Yao Qian: Digital currency will definitely go to smart money Two-layer architecture need not exclude ethereum, etc.

In the session of “Digital Currency and Future Digital Transformation”, Yao Qian, Director of Technology Supervision Bureau of China Securities Regulatory Commission and Senior Researcher of Tsinghua Economic Management Digital Financial Assets Research Center, shared his views.

Yao Qian: Digital currency will definitely go to smart money Two-layer architecture need not exclude ethereum, etc.

The International Finance Forum (IFF) 2021 Spring Meeting was held in Beijing on May 29-30. The theme of the conference was “Post-Epidemic Era: Global Governance and International Cooperation”. In the session of “Digital Currency and Future Digital Transformation”, Yao Qian, Director of Technology Supervision Bureau of China Securities Regulatory Commission (CSRC) and Senior Researcher of Tsinghua Economic Management Center for Digital Financial Assets Research, shared his views.

The following is the transcript of his speech.

Hello everyone! It is a pleasure to participate in this seminar.

In 2014, the People’s Bank of China launched the research and development of the central bank’s digital currency. I am honored to participate in it. Although I left the People’s Bank of China to work for the China Securities Regulatory Commission at the end of 2018, I am still concerned about the development of the central bank digital currency. Here, I would like to share my understanding and views on the central bank digital currency as a researcher, so please criticize and correct me.

As you may have noticed recently, Federal Reserve Chairman Jerome Powell commented on the digital yuan in his Q&A on April 28th, saying “its real use is to help the government see all the real-time transactions. It’s more relevant to what’s happening in their own financial system than it is to respond to international competition.

I don’t think “helping the government see all the real-time transactions” is the motivation for the Chinese central bank’s digital currency experiment. In China, people have become accustomed to non-cash payment methods such as Alipay and WeChat payments, and many no longer carry cash on their person. In fact, third-party payments are already technically transparent for all real-time transactions; of course, this raises issues of data privacy, anonymity, monopoly, and regulatory transparency. In the face of the digital wave, it is necessary for central banks to take the initiative to innovate legal tender issuance and circulation and explore central bank digital currencies to optimize legal tender payment functions, mitigate the impact of private digital payment instruments, and improve the status of legal tender and the effectiveness of monetary policy.

I have long referred to the “de-cashing” of private payment instruments and the rise of “decentralized” private digital currencies as the “Morning Call”. China’s central bank was one of the first to react to the “Morning Call” and act aggressively. By “government seen” or “not seen”, Powell may be referring more to the balance between privacy protection and regulatory compliance, which Governor Zhou Xiaochuan has well articulated from the perspective of controlled anonymity some time ago.

In that Q&A, Powell also commented on whether digital currencies would challenge the status of the U.S. dollar, and he generally didn’t think there was much to worry about. There’s a lot of international discussion about whether central bank digital currencies will replace the dollar. I believe that the international currency status of the U.S. dollar is historically formed, and international trade and cross-border payments are mostly based on the U.S. dollar at the moment. Although some global stablecoins, such as Libra, aim to solve the pain points of cross-border payments, weakening the international currency status of the U.S. dollar is not necessarily the goal of CBDC, and the digitization of sovereign currencies has its own intrinsic logic. In the long run, the emergence of digital currencies or digital payment instruments may of course change the existing pattern, but that is the result of the natural evolution of the digitalization process and market selection.

And I was struck by another quote from Mr. Powell: “In a world where we already have a highly evolved payment system, we have FedNow and other instantly available funds. What role will central bank digital currencies play in this environment?” What this really talks about is, how does a central bank digital currency position itself? In what scenarios should it be applied? What role does it play? There is a lot of controversy from all sides.

In the following, I would like to talk about the key points that need to be considered in the research and development of the central bank’s digital currency from seven aspects.

First, the technical route. Account-based, or Token-based? From public reports, the digital RMB has adopted the account-based route, while some countries have chosen the cryptocurrency technology route represented by blockchain technology. My personal understanding is that the account-based and token-based technology routes are not either/or. In essence, a token is also an account, but it is a new type of account – a crypto account. Compared to traditional accounts, users have more autonomy over their crypto accounts. In a sense, the early digital currency experiments of China’s central bank are in line with the idea of cryptocurrencies, and we expect to control the keys to cryptocurrencies instead of going around.

At that time, we developed a quasi-production-level prototype central bank digital currency system based on the “central bank-commercial bank” binary system. However, after repeatedly weighing the implementation, we chose to start with the traditional account-based technology, which was a pragmatic choice. I remember when I was working at the People’s Bank, Governor Zhou always taught us that we should have the concept of long-term technology evolution and look at the changes in technology dynamically. His teachings are enlightening, and I think it is necessary for us to look at the development of the central bank’s digital currency with a dynamic perspective. As the technology continues to develop and mature, the central bank’s digital currency will also absorb various advanced technologies and continuously improve its technical architecture system.

