Editor’s note: Sheng Songcheng, the author of the article, is a member of the Eleventh National People’s Congress, the Director of the Investigation and Statistics Department of the People’s Bank of China. The article was first published by WSJ China. Jiang Le is the co-author.

Sheng Songcheng,  Director of the Investigation and Statistics Department of the People’s Bank of China

Since the launch of bitcoin in 2009, we have witnessed fast development of private digital currency in various forms. International financial institutions and technology companies have been engaged in the development of digital currency, and some progress has been made [1]. In this context, the monetary authorities of major economies have begun to study the digital currency that is issued by central authority, China is no exception [2]. Why the authority want to issue digital currency? Just to replace cash? Or to save cash printing costs? Obviously not. Because the proportion of cash use has decreased year by year while the use of various electronic money has been increasing. And the economic and social costs of studying and issuing central bank digital money are huge. Central banks cannot issue digital currency simply just for replacing cash.

Private digital currency are forcing monetary authorities to study and issue central bank digital currency

A large number of private digital currency, Bitcoin as the leader, emerge in the market, gaining momentum and exerting large impact. Many economists in the world, including the central bankers, have been greatly affected, and some people even mistakenly believe that private digital money may replace the sovereign currency. As early as the end of 2013 I clearly pointed out that the virtual currency (including private digital currency) is essentially not a currency, which can not replace the sovereign currency [3]. As times passes by, the non-monetary nature of virtual currency was gradually recognized.

By adopting a series of new technology, private digital currency infiltrate the financial system and even shock the operation the modern economy. Therefore, in order to stabilize the monetary system and the entire financial system, monetary authorities must also use the same or even more advanced technology and design to study and issue central bank digital currency. If the development of private digital currency goes wild, it will bring serious impact on monetary policy regulation and economic and financial system.

First of all, private digital currency will divert and replace part of the use of sovereign money, then monetary policy effectiveness will be weakened and the mission mechanism will be distorted. Private currency and sovereign currency is in a shift relationship. With the expansion of the use of private digital money, sovereign money use will gradually decline, which will reduce the monetary authority of the sovereign currency control. At the same time, the influence of monetary policy control on the supply and circulation of fiat money will also decline and become unstable, which will weaken the effectiveness of monetary policy and distort the transmission mechanism. If the private digital currency is widely used but they are not issued or regulated by the monetary authorities, the modern economy will lose an important means of regulation and control as the economy will not function properly without monetary policy regulation

Secondly, fluctuation of private digital currency is a thread to financial stability. Private digital currency is not endorsed by national credit therefore not a real currency. The price is highly vulnerable to market expectations. The high volatility makes it hard to maintain market liquidity. With the expansion of private digital currency use and scale, the probability of a single private digital currency risk evolving into systemic risk will also increase.

Thirdly, private digital money supply is relatively fixed, which is difficult to adapt to the needs of modern economic development. Take bitcoin for instance, there is a contradiction between the system-set supply cap and the expanding social production and circulation of commodities. If it is widely used, it will cause deflation and curb economic development. This is the root cause of the collapse of the gold standard.

Fourthly, the private digital currency lacks the central regulation mechanism, which makes it difficult to satisfy the needs of stabilizing modern monetary system. The absence of centralized distributor and regulatory institutions, the so-called “de-centralization”, is a common feature of private digital money. If private digital money is universally accepted by the whole society and monetary authorities can not stabilize the fiat money through the centralized adjustment mechanism, not only the economy become unstable but the national credit-based monetary system will also be shaken. [4]

Fifthly, private digital money poses challenges to anti-money laundering, counter-terrorism financing and capital controls. Common features of private digital currency like anonymous transaction and free cross-border transfer makes it easy for criminals to cover up their sources and destination of funding. Individual can easily circumvent the personal foreign exchange remittances cap (editor’s note: One Chinese may exchange RMB for up to 50,000 USD a year)and foreign management regulations, which will facilitate money laundering, terrorism financing and evasion of capital controls.

Lastly, private digital money increases the difficulty of protecting consumer rights. Private digital currency transactions are prone to fraud, theft, and fake because of the high volatility of private digital money, the lack of regulation of market participants, the lack of user fund security and the opacity of transactions. This does not only result in the absence of consumer rights protection, but also increase the difficulty of evidence-based regulatory authorities investigation. [6]

Therefore, in order to cope with impact brought by the rapid development of private digital currency on monetary sovereignty, monetary policy, financial risks and consumer protection, monetary authorities should clearly recognize that the country should start researching digital currency issued by central banks as soon as possible. In the future, with the support of national credit central bank digital currency should continue to meet the society’s demand for money-using technology, and become settlement and payment method that are widely accepted. In this way, the monetary authorities can expand the use of sovereign money to reduce the impact of private digital currency on the monetary system and the whole financial system.

Monetary authorities have the natural advantage of issuing the central bank’s digital currency.

A wide variety of private digital money is created or distributed by different private entities and they are decentralized. They have different system settings and trading methods. Competition between them are fierce. In contrast, the central bank digital currency is controlled by the monetary authorities and therefore centralized, which makes the monetary authority gain natural advantage in the market.

