The Development And Application Of Central Bank Digital Currency: Taking China’s CBDC As An Example

introduce

China is both active and cautious in developing a central bank digital currency (CBDC). The research and development of China's CBDC began in 2014 and began to accelerate in 2019. It is currently in the pilot stage of extended reality scenarios. Digital RMB is a centralized digital cash that is planned to gradually replace traditional banknotes and coins (i.e. M0). It is backed by a traditional two-tier banking system and was not issued on a blockchain. It is technology neutral in the distribution process and the Internet. Technology companies can work with commercial banks to issue digital yuan. In the short term, digital renminbi can promote domestic financial supervision and policy implementation; in the long term, digital renminbi may play an important role in the internationalization of the renminbi and even the evolution of the international monetary system.

introduce

The emergence of Bitcoin in 2009 popularized the concept of digital currency. Currently, digital currency is developing along three paths: cryptocurrency, stable currency and central bank digital currency (CBDC). As of 2021, the issuance volume and market value of cryptocurrencies and stablecoins have increased significantly, while the development of CBDC is relatively lagging, with only a few small economies issuing CBDC. However, most major central banks are actively involved in CBDC research and development. Although the future development path of digital currency is still under discussion, its importance and its impact on the existing monetary system have been recognized.

It is also clear to academic and policy circles that private cryptocurrencies such as Bitcoin, Lite and Ethereum are unlikely to become the main currency of the future monetary system. There are at least three reasons for this. First, blockchain-based cryptocurrencies cannot handle large numbers of simultaneous transactions, i.e. there are scalability issues; Second, cryptocurrencies can affect the effectiveness of monetary policy in unknown ways; Third, and most importantly, currency issuance rights must In the hands of the government. Therefore, despite the huge success of cryptocurrencies, they do not represent the future of the monetary system. In view of these problems, some even doubt whether they can represent "money" in the sense of monetary economics.

Faced with such rapid changes and challenges, central banks around the world have begun to launch CBDC projects. A survey of 66 central banks released by the Bank for International Settlements (BIS) in January 2020 showed that fully 80% of the central banks surveyed were involved in the research, testing or development of CBDC.

This article will discuss the development and impact of China’s CBDC (digital yuan). The People's Bank of China began research on CBDC as early as 2014. In 2020, China began actual field trials of CBDC in some regions. As of December 2021, the digital renminbi is in the stage of expanding the scope of field trials. If the field experiment is successful, China may soon officially launch a digital yuan.

Our discussion can be divided into two parts. In the first part, we will briefly introduce the situation of China’s CBDC. We collated what has been publicly released and compared the digital yuan to other central banks’ CBDCs. In the second part, we will discuss the possible future development and impact of CBDC.

Before discussing the details, let us first introduce the main characteristics and impacts of China’s CBDC. First, it was called Digital Currency/Electronic Payment (DC/EP) during the research stage, and the final name was e-CNY, or digital renminbi. Electronic RMB has the same value and face value as traditional RMB; secondly, electronic RMB is technically just an encrypted string. In view of the current computing power and encryption technology, the encryption of e-CNY can be considered safe because it cannot be decrypted in a short time; Third, in terms of currency, e-CNY is equivalent to M0 and will gradually replace traditional banknotes and coins; Fourth, electronic RMB will be issued through the traditional two-tier banking system composed of the central bank and commercial banks. Telecommunications and Internet companies may cooperate with commercial banks to issue digital renminbi; fifth, the issuance of digital renminbi will have a profound chain effect on the development of financial institutions such as commercial banks; sixth, in the short term, digital renminbi will help improve Domestic financial supervision, such as anti-corruption, anti-tax evasion, anti-money laundering, etc., may also contribute to the implementation of policies, such as the issuance of targeted subsidies; Seventh, e-CNY has a limited role in the internationalization of the RMB, and the degree of RMB internationalization will It depends on its acceptance by the international community, and digitization can facilitate this process by reducing distribution costs.

CBDC in China: A brief review

Academics and policy discussions have long been interested in CBDC, although no major central bank has officially launched it to date. Shortly after the birth and popularity of Bitcoin, he (2015) proposed a cryptocurrency framework in which central banks maintain full control over the money supply.

In academia, many researchers have considered the possible impacts of currency digitization (Scott et al., 2019, 2018). International organizations such as the Bank for International Settlements and funds are also very active in research on CBDC. They published a series of working papers and reports covering CBDC technical design, monetary policy, legal environment and other aspects.

