When I understood that The People’s Bank of China (PBOC) CBDC (Central Bank Digital Currency) launch is not as revolutionary as it sounds because it copies almost entirely from the confidence established in the Uruguayan pilot project run in 2017-2018, I was somewhat relieved.
I had not realised the extent to which the global regulatory community had been spending the past few years perfecting their own idea of a digital currency, confusing the rest of us by making us think they had come up with their own cryptocurrency, when in fact, it is nothing of the sort. In fact, the PBOC is calling their digital initiative a DC/EP (Digital Currency/Electronic Payments) initiative, consistent with Bank for International Settlement (BIS) terminology.
Regulators in general appear to desperately need to develop a digital idea of seigniorage, which they do by enabling anyone and everyone to hold an account directly with their respective central banks. None will issue a standalone crypto-token, partially because the technology today does not allow a full crypto-token to be transacted easily, but more because central banks are interested in digital seigniorage only if its gives them control, just like banks are interested in blockchain only if it still has them as the intermediary.
So, here is the basic model of the PBOC’s digital currency:
– China’s CBDC will be account-based (the fact it is called “digital” should not be mistaken as a cryptocurrency). Meaning any qualified persons (citizens and people with identities accepted by the PBOC) effectively open an account with the central bank directly when they launch an app or something equivalent, even if the app is provided by one of the participating institutions.
– Users can then load or transfer equivalent fiat money value from any of the participating institutions into this account.
– The digital transactions are kept separate from fiat digital account transactions (such as Alipay, WeChat Pay and interbank transactions today, which technically are also digital), in order not to affect existing monetary policy.
– The digital value being transacted is apparently generated through an algorithm. It may be transferred outside the accounts, through devices like a dedicated chip card, but eventually has to find its way back into the account in order to be recognised as value, hence is auditable closed ecosystem.
– A lot depends on the APIs developed by application developers, end users, the banks and companies like WeChat and Alipay to extend the use of this platform to ensure its eventual success. It will run parallel to the fiat version that is already very digital today, and so the APIs must allow for seamless inter-operability and transfer of funds.
So, I still have the following questions or concerns:
1. What exactly is the business case the PBOC is trying to respond to in going “digital” in this way?
– The most credible and most needed reason for China or any trading nation to be implementing a digital currency would be to allow large value/wholesale transactions that have a bearing on the international exposure of the RMB to trade and lending without the central bank losing control to traders and short-sellers. It is the same business case that Canada, Sweden and several others have been concerned with achieving. A controlled amount of digital currency (say $30b) issued to pre-authorised participants and having sight of transactions with the ability to pull back if needed. Those were what Project Jasper in Canada, Khokha in South Africa and a similar project in Southeast Asia were about and I was under the impression that PBOC was experimenting the same.
– A national rollout to retail is a totally different ballgame and I believe the Uruguayan experiment ended inconclusively without documenting its utility, even though financial inclusion was top on the list.
– The major Chinese banks have been wanting to claim the digital wallet back from Alibaba and Tencent. This would have been just their chance, and so they would not be happy that the PBOC is including Alibaba and Tencent in the first instance. The Chinese banks would prefer a system where they can charge a fee to Alipay, WeChat to use the digital currency they issue, but now risk losing ground even more if the technology players are faster off the ground with APIs on the platform.
– I am also interested to know who the “eighth issuer” of these digital accounts will be and whether it will be a game changer institution. I won’t be surprised if it will be a telco that could issue special chip cards to carry this special digital value, as this will justify the M0 classification. The other justification for the M0 classification is based on the fact that banks cannot use the central bank account as their own. They will have to create another special account from which it becomes M2 or M3, which duplicates the costs of this entire project.
– The Uruguayan pilot was run right in the midst of an economic crisis, using the argument that the digital currency expands the economy. China is entering an economic slowdown and a debilitating trade war. But digital currency only expands the economy if it is used to generate credit, as fractional deposits does. A digital currency that is tied to M2 or M3 is closer to fractional deposits, but the PBOC insist that theirs is M0. I don’t see a totally digital platform increasing liquidity.
2. I am quite amused with the idea that any central banker would want the level of accountability that comes with being able to trace their M0 to the last cent, even if the technology makes it possible. A central bank-based account carries the onus of KYC and other risk management responsibilities on themselves. Central banks will increasingly carry the cost of circulation of the digital currency and the accountability of the accounts managed. This trend should create a new discussion on the extent of central bank control of the economy, not just for China but all other countries where central banks are making themselves increasingly powerful. I would venture to guess that the US will never have a CBDC because the Feds don’t see it within their remit to have this kind of responsibility.
3. All the cryptocurrency technology hacks know full well that crypto technology is nowhere near the functionality for widespread retail usage. So, this story of a two tier system appears to be a cautious approach, with the PBOC carrying the entire downside risk. This tells me that the digital currency being launched would be only a marginal improvement on the digital wallets already being used by Alipay, WeChat and other payment platforms.
4. A lot seem to be hinged on the personality of Ma Changchun, now director of digital currency research institute, having displaced Yao Qian, who has now been moved to China Securities Depository and Clearing Corporation, which is also an important institution that has a potential role in curating digital assets that might be created in the future. I have considerable respect for the PBOC to know that as a regulator, it has always acted to be internationally responsible. In fact, a lot of the presentation slide deck keeps close to the Bank for International Settlements (BIS) framework for CBDCs, which works for my comfort level.
