Central Bank Digital Currencies: Policies and Progress

Precious metals served as the first means of making payments and currencies followed later on. Many national and local rulers have sought to monopolize the right to issue their own currency, but their efforts were largely unsuccessful until they established a single standard for legal tender. While ushering in the new digital age, the rise of private encrypted digital technology has once again raised the challenge of denationalizing currency issuance. As an effective response to private encrypted digital currencies, CBDC embodies the state's currency sovereignty in the age of the digital economy.

What is CBDC?

Around the world, there is growing interest in Central Bank Digital Currencies (CBDC), but what exactly are they? What's the difference between them and other types of currencies? Before answering these questions, we need to examine digital currencies from the following four aspects: Who is the issuer – is it a central bank or commercial banks? Is the currency electronic or a physical unit of exchange? Is the currency issued to the general public or to specific institutions? And what is the transfer mechanism – is it centralized or decentralized?

The renminbi banknote is a physical currency issued by the People's Bank of China for use by the general public, but the reserves on deposits that commercial banks must leave at the central bank can be considered as an electronic form of currency issued by the central bank to designated institutions. Before central banks begin issuing retail digital currencies, the general public does not have direct access to any electronic currencies issued by a central bank. Deposits in accounts at commercial banks are in a sense a digital currency, however. They are not issued by the People's Bank of China but are electronic currencies issued by commercial banks and used by the general public. They also have a centralized transfer mechanism as they can be shifted from bank to bank. The use of CBDC in retail applications would be a breakthrough. For the first time, it would allow the general public to make the central bank the indebted party for the electronic currency. This would have a profound impact on the financial markets and the economy overall.

Strictly speaking, CBDC refers to various forms of electronic currencies issued by central banks. They can be divided into retail currencies (issued to the general public) and wholesale currencies (issued to specific institutions, such as commercial banks). If we distinguish them by their transfer mechanism, they can be divided into account-based CBDCs and token-based CBDCs. The technical aspects of the former are similar to the deposit account management of commercial banks, while those of the latter are more like private encrypted digital currency.

created in an oligopoly market have led to excessive retail payment rates. This has adversely affected economic development. Being independent from the existing payment and settlement system, the issuance of CBDCs would help stimulate the retail payment market.

Financial inclusion is seen as another benefit. Due to an insufficient financial reach of the central bank, disadvantaged groups in certain countries are unable to enjoy basic financial services as they are not covered by the banking system. Instead of relying on bank accounts, token-based CBDCs rely on a digital wallet. In that way they can fill the gap in the market to a certain extent and expand the availability of financial services.

CBDCs are also seen as helpful in fighting financial crime. Due to the complete anonymity of transactions, excessive use of cash is often associated with terrorist financing, tax evasion, and money laundering. This leads to a number of economic and social problems. In contrast, CBDC is anonymous but also more controllable. While trading parties can remain anonymous when dealing with their peers, the central bank as a third party has the right to see who the parties are. This greatly facilitates the prevention of tax evasion, terrorist financing and money laundering.

Another argument for CBDC is to cope with the challenge to sovereign currency from encrypted digital currency. Private encrypted digital currency like bitcoin have already posed challenges to the local legal tender of certain countries that are experiencing hyperinflation or have strict foreign exchange controls. Global central banks displayed a sense of impending crisis when online social media company Facebook tried

for large deposits and savings by restricting holdings of cash.

Different policy objectives are leading to different CBDC designs. For example, if central banks have insufficient faith in commercial banks, they can design an extreme CBDC which would allow residents to directly open bank accounts with the central bank and borrow directly as well. But if they want to reduce the uncertainties in the banking sector, a "near cash" CBDC is the preferred choice. That means that when issuing CBDC: (1) the central bank releases CBDC to the public through the banking sector; (2) commercial banks may open accounts at the central bank or at a clearing bank that has already opened an account with the central bank; (3) banks should follow the rule of know your customer, antimoney laundering, and combating the financing of terrorism, though once the CBDC is taken out, it needs to be completely anonymous; (4) residents and enterprises are not allowed to obtain CBDC directly from the central bank. In order to reduce the impact on commercial banks, China is using a "central bank – commercial bank" dual-credit model for the possible issuance of CBDC. To be specific, CBDC is designed to replace M0, commercial banks could open accounts at the central bank to hold CBDC positions. On the technological side, commercial banks would be able to choose freely from an account system or a token-based system according to their own needs.

