Text│ Chen Zhong, Professor and Director of Blockchain Research Center, School of Information Science and Technology, Peking University
The Bitcoin system based on blockchain technology, with its open source feature and community-based operation mechanism, has triggered the subsequent boom of blockchain and crypto-digital currency innovation. The emergence of blockchain and digital currency one after another has caused people to envision and explore the future development of the Internet from the information Internet to the value Internet. The digital economy is also given new connotations on the basis of the Internet, especially the technical support of value and trust brought by blockchain technology, which has the potential to bring about changes in human production and life. 2020, China’s digital RMB began to be applied in Shenzhen, Chengdu, Suzhou, Xiong’an New Area and the future Winter Olympic Games venue on a pilot basis. This paper discusses the security and development of blockchain and digital currency.
I. The Meaning and Impact of Digital Currency
The large-scale application of the Internet has given rise to the facilitation of payment settlement, usually called electronic payment or mobile payment, and later collectively referred to as network payment. Network payment refers to the act of transferring monetary funds between payers and receivers relying on public or private networks, including currency exchange, Internet payment, cell phone payment, fixed telephone payment, digital TV payment, etc. Due to the convenience and extensiveness of mobile Internet, Tencent and Alibaba, with their monopolistic position in third-party payment services in China and their WeChat Pay and Alipay penetration rates of over 90%, have also made great contributions to cashless payments.
However, the introduction of Bitcoin has triggered technological innovation in crypto-digital currencies, which has also impacted and driven fintech innovation in traditional financial institutions and central banks.
Digital currencies are an important part of the financial technology (FinTech) sector, and as a specific application of FinTech, they have been developing rapidly since their inception. The issuance of digital currencies will not only have a direct impact on the financial and monetary system of the country, but may also have a significant impact on the global financial system and the global monetary ecosystem. In general, digital currency is a kind of virtual currency based on information network and cryptographic algorithm design.
Currently, digital currencies are classified according to six dimensions such as whether they are issued by central banks, whether they are legal tender, whether they are backed by central banks, whether they are pegged to legal tender, whether they support peer-to-peer transmission, and whether they are programmable, and four main types of digital currencies exist, namely central bank digital currencies (CBDC), synthetic central bank digital currencies (sCBDC), stabilized coins ( Stablecoins) and crypto assets. A CBDC is a digital manifestation of a sovereign currency that is issued by a regional financial regulator and appears on the liability side of the central bank’s balance sheet.
Synthetic central bank digital currencies are legal tender issued with the backing of the central bank, but do not themselves create claims against the central bank. Stable coins are crypto assets pegged to fiat currencies, while crypto assets are generally privately issued tokens that are digital representations of value but are not denominated in fiat currency. It should be noted that the classification of digital currencies is also subject to change in the future. Digital currency is generally a legally recognized form of money, or a form of money that is not prohibited by law and recognized by the general public, which can be used to purchase goods or services like traditional money, while supporting the fulfillment of related financial obligations, and may also assume the innovation of value exchange in the digital economy, presenting characteristics that traditional money does not have. For example, cryptographic digital currencies, based on the blockchain’s property of supporting programmability, can have contracts embedded in the form of computer programs that support automatic execution.
Currently, smart contract-based decentralized finance or distributed finance (DeFi) applications show many financial innovation features that were not previously available in finance. Digital currency security generally has two meanings: one is the security of the digital currency itself, which is mainly manifested in the security technologies that must be adopted to realize the form and characteristics of digital currency, including passwords, security chips, system security, network security, data security technologies, etc.; the other is the security of the monetary system or financial system brought by digital currency, which includes laws, regulation, compliance, risk control, etc. For example, the real name of users/anti-money laundering/anti-terrorist financing (KYC/AML/CFT), etc., which is usually involved in financial regulation.