However, to a large extent, research on CBDC is like research on ghosts, with a growing literature but no publications from major central banks. Fortunately, the People’s Bank of China (PBoC) is about to issue a CBDC.

The People's Bank of China began studying digital currency issues as early as 2014 and established the Institute of Digital Currency (IDC) in 2017. In 2019, the research and development of CBDC accelerated. In July of the same year, the State Council officially authorized the research and development of CBDC and designated the People's Bank of China to take the lead in carrying out the project. Commercial banks and financial technology companies such as Tencent, Alibaba, China Telecom, China Mobile, and China Unicom participate in research and development.

In the following months, discussions about the digital yuan intensified. People's Bank of China officials are beginning to reveal more information about its research and development. The name of the research project DC/EP (Digital Currency/Electronic Payments) has been officially used in public forums and writings. For example, Mu Changchun, director of the Payment System Department of the People's Bank of China, announced at a public forum in Yichun, Heilongjiang Province that my country's digital currency/electronic payment is in the leading stage and its product (digital renminbi) is under development. "It's almost ready." Fan Yifei, deputy governor of the People's Bank of China in charge of payments, also publicly wrote a letter to introduce and promote DC/EP. According to official statistics, as of August 21, 2019, the People's Bank of China IDC has obtained 74 patents. Private companies such as Alibaba have also obtained patents related to digital currencies.

In April 2020, the People's Bank of China began testing electronic currency in a closed environment and conducted tests in four cities: Shenzhen, Suzhou, Chengdu, and Xiongan. The test will also be held during the 2022 Winter Olympics in Chongli, Hebei Province, China.

On October 8, 2020, such an experiment was conducted in Shenzhen, China. Fifty thousand Shenzhen residents were randomly selected and each received 200 yuan, worth 10 million digital yuan. This money can be spent freely at 3,389 offline stores in Shenzhen. Unused money will be sold on October 18th (October 24th). The previous view has been withdrawn. All four major state-owned commercial banks participated in this pilot.

On December 15, 2020, a similar experiment was conducted in Suzhou, China. 20 million e-renminbi were sent to 100,000 randomly selected residents, doubling the scale of Shenzhen’s experiment. On December 28, unused electronic renminbi were recycled. This time, in addition to more than 5,000 offline stores, the money can also be spent on JD.com. It also supports offline payments via Bluetooth and NFC (Near Field Communication). In addition, two other large state-owned commercial banks, Bank of Communications and Postal Savings Bank, have also joined the pilot.

In these two experiments, 150,000 residents used DC/EP worth a total of 30 million in offline and online stores. As far as I know, this is the largest real-life field experiment of CBDC to date, which will accumulate rich data for further research.

Starting from November 2020, Shanghai, Hainan, Changsha, Xi'an, Qingdao, and Dalian will join the pilot. As of June 30, 2021, electronic RMB has been used in more than 1.32 million scenarios, covering public utility payments, catering services, transportation and shopping, government services, etc. More than 20.87 million personal wallets and more than 3.51 million corporate wallets have been opened, with a transaction volume of 70.75 million and a transaction volume of approximately 34.5 billion yuan.

In addition to China, other countries also tested or launched CBDC in 2020. Sweden’s CBDC, EE-, has also been tested in isolation settings. In March 2020, the first CBDC officially launched was the “Sand”, a digital version of the Bahamian dollar. The Central Bank of the Bahamas officially launched a digital version of the Bahamian dollar in October 2020, which all Bahamian residents can pay through a mobile app or in kind. Card access digital wallet.

What does digital RMB look like?

In this section, we summarize the main characteristics of electronic money. Since many people are still relatively new to this new form of currency, let’s first briefly explain how to use it. In January 2022, the e-wallet application will be officially launched in Apple electronic stores. People in specific regions can download these apps, register an account, connect the account to a bank account, exchange currency from the bank account, and spend money in pilot stores. By the beginning of 2022, 9 banks and 11 regions have participated in the pilot work. These banks include the major large state-owned banks and two private banks.

