China has started testing its government-backed digital legal tender, digital currency and electronic payment (DC/EP), in some regions before it is widely applied to replace paper notes and coins in circulation, the digital currency research institute of the People's Bank of China (PBC) revealed in an interview with China Central Television on April 17, showing China's scaled-up efforts to boost the digital economy and cope with the impacts of the novel coronavirus outbreak.

The digital renminbi (RMB) payment system is based on controllable and anonymous operation, and the trials of the central bank digital currency (CBDC) are being conducted in a closed environment in pilot regions including Shenzhen, Suzhou and Chengdu as well as Xiongan New Area in Hebei Province, north China. The application of the digital currency for the Beijing 2022 Winter Olympics is also under testing, the research institute said.

It stressed that the tests will not affect the current sovereign currency issuance and circulation system. A statement issued by the PBC on April 25 announced that the central bank's digital currency will not be issued in large amounts in the short term or lead to inflation since the current velocity of money circulation will remain consistent.

According to the research institute, the PBC will be the sole issuer offering the digital currency only to commercial banks and other financial institutions before the money reaches the public. People will then be able to convert the money in their bank accounts into digital money and deposit it in electronic wallets.

Pan Helin, acting Dean of the Digital Economy Institute at the Zhongnan University of Economics and Law, told Beijing Review that the boom of mobile payment and fin-tech has accelerated the digitalization of currency. "The CBDC issuance will help curb anonymous money forgery and laundering, as well as illegal fundraising and financing because regulators can monitor the currency flow through technologies such as big data. It can also reduce the cost of currency issuance and contribute to the internationalization of the RMB by improving the efficiency and security of cross-border settlement," he said.

Digital boom

The PBC started research on DC/EP in 2014 when bitcoin was gaining steam. The State Council, China's cabinet, approved the digital currency development program jointly launched by the central bank and qualified commercial banks and institutions in 2017. As recent tests draw the application of digital money closer, China is expected to embrace an even more digitalized society since mobile payment platforms such as Alipay and WeChat Pay are already widely used across the country.

DC/EP technology is different from Alipay and WeChat Pay, which rely on the Internet, because it allows the exchange of digital money without the need for the Internet, Mu Changchun, head of the PBC digital currency research institute, said during an online class, explaining that transactions via digital currency can be made when two mobile phones with electronic wallets are put close to each other.

Once applied, digital currency will only replace physical cash in circulation, while the money in commercial bank accounts will not be converted. Therefore, the utilization of digital money will only offer an alternative choice and will not affect the use of mobile payment platforms which are still based on bank deposits, Mu said.

The development of digital currency has brought the blockchain technology, a kind of digital ledger of economic transactions, to the forefront. Yao Qian, head of the technology regulation bureau of the China Securities Regulatory Commission, wrote in an article published by Yicai.com, a financial media outlet, that the DC/EP trials in most central banks around the world are based on this technology, which has generated various cryptocurrencies. However, the decentralized aspect of blockchain is contradictory to the central bank's centralized management system, triggering concerns about the adoption of the technology. Many global central banks, such as Bank of England (BoE) have admitted that government-backed digital currency could use more conventional centralized technology.

Thus, since the payment services need to be managed under the PBC's centralized system, blockchain technology is not supposed to be used for fully reshaping the traditional payment system. Its operation efficiency and users' privacy issues need improvements, making it still unsuitable for highly concurrent transactions in retail sales, another article by the institute published in China Finance, with Mu as the lead writer, suggested in February.

While monetary authorities remain conventional about adopting blockchain technology, there is great potential for it to drive fin-tech industries, which have seen robust development in recent years. According to a report released in February 2020 by International Data Corporation, a global market intelligence firm, 10 percent of Chinese cities will start using digital currencies based on blockchain technology by 2023 to ensure economic stability and drive e-commerce growth.

In addition, blockchain has been involved in China's new infrastructure projects for innovation-driven growth, according to the National Development and Reform Commission on April 20. The State Information Center announced the commercial use of a blockchain-based service network to drive the innovation of the digital economy on April 25.

According to the China Finance article, the PBC has applied for a large number of blockchain-related patents, ranking first among all global central banks. To better adopt the technology while hedging risks, the PBC issued the first set of security standards for the distributed ledger technology, or blockchain, in the financial sector in February to regulate its application and improve information security.

Given the close link between blockchain and the financial industry, the security standards will accelerate the development of the DC/EP, Gao Chengshi, a member of the Blockchain Committee of the China Computer Federation, told an online economic forum earlier this year.

The decentralization of blockchain focuses on the removal of intermediary platforms, but risk regulators will still be able to play a role in a centralized manner. Therefore, related departments can explore the combination of the centralized digital currency system with blockchain through innovative modes, Yao suggested.

Coping with the pandemic

China is not alone in promoting digital currency as the pandemic makes a great impact on offline businesses and triggers concerns about the use of cash. Since the virus can persist on and transmit via paper notes and coins, which are frequently touched, many central banks have taken measures such as disinfecting physical money to ensure safety. Several seriously hit countries such as Iran have also called for the reduction of cash use.

Amid the pandemic, digital currency which can ensure contactless transactions has seen greater demand and become the core of global digital economy competition. Monetary authorities and hi-tech institutions across the globe have been exploring how to design digital money in an emerging race. For example, Facebook unveiled the Libra 2.0 white paper on April 16, which detailed plans to create a new digital currency called Libra in October 2019. After the central bank of Sweden conducted tests on its digital currency called e-krona on February 21, the BoE issued a paper in March disclosing that it has set out an illustrative CBDC model, where digital currency would serve as a payment platform and provide new opportunities for commercial innovation.

In addition, according to a research report released earlier this year by The Block, a U.S.-based digital asset website, 18 of the analyzed global central banks, totaling about 60, publicly acknowledged the development and/or launch of their own CBDC.

Along with enabling contactless transactions, the use of digital currency is expected to help warm up the virus-affected economy. Zou Chuanwei, chief economist with Wanxiang Blockchain, a service provider, told 21st Century Business Herald that digital currency will allow monetary and fiscal policies for supporting enterprises in China to be launched more effectively and see accelerated development during recovery from the pandemic.

Through DC/EP, financial departments can directly deposit supporting funds in the digital RMB accounts of small and medium-sized enterprises and low-income households to alleviate the pandemic's impacts. Meanwhile, the unreasonable use of funds in areas such as real estate speculation, peer-to-peer lending and company share repurchases will be prohibited to ensure funds are used in a targeted manner to boost the economy, Zhang Chunxin, a professor with the Fanhai International School of Finance, Fudan University, told Yicai.com.

Future outlook

Despite the promising prospects of CBDC, according to a Xinhua News Agency article by Lu Zhengwei, chief economist at Industrial Bank, the digital currency with higher security than bank deposits may lead the latter to face greater competition. Therefore, the amount of digital currency issuance and whether to limit the exchange among CBDC, as well as cash and deposits, remain to be determined.

Pan also stressed that more efforts are needed to make the application of blockchain technology more full-fledged in the promotion of digital legal tender. The issuance and circulation of digital currency call for more sophisticated laws and regulations in areas where risks are likely to emerge.

Thus, due to technological barriers and the time needed to change user habits, digital currency may not fully replace physical cash in the short term, Dong Ximiao, a researcher at the National Institution for Finance and Development, told 21st Century Business Herald.

(Print Edition Title: Smarter Money)

Copyedited by Rebeca Toledo

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