Central Bank Official Sheng Songcheng: Why should monetary authorities issue central bank digital currency?

“Future central bank digital currencies should, with the support of national credit, continue to meet society’s requirements for currency technology and become a widely recognized settlement and payment method. Only in this way can monetary authorities expand the use of sovereign currencies and reduce the impact of private digital currencies on the monetary system and the entire financial system.”

Text\ Sheng Songcheng and Jiang Yile. The author works for the People's Bank of China. This article only represents the author's personal views.

Since the advent of Bitcoin in 2009, various forms of private digital currencies have developed extremely rapidly. International financial institutions and technology companies have invested in the research and development of digital currencies and have made certain progress ^[1] . Against this background, monetary authorities of major economies have begun to study central bank digital currencies, and China is no exception ^[2] . Why do monetary authorities want to issue central bank digital currencies? Is it just to replace cash? Is it just to save the cost of printing cash? Obviously not. Because the proportion of cash usage has been declining year by year, various electronic currencies that replace cash have been increasing year by year, and the economic and social costs of researching and issuing central bank digital currencies are huge. Central banks of all countries cannot issue central bank digital currencies simply to replace cash.

Private digital currencies force monetary authorities to start researching the issuance of central bank digital currencies

At one time, various private digital currencies, represented by Bitcoin, emerged in large numbers, developed rapidly, and had a huge impact. Many economists and financiers in the world, including central bankers, were greatly shocked, and some even mistakenly believed that private digital currencies could replace sovereign currencies. As early as the end of 2013, the author clearly pointed out that virtual currencies (including private digital currencies) are not currencies in essence and cannot replace sovereign currencies ^[3] . As time went by, people gradually realized the non-monetary nature of virtual currencies.

Private digital currencies use a series of new technologies that have a strong penetration into the financial system and even have an impact on the operation of modern economic and financial systems. Therefore, in order to maintain the stability of the monetary system and even the entire financial system, monetary authorities must also use the same or even more advanced technologies and designs to study and issue central bank digital currencies. If private digital currencies are allowed to develop disorderly, this will have a serious impact on monetary authorities' policy regulation and the economic and financial system.

First, private digital currencies have diverted and replaced the use of part of sovereign currencies, which will weaken the effectiveness of monetary policy and distort the transmission mechanism. Private currencies and sovereign currencies are in a relationship of mutual growth and decline. As the scope of use of private digital currencies continues to expand, the use of sovereign currencies will gradually decline, which will reduce the control of monetary authorities over sovereign currencies. At the same time, the influence of monetary policy regulation on the supply and circulation of sovereign currencies will also decline and become unstable, which will weaken the effectiveness of monetary policy and distort the transmission mechanism. If private digital currencies are widely used but not issued and regulated by monetary authorities, the modern economy will lose an important means of regulation, and the economy will not be able to operate normally because it is not regulated by monetary policy.

Second, the value of private digital currencies fluctuates greatly, posing a threat to financial stability. Private digital currencies are not backed by national credit and are not real currencies. Their prices are easily affected by market expectations, have extremely high volatility, and market liquidity is difficult to guarantee. As the scope and scale of private digital currency use expands, the probability of a single private digital currency risk evolving into a systemic risk will also increase.

Third, the supply of private digital currencies is relatively fixed and difficult to adapt to the needs of modern economic development. Taking Bitcoin as an example, there is a contradiction between the upper limit of supply set by the system and the ever-expanding social production and commodity circulation. If it is widely used, it will cause deflation and inhibit economic development. This is also the fundamental reason for the collapse of the gold standard.

Fourth, private digital currencies lack a central regulatory mechanism and are unable to meet the needs of a stable modern monetary system. The lack of a centralized issuing and regulatory agency, or so-called “decentralization,” is a common feature of private digital currencies. If private digital currencies are widely accepted by society, and monetary authorities are unable to stabilize the value of the currency through a central regulatory mechanism, this will not only cause economic fluctuations, but will also shake the monetary system based on national credit. ^[4]

Fifth, private digital currencies pose challenges to anti-money laundering, anti-terrorist financing, and capital control. Private digital currencies generally have the characteristics of anonymous transactions and free cross-border flow of funds, making it easy for criminals to conceal the source and destination of their funds, and for individuals to circumvent foreign exchange quotas and foreign exchange remittance regulations ^[5] , which facilitates money laundering, terrorist financing, and evasion of capital control.