Progress of CBDC Issuance in Each Country

According to a report by the International Monetary Fund, major countries around the world are actively exploring the feasibility of CBDC issuance, yet opinions vary on the desirability and possible methods to be used for issuing the currency.

Some countries are reviewing and amending legislation to provide legal support for the formal issuance of a CBDC. Others are actively running pilot projects to explore feasibility and determine the potential economic impact. Most central banks are now working closely with private banks in an effort to expand their resources and financial technology.

Less developed countries are more eager and they seem most interested in promoting retail CBDCs. So far there have not been any successful examples, however. One example is Ecuador, which abandoned its legal tender and became dollarized in 2001 due to the country's problems with hyperinflation. Later, residents began to use bitcoin in large quantities with the rise of private encrypted digital currency. The Ecuadorian government later discovered an opportunity to re-issue legal tender using CBDC. The Ecuadorian currency was once again officially launched in February 2015, however, electronic central bank credits failed to win people's trust and the project was suspended in April 2018. Another example is Uruguay, which launched a pilot project in November 2017 to issue, circulate and test its e-peso (or electronic peso) to advance its broader financial inclusion goals. However, after six months of using a digital peso, this pilot project was discontinued and electronic pesos were declared null and void.

At present, no major economy has announced a plan for a CBDC, though there are a number of countries doing tests. Singapore and Canada are ahead of the pack with their research on CBDC for wholesale purposes. The Bank of Canada and the Monetary Authority of Singapore jointly developed the Jasper-Ubin project in 2019, achieving the application of CBDC in cross-border, cross-currency and cross-platform payments without intermediary agents. The European Central Bank released a CBDC proofof-concept project called EURO chain at the end of 2019. This was mainly targeted at wholesale CBDC. Developed economies have also been more interested in researching and developing CBDC ever since Facebook announced its Libra plan.

As a pioneer in CBDC research, the People's Bank of China began its study of the subject in 2014. China's version of CBDC is also referred to as DC/EP (Digital Currency/ Electronic Payment). Despite six years of experience, we are still not sure when and how DC/EP will be officially rolled out. On April 10, Zhou Xuedong, director of the General Administration Office of the People's Bank of China, pointed out at the financial statistics release conference for the first quarter of 2020 that the People's Bank of China is proceeding as planned with CBDC. However, there has been no public disclosure of an official schedule for issuance. Private beta testing of CBDC in Suzhou and Chengdu in April was made public via social media and has attracted widespread public attention. But this was merely part of an internal trial for research and development. It is not unlike the pilot projects in other major countries and does not suggest that DC/EP will be launched anytime soon.

According to media reports, China’s CBDC mainly involves retail payments, which is consistent with DC/EP's positioning at the initial stage of research as retail CBDC. However, the former governor of the People's Bank of China, Zhou Xiaochuan, told a meeting at the end of 2019: "Theoretically speaking, the digital currency issued by the People's Bank of China could also be used for retail services. However, it would be a great shock to the current financial system. We are being very cautious as far as issuing CBDC is concerned." He went on to say: "The People's Bank of China might focus on issuing a digital currency that can facilitate the wholesale transactions among banks and for third-party payments." Therefore, whether DC/ EP will be retail-oriented or focused more on wholesale remains unknown at present.

For China, the major value of CBDC issuance lies in its facilitation of renminbi internationalization. We have been working hard to achieve this goal for a number of years, yet the results have not been entirely satisfactory. One of the reasons behind this is the crossborder payment and settlement system is still dominated by the US dollar. If the DC/EP is to be applied to cross-border payments, it will promote the establishment of a brand-new cross-border payment and settlement system and create a basis for the internationalization of the renminbi. At present, mobile payments for infrastructure construction among the countries participating in the "Belt and Road" program are relatively weak. DC/ EP-based mobile payment solutions would promote the construction of a modern financial infrastructure in these countries and that would achieve a win-win situation for both parties. Since every country takes a prudent attitude toward monetary sovereignty, more emphasis should be placed on DC/EP's positioning of cross-border payment solutions and downplay its feature as a currency during the promotion of the DC/EP's internationalization.