Fan Yifei, Deputy Governor of the Central Bank: Several Considerations on the Central Bank's Digital Currency

In recent years, central banks and monetary authorities in major countries and regions have been conducting research on issuing central bank digital currencies. The Central Bank of Singapore and the Swedish Central Bank have begun relevant experiments, and the People's Bank of China is also actively exploring and researching. This article puts forward some thoughts on the issuance arrangements of my country's central bank digital currency.

Fan Yifei, Deputy Governor of the People's Bank of China

1. China’s central bank digital currency should adopt a two-tier issuance system

The issuance of central bank digital currency by a large country is a complex system project. my country has a vast territory and a large population. The economic development, resource endowment and educational level of the population vary greatly among regions. In the process of designing, launching (issuing) and circulating central bank digital currency, we must fully consider the diversity and complexity faced by system and institutional design. For example, it is necessary to consider the use of remote areas with insufficient network coverage. If a single-tier (one-tier) is adopted, it will face great challenges brought by the above factors. In order to improve the convenience and service availability of central bank digital currency and enhance the public's willingness to use it, it is possible to consider the use of two-tier (two-tier) to deal with the above difficulties.

"Double-layer placement" is conducive to making full use of the existing resources, talents, technologies and other advantages of commercial institutions, and promoting innovation and competition through market-driven selection. The IT infrastructure application and service system of commercial banks and other institutions is relatively mature, the system has strong processing capabilities, has accumulated certain experience in financial technology applications, and has sufficient talent reserves. Therefore, starting from scratch and duplicating construction outside the existing infrastructure, human resources and mature application and service systems of commercial banks is a huge waste of social resources. Under the premise of safety and reliability, the central bank and commercial banks and other institutions can work closely together, without presetting technical routes, fully mobilize market forces, achieve system optimization through competition, and jointly develop and operate. This is conducive to integrating resources, exerting synergy, and promoting innovation. Moreover, the public is accustomed to handling financial business through commercial institutions such as banks, and double-layer placement will also help to enhance the public's acceptance of the central bank's digital currency.

"Dual-tiered issuance" helps to disperse and defuse risks. In the past, the central bank has accumulated rich experience in the development of the interbank payment and clearing system. However, the interbank clearing and payment system directly serves financial institutions, while the central bank's digital currency directly serves the public, involving thousands of households. If the central bank relies solely on its own strength to carry out research and development and support such a large system, it must not only meet the goals of security, efficiency, and stability, but also meet the needs of user experience, which is not easy. At the same time, the central bank is also subject to objective constraints such as budget, resources, personnel, and technology. Through the design of two-tier issuance, it can avoid excessive concentration of risks.

"Double-layer issuance" can avoid "financial disintermediation". Under "single-layer issuance", the central bank directly issues digital currency to the public, and the central bank's digital currency and commercial bank deposit currency will form a competitive relationship. Obviously, the credit rating of the central bank's digital currency endorsed by the central bank is higher than that of commercial bank deposit currency, which will have an crowding-out effect on commercial bank deposits, and may lead to "deposit migration", which will in turn affect the commercial bank's loan issuance capacity. In addition, the reduced ability of commercial banks to absorb deposits will increase their dependence on the interbank market, raise the price of funds, increase social financing costs, damage the real economy, and trigger "financial disintermediation". In order to maintain its lending capacity and financial stability, the central bank will have to subsidize commercial banks. In extreme cases, it will also subvert the existing financial system, and a "grand unification" situation will emerge where the central bank takes charge of everything.

In summary, the two-tier issuance model of "central bank-agent commercial institution" is a choice that is suitable for my country's national conditions and can make full use of existing resources and mobilize the enthusiasm of commercial banks. First, it does not change the creditor-debtor relationship of currency in circulation. In order to ensure that the currency is not over-issued, the agency issuance institution needs to pay 100% of the reserve to the central bank. Therefore, the central bank digital currency held by the public is still a liability of the central bank, guaranteed by the credit of the central bank, and has unlimited legal compensation. Secondly, it does not change the existing currency issuance system and binary account structure, will not constitute competition for commercial bank deposit currency, will not increase commercial banks' dependence on the interbank lending market, will not affect commercial banks' lending capacity, and will not lead to the phenomenon of "financial disintermediation". Thirdly, since it does not affect the existing monetary policy transmission mechanism and will not strengthen the procyclical effect under pressure, it will not have a negative impact on the current operation mode of the real economy. Finally, this model is more conducive to giving full play to the advantages of central bank digital currency, saving costs, increasing the speed of currency circulation, and improving payment convenience and security. In addition, due to the credit advantage of the central bank's endorsement, it is conducive to curbing the public's demand for private encrypted digital currency and consolidating my monetary sovereignty.

2. Under the two-tier issuance system, my country's central bank digital currency should be issued in a loosely coupled account manner and adhere to a centralized management model.

In order to maintain the attributes of the central bank's digital currency and achieve the goals of monetary policy and macro-prudential management, my country's central bank's digital currency two-tier issuance system should be different from the decentralized issuance model of various tokens. First, because the central bank's digital currency is still a liability of the central bank to the public, its creditor-debtor relationship has not changed with the form of currency, so the central bank's central position in the issuance process must still be guaranteed. Second, it is necessary to ensure and strengthen the central bank's macro-prudential and monetary policy regulation functions. Third, the dual account system should not be changed, and the original monetary policy transmission method should be maintained. Fourth, in order to avoid over-issuance of currency by agency issuance institutions, corresponding arrangements are needed to enable the central bank to track and supervise the issuance of digital currency.

