Fan Yifei, Deputy Governor of the Central Bank: China's legal digital currency research and development is entering a new stage

Editor's note: The author of this article is Fan Yifei, Deputy Governor of the People's Bank of China. Governor Fan said that the People's Bank of China's digital currency research and development work is currently entering a new stage, including strengthening internal and external exchanges and cooperation, setting up specialized research institutions, further improving the legal digital currency issuance and circulation system, accelerating the construction of legal digital currency prototypes, and conducting in-depth research and attempting to apply various information technologies related to legal digital currency.

In recent years, the craze for digital currency has emerged, and some underlying technologies related to it, such as blockchain technology and distributed accounting methods, have also shown broad application prospects. Digital currency has moved from theory to reality, and its necessity, feasibility and security are being tested by the market. Some types of digital currencies, represented by Bitcoin, have been first used in the private sector. Central banks in some countries are also actively researching and exploring the institutional design and key technologies of legal digital currencies. As a central bank, it should comprehensively consider factors such as maintaining the stability of the financial system, promoting financial innovation, and conforming to the path of technological evolution, and gradually realize the issuance and circulation of legal digital currencies and effective supervision of private sector digital currencies.

Digital currency is an inevitable development of history

There are many interesting phenomena in the evolution of currency. The original barter was a completely decentralized arrangement. However, since the dual coupling of supply and demand in this situation is difficult, the transaction efficiency is extremely low, which greatly restricts the development of trade and makes it impossible to measure the value uniformly. Driven by the "market", monetary media emerged, and gradually transitioned from physical currency to precious metal currency, and then to gold and silver currency. The form and value of currency became more and more stable, and the scope of the medium became wider and wider. The development of physical currency and gold and silver currency has gone through a long history, but due to credibility issues, this type of decentralized currency is prone to counterfeiting, inferior goods, and short weight. With the emergence of national legal tender, mankind has finally entered the era of monetary centralization.

The emergence of paper money is another huge leap in the history of currency. In order to solve the problems of natural loss and inconvenience in carrying of gold and silver currencies, the state issued paper money to replace physical currency with public power and credibility. Paper money was also anchored to gold or silver at the beginning to maintain currency stability and public confidence. Later, people discovered that paper money could exist independently of gold and silver, so pure credit currency appeared, which is a more typical centralized currency. The separation of the value of paper money from its face value not only saves the cost of issuance, but more importantly, it can greatly promote trade development, and monetary policy operations have become possible since then.

Entering the 21st century, Internet technology is in vogue, and digital currency based on the Internet and digital encryption technology is a natural outcome. Digital currency, like paper currency, is essentially a pure credit currency, but digital currency can further reduce operating costs and can be applied in a wider range of fields with higher efficiency. From the perspective of some existing digital currencies, there is a decentralized mechanism behind them, and the trust system is mainly established through distributed accounting methods. However, these digital currencies still have the same fundamental defects as private currencies in history: unstable value, weak credibility, limited acceptable range, and easy to generate large negative externalities. Therefore, it is inevitable for the central bank to promote the issuance of legal digital currency. The central bank's digital currency is guaranteed by national credit, and can achieve simultaneous online and offline applications to the greatest extent, maximizing transaction convenience and security.

The form and operating framework of legal digital currency

Legal digital currency is bound to be affected by the existing payment system and information technology, but it also needs to be appropriately distinguished from the existing payment system in order to focus on its own service areas and play its role in replacing traditional currency. In theory, the payment system mainly deals with the demand deposit part (M1-M0) in the broad money, while digital currency mainly belongs to the category of cash (M0). Any kind of currency must have a specific form and way of carrying, such as physical currency, gold and silver currency or paper currency, and digital currency is no exception. The specific form of digital currency can be a number from a physical account, or a string of numbers recorded in the name that is verified by specific cryptography and consensus algorithms. These digital currencies can be embodied or carried in digital wallets, which can be applied to mobile terminals, PC terminals or card bases. If it is just an ordinary number with a digital wallet, it is still just electronic currency; if it is an encrypted number stored in a digital wallet and running in a specific digital currency network, this is pure digital currency. The advantage of electronic money is that it is simple in form and can be completed with a slight change in the existing payment system; the disadvantage is that it relies heavily on the account system, has weak anti-tampering capabilities, and has high costs for KYC (Know Your Customer) and AML (Anti-money Laundering). The advantage of pure digital currency is that it can learn from and absorb the advanced technologies of various types of digital currencies today, and operate in a way that is more difficult to tamper with, easier to operate online and offline, more visible, and with a wider range of channels; the disadvantage is that it requires the construction of a new ecosystem, with higher technical requirements and greater difficulty in system operation and maintenance. The above two forms are complementary to a certain extent, and can be used in different application scenarios to meet different needs.