In 2016, Wang Yonghong summarized the main characteristics of digital currency in the article “Digital Currency Technology Implementation Framework”, including negotiability, storability, offline transaction, controlled anonymity, non-forgeability, non-repeatability, and non-repudiation, which is a more comprehensive description of digital currency and its security requirements, and all the characteristics that digital RMB has at present. All of these characteristics, except for offline transactability, are also applicable to blockchain-based cryptographic digital currencies. Digital currency security includes safeguards and technical means for these characteristics, which will not be discussed here.
II. The development of central bank digital currency
Cryptographic digital currencies bring a strong momentum of global central digital currency research. According to the results of the survey of 66 central bank digital currencies by the Bank for International Settlements in 2019, nearly 80% have carried out CBDC issuance feasibility analysis, and 10% are already close to the issuance stage. Currently, the current status of CBDC issuance in some foreign countries is shown in the table below.
From the above table, we can see that in recent years, countries have started to lay out CBDC-related research activities, and it is not limited to the developed financial industry in Europe and America. At present, the RMB accounts for about 2% of global foreign exchange reserves, the Euro accounts for about 20%, and the US dollar accounts for more than 60%, indicating that the US dollar is still the dominant currency system. With the “One Belt, One Road” initiative, the number of countries and populations using the RMB will continue to increase, and the launch of the Chinese central bank’s digital currency can further enhance the convenience of using the RMB, but there are still risk points to be aware of.
In the CBDC space, China is the first country to launch related operations. As early as 2017, China conducted research and experiments on the Chinese version of CBDC, which was later named Digital Currency Electronic Payment (DC/EP), or Digital RMB (e-CNY) for short, and started to be launched on August 14, 2020 in It will be issued on a pilot basis in Beijing, Tianjin and Hebei, the Yangtze River Delta, and the Guangdong, Hong Kong and Macao Greater Bay Area on August 14, 2020.
At present, e-CNY is designed to replace RMB cash, i.e. M0, and does not directly adopt the underlying blockchain technology and its “programmable” feature, taking into account the payment efficiency and the universal demand for offline payment, but it can effectively reduce the dependence on accounts in the transaction process, facilitate the circulation and internationalization of RMB. CBDC is currently a hot topic of international research.
Firstly, CBDC can enhance the market competitiveness of national payment systems and effectively resist the monopoly of traditional payment systems; secondly, CBDC can reduce the cost of issuing physical currencies and provide inclusive financial services to some remote areas with underdeveloped financial systems; it can enhance the sensitivity of policy regulation of economic markets and facilitate the rapid transmission and effectiveness of monetary policies; it can also reduce or stop the issuance of private currencies and It can also reduce or discourage private currency issuance, avoid financial risks induced by these currencies, and achieve effective regulation of the currency market; help enhance the attractiveness of currency payments and reduce dollarization; in areas or populations not easily reached by fiscal incentives, CBDCs can play a role. It is important to note that issuing CBDCs also faces some risks.
First, CBDCs may change the exchange rate transmission channel and affect the transmission of monetary policy. the introduction of CBDCs may change the composition of base money demand in an unpredictable way, altering the elements of the currency composition and affecting the elasticity of money market demand to changes in interest rates. CBDCs may also accelerate the pace of monetary management policies introduced in response to exchange rate changes in global markets, which in turn could trigger Stronger and more unpredictable currency market exchange rate movements.
Second, CBDCs may affect financial stability in the process of competing with bank deposits. If there is no interest, CBDCs are undoubtedly the closest to cash, but this may affect their promotion; if interest is paid to users for holding CBDCs, this will certainly compete with bank deposits.
Third, CBDCs may also have an important impact on central bank balance sheets. If CBDC issuance is disintermediated by the central bank, then the central bank can lend back to these banks the funds that were diverted from them, increasing the amount of money issued in the market and potentially inducing inflation, which would defeat the original purpose of CBDC issuance by the central bank. If the central bank were to issue digital currency only for physical cash, it might cause minimal disruption to the normal monetary order of the market and keep the size of the central bank’s balance sheet unchanged, but it might also weaken the impact of CBDCs.
