Antai Insight


Industry Research Comments | Li Nan and Chen Kaiyu: is digital RMB a "Trojan horse"?


In the past few weeks, as the trials of the People's Bank of China for digital RMB has gradually expanded from Shenzhen to Beijing, Shanghai and other cities, digital RMB has become a hot topic. Li Nan, associate professor of the Antai College of Economics and Management, Shanghai Jiao Tong University, and Chen Kaiyu, member of the Chinese banking research team of the Industry Research Institute, found that many reports of media, especially overseas media, had a lot of misunderstandings about the digital RMB. Some even misinterpreted it, said that digital RMB was a tool for Chinese government to grab data from third-party payment institutions such as Alipay, and was a Trojan horse to monitor people's every move. Others think Bitcoin is the free-market-oriented substitute of legal tender, and a weapon against inflation caused by the liquidity injection by the central bank. Some even worry that digital RMB will replace the world currency status of the USD and then monitor all the people in the world.

Is digital RMB a "Trojan horse” as reported by Western media? Is Bitcoin a “good money” to avoid seigniorage and fight against inflation? 

 I. Digital RMB is a legal tender in digital form, while Bitcoin is just a speculative bubble.

Digital RMB is a legal tender in digital form, and is issued on the basis of national credit, which is exactly the essential difference between all Central Bank Digital Currencies (CBDC) and the "digital currencies" such as Bitcoin or "stable currencies" such as Diem.

In August 1971 when Nixon Administration announced that the USD was no longer linked to gold and the United States would no longer convert dollars to gold at $35 per ounce, the Bretton Woods system was ended. Since then, the value of money is no longer guaranteed by its convertible precious metal (gold silver), but by the national credit represented by the issuers of the legal tender (such as the Bank of Japan, the European Central Bank, the Federal Reserve and the People's Bank of China). National credit is exactly the issuing basis of digital RMB. In this sense, the digital form of RMB and the paper money and coin form of RMB are completely equivalent. They are both currencies in circulation, namely M0, which measures the function of currency as a commodity exchange intermediary.

Now there are various digital currencies in the market, which only share the same word “digital” with Central Bank Digital Currency. All digital currencies not issued by central banks are not guaranteed by any national credit. The guarantee for their currency value is only the belief in the so-called global free circulation currency put forward by the legendary inventor of Bitcoin, Satoshi Nakamoto, or the fanatical pursuit of the value that blockchain technology may bring.


II. Why did the People's Bank of China take the lead in issuing digital RMB?

China has sufficient reasons and good foundation to walk in the forefront of the research on CBDC. For all central banks, the greatest significance of issuing and using CBDC is to reduce the cost of cash management and maintenance. According to the estimate of the European Central Bank, the social cost of retail payment instruments in 27 EU member countries is about 130 billion euros, accounting for 1% of GDP.

Currently, China has established a huge system for the issuance, printing, storage, use and recovery of cash, which bears huge operating costs and risk control costs, including: a large amount of fixed asset investment in various systems such as banknote printing plant, treasury, cash escort, cash counter and ATM; a large number of human resources with professional skills such as cash counting, counterfeit identification, printing, treasury management, cash management and security; and the costs of risk control at various links, such as anti-theft, anti-damage, anti-counterfeiting, anti-money-laundering and other risk control.

With the decrease of cash usage ratio in retail payment field in China, it is obviously not cost-effective to maintain the cash system which consumes a lot of fixed assets, professional personnel and operating costs and also bears great risks. At present, most of the RMB in circulation in China is not in the form of physical cash, but has entered the social and economic life in the digital form. The volume of physical cash transactions has been in a significant decline, and the proportion of cash use will continue to decline in the future. Therefore, by taking the lead in developing digital RMB, the People's Bank of China conforms to the general trend of digital economy, with sufficient reasons and conditions. The increasing improvement of domestic non-cash payment system constitutes the necessary infrastructure and guarantee for the central bank to issue digital RMB in place of physical cash.


III. Core features of digital RMB

As a legal tender in digital form, in addition to the position as the currency in circulation, digital RMB has two core features: controllable anonymity and issuance design of two-tier system.

(1) Controllable anonymity

Cash has complete anonymity, so it is inconvenient to carry, easy to lose and damage, and subject to the risk of money laundering and other criminal acts.

