What is sovereign digital currency? What is its role and value?

Bitcoin was born from the ideals of anarchists, and blockchain technology has since become popular. Technology has no stance, and it only serves people with goals. Central banks in many countries have successively proposed to use blockchain technology as the main research object to promote the issuance of sovereign digital currencies.

What does sovereign digital currency mean?

Many people may wonder, nowadays we are using less and less paper money, and paper money has long been digitized, so why do we need to separately propose the issuance of digital currency?

Before answering this question, we need to briefly review the knowledge of monetary banking. There are many forms of base money issued by sovereign central banks: such as purchasing foreign exchange, purchasing government bonds, and purchasing other assets. At this time, the currency issued by the central bank is equivalent to the central bank's liabilities. If all are paid in paper money, each paper money is a credit note of the central bank. These liabilities are not directly held by individuals or non-bank institutions. Instead, they are in the hands of banks or governments. Only after the consumption and loan process can they enter the circulation link, and the currency directly issued by the central bank is far less than the circulation required by the market. These circulations are amplified through the links of bank savings and credit, which is the process of creating money.

When we use online banking and other means to make electronic payments in our daily lives, we are actually transferring our own deposits to other people's deposits. These electronic numbers represent deposits, that is, the credit of commercial banks rather than the credit of the central bank. Simply put, if the bank goes bankrupt, these numbers will really become numbers. If you hold paper money in your hands, as long as the credit of the sovereign government exists, the paper money can be exchanged for foreign exchange and other assets at any time from the central bank.

Sovereign digital currency refers to the base currency backed by the credit of the central bank that can replace paper money. In other words, the "digital currency" here is not the "IOU" of a commercial bank but the "IOU" of the central bank.

Benefits of sovereign digital currency for sovereign governments

The issuance of sovereign digital currency has at least the following benefits for sovereign governments:

1. Paper money is bearer and can be easily used for illegal purposes such as bribery, money laundering, tax evasion, and drug trafficking. The recent abolition of large-value banknotes by the Indian government has attracted widespread attention and has had a great impact in India. One of the purposes of the authorities is to prevent tax evasion. If digital currency is issued, the records of currency are in a unified system, and the flow can be easily grasped. Combined with the real-name policy, some illegal transactions will be greatly hit.

2. Paper money has high manufacturing, transportation, and counting costs, while digital currency will be much smaller. For obvious reasons, the sovereign digital currency of any country will basically not adopt the POW consensus algorithm, and the "mining" resource consumption will not exist. The cost of maintaining the distributed system itself will of course be much lower than the production and transportation cost of paper money.

3. The settlement of digital currency under the distributed ledger can be independent of third parties and can be completed faster. The settlement of currency is a relatively complex and costly task. At present, the settlement of currency mainly relies on third-party clearing institutions at various levels. The clearing institution can be a central bank, a banking organization, or a commercial bank. Regardless of who it is, the most basic principle is that both counterparties open accounts in third-party institutions and deposit a certain amount of currency. When the two parties have currency transactions, the third party deducts and adds the corresponding amount in the corresponding account. Taking the RMB as an example, the People's Bank of China's large-amount real-time payment system and small-amount batch payment system are all systems that use the central bank as a third party for clearing. The extremely important significance of blockchain lies in the concept of distributed ledger: everyone shares a book, and the clearing and bookkeeping work is completed simultaneously while the funds are transferred. The trust in the third party is replaced by the distributed ledger mechanism, and the concept of clearing disappears in this mechanism. A large amount of economic costs, time costs, and friction costs caused by clearing will be greatly reduced.

The impact of sovereign digital currency on the current system

It is precisely because of the above advantages that many governments are working hard to study digital currencies. However, benefits also come with new problems. For central banks and governments, it is more important to evaluate the possible impact of digital currencies than the obvious benefits. The People's Bank of China and the Bank of England have relatively in-depth discussions and public information in this area, and we can also find that the main impact may come from the following aspects:

1. Paper money, as the debt of the central bank, is interest-free. If digital currency is also interest-free, due to the convenience of digital currency circulation, digital currency will flow quickly in transactions, and the impact of interest-free digital currency on the overall currency interest rate will be greater than that of traditional paper currency, causing a decline in the actual interest rate of currency. If digital currency is interest-bearing, digital currency will have an crowding-out effect on demand deposits, especially when the economic situation is not good, people are more willing to hold digital currency, and banks will lack sufficient sources of deposits, which will in turn affect the role of credit in promoting the economy.

2. The issuance of paper money is completed through commercial banks or institutions authorized by the central bank. The issuance of digital currency can be done in this way, and other institutions can also be connected to the central bank's balance sheet, such as third-party payment, other financial institutions, etc. The more institutions connected means the higher the efficiency of clearing, and the greater the impact and influence on commercial banks. According to the relevant report of the People's Bank of China, the issuance of digital currency in my country is basically determined to follow the current "central bank-commercial bank" binary structure. The advantage of doing so is to fully mobilize the enthusiasm of commercial banks and not change the existing commercial banking system.

