The bellwether of Central Bank Digital Currencies-DC/EP
Author: Wei-Chieh(Jack), Chai
The Chinese currency has a long history, and by the Yuan Dynasty (the 1270s), China issued the world’s first legal tender. And now it’s China again. Through China’s version of the central bank’s digital currency — DC/EP, the country’s currency is being fully digitized, although *piloting* is still ongoing. Therefore, it has not been officially launched, but as the first country in the world’s major economies to pilot CBDC, it is still setting a good example for central banks worldwide.
This article will thoroughly introduce China’s digital renminbi(RMB) so that readers can have deeper insights into the leader of CBDC.
*a “pilot” is when China begins a reform in certain places (called “points”) for trial implementation, to absorb the experience, improve the plan, and then promote it in various places (called “plane”).
【Background】
One of the biggest financial developments in recent years is probably the rise of cryptocurrencies. When Bitcoin reached its peak price of around $68,000, its estimated market value even surpassed that of Visa and Mastercard, two multinational financial payment service companies.
Even the tech industry wants to make a foray into cryptocurrency payments. The most obvious example is Facebook’s libra coin, which announced in 2019 that it would issue a digital currency called Libra(Now called “Diem” ).
While everyone is raving about cryptocurrencies and their future possibilities, central banks feel like they are facing an enemy and are alerted that they are under “some kind of threat”. Therefore, various countries have greatly enhanced the discussion on central bank digital currencies(CBDCs), and many countries have even formulated specific plans to develop and launch the central bank digital currency. Among them, mainland China has played a leading role in this competition.
【Intro】
China’s central bank digital currency can be called E-CNY or “DC/EP”.In this case, "DC" stands for Digital Currency, and “EP” is Electronic Payment.
Briefly speaking DC/EP is a digital currency that runs by a central private network using blockchain technology. The People’s Bank of China has full ownership and control of the currency. The concept of DCEP is in stark contrast to existing cryptocurrencies such as Bitcoin.
First, let me introduce the "basic characteristics" of DC/EP
DE/CP is the fiat currency issued by the central bank.
Monetary has three main functions: 1. store of value 2. medium of exchange 3. unit of account. For consumers in various countries, the most basic function is as a medium of transaction or payment. Therefore, the goal set by the People’s Bank of China is to make the DC/EP quickly achieve the same experience as all other mobile payments in the market. Second, DC/EP is the digital form of fiat currency, which means that the issuance and circulation management mechanism of DC/EP is the same as that of the physical Renminbi. The difference is that value transfer is realized in digital form as well as DE/EP cannot transfer privately. Just like how we spend the cash at the grocery store, only the shopkeeper knows how much I paid.
Unlike community currency and enterprise currency, DC/EP is a currency issued by the country combined with its own currency development needs, combined with existing technologies, and endorsed by national credit. Like cash, the store must not refuse to accept it, and it is supported by national credit, with a very high level of security.
DC/EP adopts centralized management and a two-tier distribution model
The right to issue and mint DC/EP belongs to the central bank, and the People’s Bank of China has the highest position in the DC/EP operating system. At the first level, it is responsible for issuing and managing DC/EP to commercial banks as designated operating institutions (such as the current six large state-owned banks and two online banks). On the second floor, designated operating institutions distribute DC/EP to retail market participants including the general public, and provide related payment services together with other payment institutions (such as Alipay, WeChat Pay, etc.), while the delivery process of DC/EP and paper banknotes are the same. Commercial banks open accounts in the central bank and pay 100% of the reserves. Individuals and enterprises open digital wallets through commercial banks or commercial institutions.
Many people worry that the central bank digital currency will affect the development of banks and the existing digital payment system, but China’s approach is quite clever. Compared with the single-tier structure, this two-tier distribution model is expected to allow commercial banks to play a greater role and take more responsibility. This two-tier delivery system will be similar to the practice of physical currency, which is very suitable for China’s national conditions. It can not only use existing resources to mobilize commercial banks but also smoothly improve the acceptance of digital currency. And to reduce the competition with bank deposits, the deposit of DC/EP will not bear interest, and it will circulate in a two-tier system where the People’s Bank of China issues currency and commercial banks exchange DC/EP for the public, just like a physical currency.
