system, Vice Governor Fan Yifei's idea is consistent. That is, the issuance of the central bank's digital currency must be in a way that has the least impact on the existing monetary system, business structure and infrastructure. This point is fully discussed in the "Consideration" article and will not be repeated here.

3. Loosely coupled accounts and controllable anonymity  

1. Digital currency is loosely coupled with accounts in form

Any kind of currency must have a specific form and a way to carry it, whether it is physical currency, gold and silver currency or paper currency, or digital currency. The specific form of digital currency can be a number from a physical account, or a string of numbers recorded under a name and verified by a specific cryptography and consensus algorithm. The technical routes of digital currency can be divided into account-based and non-account-based, or they can be layered and used to coexist. Central bank digital currency can be account-based or non-account-based. JP Koning, who first proposed FedCoin, proposed the difference between central bank digital accounts (CBDA) and central bank digital currencies (CBDC). The European Central Bank also put forward a similar view, believing that the digital base currency issued by the central bank has two optional forms: account-based and value-based. These two forms are complementary to a certain extent, and can be used preferentially in different application scenarios to meet different needs.

2. Loose coupling with bank account system

The "Consideration" mentioned: "The central bank's digital currency should be based on a loosely coupled account form, so that the transaction link's dependence on the account is greatly reduced. In this way, it can be as easy to circulate as cash, and can achieve controllable anonymity."

When discussing this issue, we understand that a bank account is actually a set of contracts that integrate all services between the bank and the user. This is an asset formed under the traditional concept of large-scale centralization and one account. In the current distributed environment, in order to determine the degree of coupling of the system, it needs to be re-examined.

First of all, since there are multiple entities acting as agents for placement and their respective business organization methods are also different, if they rely heavily on bank accounts, the complexity of the central bank's clearing system and clearing costs will increase significantly.

The second is the ownership or control of the processing logic. If you rely on bank accounts and core centralized management business, the service is statically bound to the account system, and different sub-processes and transactions will be tightly coupled. However, due to the unique data structure of the central bank's digital currency, it can express a lot of information that originally required the account system to verify, so the business process is highly distributed (for example, in a B2B environment across institutions), and different sub-processes and transactions are usually more independent. The loose coupling method helps improve efficiency and realize dynamic services.

Finally, considering that the account systems of many advertising agencies have been built for a long time and have formed their own characteristics, in order not to waste existing IT investments, a loosely coupled account design is adopted to reduce platform dependence.

3. Concept of loose coupling between digital currency and bank accounts

From the perspective of maximizing the protection of commercial banks' existing system investments, we have conducted preliminary research on the specific design of loose coupling between digital currency and bank accounts, and put forward the following implementation ideas for industry reference.

It is possible to consider introducing digital currency wallet attributes into the traditional account system of commercial banks, so that one account can manage both existing electronic currency and digital currency. Electronic currency and digital currency management have similarities, such as account usage, identity authentication, fund transfer, etc., but there are also differences. Digital currency management should comply with the central bank's wallet design standards, similar to the concept of a safe deposit box. The bank will manage the safe deposit box according to the authority agreed with the customer (for example, it must have two keys from the customer and the bank to open it, etc.), retaining all the attributes of digital currency as a cryptocurrency, and using these attributes in the future to flexibly customize applications.

The advantage of this is that the two-tier currency issuance approach is followed. Digital currency belongs to the M0 category and is a liability of the central bank. Since commercial banks still manage customers and accounts in a substantial manner, it will not lead to the channelization or marginalization of commercial banks. Unlike the previous cash deposit, digital currency does not rely entirely on bank accounts. It can be directly confirmed through the agency issuing agency and use the client's digital currency wallet to realize point-to-point cash transactions.

Under the two-tier issuance system, digital currency transactions between customers are conducted point-to-point, and the agency issuing institutions confirm and manage transactions (whoever issues the currency manages the currency), and the central bank assumes the responsibility of supervision; transactions of electronic currency are consistent with the existing process and are completed through the central bank's interbank payment system and the core business system of commercial banks. It should be noted that the interconnection between the agency issuing institutions and the central bank and between the agency issuing institutions will be designed at the top level by the central bank.

From the perspective of reflecting the idea of ​​​​layered use and continuing the customer-centric thinking of commercial banks, the specific implementation of this loose coupling can add a digital currency wallet ID field to the basic bank account. The wallet serves as a safe deposit box and does not participate in business such as end-of-day provision, minimizing the impact on the existing bank's core business system. The confirmation of digital currency relies on the agency of issuance. The combination of traditional accounts and digital currencies can greatly enhance the bank's customer due diligence (KYC) and anti-money laundering (AML) capabilities.

(IV) Technical discussion on controllable anonymity of central bank digital currency

A major technical pillar on which the central bank's digital currency relies is the cryptographic algorithm. The existing purely anonymous method of encrypting digital assets has caused the risk of user property loss, which must be thoroughly resolved in the central bank's digital currency system. At the same time, in the user experience of the central bank's digital currency, it is also necessary to take into account the needs of users for personal privacy protection, ensure the security of user data through privacy protection technology, avoid the leakage of sensitive information, and do not damage usability, so as to create a healthier use environment for the circulation of the central bank's digital currency and reflect the competitive advantage of the central bank's digital currency. In terms of the supervision of the central bank's digital currency, the characteristics of digital currency "voluntary at the front desk and real-name at the back desk" are used to manage the use rights of relevant data through security and privacy protection technology, achieve traceability under certain conditions, and ensure that regulatory technologies such as big data analysis are useful.

With the maturity of technologies such as trusted cloud computing, security chips and privacy protection, the central bank's digital currency can also consider user-centric management, which will greatly reduce many intermediate links in currency operations. The central bank can also directly penetrate to the end user and provide a new means of economic regulation.

4. Market-driven competitive selection  

The market-driven competitive selection strategy can effectively mobilize the resources of commercial institutions and help explore the best implementation plan for the two-tier system. At the same time, the central bank must also fully consider how to achieve the combined effect of integrating resources to avoid the barrel effect.

The Considerations clearly proposed that the central bank’s digital currency should be different from the decentralized issuance model of various tokens. According to the thinking of the Considerations, the central bank’s digital currency will “not pre-set the technical route, but mobilize market forces such as commercial banks to jointly develop and operate”. In view of this, the technical interpretation of this article is only a reference to some extent. We believe in the wisdom of the market, and more and better solutions will emerge on a series of core issues of the central bank’s digital currency.

Recently, The Economist published an article titled "Future Wars: Great Power Competition and the Struggle of New Technologies". Its main point is that future great power competition needs to be based on robots, artificial intelligence, big data and targeted intelligent weapons. Obviously, digital currency, as the cornerstone of the development of the digital economy, is also the focus of great power competition. The dream of converting physical currency into digital currency has been first launched and tested by the private sector. As a monetary authority, the central bank is catching up, which is of great significance. (The author is the director of the Digital Currency Research Institute of the People's Bank of China)