There are strict restrictions on transactions and balances, with a balance limit of 10,000 yuan. The single transaction limit is 2,000 yuan, the daily transaction limit is 5,000 yuan, and the annual transaction limit is 50,000 yuan. Other requirements include valid identification (ID) linked to a valid bank account, and in-person document processing at a bank branch. When requirements are met, transaction limits and balances are increased. When all four requirements are met, there are no upper limits on transactions and balances.

The structure of the digital yuan is similar to that proposed by the Bank of England in 2015. It is a digital cash that runs on the existing two-tier banking system.

Secondly, e-RMB is token-based rather than account-based. e-CNY is an encrypted string, so it must be stored in a smartphone app or other device, where it will naturally be linked to the account. However, this differs from the account-based approach in two ways. First, the token can be detached from the account since it is an independent string that can be checked and accepted (or rejected) by another smartphone. This feature is especially useful when both phones are offline (i.e. not connected to the internet). Second, the electronic RMB device (smartphone or other device) can be detached from the individual or other type of user, so the money can be semi-detached from the user. For these two reasons, the design is also called a semi-account-based design, i.e. it is account-dependent but can sometimes be independent of the account.

Third, electronic RMB will be distributed and supported by a two-level operating system with the central bank as the center and commercial banks as branches. In other words, electronic money will be supported by the traditional two-tier banking system. Central banks issue money to commercial banks, who then conduct transactions with households, companies, and other entities. When commercial banks obtain digital renminbi from the central bank, they need to deposit 100% cash as reserves, so digital renminbi will not directly affect the supply of M0.

We emphasized the word "directly" when we said that electronic renminbi will not affect M0, because the indirect impact of digital renminbi on money supply is quite complex and may be very important. A digital yuan may reduce M0, as faster currency circulation may result in less “cash” being needed. The traceability of e-CNY makes it less attractive for gray market transactions, which will further reduce the demand for M0. As for M1 and M2, the impact is more complex, and the commercial banking system may be greatly affected. Additionally, the behavior of individuals and companies may be significantly affected.

One change in the two-tier banking system is that non-commercial banks such as large financial technology companies and telecommunications companies may also participate in issuing electronic money to the public in the future. If this happens, fintech companies and telecom companies will also be required to deposit 100% reserves. However, without a banking license, it can only provide payment services, cannot accept deposits from residents, and cannot issue loans to businesses and households.

This discussion tells us that an important change may occur after the launch of electronic money. Traditionally, commercial banks provide three services: taking deposits, making payments, and issuing loans. After the rapid development of third-party payment in recent years, payment services can be separated from commercial banks. In fact, payment services are a rapidly developing area of ​​fintech, not only in China but also around the world.

Alternatively, deposit services could be spun off from commercial banks. Residents can purchase investment services, such as mutual funds, directly from professional providers. People can now conveniently buy and redeem money market funds using their smartphones, significantly reducing the need for deposits. The origination of loans could also be separated from commercial banks. Anyone with credit information on a company can help facilitate the issuance of a loan. In fact, we are already seeing large tech companies like Alibaba play a significant role in loan origination. With the launch of the digital yuan, financial flows will be more accurately recorded and available to a wide range of data analysts. Loan disbursements can be based more on data analytics rather than local soft information such as personal relationships.

Over the past few decades, traditional banking services have become fragmented due to the digitization of financial services. For example, third-party payment differentiates the payment business of commercial banks to a certain extent.

People can also use third-party payment facilities to purchase instruments such as money market funds. Big tech companies are fragmenting commercial banks’ loan origination operations, and CBDCs may further alter commercial bank operations in both foreseeable and unforeseen ways. The main difference is that a central bank has the potential to track all transactions and maintain a central database of all transactions.

In addition to the two-tier banking system, there is another single-tier system. The central bank would issue digital yuan directly to residents, but this alternative is technically complex and challenging given the size of China’s population. For example, on November 11, 2018, the day of Alibaba’s recently launched annual shopping carnival, transaction volume peaked at 544,000 transactions per second. Alibaba's system can support 61 million transactions per second. With further economic growth, urbanization and digitization, the transaction volume will be greater in the future, so it will be very difficult to build a single system to support all transactions.

In addition to technical difficulties, single-layer systems have two disadvantages. First, it distracts central banks from their core task of setting monetary policy. In modern society, central banks have become divorced from daily commercial banking services and specialize in monetary policy formulation and financial supervision. A single-tier system would have a significant impact on this specialized functionality. Secondly, the single-layer system also exposes the central bank directly to any unknown risks that the digital renminbi may bring. As a new, promising tool, it may still have unforeseen flaws and problems. These mistakes and problems could pose huge risks if they spread throughout the monetary system. A two-tier system will help eliminate or at least reduce these risks, and in an emergency, a firewall can be set up.