Second, value attributes. Is the central bank directly indebted, or is it an operating institution? The essence of the difference lies in the column of liabilities in the balance sheet of the central bank, which records whether the central bank digital currency of the end-user or the reserve of the agency operator. If the operating agency deposits 100% of its reserve with the central bank and uses this as a reserve to issue digital currency, such a central bank digital currency is known internationally as a synthetic CBDC, similar to Hong Kong’s note-issuing bank system, and this model has attracted the research attention of many institutions, including the Chinese central bank and the International Monetary Fund. Of course some countries are still using the traditional central bank direct liability model.

Third, the operational structure. Double-layer, or single-layer? In my article “Digital Currency and Bank Accounts” in 2017, I proposed the architecture system of “traditional accounts of commercial banks + digital currency wallets” to avoid the impact of central bank digital currency on commercial banks. At present, the two-tier structure is gradually forming a consensus among countries. Digital RMB also adopts a two-tier operation system. I personally think that the two-tier operation and single-tier operation are not an either/or relationship, just like a cab and a bus, they can go hand in hand and be compatible for users to choose. We can imagine that if the central bank digital currency runs directly on blockchain networks such as Ether, Diem, etc., then the central bank can use their BaaS services to provide the central bank digital currency directly to the users without the need for intermediaries. The single-layer operation can make the central bank digital currency better benefit the unbanked groups and achieve financial inclusion.

Fourth, whether it bears interest or not. Some people have doubts about interest-bearing central bank digital currency, worrying that it will lead to the transfer of deposits from commercial banks to central banks, resulting in the shrinking of the credit capacity of the entire banking system and becoming a “narrow bank”. In recent years, central banks seem to have become less “fearful” of the narrow banking implications of CBDC. For example, the European Central Bank’s Digital Euro report proposes a so-called tiered remuneration system, which would charge interest at variable rates on different digital euro holdings to mitigate the potential impact of the digital euro on the banking sector, financial stability and monetary policy transmission. The digital RMB is currently not considered to be interest-bearing.

V. Issuance Model. Issuance, or exchange? The difference between currency issuance and exchange is that the former is initiated by the central bank and is an active supply; the latter is initiated by currency users and is an on-demand exchange. Is the generation of central bank digital currency issuance or exchange? Depends on its positioning and the needs of monetary policy. If it is only an M0 replacement, then it is an on-demand exchange, just like cash; if the central bank initiates the issuance of digital currency to the market through asset purchases in order to achieve monetary policy objectives, then it is an extended form issuance. Expanded table issuance is subject to defining eligible asset types and operating at appropriate quantities and prices.

VI. Smart Contracts. There are concerns that loading smart contracts in addition to the function of the legal tender itself will affect its forensic function, and therefore a cautious approach to loading smart contracts on central bank digital currencies is recommended. And the central bank digital currency research projects conducted by Canada, Singapore, the European Central Bank and the Bank of Japan have experimented with smart contracts. My personal view is that digital currency cannot be a simple simulation of physical money, but if we want to take advantage of “digital”, the future digital currency will definitely go to smart money. Of course, we have also observed some system disasters caused by security vulnerabilities in smart contracts, indicating that the maturity of the technology still needs to be improved. Therefore, the central bank’s digital currency should start from a simple smart contract and gradually expand its potential on the basis of full consideration of security.

Seven, regulatory considerations. As mentioned earlier, we need to strike a balance between privacy protection and regulatory compliance. On the one hand, KYC, anti-money laundering, anti-terrorist financing and anti-tax evasion are the basic guidelines that central bank digital currencies should follow, while on the other hand, the protection of users’ personal privacy should be fully considered. The design of privacy mechanisms for central bank digital currencies is a current research hotspot, and the results of the recent ECB public consultation on the digital euro also show that residents and professionals who participated in the consultation agreed that privacy is the most important design feature to focus on for the digital euro. In my personal opinion, in the digital world, the issue of authenticity, privacy, and security of digital identity may involve larger social governance propositions that need to be studied in depth.

In general, the central bank’s digital currency development is a complex systemic project, not only in the technical field, but also in the broader fields of laws and regulations, financial stability, monetary policy, financial supervision, international finance, etc. There are many issues that still need to be studied in depth. In particular, the digital dollar, digital euro and digital yen seem to be ready to take off, compared with them, what is the competitiveness of the digital RMB? It is worthwhile for us to ponder and explore.

The above are some of my basic views, which are purely empirical and actually need to be tested by practice. In particular, I would like to clarify that I have left the PBoC and what I have said represents my personal academic views, not the PBoC or my current institution.

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