The operating framework of legal digital currency is also a very critical issue. There are two modes 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 a common mode of some digital currencies. 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.

Technical Keys and Competitive Advantages of Legal Digital Currency Operation

The safe operation of legal digital currency must rely on strong technical support, mainly including the overall architecture of digital currency, and digital ledger technology constructed by elements such as protocols, data formats, digital signature mechanisms, and digital wallets.

Judging from the current development of the industry, the various types of digital currencies launched by the private sector mainly use blockchain technology and encryption technology to ensure the security of the system operation through competitive accounting and public and private key signature verification methods. Legal digital currency is different from private sector digital currency: the latter is decentralized; while the former must be centralized or partially centralized to ensure efficiency and security. This feature determines that legal digital currency must continue to innovate and transform on the basis of learning from and absorbing private sector digital currency technology. For example, change the flat network to a hierarchical architecture, change the public chain to a consortium chain, change competitive accounting to cooperative accounting, and let some key nodes participate in the accounting system.

Another major technical pillar on which legal digital currency relies is cryptographic algorithms. Judging from the operation of private sector digital currencies, it is based on strict cryptographic algorithms and the use of private key signatures to operate accounts, thereby protecting user transaction security. Unfortunately, due to the anonymity of private digital currencies, we often see situations where monetary assets are stolen due to private key leaks but are difficult to recover. Legal digital currencies must completely solve this problem. They must not only ensure the security of digital currency users through cryptographic algorithms, but also establish a controllable anonymity mechanism through technical means to achieve traceability under certain conditions, so as to further enhance the security of legal digital currencies.

Legal digital currency must be tested by the public and the market. Only legal digital currency accepted by the public and the market has vitality and can truly replace traditional currency. Therefore, legal digital currency must pay close attention to its own service capabilities and competitiveness from the day of research and development, including market credibility, payment convenience, system security, operational flexibility, diversified application scenarios, system efficiency, etc. Although legal digital currency naturally has legal status, no person or institution may refuse to accept it under the condition of a circulation environment. However, how to scientifically determine and regulate the issuance of digital currency to ensure currency stability should be the most important consideration for the central bank to issue legal digital currency, and it will also increasingly become the key for different monetary authorities to compete in digital currency in the cyber world.

The impact of legal digital currency on the financial system

Legal digital currency will have a profound impact on all aspects of the economy and society, especially on the financial system. At present, it is impossible to accurately assess these impacts, but logically, several results may occur: First, the currency structure changes and the money multiplier increases; second, the demand for physical currency continues to decline, and the conversion rate of financial assets accelerates; third, the measurability of money circulation speed has improved, and the foundation of big data analysis is more solid, which is conducive to better calculating the total amount of money and analyzing the currency structure; fourth, reducing KYC and AML costs and improving regulatory efficiency; fifth, providing an efficient shared financial environment to drive financial innovation.

Legal digital currency may also bring another important change to the financial system, which is that it is more likely to cause financial disintermediation and affect money creation. Since digital currency makes the conversion of deposits (M2-M0) to cash (M0) very convenient, financial panic and financial risks will accelerate the spread once they occur, exacerbating the damage to financial stability and financial security. In view of this, appropriate mechanisms must be set up under certain conditions to limit it.

Of course, the actual impact of legal digital currency on the financial system can only be truly known to people after it has been issued and circulated as currency. We must assess the situation and actively and prudently make institutional arrangements and macro-control to ensure that the positive impact of legal digital currency on the financial system is maximized and the negative impact is minimized.

To deepen the research and development of my country's legal digital currency

Under the care and guidance of Governor Zhou Xiaochuan, the People's Bank of China has been paying close attention to the development of digital currency and actively carrying out relevant research. Since 2014, it has organized experts to set up a special research team, and further strengthened its strength in early 2015. It has conducted in-depth research on the issuance and operation framework of digital currency, key technologies of digital currency, the circulation environment of digital currency issuance, legal issues faced by digital currency, the impact of digital currency on the economic and financial system, the relationship between legal digital currency and private digital currency, and the issuance experience of foreign digital currency, and has achieved phased results.

At present, the digital currency research and development work of the People's Bank of China is entering a new stage, including strengthening internal and external exchanges and cooperation, setting up special research institutions, further improving the issuance and circulation system of legal digital currency, accelerating the construction of legal digital currency prototypes, and conducting in-depth research and trying to apply various information technologies involved in legal digital currency. In this process, we will actively explore and practice prudently with a scientific, rigorous and open attitude, and will not exclude any safe and effective new technologies and methods. We also look forward to extensive and in-depth exchanges and cooperation with all sectors of society to jointly promote China's legal digital currency to become a reality as soon as possible and contribute to the country's economic and social development.