3. Distributed ledgers can be understood as a huge accounting and clearing system. At present, many central banks, including the People's Bank of China and the Bank of England, are the most important clearing centers, but these clearing centers can only be accessed by commercial banks or very few authorized institutions for clearing. In the entire economic operation process, there are many clearing scenarios, which cannot use the central bank's clearing system and rely more on commercial banks. Distributed ledgers can enable more institutions and individuals to use this clearing system. The simplest example is that we no longer need to conduct remittance business through commercial banks, but directly through the central bank's distributed ledger, which will greatly improve the efficiency of clearing. Of course, problems also follow. Commercial banks that act as payment intermediaries may lose a lot of liquidity as a result.

4. After the issuance of digital currency, the improvement of transaction efficiency and the reduction of costs will increase the speed of money circulation. The crowding-out effect on commercial bank deposits mentioned above will reduce the credit base of commercial banks and affect the money creation process. The transmission of monetary policy based on the current monetary system will inevitably be affected to a certain extent.

5. Commercial banks, third-party payment companies, and card organizations such as Visa and UnionPay that are closely related to currency will inevitably be greatly affected by digital currency. Those who seize the opportunity may soar to the sky, otherwise they will face being eliminated by the market.

6. The improvement of overall efficiency will inevitably lead to the demise of some industries. For example, the transportation and protection of banknotes is a market worth tens of billions of yuan in China, and it also provides a large number of jobs. Other industries related to banknotes, such as ATMs, currency detectors, and money counting machines, will gradually withdraw from the stage of history. New industries will also be born, such as digital wallets. Of course, new digital currency theft and digital currency security will also start a new round of competition.

Characteristics that a distributed ledger of a sovereign digital currency needs to possess

If a distributed ledger is used as the infrastructure of a sovereign digital currency, what characteristics should it have? How far does the current technology have to go?

1. The issuance of sovereign digital currency is controlled by the central bank. An important feature of sovereign currency is that the government obtains "seigniorage" by issuing currency, which is part of the government's revenue. Currency itself is the basis of economic operation and is related to national security and economic stability. Based on the above factors, no matter what type of government, it will not give up the control of currency issuance. Satoshi Nakamoto created a "currency" based on a distributed ledger for us that is out of government control. Any sovereign government may need a distributed ledger, but it certainly does not need to be out of control. The issuance of digital currency based on a distributed ledger must not be controlled by a program like Bitcoin. There is no obvious technical obstacle for the central bank to control the issuance.

2. Sovereign digital currency does not require computing power support, and performance is more important. In addition to the distributed ledger, another great creation of Satoshi Nakamoto in Bitcoin is to strengthen the security of the network through competition to resist attacks, that is, the proof of work mechanism (POW). As an open network, Bitcoin cannot prevent the participation of malicious nodes. Therefore, through the POW method, the cost of malicious nodes is increased to at least 51% of the computing power of the entire Bitcoin network. The price paid for this is that a large amount of electricity is used for random number calculations that are meaningless for bookkeeping. For sovereign digital currency nodes, they must be nodes certified by the central bank and are all trusted nodes. The intensity requirements for preventing evil do not need to be the same as those for open networks. The most important application scenario of sovereign digital currency is small payments, which have extremely high requirements for transaction volume and timeliness. The current mainstream blockchain platform cannot meet the requirements of high-throughput real-time clearing. The performance of the blockchain depends on many factors such as consensus algorithm, block size, network conditions, node computing efficiency, sharding technology, side chain technology, etc. Many blockchain underlying companies are constantly improving blockchain performance, and performance improvement is only a matter of time.

3. Balance between regulation and privacy of sovereign digital currency. As personal property, currency must be anonymous to the public and non-regulatory agencies, while digital currency must have regulatory tracking characteristics for anti-money laundering, anti-bribery, anti-tax evasion and other regulatory aspects. The solution mentioned by the People's Bank of China in its public report is to make the account anonymous in the foreground and real-name in the background, which is similar to the current domestic regulatory methods for social platforms and third-party payments. Therefore, for blockchain platforms, it is not necessary for the asset flow to be completely anonymous, and the account anonymity method similar to Bitcoin can already support it; in addition, there must be strict control methods for the access node permissions and user permissions to prevent infringement of user privacy.

4. There are many factors that need to be considered in the distributed ledger of sovereign digital currency. For example, the security of the entire system and personal accounts, how to connect with the current clearing and payment systems, how to connect with more application scenarios, etc. We believe that the development of any application is gradually improved. With continuous investment and practice, sovereign digital currency will enter everyone's life and business with the development of technology and applications.

Outlook for sovereign digital currencies

With the development of banking systems, online payment, mobile payment and other tools, paper money has been used less and less. The launch of sovereign digital currency has a good market foundation. Due to its advantages over paper money in many aspects, the launch of digital currency is only a matter of time.

From a technical point of view, due to the success of Bitcoin and the advantages of blockchain, digital currency based on distributed ledger is one of the important choices. As blockchain technology matures, many current bottlenecks and problems will be solved one by one. In addition, for central banks of various countries, issuing digital currency in a traditional centralized way is also an option, at least there is a relatively mature solution in technology.

The advantage of blockchain technology is that digital currency based on this technology is not just another form of currency. More importantly, it will become an important transaction medium for the blockchain value circulation network, promoting the formation of a blockchain-based value circulation network. Real financial assets, virtual assets, energy, smart devices, and other assets that can be registered on the chain can be more smoothly completed in the blockchain network without trust or third-party participation. The formation of this network will greatly reduce friction in the transaction process, greatly improve the operating efficiency of the entire society, and bring human economic development into a new stage.