Fourth, a poorly designed CBDC could trigger a serious economic crisis or even accelerate a bank run. In the event that individual banks become insolvent, the first signs of a run could easily spread to the entire banking system in a very short period of time, and while a CBDC would allow the central bank to inject capital into troubled banks as soon as possible and mitigate the corresponding financial risks, there is still a corresponding possibility. Finally, in countries with inflation and unstable currency exchange rates, nationals may increase their holdings of CBDCs from other countries, which may accelerate currency substitution, and most typically may promote dollarization of the national currency.
From the above analysis, it is clear that the country needs to conduct a comprehensive analysis when issuing CBDCs, in advance as a risk management. These considerations include review of laws and regulations, effective cooperation of stakeholder groups, technical infrastructure support, talent pool and expertise reserve, etc. The issuance of CBDC is a comprehensive project that has exceeded the function of traditional central bank role and needs to be considered comprehensively.
III. Blockchain-based Digital Currency
Although China’s DC/EP as a CBDC does not adopt a blockchain-based technology base, blockchain distributed ledger technology is still the mainstream technology route considered by international CBDCs, but most countries have not yet launched pilots, and some of the early pilot projects have not achieved substantial success (e.g. the Bank of England’s RSCoin, the Bank of Canada’s Jasper, etc.).
Blockchain is used for digital currency practices outside of CBDC, mainly including digital assets and stablecoins. in January 2009, the bitcoin system was released in the form of open source software and generated the founding blocks, which then took an open source and community governance model to run slowly. Today, the total market capitalization of Bitcoin is over a trillion dollars. Bitcoin as an experiment proved one thing: a digital currency was issued and utilized without the control of a central authority, disrupting the traditional concept and system of money. Measured by traditional monetary concepts and theories, Bitcoin is not a currency at all; to be precise, Bitcoin is a digital asset. However, when viewed according to new economic theories, Bitcoin’s innovation brings new challenges and opportunities. Since its introduction, Bitcoin’s open source and open development model has inspired tens of millions of cryptocurrency innovations, including open source startup community leaders, renowned university professors, and Turing Award winners, and has also led to a global proliferation of illegal fundraising scams in the name of “coin distribution”.
Some individuals and organizations have also taken advantage of the lack of regulation of crypto-digital currencies to commit illegal, irregular, and even criminal acts such as money laundering and illegal cross-border transactions. As such, Bitcoin’s innovation can be considered as the most controversial information technology innovation, which has tied finance and technology together from the very beginning, so much so that nearly 200 countries and regions around the world have adopted different legal and regulatory policies on Bitcoin and subsequent crypto-digital currencies, including legalization, restriction, and prohibition. Crypto-digital currencies anchored to fiat currencies, known as stable coins, have been in practice for years and require not only technically innovative support from blockchain technology, but also permission from the relevant national authorities. According to relevant statistics, the total on-chain trading volume of stablecoins hit a new high of $178.34 billion in December 2020.
On January 4, 2021, the Office of the Comptroller of the Currency (OCC) issued an explanatory letter stating that U.S. national banks and federal savings associations can become operational nodes for blockchain stablecoins and use the associated stablecoins for “permitted payment activities,” arguing that blockchain stablecoin networks can be used as The blockchain stablecoin network can be used as a “cheaper, faster, and more efficient” payment method to reduce the cost of cross-border transactions, thus authorizing banks to use the blockchain and its stablecoin to convert back and forth between legal tender during remittances, or banks can choose to issue their own stablecoins (e.g. JPMorgan Chase Bank has offered to launch its own dollar stablecoin, JPMcoin etc.).