Sixth, private digital currencies increase the difficulty of protecting consumer rights. Private digital currencies have large price fluctuations, market participants are almost unregulated, user funds are not secure, and transactions are opaque. Therefore, private digital currency transactions are prone to fraud, theft, and counterfeiting. This not only makes it difficult to protect consumer rights, but also increases the difficulty for regulatory authorities to collect evidence and conduct investigations. ^[6]

Therefore, in order to cope with the impact of the rapid development of private digital currencies on monetary sovereignty, monetary policy, financial risks, and consumer rights protection, the monetary authorities clearly realize that the country should start researching and issuing central bank digital currencies as soon as possible. In the future, central bank digital currencies should, with the support of national credit, continue to meet the society's requirements for currency usage technology and become a widely recognized settlement and payment method. Only in this way can the monetary authorities expand the use of sovereign currencies and reduce the impact of private digital currencies on the monetary system and the entire financial system.

Monetary authorities have natural advantages in issuing central bank digital currencies

There are many types of private digital currencies created or issued by different private entities, which are decentralized and have different system settings and transaction methods. The competition is very fierce. In comparison, the central bank digital currency is issued and regulated by the monetary authority and is centralized, which gives the monetary authority a natural advantage in issuing the central bank digital currency.

First, the central bank's digital currency is backed by national credit and is more likely to be widely accepted by society. The central bank's digital currency is a new form of sovereign currency, which has the same legal tender and compulsory nature as sovereign currency. Therefore, society can use the central bank's digital currency like existing sovereign currencies, without the need to reprice the central bank's digital currency, and is more likely to be widely accepted by society. However, various private digital currencies are not backed by national credit, and their prices are prone to fluctuations. They need to be repriced in real time during use, which is why private digital currencies will not be widely accepted by society.

Second, the central bank's digital currency is more conducive to improving the liquidity of the economic system and reducing transaction costs. Each private digital currency has its own system settings, and the systems face exchange and compatibility issues, which actually increases the complexity of economic transactions. In contrast, the central bank's digital currency, which is backed by national credit, adopts a unified system standard. The improvement in transaction convenience will increase the total transaction volume, thereby improving the liquidity of the entire economic system.

Third, central bank digital currencies have monetary authorities as lenders of last resort, making it less likely to experience a currency run crisis. Like other forms of sovereign currency, monetary authorities are lenders of last resort for central bank digital currencies, providing a guarantee for currency stability. However, private digital currencies do not have lenders of last resort, and once a risk event occurs, currency suppliers and trading platforms are prone to currency runs ^[7] .

Fourth, the supply of central bank digital currency is regulated by the monetary authorities to meet the needs of modern economic development. Unlike private digital currency, once the central bank digital currency begins to be issued and used, the monetary authorities will adjust the supply of central bank digital currency according to the needs of economic development, thereby maintaining the applicability of central bank digital currency and facilitating the development of the modern economy.

Fifth, the monetary authorities can maintain the stability of the central bank's digital currency through the central regulation mechanism to ensure the normal operation of the modern economy. Relative stability of value is a prerequisite for a currency to serve as a value scale and a means of circulation. In addition, economic fluctuations are often accompanied by currency fluctuations. Therefore, maintaining currency stability is also a necessary condition for the normal operation of the modern economy.

Sixth, the monetary authorities will certainly use technical means to enhance the security of the central bank’s digital currency and protect the legitimate rights and interests of consumers. In stark contrast to private digital currencies, the central bank’s digital currency will use cryptographic algorithms to ensure the security of digital currency users, and will also use technical means to establish a controllable anonymity mechanism to achieve traceability under certain conditions, in order to further enhance the security of the central bank’s digital currency and thereby protect the security of user transactions ^[8] .

Issuing central bank digital currency is conducive to the effective operation and transmission of monetary policy

Different from the existing electronic standard currency, the future central bank digital currency may be a standard currency involving blockchain ^[9] , mobile payment, trusted and controllable cloud computing, cryptographic algorithms, security chips and other technologies. Therefore, the future central bank digital currency will help China build a new financial infrastructure in various aspects, further improve China's payment system, and enhance payment and settlement efficiency. More importantly, the central bank digital currency can eventually form a big data system to enhance the convenience and transparency of economic transaction activities, which will be conducive to the effective operation and transmission of monetary policy.

First, central bank digital currency can help regulators track the flow of funds when necessary, thereby reducing money laundering, tax evasion, and evasion of capital controls. Existing digital currency technology can not only record every transaction, but also track the flow of funds. In stark contrast to private digital currencies, regulators can adopt a controllable anonymity mechanism to grasp the use of central bank digital currency, supplement the existing monitoring and control system, and thus enhance the effectiveness of the existing system ^[10] .

Second, the information advantage of the central bank’s digital currency can improve the accuracy of monetary indicators. The big data system formed by the central bank’s digital currency will not only help improve the measurability of money circulation velocity, but also help better calculate the total amount of money and analyze the monetary structure, which will further enrich the monetary indicator system and improve its accuracy ^[11] .