Controllable anonymity can be realized on digital RMB through unique digital technology. For example, digital RMB allows "dual offline payment", which means payments can be made directly from the payer to the payee with the wallet app on smart phone while neither is connected to the Internet. Such "dual offline payment" function allows small transactions to be processed through the "digital RMB wallet” app, so that privacy preference of the public is safeguarded, and smart phones with "digital RMB wallet" are just like physical wallets with banknotes and coins, entering our daily transaction activities and realizing cashless retail transactions, especially in a place where the Internet signal is weak or unavailable. Digital RMB with controllable anonymity feature can not only meet the privacy requirements of the public, but also give full play to the advantages of digital RMB in identifying large-amount illegal transactions such as money laundering.

(2) Issuance design of two-tier system

The so-called two-tier system refers to the path of currency issuing, that is, digital RMB will be issued by the central bank, and the commercial banks will be responsible for getting the currency into the hands of the public. Such two-tier system design is exactly the same as the current way of issuing RMB.

In the existing financial system, by accepting deposits and issuing loans, commercial banks create broad money, M2 (measuring the function of money as a store of value), transfers money from the central bank to the public and gets the money into social and economic life. In December 2020, China's M2 was 218.7 trillion yuan, more than 25 times that of M0, mainly created through the loan business of commercial banks. Digital RMB will be issued in exactly the same way, that is, it will be spread to social and economic life through the commercial banking system, instead of being directly issued by the central bank to the public.

An important connotation of the two-tier system is that the issuance of digital RMB will not lead to the "financial disintermediation" of commercial banks or third-party payment institutions. Let's make a simple analogy: if the payment system supported by commercial banks is the artery of economic subjects, then the third-party payment is capillary, while cash or currency in circulation (whether digital RMB or cash RMB) is only blood in artery or capillary, and blood cannot exist independently from the blood vessel.

On the other hand, in the two-tier system, monetary policies are mainly transmitted through commercial banks, so the efficiency of monetary policy transmission mechanism depends on the efficiency of the banking system and the whole financial market and the existing constraints, and has little to do with whether RMB exists in digital form or not.


IV. Is digital RMB a "Trojan horse” designed to monitor all transactions?

Some foreign media believe that the digital RMB is a Trojan horse and once it is used, the transactions of the public will no longer have privacy, especially the privacy of transactions through third-party payment institutions, which will be fully grasped by China's central bank. Is that true?

Firstly, according to Okam's razor, the simplest reason is the most reasonable explanation. The central bank's issuance of CBDC can save huge social costs of retail payment instruments, which is enough to explain the motive of central bank's issuance of digital RMB.

Secondly, all the payment methods through non-cash payment channels, whether  card swiping or code scanning, are traceable and non-anonymous in theory, while the controllable anonymity of digital RMB issued by China's central bank can really meet the public's demand for anonymity of retail payment business.

Thirdly, transactions through third-party payment institutions are not the blind spot of financial regulation. From July 1, 2018, all online transactions of third-party payment platforms must be cleared through NetsUnion Clearing Corporation (NUCC) platform, which is regulated by the People's Bank of China. In other words, the transaction volume through third-party payment institutions has been included in the regulatory scope of the People's Bank of China, which is not the so-called “privacy” mentioned by Western media.

Finally, the transaction volume involved by third-party payment platforms only accounts for a very small part of the total social transaction volume. The total amount of online and offline transactions conducted through the banking system in China in 2020 reached 8195 trillion yuan, most of which was completed through the High Value Payment System developed ten years ago. This figure is about 25 times the total transaction volume of third-party payment platforms such as Alipay.

Launching digital RMB with great efforts just to monitor the transaction data of third-party platforms, which are already within the regulatory scope and only account for less than 3% of the total transaction volume, isn't it "moving stones into the mountains"? Only self-righteous "China conspiracy theorists" can think of such ridiculous logic.


V. Challenges of digital RMB

Although China's central bank has been leading in the world in the research and development of digital RMB, there are still many challenges in issuance and use of digital RMB in the real economy. The biggest uncertainty in issuance and use of digital RMB lies in the security and reliability of the network. As the saying goes, "the devil is in the details". The issuance of digital RMB involves many complex technologies and potential risks. Therefore, it is required to repeat trials in multiple scenarios to find as many potential problems and risks as possible and find solutions before formal use. This is why China's central bank is active in R&D and trials, but conservative in setting a timetable for issuing digital RMB. Such conservatism is not only of great significance to ensure the successful issuance of digital RMB by the central bank, but also of great significance to the construction of "digital financial system".

Authors: Li Nan, associate professor of the Antai College of Economics and Management, Shanghai Jiao Tong University; Chen Kaiyu, member of the Chinese banking research team of the Industry Research Institute; and John Van Fleet, responsible for external corporate relations of the Antai College of Economics and Management, Shanghai Jiao Tong University.