This means a new milestone for regulators and innovators of stablecoins, in which blockchain technology uses permissioned blockchain (federated chain) technology to meet regulatory compliance requirements such as real user names, anti-money laundering and anti-terrorist financing, and to reflect the expansion of U.S. dollar hegemony by anchoring it to a single currency. The stablecoins mentioned here are those that have been reviewed and approved by regulators and subject to their ongoing supervision. Currently, such stablecoins mainly include USDC, GUSD, PAX, etc. Libra, a virtual cryptocurrency led by Facebook, was initially designed to be relatively stable in real purchasing power rather than stable against the U.S. dollar, and in December 2020, Libra changed its name to Diem and is set to launch in 2021 with a U.S. dollar-pegged On June 18, 2019, Facebook joined 28 companies around the world to officially release the Libra white paper.Libra is built based on federated blockchain technology, which is inherently secure and has a certain stable value. Its emergence breaks the traditional sense of monetary sovereignty and has exclusivity, and it is difficult for sovereign countries to regulate it.
With the release of White Paper 2.0 in 2020, the statement changed from anchoring a basket of currencies to first anchoring a U.S. dollar currency, and blockchain technology changed to permanently using federated chain technology to meet regulatory compliance requirements. Diem has attracted global attention not only for its initial vision of “building a simple, borderless set of digital currencies and financial infrastructure for billions of people,” but also as a technology benchmark for its autonomous innovation and embrace of regulation through the use of federation chain technology. Although Diem has not yet been launched for trial, its innovation cannot be ignored. In addition, the Diem Association stated in a January 7, 2021 post that it hopes to launch this stablecoin payment project sometime this year. It is expected that more stablecoin projects, including Diem, will emerge in 2021.
Diem as an example to compare the significance of e-CNY issuance
Diem has certain advantages compared with other existing digital currencies. First of all, Diem is anchored to the relevant legal tender and achieves 1-to-1 exchange, so its value is not created out of thin air. Secondly, Diem is essentially a blockchain technology based on Byzantine Fault Tolerance (BFT) consensus mechanism, with features such as decentralization, tamper-evident, and excellent characteristics such as low latency. Once again, Diem is pegged to real currencies and can be backed by sovereign states.
After Diem is anchored with the sovereign national currency, for every unit of Diem issued and destroyed, the equivalent value of currency has to be reserved and destroyed to prevent inflation. diem and e-CNY, although both belong to digital currency, there are major differences between them.
Firstly, the audiences are different. e-CNY mainly serves Chinese users, while Diem has a broader audience and aims to become a global currency.
Second, the two implementations have different architectures. e-CNY mainly adopts a centralized implementation architecture, while Diem mainly adopts a decentralized implementation architecture in the top-level settlement module.
The two are different in terms of anchored assets. e-CNY is mainly RMB, while Diem uses a basket of currencies as asset reserves. Finally, the network requirements of the two are different. e-CNY supports dual offline payments, which can be completed even if both parties are not online, while Diem requires network support. In the current game scenario between China and the U.S., this smokeless war has spread to the digital currency field, and whoever can have the first opportunity will be able to control the direction of the future development of the financial field. diem points to the international monetary system, which may pose a challenge to the sovereignty of each country’s own currency and the status of fiat money, and has caused great concern among governments.
Although Diem claims not to compete with national fiat currencies, but to be a complement to them, objectively speaking, competition between Diem and fiat currencies is inevitable. Compared with CBDC, Diem is more widely used, has a wider variety of participants, and has a more profound impact. However, e-CNY also has its own advantages, as it can reach remote areas where the network infrastructure is not perfect, allowing low-income people to use e-CNY, which can effectively achieve financial inclusion, especially in areas such as precise poverty alleviation.
While demonstrating the powerful power of China’s central bank digital currency, we still need to maintain a calm observation and flexible strategic strategy: first, we should pay close attention to the progress of Diem and the technical basis and innovation logic behind it; second, we should pay close attention to the innovative significance and role of crypto digital assets in the digital economy and study the combination of technological innovation and financial innovation behind it; third, we should pay close attention to the programming language of smart contracts and its programmability in blockchain technology. technology and the impact of smart contract programming language and its programmability on the future digital economy, and achieve innovation leadership in regulatory technology and digital government.
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