Third, the information advantage of the central bank's digital currency can help regulatory authorities use policy tools more accurately and flexibly, track capital flows, and comprehensively monitor and assess financial risks. After the central bank's digital currency is widely accepted and used by the whole society, the transparency of economic activities will be greatly improved, and regulatory authorities will be able to collect real-time, complete, and authentic transaction books of different frequencies and institutions as needed, which can provide a huge data foundation for monetary policy and macro-prudential policy.

Fourth, the central bank's digital currency technology is conducive to the interest rate transmission of monetary policy. Existing digital currency technology supports "point-to-point" payment and settlement, which can improve the liquidity of market participants. Only the central bank's digital currency that is generally accepted by the whole society can radiate this advantage to participants in different financial markets, thereby improving the liquidity of funds between different financial markets and the market liquidity of a single financial market. This will lower the interest rate level of the entire financial system, make the interest rate term structure smoother, and make the monetary policy interest rate transmission mechanism smoother.

To sum up, the innovation of the central bank's digital currency is to adapt to the development of the situation, keep pace with the times, retain control over monetary sovereignty, and better serve currency issuance and monetary policy, rather than just replacing paper cash circulation.

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[[6] See Wang Xin and Ren Zhe: “Virtual Currency and Its Regulatory Response”, China Finance, No. 17, 2016. [[6]]

Notes (↵ returns to text)

1. For example, R3, founded in September 2015, is responsible for developing blockchain technology for the banking industry. The first round of team recruitment includes 42 banks including Goldman Sachs, Morgan, and Bank of America. Another public document shows that Goldman Sachs has developed its own "super bitcoin" - a digital cryptocurrency called SETL Coin, which is used to trade stocks, bonds and other assets. In the same year, Blythe Masters, the former global head of commodities at JPMorgan Chase, known as the "Queen of Wall Street", is raising funds for her blockchain startup Digital Asset Holdings. Recently, blockchain payment company Ripple has reached a cooperation with a domestic bank, mainly for cross-border payment settlement. ↵

2. my country's central bank has established a special central bank digital currency research team since 2014. In February 2016, the British monetary authorities announced the release of the central bank digital currency RSCoin code and conducted tests. In the past two years, monetary authorities in Europe, the United States, Canada, Japan, the Netherlands and other countries have begun to study and practice digital currencies. ↵

3. Sheng Songcheng and Zhang Xuan: "Virtual Currency is Not Currency in Essence - Taking Bitcoin as an Example", China Finance, No. 1, 2014.

4. See Sheng Songcheng and Zhang Xuan: "Virtual Currency is Not Currency in Essence - Taking Bitcoin as an Example", China Finance, No. 1, 2014; Sheng Songcheng and Zhai Chun: "The Concept of Denationalization of Currency and the Utopia of Bitcoin", China Finance, No. 7, 2014; Sheng Songcheng and Jiang Yile: "Central Bank Digital Currency is the Real Currency", China Finance, No. 14, 2016. ↵

5. Take Bitcoin as an example. Both transactions and settlements can be freely carried out across borders. Bitcoin purchased in RMB in China can be easily transferred to foreign trading platforms and then sold in US dollars. This is a new way for capital outflows. ↵

6. ↵

7. See Wang Xin and Ren Zhe: "Virtual Currency and Its Regulatory Response", China Finance, No. 17, 2016; Xu Zhong, Tang Yingwei, and Lin Xue: "Theoretical Discussion on Central Bank Digital Currency", China Finance, No. 17, 2016. ↵

8. See Fan Yifei: "Theoretical Basis and Architecture Selection of China's Legal Digital Currency", China Finance, No. 17, 2016.

9. Blockchain is essentially a perfect mathematical solution for building a trust mechanism between the parties to a transaction. It uses mathematical algorithms to establish a trust relationship between the parties to a transaction without the need for a third party. Its database is shared by all network nodes and can be shared and updated by everyone, who can confirm that the recorded transactions are unique (Melanie Swan: Blockchain - New Economic Blueprint and Introduction, New Star Press, 2016). ↵

10. See Sheng Songcheng and Jiang Yile: “Central Bank Digital Currency is the Real Currency”, China Finance, No. 14, 2016; Fan Yifei: “The Theoretical Basis and Architecture Choice of China’s Legal Digital Currency”, China Finance, No. 17, 2016; Zhang Zhengxin and Zhao Yue: “Central Bank’s International Experience in Exploring Legal Digital Currency”, China Finance, No. 17, 2016. ↵

11. See Fan Yifei: "Theoretical Basis and Architecture Selection of China's Legal Digital Currency", China Finance, No. 17, 2016.