China's central bank delves deeper into digital currency

Signs on window advertise a bitcoin ATM machine that has been installed in a Waves Coffee House in Vancouver, Canada, on October 28, 2013. Photo: Reuters

China's central bank has unveiled a new plan to hire professionals specializing in digital currency's technological architecture and cryptographic algorithm, in a sign that the world's second-largest economy is stepping up efforts to develop its own sovereign electronic money.

A similar move has been made by central banks of several foreign countries like Sweden's Riksbank, which is reportedly mulling the introduction of its sovereign digital currency in the face of a decline in the domestic use of paper banknotes and risks brought by the private digital currencies such as bitcoin, an electronic currency that the Chinese government has banned from being used by the traditional financial institutions out of concern that it may weaken the government's control on currency supply and cross-border money flows.

China began to study prospects of an electronic version of its currency in 2014 when the People's Bank of China (PBOC), the country's central bank, set up a special research and development team to delve into digital currency-related issues ranging from technical and operating frameworks for issuing and circulating digital currency to its likely impacts on the country's financial and monetary systems.

The ultimate goal of introducing central bank-backed digital currency is to replace physical cash to reduce the costs of issuing and circulating traditional paper banknotes, enhance the transparency and convenience of economic transactions, combat criminal activities including money laundering, tax evasion and illicit money flows, and strengthen the government's role in managing currency supply and circulation, according to a statement released by the PBOC.

PBOC Governor Zhou Xiaochuan stressed that the process of the replacement will be gradual with the coexistence of digital and physical currencies continuing for a long period of time, highlighting the digital currency's advantages in saving transaction costs and people's increasing interest in completing deals through mobile platforms.

According to Yao Qian, who leads the PBOC's digital currency research center, the central bank has completed two rounds of improvements for the prototype system of official digital currency, which is expected to be applied to some designated application scenarios such as the bill market. But he said that there is no timetable for the launch of the official digital currency.

Higher security levels

Unlike various mobile payment services such as Alipay and WeChat Payment, through which users actually complete payments by using the paper banknotes deposited in their bank accounts linked with these Internet-based payment tools, sovereign digital currency is a brand-new type of real central bank-endorsed, Internet technology-driven cryptocurrency, whose issuance must conform to the rules for issuing paper banknotes.

Thus, state-backed digital currency presents much higher security levels than the private digital currencies such as bitcoin, whose issuance, management and exchange is decentralized.

The Chinese government has explicitly announced that bitcoin is not a real currency, saying that the virtual money would increase the risks of speculation, money laundering and fraud.

However, some analysts said that the restrictions on the use of bitcoin by financial institutions reflect the PBOC's intent to safeguard the legal tender status of the yuan and protect its monopoly over currency and credit creation in China, as bitcoin is becoming popular among Chinese investors due to its huge potential to appreciate. At present, one bitcoin equals more than $700.

In 2013, the PBOC joined hands with several government agencies including the Ministry of Industry and Information Technology, China Banking Regulatory Commission, China Securities Regulatory Commission and China Insurance Regulatory Commission to issue a document to bar China's financial and payment institutions from offering services associated with bitcoin transactions.

Earlier, Yao warned of the threats of private digital currencies to the stability of China's payment, monetary and financial systems, saying that the central bank should keep an eye on digital currencies that are beyond its control.

Technologies needed

In a previous interview, PBOC Governor Zhou revealed that the central bank was considering technologies of mobile payment, cloud computing, cryptographic algorithm, security chip and blockchain as options needed to develop and operate its sovereign digital money system.

In response to the conjecture that the PBOC will mainly adopt the popular blockchain technology to develop its own digital currency, the governor said that the central bank has invested huge resources to study the technology, whose biggest attribute is the ability to better protect users' private information. But Zhou also described blockchain technology as one consuming too much resources in computation and data storage, leading to its inability to deal with desired transaction volume. Blockchain technology is now widely used by many virtual currencies such as bitcoin.

Yao said that the application of blockchain technology in sovereign digital currency is still at the exploratory stage, adding that a reasonable application will help improve the efficacy of financial transactions, enhance the quality of financial services and reduce the costs of financial activities.

Impacts on monetary policy

The issuance and circulation of a central bank-backed digital currency has added to public fears that people's physical cash or paper banknotes deposited in bank accounts will be affected.

Yao said that the central bank will take into full consideration the current monetary policy, currency creation and supply mechanism, as well as the impacts that official digital currency may have on currency supply and circulation, monetary multiplier and space-time distribution before designing and developing its own digital currency.

Huang Zhen, director of the Financial Law Research Institute at the Beijing-based Central University of Finance and Economics, also downplayed the concerns, saying that the issuance of state-backed digital currency will not change the overall scale of the yuan issuance which is firmly controlled by the central bank. Digital currency is just a new form of Chinese currency, noted the expert.

But the use of official digital currency will speed up currency circulation due to its convenience, according to Yao, who called on the public to keep a level head for the new phenomenon.


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