Therefore, the central bank's digital currency should adhere to the centralized distribution model. However, the centralized distribution model mentioned here is also different from traditional electronic payment tools. The transfer of funds of electronic payment tools must be completed through accounts, using a tightly coupled account method. The central bank's digital currency should be based on a loosely coupled account form, which greatly reduces the dependence of the transaction link on the account. In this way, it can be as easy to circulate as cash and can achieve controllable anonymity. Central bank digital currency holders can directly apply it to various scenarios, which is conducive to the circulation and internationalization of the RMB. In addition, if there is no anonymity of the third party in the transaction, personal information and privacy will be leaked; but if complete third-party anonymity is allowed, it will encourage crimes such as tax evasion, terrorist financing and money laundering. Therefore, in order to achieve a balance, controllable anonymity must be achieved, and transaction data must be disclosed only to the third party of the central bank. Under the loosely coupled account system, the agency can be required to asynchronously transmit transaction data to the central bank every day, which is convenient for the central bank to grasp the necessary data to ensure that regulatory goals such as prudent management and anti-money laundering are achieved, and it can also reduce the system burden of commercial institutions.

3. China’s current central bank digital currency design should focus on replacing M0 rather than M1 or M2

At this stage, M1 and M2 are based on commercial bank accounts and have been electronicized or digitized. There is no need to digitize them again with digital currency. The interbank payment and clearing systems (such as large and small payment systems and online payment interbank clearing systems, etc.) that support the circulation of M1 and M2, the internal systems of commercial banks, and various network payment methods of non-bank payment institutions are operating normally, and are constantly being improved and upgraded, becoming increasingly efficient, and can meet the needs of my country's economic development. Replacing M1 and M2 with central bank digital currency will not help improve payment efficiency, but will also cause a huge waste of existing systems and resources. In contrast, the issuance, printing, collection and storage of existing banknotes and coins are costly, the circulation system has many levels, and they are inconvenient to carry, easy to be forged, anonymous and uncontrollable. There is a risk of being used for illegal activities such as money laundering, and the necessity of digitalization is increasing day by day. In addition, non-cash payment tools, such as traditional bank cards and Internet payments, are based on a tightly coupled account model and cannot fully meet the public's demand for easy-to-use and anonymous payment services. It is impossible to completely replace M0, especially in areas with poor account services and communication network coverage, where people still rely heavily on cash. The central bank's digital currency maintains the properties and main features of cash, meets the needs of portability and anonymity, and will be the best tool to replace cash.

Because the central bank's digital currency is a substitute for M0, no interest should be paid on it. This will neither cause "financial disintermediation" nor lead to inflation expectations. Correspondingly, it will not have a major impact on the existing monetary system, financial system and real economic operation.

Similarly, since the central bank's digital currency is a substitute for M0, it should also comply with all current regulations on cash management and anti-money laundering, anti-terrorist financing, etc. In order to cooperate with anti-money laundering and other related work, relevant institutions may be required to report large and suspicious transactions of the central bank's digital currency to the central bank. At the same time, in order to guide the central bank's digital currency to be used in small retail business scenarios, not to have a crowding-out effect on deposits, and to avoid arbitrage and procyclical effects under pressure environments, daily and annual cumulative transaction limits may be set for it, and large-amount reservations may be required for exchange. If necessary, it is also possible to consider implementing a tiered fee for the exchange of the central bank's digital currency, with no charge for small-amount, low-frequency exchanges, and higher fees for large-amount, high-frequency exchanges and transactions to increase exchange costs and institutional frictions. In the case of a zero lower bound on interest rates, this arrangement can also create conditions for the central bank to implement a negative interest rate policy.

4. Be cautious about loading smart contracts on central bank digital currencies

According to the definition given by Nick Szabo, a smart contract is a set of digitally defined promises, including protocols on which the parties can execute these promises. Smart contracts are written into computer-readable code. Once the triggering conditions are met, they are automatically executed by the computer. Preconditions such as time and credit can be loaded, and they can also be applied to various scenarios such as tax payment and anti-terrorism financing.

However, as mentioned above, the central bank's digital currency is a substitute for M0 and has unlimited legal compensation, that is, it assumes the functions of value scale, means of circulation, means of payment, and value storage. The original cash does not carry any other social and administrative functions. The "Regulations on the Administration of Renminbi of the People's Republic of China" stipulates that it is prohibited to deliberately damage the renminbi. Therefore, adding additional social or administrative functions to cash is actually suspected of damaging the renminbi.

In order to maintain the legal status of unlimited legal tender, the central bank's digital currency should not assume other social and administrative functions besides the four functions of currency. Loading smart contracts other than the functions of legal tender itself will affect its legal tender function, and even degenerate it into a valuable ticket, reducing the free use of my country's central bank's digital currency, and will also have an adverse impact on the internationalization of the RMB. It will also reduce the speed of currency circulation, affect the transmission of monetary policy and the central bank's performance of macro-prudential functions. At the same time, it may also infringe on citizens' privacy rights and is not conducive to the protection of personal rights and interests.

(The author is Deputy Governor of the People's Bank of China)