Firstly, the central bank’s digital currency is backed by national credit and could be accepted by the public more easily. Central bank digital currency is a new form of sovereign currency, which is the the same legal tender and mandatory bills like sovereign money. As a result, the public can quickly adopt to the use of central bank’s digital currency just like the existing sovereign money, which requires no re-pricing of the central bank’s digital currency. Various private digital currencies has no national credit support, and high volatility will trigger realtime re-pricing in the course of transaction, which is why the private digital currency will not be widely accepted by society.

Secondly, the central bank’s digital currency is more conducive to improve the liquidity of the economy and reduce transaction costs. Each private digital currency has its own system settings. The compatibility and fungibility problems between the various systems actually increase the complexity of economic transactions. In contrast, central bank digital currencies with national credit support adopt a unified system standard, and the increase in transactional convenience will increase the total volume of transactions, thereby increasing the liquidity of the whole economic system.

Thirdly, the central bank digital currency has the monetary autorities as the lender of last resort (LLR), bank run is not likely to happen. Like other forms of sovereign money, the monetary authority is the lender of last resort in the central bank’s digital currency, providing protection for monetary stability. And private digital money has no LLR, currency providers and trading platform is prone to deposit runoff in urgent events.[7].

Fourthly, the supply of central bank’s digital money is controlled by monetary authorities to meet the needs of modern economic development. Unlike the private digital money, once the central bank’s digital currency is released, the monetary authorities will adjust the supply of central bank’s digital money supply in accordance with the needs of economic development, so as to maintain the feasibility of the central bank’s digital currency and promote the development of the modern economy.

Fifth, the monetary authorities can maintain the stability of the digital currency via centralized regulation mechanism to ensure the normal operation of the modern economy. Low value volatility is a prerequisite for currency to act as a measure of value and means of circulation, and economic fluctuations are often accompanied by currency fluctuations, so maintaining currency stability is also a necessary condition for the normal operation of modern economy.

Sixthly, the monetary authorities will enhance the security of central bank digital currency through technical measures to protect the legitimate rights and interests of consumers. Unlike private digital money, the central bank digital currency will protect the user’s fund safety through cryptographic algorithm, and establish a controllable anonymous mechanism to achieve traceability under certain circumstances. These measures will further enhance the safety of central bank’s digitial currency and protection of user transaction safety.

A central bank digital currency is conducive to the effective operation and transmission of monetary policy

Unlike the existing electronic form of the fiat currency, the future central bank digital currency will likely be the standard currency for a combination of technologies such as blockchain, mobile payments, trusted cloud computing, cryptographic algorithms, security chips and so on. Therefore, the future central bank digital currency will help China in all aspects of building a new financial infrastructure, improving China’s payment system, lifting efficiency of settlement and payment. More importantly, the central bank’s digital currency can eventually form a large database, enhancing the convenience and transparency of economic activities, which will help the effective operation and execution of monetary policy.

First of all, the central bank’s digital currency helps regulators track money flows when necessary, thereby reducing money laundering, tax evasion and evasion of capital controls. Existing digital currency technology can not only record each transaction but also to track the flow of funds. In contrast to private digital money, regulatory authorities can control master the use of central bank digital money via controllable anonymity mechanisms, which is a supplementary part to the current monitoring and control systems and the effectiveness of existing systems [10].

Secondly, the central bank’s digital currency information superiority can improve the accuracy of monetary indicators. The bigdata system formed by the central bank’s digital currency will not only improve the measurability of monetary velocity, but also facilitate the calculation of monetary aggregates and the analysis of monetary structure, which will further enrich the monetary indicator system and improve its accuracy.

Thirdly, the information superiority of the central bank’s digital currency can help regulators to use policy instruments more accurately and more flexibly to track capital flows and to monitor and evaluate financial risks in an integrated manner. The transparency of economic activity will be greatly enhanced when the central bank’s digital currency is universally accepted and used by society as a whole, and regulators can collect real-time, complete and authentic transaction ledgers at different intervals for various institutions, which is the analytical database for monetary policy and macroprudential policy.

Fourthly, the central bank’s digital currency technology will help the interest rate effectiveness of monetary policies. Existing digital money technology supports “peer to peer” payment and settlement, which increases the liquidity of market participants. Only the central bank’s digital currency, which is universally accepted by the whole society, can radiate this advantage to participants in different financial markets, thereby increasing the liquidity of different financial markets and the market liquidity of individual financial markets. This will lower the interest rate level of the entire financial system, making the interest rate term structure smoother and the monetary policy interest rate transmission mechanism smoother.

To sum up, the innovation of central bank digital currency is to adapt to the development of the situation, keeping up with the pace of the times, retaining the control of monetary sovereignty,better serving the currency issuance and monetary policy, not just to replace the cash flow of paper currency.

(This article is the author’s personal point of view, does not represent the views of the institution that the author work for)

Detail of reference is here.