But for a senior manager to make references to Libra, when it is not yet a fully formed entity, looks nothing like the CBDC, and something that even their US counterparts have not wrapped their minds around, is not in character with the PBOC I know. It also pushes the US government to act more decisively, as the Japanese found out when they stirred the pot at Pearl Harbour.
5. The powerpoint slide decks purportedly delivered by PBOC officials are dated 2016 and 2018, and do not seem to have been updated with more recent developments. It is totally silent on the Uruguayan experiment, which really needs to be studied in greater detail. Also they refer to concepts that I have difficulty with:
– “Controlled anonymity”. One slide deck purports that PBOC wants to create “controlled anonymity” meaning the CBDC can be anonymous under different circumstances, such as when it is used outside the account, like in a certified chip card, which incidentally is also technically an account created specifically to sit on a chip. It’s like saying “controlled pregnancy”. You are either pregnant, anonymous or not. Very simply, every time the digital currency comes back into an “account” there is an audit trail and the account is the only way it is possible to monetise the currency.
– “Executable script”. Meaning issuers or users will be able to add scripts to add functionality just like Ethereum? Did anyone think about the immense prospects for fraud in a country like China if a central bank allowed such a functionality to a digital M0 currency? The number of crypto mining labs, the size of the exchanges and the number of hacking talent in China is mind boggling. If the rules are not put in place, it risks a repeat of the peer-to-peer phenomenon where China had more than 4,000 P2P lending sites, of which about 1,000 were found to be fraudulent or not meeting the law when it was eventually implemented. But this might not happen here because the API platform for developing applications may be limited to a closed community of participating organisations only.
6. When rumours of an impending launch circulates in this manner, the ordinary Chinese speculator will sell his RMB and buy gold and other currencies to remain anonymous. So far, this has not happened. This tells me that the China launch is incremental and even experimental, and co-exist with current digital wallets with a view of pulling back if there are adverse outcomes.
7. There are a number of related developments an issuing authority needs to make before issuing digital currency, such as setting up a digital certification agency, putting in place the custodian laws, and also a number of financial inclusion infrastructure, focusing on personal identity and operational risk. I think these developments will be good for China and the rest of the world, and may ironically pave the way for real cryptos when they arise.
8. If it is account-based, I don’t see how it can help make the RMB “borderless” immediately and out of PBOC’s control. I would argue that a digital yuan does not increase, but decreases, the tepid liquidity of the already limited RMB in circulation outside China. The biggest users of off-shore RMB are the Chinese corporations themselves. Now, why would they want to be further traced? Still, the PBOC official insists that the digital currency will be sold in the United States through correspondent banking networks. To whom? If American and Chinese traders abroad are not buying physical RMB in the first place, what appetite will there be for digital RMB. Instead, some Chinese corporations will be tinkering with this development to see how they can leverage their cost of business abroad.
9. Policy makers should be careful what they wish for. From the days of the printing press, the first players to embrace innovation are usually the pornographers, fraudsters and traders in the dark web. Ironically, this not necessarily a bad thing, because historically it is these users who create all the reasons that an innovation will eventually be successful – the Chinese gamblers in the Philippines, poachers in Africa, and even those on the dark web, causing all sorts of havoc with the guarantee of their own digital currency. I am not saying this is a bad thing, it can even be a good sign that there is the use case, but just treat me as a rascal on this one.
10. China’s PBOC and the US Fed are diametrically the opposites in their respective monetary policies (and other countries are somewhere in between). China wants more control of its currency, afraid of being shorted and also retain its ability to control domestic policies, while it is in the interest of the US Fed to not even know where its “IOU notes” (which is what a currency is) are circulating – the further its IOU notes circulate outside the US, the better, so that the debt it implies does not come back to haunt them all at once. In a country as large and complex as China, with money in circulation limited to the established institutions, only a totally libertarian crypto would behave like anonymous cash and reach the far flung extensions of the economy. The current experiment only increases and centralises the power of the PBOC.
At the end of the day, the crypto currency, as a precursor to the digital currency, is a libertarian idea. For central bankers to be so infatuated and even benefit from libertarian ideas and at the same time insist on and even increase control over their countries social and economic assets, is one of the most profound ironies of our times. The positive spin of this reality is that only a competent state can play this game. There is no competent state like China today. The negative side is that the same state can be its own worst enemy. It’s a development worth watching.
A second news that caught my attention was that the cryptocurrency “Tether’s” parent was going to issue an offshore Chinese offshore yuan stablecoin apparently called CNHT and that Tether was also going to launch stablecoins backed by bulk commodities like gold, rubber and crude oil. Much as these would be desirable developments, global regulators are not in the mood for commercially manipulated stable coins at the moment, and commodities as a stable coin sounds to me like another excuse for yet another speculative asset.
The funny thing about CBDCs is that it puts all the discussion on the real development of cryptocurrency to the backburner. Which leads me to think about the aggressive use of social media by what I call “libertarian crypto-mafias” who are propagating sensational news to influence the US and not Chinese government. This is another story.
Emmanuel Daniel
great write up. very useful