M0: Cash in circulation
Cash is now at risk of being counterfeited, and there are risks such as money laundering and terrorist financing. In addition, the current digital payment tools, such as Credit cards, Debit cards, and mobile payments, all need to bind bank accounts, and the public’s demand for payment cannot be fully satisfied. Therefore, mobile payment can not completely replace M0. Unlike mobile payment systems that are very popular today, DC/EP can be used offline with the help of NFC technology, not just through the wallet interface on mobile devices, but also cold wallets, thus bringing it closer to cash. Chinese officials say this will help popularize DC/EP in rural areas with poor mobile internet coverage and among older people who don’t use smartphones regularly.
Interest payments are currently prohibited on DC/EP, and the PBOC wants to replace cash with only a limited amount of DC/EP in circulation, not bank deposits. Therefore, DC/EP is mainly positioned as cash in circulation and will coexist with the physical renminbi for a long time. Both digital renminbi and physical renminbi are liabilities of the central bank to the public. They have the same legal status and economic value, and more importantly, have the same liquidity as cash. DC/EP will be issued in parallel with the physical renminbi, and the central bank will conduct statistics, analysis, and management of the two.
DC/EP is a retail central bank digital currency
There are three important areas for CBDC applications: retail, wholesale and cross-border, and proposals in each area may inspire much imagination. Wholesale central bank digital currency is mainly issued to institutional entities such as commercial banks and is mostly used for large-value settlements; while retail central bank digital currency is issued to the public and used for daily transactions. Countries have different priorities for developing central bank digital currencies, some focus on wholesale transactions, and some focus on improving the efficiency of retail systems. At present, the research on CBDC in many developed economies mainly focuses on wholesale CBDC, and China’s goal is very clear from the beginning. The main purpose of developing DC/EP is to meet the needs of domestic retail payment, improve the domestic retail payment system, and improve financial inclusion. Therefore, DC/EP is a retail central bank digital currency issued to the public.
Data generated by a DC/EP will provide new levels of transparency, helping authorities detect unusual payment patterns or illegal activity. When a suspected illegal and suspicious transaction is detected, the competent authority may inquire about and use the user’s personal information with the operating agency in accordance with the law. However, this has raised serious concerns about privacy, a key issue that Taiwan is grappling with as it develops the possibility of a CBDC.
Digital payment system (bank and mobile payment)
DC/EP and the account funds of designated operating institutions are universal and together constitute a payment tool. Commercial banks and licensed non-bank payment institutions can participate in the DC/EP payment service system when they comply with anti-money laundering, anti-terrorist financing, and risk regulatory requirements and are approved and supported by the central bank.
In addition, as DC/EP enters a highly competitive market, people are concerned about how DC/EP can coexist with the current mature mobile payment. In China, where about four-fifths of payments are made through Tencent’s WeChat Pay or Alibaba’s Alipay. In this case, China has made it mandatory for all stores that accept digital payment tools to also accept the DC/EP as legal tender. Also, Chinese regulators have stressed that the government has no intention of scrapping other payment systems.
Alibaba and Tencent, China’s largest mobile payment operators, have put DC/EP payment options into their interfaces. This shows that the currency being developed by the PBOC will not compete with other payment system operators, but should complement them. In terms of user experience, it won’t be much different from using the usual Alipay and WeChat Pay, except for the aforementioned offline payment option. The digital currency operates similarly to Alipay and WeChat Pay, both of which are leading digital payment systems in China. For consumers, the main advantages are convenience, lower transaction costs, and the ability for users to transact even without a mobile network.
The relevance between DC/EP and blockchain
Many people may have the same question, that is, China has banned cryptocurrencies and ICOs, so will blockchain technology still be used? However, the two are completely unrelated, and China has instead vigorously promoted the development of blockchain technology.
At present, China has comprehensively promoted the development and implementation of blockchain technology throughout the country, intending to improve efficiency and innovation and become a world leader in blockchain technology. Xi Jinping asked China to speed up the development of blockchain technology. I think China’s digital yuan adopts blockchain instead of cryptocurrency and vigorously uses the advantages of blockchain technology.