Fourth, the digital renminbi will not be based on the blockchain when it is issued, but it will be technology neutral when it is issued. With cryptocurrencies such as Bitcoin, the advantages of blockchain technology are widely recognized. Blockchain is a decentralized, traceable, non-rewritable distributed ledger technology (DLT). This technology can establish trust between untrusted parties, but at the expense of redundant computing and storage, so it is not suitable for resale transactions. Therefore, it is difficult for electronic RMB to be issued based on blockchain. At this stage of technology development, this is not technically feasible. In fact, this is not necessary. A country's central bank, commercial banks and other large technology companies are all trusted players in the modern economy. Their credit can be used to replace some redundant computing and storage, and supervise when necessary to build and enhance their credibility.

However, when distributing the digital yuan into the monetary system, commercial banks and large technology companies can choose to use any technology, including blockchain technology. This is similar to existing stablecoins such as USDT and USDC, and also similar to the proposed new stablecoin Libra. The advantages of this design are twofold. First, the central bank can specialize in currency issuance and central data management; second, it can introduce competition among commercial institutions and promote technological progress.

Comparison of digital renminbi with other electronic payments

When people talk about digital payments in China, they usually mention Alibaba Pay, WeChat Pay or cryptocurrencies. E-RMB is a new digital payment method, and some comparisons can clarify the differences between e-money and existing digital tools. There are three important differences between the e-RMB and other digital currencies.

First, it is issued by the central bank and is therefore backed by government law. By law, when residents own a device, they must accept the digital yuan as a legal payment method. On October 23, 2020, the People's Bank of China announced that it planned to amend the "People's Bank of China Law". With this revision, the digital renminbi will be officially included as a legal form of payment along with traditional banknotes and coins. As long as there are appropriate facilities, people cannot legally refuse to accept electronic money. However, its popularity depends on its user-friendliness, which in turn depends on its specific design. Otherwise, both payers and payees may be reluctant to use the digital yuan. In contrast, other forms of digital currency, including Alibaba Pay and WeChat Pay, are not official currencies. Therefore, people can choose not to accept Alibaba Pay or WeChat Pay.

Technology-based cryptocurrencies, such as Bitcoin, are not issued by a central bank or other government agency, but are generated by algorithms run by the Internet community. Since governments cannot control their supply, cryptocurrencies will have to compete with governments for the right to issue currency. This is why many governments do not welcome technology-based cryptocurrencies. As long as modern social life remains organized around national governments, the space for technology-based cryptocurrencies will be limited.

e-CNY is also different from the proposed Libra, which was renamed Diem in December 2020 and the currency is being revised. By design, it is a stablecoin pegged to a basket of currencies or a single currency such as the US dollar, and in this respect it is similar to other stablecoins such as USDT and USDC. Libra (Diem) has attracted a lot of attention due to its ability to be distributed through vast social media networks. With an estimated 2.4 billion users worldwide, the potential impact of Libra (Diem) is beyond imagination. Libra (Diem) is currently experiencing some major setbacks, likely due to its potentially huge impact on the existing monetary system.

Secondly, electronic RMB supports offline transactions. In contrast, all other digital currencies and third-party payment tools require both parties to the transaction to be online. Offline transactions are supported by Bluetooth and NFT communication technologies, features now available on most smartphones. Offline transactions may not account for a large proportion in the future. However, this feature is still necessary because the digital yuan is an official currency and must take into account the rare situation where people do not have an internet signal or the signal quality is low. In addition, offline transactions may be limited to small transactions to provide convenience and prevent risks. Finally, although these transactions are conducted offline, information can still be uploaded and recorded when the Internet is available.

Third, e-CNY supports semi-anonymity, and the transaction party does not need to know the identity of the counterparty. Transactions are guaranteed by the underlying system, which verifies transactions and prevents double-spending issues. In contrast, technology-based cryptocurrencies typically support complete anonymity. In fact, the popularity of Bitcoin and other cryptocurrencies is due at least in part to their complete anonymity, although the true identities of transacting parties can be detected. Semi-anonymity is very different from full anonymity: semi-anonymity is only between the two parties to the transaction, not anonymous to the central bank. Technically, the central bank can track all transactions and store all transaction information, even if offline transactions are still recorded in the database. By using this database, transactions between parties can be monitored and managed.

