A staff member of an Industrial and Commercial Bank of China branch in Beijing shows 2019 edition renminbi banknotes and coins on August 30, the day of their issuance (XINHUA)
After the remarkable success in digitalizing payments nationwide, China is ready to unveil its next financial innovation by launching its own digital currency, the central bank digital currency (CBDC).
The flourishing of the world's first cryptocurrency Bitcoin, a private initiative, following its launch in 2008 opened new possibilities in financial technology. But then its subsequent debacle and growing concerns that such anonymous transactions could be used to fund terrorist attacks and other crimes highlighted the need for regulations and greater monitoring. China banned initial coin offerings and direct trading between the yuan and virtual currencies, including Bitcoin, in 2017.
When China's central bank, the People's Bank of China (PBC), issues the digital currency, it would carry the stamp of reliability, being overseen by one of the strictest financial regulatory systems in the world, and also be more professional, given Chinese companies' expertise
in this area. Mu Changchun, a senior official with the PBC, made the remarks at the China Finance 40 Forum in Yichun, northeast China's Heilongjiang Province, on August 10.
The major difference between the Chinese CBDC and cryptocurrencies like Bitcoin or Facebook's Libra is that it will be issued by an established financial authority, the PBC, and have a centralized management model with supervision.
"The CBDC will still be the central bank's liability to the public. The nature of this liability will not change just because of the physical form of cash is going to be digitalized," Fan Yifei, Deputy Governor of the PBC, wrote in a commentary for Yicai magazine.
Also, the Chinese CBDC will not operate through an anonymous and untraceable peer-to-peer mechanism, like cryptocurrencies do. Its transactions will be visible to the central bank and be subject to third-party oversight to prevent illegal financing.
The system it will follow will be two-tiered with the central bank on top and the second tier consisting of commercial banks. Seven banks and Internet companies working in third-party payment services such as Alipay and Tencent will be involved in the initial phase.
A defining feature of cryptocurrencies is their use of the blockchain technology, the blockchain being a kind of online ledger. However, Mu said that given the sheer size of China's economy and population, the Chinese CBDC would not follow the same technology.
"As one can imagine, to issue digital fiat currency in a country as big as China, the employment of pure blockchain architecture cannot fulfill the throughput required for retail usage. Eventually, we decided that at the level of the central bank, we should remain technology-neutral and not preset a technology roadmap, meaning not to rely on a specific technology," he said.
The PBC launched the digital currency/electronic payment (DC/EP) project in 2014. A research team was set up to innovate and develop the product according to national strategic conditions. At last count, 74 patents had been filed by the Digital Currency Institute, the central bank's cryptocurrency research lab opened in 2017.
"The DC/EP is digital payment providing the same functions as paper notes," Mu said at the forum.
Commercial banks have to maintain reserves or deposits at the central bank to ensure that the digital currency is not used excessively. It would be used as a substitute for M0 (cash in circulation) but not bank deposits because that would generate interest and affect monetary stability. The digital currency will not change the existing money supply system and the debtor-creditor relationship, nor will it affect the real economy.
After commercial banks and other authorized financial institutions obtain the digital currency from the central bank, they will sell them to consumers and businesses, who will use an electronic wallet to swap their yuan for the digital money.
The system can be used without Internet connection. Users have to download the app and register with a real-name verification. Then they can put money into their electronic wallets. The bank account would be needed only to top up the wallet. Therefore, the dependence on bank accounts will be reduced to a great extent. According to Mu, the system will cut the cost of circulating traditional paper money which entails high costs of printing and distribution. There will be measures to prevent money laundering, financing terror acts and tax evasion.
The digital currency will lead to innovation in clearing and settlement and other services by commercial banks and other financial institutions. Besides, experts can analyze the movements of the currency with big data to promote the construction of a financial market. It can also be used as a reference tool for decision-makers before implementing monetary policy, even for macroeconomic control.
When will the Chinese CBDC be launched? According to Xinhua News Agency, it is in the phase of "closed-loop testing," meaning certain transaction scenarios are being simulated to test it in specific conditions. At the initial stage, it will be for domestic use only but in the future, it can adopt the same exchange rate as physical money. For cross-border transactions, which will be much more complicated, policy coordination with other countries will be required.
Regarding smart contracts, the function in blockchains to conduct transactions between anonymous parties without a central authority or supervision, Fan said the central bank will remain cautious about including the feature. Since the digital currency would be a substitute for the national fiat currency, he expected it to be regulated by the same laws that apply to the yuan.
The headquarters of the People's Bank of China in Beijing (XINHUA)
The Chinese digital currency announcement came after Facebook announced it was launching its own cryptocurrency Libra. Zhou Xiaochuan, former PBC Governor who is regarded as one of the thinkers behind the Chinese CBDC, said at the beginning of July that Libra was a potential threat to national currencies and existing cross-border payment systems. He said China should make full preparations to prevent possible risks.
There is widespread concern over a non-government cryptocurrency like Libra. Besides the risk of private information leak, Libra will not be responsible for countering money laundering or financing of terrorism like general financial institutions. Such problems will not occur with the Chinese CBDC which will be under a centralized management where the economic and trade activities are transparent.
Many virtual currencies are not currencies in nature, and they have no national credit support. Due to tighter regulations and technology, their prices often fluctuate wildly, impacting currencies and financial systems.
To protect the financial system and for macro-control, central banks around the world are realizing that the development of the digital currency should be based on state credit and they should be the ones to issue such currency. Former IMF chief Christine Lagarde has said it is not farfetched to think that one day a digital currency may replace the ones in the IMF's special drawing rights basket.
"Less than one quarter of central banks around of the world are actively exploring the possibility of issuing CBDCs, and only four pilots have been reported," Tobias Adrian, financial counselor and Director of the IMF's Monetary and Capital Market Department, was quoted as saying.
So if China issues the world's first CBDC, it will inspire other countries to accelerate their research and join the effort, Huang Yiping, Director of the Institute of Digital Finance at Peking University, told Xinhua News Agency.
Copyedited by Sudeshna Sarkar
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