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Tuesday, September 08, 2020
China Needs to be Cautious in Its Push for Digital Currency
ANBOUND

2020 is the year that central bank digital currencies (CBDCs) are truly taken off, according to a new report published on August 24 by the Bank for International Settlements (BIS). At the same time, the BIS report shows that since the end of 2018, the number of people giving positive comments on retail and wholesale CBDC in public information has also been increasing. As of mid-July 2020, at least 36 central banks around the world have issued retail or wholesale CBDC work. Pilot retail CBDC models have been completed in at least 3 countries (Ecuador, Ukraine, and Uruguay), and 6 retail CBDC pilots are under way in the Bahamas, Cambodia, China, Eastern Caribbean Currency Union, South Korea, and Sweden. 18 central banks have published studies on retail CBDC, and another 13 banks have announced that they are working on wholesale CBDC. The coronavirus outbreak is also accelerating the development of CBDC. The rapid development of digital payment technology has further accelerated the shift in digital payment methods amid concerns that banknotes could spread the virus. It is against this background that the development of China's digital currency is accelerating and attracting attention.

The BIS believes that different countries have different motivations and considerations for CBDC development. In advanced economies, central banks are studying CBDC to promote security and soundness, or domestic payment efficiency, according to a central bank survey by the BIS and the Committee on Payments and Market Infrastructures (CPMI) in late 2019. Concerns about financial stability may also be an important driver of research and development efforts. On the other hand, emerging market countries attach great importance to financial inclusiveness and take the lead in the development of CBDC. Given the risks associated with digital currencies, researchers at ANBOUND believe that the development and research of CBDC in China still need to be handled with caution to avoid unintended consequences if it is pushed and popularized too quickly.

In China, the pace of digital currency development has been accelerated and the central bank has begun a pilot of retail CBDC in several cities. In early August, a state-owned bank said that in recent days, China's Big Four banks (Bank of China (BOC), China Construction Bank (CCB), Agricultural Bank of China (ABC), and Industrial and Commercial Bank of China (ICBC)) have been testing the "digital currency" electronic wallet, which is still in the private stage due to the system load and other reasons. Digital wallet apps are being tested on a large scale in places such as Shenzhen in preparation for the launch of the digital currency, according to several state-owned banks. However, from birth to the popularization of digital currency, it will face a variety of problems. This process involves not only the use of retail, but also transactions, investment, overseas circulation, and other factors. In this process, it will face various new problems.

Under its information-controlled environment, China's digital currency has become a hot topic. A nationwide push for digital currency is on the way. In some places, it has been stipulated that part of the salary should be paid in digital currency. But what is going on with digital currency? Few people can tell. To promote digital currency in China, the first thing to do is to distinguish it from various commercial cryptocurrencies to avoid the interference of various untrue information. Commercial cryptocurrencies, such as Bitcoin and Facebook's Libra, aim to use sovereign digital currencies to promote commercial digital currencies in order to reap the benefits of "coinage rights". On the one hand, these commercial "cryptocurrencies" compete with the central bank's sovereign digital currencies; on the other hand, various commercial "cryptocurrencies" have been packaged and hyped with the help of the central banks' digital currencies, which has also confused many people for investment and speculation. If this commercial cryptocurrency enters the circulation along with China's digital currency, it will bring chaos to the current monetary system, just like the digital counterfeit currency. Therefore, the clean-up of various commercial "cryptocurrencies" is the premise for the further promotion of digital currency.

In fact, the essence of digital currency is not technical, but financial. Judging from the information currently disclosed by the central bank, digital currency is an electronic form of central bank currency. As the central bank's digital liabilities, it can be divided into two levels. The first level corresponds to the central bank's wholesale CBDC for commercial banks and digital currency-issuing institutions, it can become the new tool for settlement between financial institutions. The second level is the commercial banks' retail (or general-purpose) CBDC for households and enterprises, it can link both paper currency and digital currency, and to adopt a new way of payment and financial transactions. At present, most CBDCs are originating in the major innovative economies, and their development of digital currencies is aimed at providing a digital supplement to paper currency rather than a direct replacement.

The People's Bank of China has made it clear that digital currency is a substitute for M0. Although in terms of wholesale digital currency, the central bank and commercial banks have formed electronic currency transactions, the wholesale digital currency does not have much impact on the central bank and interbank lending. Therefore, it is necessary to re-establish the institutional digital currency transaction and clearing platform. At this level, the central bank has a clear definition of digital currency: central bank digital currency is an interest-bearing asset, which can meet the needs of the holder's property security and reserves. This means that the central bank is facing the reconstruction of the monetary system, establishing a combined offline and online monetary system, and influences the interest rate of bank deposits by adjusting the interest rate of the central bank's digital currency.

In terms of investment, these digital currencies are similar to deposits that earn interest. This kind of income is relatively stable and basically risk-free. But can China's financial markets, including the foreign exchange market, the bond market, and the stock market, be able to trade the digital currency? The popularization of digital currency inevitably requires the reconstruction of digital infrastructure in the field of financial investment. Otherwise, the failure of digital currency to enter the financial market means that the digital currency is no different from various "commemorative coins" issued by the central bank and has no real monetary value. At the same time, digital currency is also facing a process of acceptance in the international market, which needs to be coordinated and adapted with the development of digital currency in other countries.

In terms of retail digital currency, the popularity of digital currency has more uncertainties. Will there be any difference between digital currency deposits and bank deposits? Can China achieve what the central bank calls undifferentiation? These issues still need to be tested by the market. Unlike paper currency, the application and circulation of digital currency can only exist between electronic devices, such as electronic wallets on mobile phones. There is no definitive conclusion as to whether this kind of circulation will lead to the expansion or contraction of the currency, and cautious experiments are still needed. Without a clear understanding of the basic meaning of digital currency, blind expansion is no different from compulsive low-interest savings. It can only lead to a further decline in consumption and, in severe cases, financial instability and economic contraction.

In particular, although digital currency has its foundation in large cities and the more developed eastern regions of China due to the popularity of mobile payment, its application and circulation among the elderly population and the corresponding poor population in less developed regions still face various obstacles. These regions are still dependent on paper currency. There are also obstacles and doubts about the acceptability of the digital currency for overseas investors and visitors to China. This could lead to two systems of currency circulation for a long time to come. Under such conditions, the extensive promotion of digital currency may cause the circulation system of digital currency to form a self-closed cycle, which will not only affect the financial system, but also affect the final consumption, and may not be beneficial to the balance of regional development.

Final analysis conclusion:

On the issue of digital currency experimentation and promotion, it is undoubtedly the right policy option for China to proceed cautiously. The development of sovereign digital currency also has some rules corresponding to the development of the digital economy. In the current pilot, further research and experiments are needed to avoid the risk of uncertainty.

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