Currency can be divided into two parts: issuance and circulation. The issuance right of DC/EP lies with the central bank, and its issuance model is centralized, so we can think that the issuance of DC/EP does not require the use of blockchain technology. However, blockchain technology will be used in circulation, and there are many advantages of using blockchain technology in currency circulation.
I found this part in the white paper
“The selection of the technology roadmap of e-CNY features long-term evolution, constant, iteration, and dynamic upgrading. Regular evaluations based on market needs are carried out for continuous improvements. Authorized operators may select their technology roadmaps based on their actual demands and technological advantages, to maintain insight and foresight into future technology.”
This means that the distribution agency can choose and develop the corresponding blockchain technology.
The use of blockchain technology can not only solve the most basic accounting requirements but also inherit the non-tampering and traceability characteristics of the blockchain. Because the decentralization feature is not so important in this scenario, the “Consortium Blockchain” system can also be used; however, the scenario might be changed after the emergence of Layer 2. In addition, the PBOC said that in the pilot program, smart contracts are also being used to make the DC/EP programmable, scalable, and better integrated into various scenarios. For example, in such prepaid consumption as house rent and school tuition, there have been many cases where the owners of closed businesses absconded with the prepaid funds of consumers. DC/EP’s smart contracts are believed to have the ability to help prevent such thefts. In addition, smart contracts can interact with subsidies or allowances provided by the program to limit the use of proceeds or set deadlines for such use.
Next, I will tell you "why China wants to develop a DC/EP."
The following are divided into internal and external reasons.
Internal Reform
Declining use of cash
China’s cash use rate continues to show a downward trend. At the same time, due to the vast territory of mainland China, the cost of cash management is relatively high. Its design, printing, transportation, identification, destruction, and anti-counterfeiting cost a lot of manpower and financial resources.
Over time, new technologies have driven the emergence of new models and new industrial forms of the digital economy. Since the outbreak of COVID-19, new forms of life such as online shopping, online office, and digital learning platforms have become more active, the coverage of the digital economy has continued to expand, and the demand for online financial services among people in backward and remote areas has become increasingly strong. In recent years, China’s electronic payment, especially mobile payment, has developed rapidly. Through the issuance of the central bank digital currency, the needs of the digital economic system can be effectively met.
According to the 2019 People’s Bank of China survey, the number and amount of mobile payment transactions accounted for 66% and 59% respectively. The number and amount of cash transactions were 23% and 16%, and 46% of the respondents did not have cash transactions during the investigation.
Mobile payment companies monopolize the market
China has a very special payment environment. Unlike most countries, more than 80% of the urban population no longer use cash but use mobile payment services such as Alipay and WeChat pay. As private payment services become more and more popular, the market share of cash continues to lose, which will gradually diminish the key role that the state originally played in retail payment by providing the cash. Therefore, the government’s introduction of CBDC can supplement the disappearing gap of cash, while avoiding private monopoly, maintaining the country’s role in the payment market, and protecting currency sovereignty.
It also acts as a backup system to prevent the failure of the national payment system in the event of a financial or technical accident that occurs in the private sector that has monopolized the action payment market.
Financial Inclusion
According to statistics in 2017, there are 1.7 billion people in the world who are unbanked, especially in remote areas that lack banking services and mobile payment services. So for economies where large segments of the population are unbanked or where physical cash distribution is costly, the top priority of a CBDC is financial inclusion.
People do not need to open a bank account to use DC/EP; compared with the stricter know-your-customer (KYC) procedures for bank account opening, DC/EP has a lower entry threshold, and different levels of KYC correspond to different transaction limits. Thus, improving the efficiency of the central bank’s payment system, and promoting financial inclusion.
Statistical Models and Economic Data
DC/EP can provide more efficient statistical models and economic data. The current currency issuance method lacks effective and real-time monitoring and recording means for currency circulation after issuance but instead relies on estimation. The distribution of digital currency by the central bank will make the timely recording and integration of data such as minting, accounting, and flow a simple matter. Through in-depth analysis of technical means such as big data, provides a useful reference for currency investment, monetary policy formulation, and implementation, and provides useful means for economic regulation.
Preventing financial crime and terrorism financing
Commercial banks distribute digital currency to users and maintain a database together with the central bank to record the flow of DC/EP between users, which is difficult to achieve with cash. You can monitor any major domestic and foreign payments, and transaction processes through digital currency.