It is also helpful to compare the e-RMB with other countries’ CBDCs. As we mentioned before, many central banks are involved in CBDC research, trials, or development, including the Federal Reserve, Bank of England, European Central Bank, Bank of Japan, and Bank of Canada. The main difference between e-CNY and these CBDCs being discussed is that e-CNY is not based on DLT or blockchain. The People's Bank of China explained that DLT cannot meet the large number of simultaneous retail transactions in China and may be more suitable for smaller economies or specific scenarios.

Of the CBDCs discussed, the closest to a digital yuan was proposed by the Bank of England in 2015 and was also proposed as a digital cash operated by the existing two-tier banking system. Most current CBDCs will use a two-tier banking system.

What are the possible impacts of the digital renminbi?

At this point, we have a relatively clear concept of digital renminbi. Next, we'll discuss the possible impacts after rollout. Opinions on this vary widely. Some believe that since most payments are already done online, the impact of the digital yuan will be minimal. Since both Alipay and WeChat Pay are very convenient and user-friendly, the digital renminbi may not be easily popularized. Some even doubt the necessity of electronic money. But some people believe that electronic currency will bring about fundamental changes and even help the internationalization of the renminbi. My view is somewhere in between. I believe that although the digital renminbi will not have an obvious impact in some areas, its potential impact in other areas is considerable and may be immeasurable. Regarding the internationalization of the RMB, I would say that the short-term impact is likely to be quite limited.

First, the impact of the digital yuan on resale payments may be somewhat limited. This is because digital payments such as Alibaba Pay and WeChat Pay are already common and very convenient. Unless electronic RMB wallets are equally easy to use, people will continue to use Alibaba Pay and WeChat Pay.

Second, electronic money may have a significant impact on financial regulation and the implementation of economic policies. This is because all transactions can be tracked and recorded in the People's Bank of China's database, and such databases are very useful in many areas, such as anti-corruption, anti-money laundering and anti-tax evasion. With such a database, future monetary and fiscal policies can be better monitored and their effectiveness increased.

Third, in the short term, electronic renminbi will have little impact on the internationalization of the renminbi. The internationalization of the RMB depends on the acceptance of the RMB by the international community, especially neighboring countries and China's trading partners. When the yuan is accepted, the digital yuan can help promote the development of the yuan. Until then, its role in the internationalization of the renminbi will be limited.

Summarize

This article introduces the development of CBDC in China. Since my country's CBDC has not yet been officially launched, we only compiled a clearer picture from public information. We also compare it to other digital tools and discuss its potential impact.

The official name of China’s CBDC is e-CNY. It is digital cash designed to replace traditional banknotes and coins (M0). It is currently in the stage of controlled experiments in specific areas. It will be distributed into the monetary system through a two-tier system with the central bank as the center and commercial banks and large technology companies as branches. It will not be based on blockchain when it is issued, but it will be technology neutral when it is issued, and commercial banks and technology companies will play an important role in developing and operating the infrastructure and managing fund accounts.

There has been controversy over the relationship between the e-renminbi and existing digital payment facilities. They are not competitors, but vertical collaborators in the monetary services field. With the introduction of e-money, existing payment facilities can be linked to the digital yuan in the same way as traditional currencies. People can choose not to switch to digital renminbi, and digital renminbi can also compete for market share in the electronic payment field.

Overall, electronic currency may have a significant impact on domestic financial supervision, such as anti-corruption, anti-tax evasion, and anti-money laundering, and can also effectively influence monetary policy. The impact will be gradual but potentially profound, as future banking systems will evolve accordingly. When all the data in a large data set is available, whoever has access to that data and can analyze it is the potential banker. The future banking industry may be divided into savings institutions, payment institutions and lending institutions. At this stage, it is difficult to foresee how profound these changes will be and how quickly they will occur. Until the RMB is better accepted by the international community, the impact of electronic currency on the internationalization of the RMB may be limited in the near future. When the RMB is better accepted by the international community, the digital RMB can help the internationalization of the RMB, but not vice versa.

标签： #People's Bank of China #Electronic Money #Banks #Central Bank #Digital Currency