Due to the controllable anonymity mechanism, the anonymity of cash is removed, so the central bank’s digital currency can effectively prevent money laundering, corruption, and bribery. Although this is expected to help combat money laundering and terrorist financing activities, it also causes people to worry about DC /EP compromises people’s privacy rights.
External Opening
Fight against cryptocurrencies and stablecoins
Since the advent of Bitcoin, the private sector has launched various cryptocurrencies. According to statistics, there are currently 20,679 types of cryptocurrencies, with a total market value of more than $1.02T. Cryptocurrencies such as Bitcoin use blockchain and encryption technology, claiming to be “decentralized” and “completely anonymous”, but the price fluctuates violently and the transaction fee is high. Constraints such as low energy consumption and huge energy consumption make it difficult to perform monetary functions in daily economic activities. At the same time, cryptocurrencies are mostly used for speculation, potential risks are threatening financial security and social stability, and they have become payment tools for illegal economic activities such as money laundering.
In response to the shortcomings of the relatively large price fluctuations of cryptocurrencies, some commercial institutions have launched so-called “stablecoin” in an attempt to maintain currency stability by anchoring with sovereign currencies or related assets. Some commercial institutions plan to launch a global stablecoin, which will bring many risks and challenges to the international monetary, payment, and settlement system.
A company’s credit risk, for example, is an open issue. Stablecoins are essentially centralized digital currencies. In the absence of supervision, problems that may arise including stablecoin companies may cause violent fluctuations in the price of stablecoins due to excessive issuance of stablecoins or will raise funds used for high-risk investment activities, etc. On the contrary, CBDC is essentially the same as cash, which belongs to the central bank’s liabilities and has national credit.
RMB Internationalization and U.S. Dollar Hegemony
Mainland China wants to use the DC/EP to realize the vision of internationalization. One of the purposes of the Chinese mainland’s Belt and Road Initiative in 2013 and the development of the Cross-Border Inter-Bank Payments System (CIPS) in 2015 is to promote the internationalization of the renminbi.
DC/EP will initially only be used for payments within China, but with the development of the Cross-Border Inter-Bank Payments System (CIPS), this system allows RMB-denominated transactions to bypass the SWIFT system dominated by Western countries for international payments. In addition, small developing countries with close trade and financial ties to China may begin to invoice and settle transactions directly in RMB, especially China’s Belt and Road policy partners.
On the other hand, since the US dollar has an important position as the international reserve currency, China hopes to make the RMB replace the US dollar as the global reserve currency, and DC/EP can help them achieve this goal and strive for international economic dominance through digital currency. Iran, North Korea, Venezuela, and these anti-US forces may have application space for DC/EP.
【Closing】
The People’s Bank of China attaches great importance to the research and development of digital fiat currencies. The related concept was proposed in 2014, and the Digital Currency Research Institute was established two years later to develop the prototype of the first generation of digital fiat currency. At the end of 2017, with the approval of the State Council, the People’s Bank of China began to cooperate with commercial institutions to develop and test digital fiat currencies. So far, design, functional development, and system testing have been completed.
As of this year, the cumulative number of digital renminbi transactions in the pilot areas is about 264 million, with an amount of about 83 billion yuan, and the number of merchant stores that support digital renminbi payment has reached 4.567 million. A total of 140 million individual users have opened e-wallets and people use them for shopping, dining, paying taxes, personal finance, and hiring employees.
China will be the first major country to launch a CBDC, making China’s CBDC one of the potential major CBDCs with global impact. May become a potential game changer in international commerce and affect the international trading system. Although China’s DC/EP is still in the pilot stage for domestic use, it could eventually lower the barriers to using RMB for cross-border payments. If successfully implemented, DC/EP can enhance the international influence of the RMB in the long run, making China further move towards the goal of RMB internationalization.
It is often seen in various competitions that first place in the past does not mean first place today or in the future. As Taiwanese, we should all have more knowledge and understanding of cryptocurrencies or digital currencies, and choose our path, because this is about to become a part of our life shortly.
- This research was published on GIS Taiwan’s LinkedIn under the same title. But this one is the full version of my research.*
- “Special thanks to Chang-Wu Chen for his valuable insights and feedback, greatly enhancing this article.”
