Abstract: The evolvements of the nature of money and the supply of money stand out in the development of the monetary system. Digital currencies are a new type of carriers of money, but they do not promote the evolvement of credits of money. The encryption system of money features a triple structure – the encryption of base digital currencies, the encryption of the digital accounts and the encryption of the entire payment and settlement system. In the future, digital currencies may totally squeeze out traditional money, as they could be unencrypted and stored as a balance in encrypted digital accounts. Digital currencies may change our modes of payments and the position of central banks in the financial market. Traditional payment modes supported by commercial banks may be phased out, while “super central banks” that can create demands for credits may play a bigger role in the national economic systems.
I. The evolvements of credits and carriers in the monetary system
To take stock of digital currencies from the perspective of the nature of currencies, we need to observe the evolvements of the nature of currencies and the supply of money.
The nature of money lies in its functions, and thus it does not need to exist in any physical form. Anything that fulfills the functions of money can be regarded as money. In human history, money evolves in two perspectives: its credits and its carriers. First, let’s talk about the evolvement of money’s carriers. At an early stage, the carriers of money were stones; later, plastics; and during a long period of time, money has had different carriers. Finally, gold stood out among others and became a permanent carrier of money, and this is when the gold standard came into shape. The reason why gold became the standard is that it was expensive and useless. As Robert Triffin famously remarked, “nobody could ever have conceived of a more absurd waste of human resources than to dig gold in distant corners of the earth for the sole purpose of transporting it and reburying it immediately afterwards in other deep holes, especially excavated to receive it and heavily guarded to protect it.” A very important thing about gold is that it is unforgeable and has exceptionally good credit. However, since the Bretton Wood System was forged, dollar has replaced gold as the de-facto standard, bringing a victory of state credit over metal’s credit. Under the gold standard, bad money drives out good; but when credit becomes the standard, it is the other way around. As we enter the era of credit money, not all central banks necessarily enjoy the right to issue money, because sovereign credits of different countries compete with each other. A country with strong credits will override another with weak credits, as de jure dollarization and de facto dollarization have shown.
Based on the above observations, to a large extent, digital currencies are mostly just a new type of money’s carrier, which has no influence on money’s credit. If the People’s Bank of China issues digital legal tender, it’s still the central bank - the state - credit. Digital currencies are mostly targeted at individuals and the retail business and it replaces M0; it has hardly any influence on the wholesale industry, institutions or real-time transactions in large amounts.
In addition, supplies of money and demands for credits are two things that should be viewed separately. For example, we now often refer China’s monetary policy as “l(fā)oose money and tight credit”. Central banks can provide monetary base, but they cannot provide social credits, as credits are not supplies, but demands. The development of the whole system - from money to credits - is based on the transmission function of the financial market and financial intermediaries. If central banks directly issue digital currencies to individuals under a single-tier issuance framework, we would have a lot of troubles, as central banks could only issue money, but not credits. As a result, the entire social credit system could collapse. Thus, such a single-tier issuance framework is totally unfeasible.
Double-layer structure ensures the central bank only issues money, electronic money, cash, or digital money. Central bank could not create the demand for social credit. Credit demand depends on the economic aggregate and business cycles. Therefore, to a large extent, what the central bank can control is inflation and credit supply, namely the CPI and PPI, but not the currency value. With this in mind, we can understand how the central bank stimulates the economy, through monetary policies, not note-issuing. The central bank directly responds to the capital demand of financial institutions for purchasing corporate assets, thereby adopting various instruments including PSL. By buying assets, the central bank injects credit into the market but cannot increase the credit demand, which leads to a huge gap between money supply and credit demand.
II. Three layers in the digital currency system
There are three layers of encryption in the digital currency system, the currency, the account, and the payment and settlement system. Increasing encryption reduces the efficiency, pushes up the cost and brings more troubles to transactions.
First, it is viable to encrypt the payment system. We have two types of systems; one is a centralized system, general ledgers drilling down to sub ledgers, which runs efficiently without mistakes, and the other is a distributed system which Libra will adopt. The intrinsic weakness of the distributed system is low efficiency resulted from direct pairs trading. If we need to encrypt the payment system, there is no doubt that the crypto centralized system will run more efficiently than the distributed one. However, there is a flaw in the current system, cash. In the offline scenario, we conduct distributed pair trading through the use of notes and fractional money. For example, Joe gives money to Justin, an occasional issuance. If the future payment system can get rid of cash - notes and fractional money - the central bank’s payment system will be flawless.
Second, the crypto account. Here are two types of accounts, one is the online crypto account and the other is the digital identity authorized by the crypto account. The digital account and the digital identity can be seen as two layers or one layer. In the future, one digital account is enough and all the offline cards will be ditched. The offline payment instruments including bank cards, debit cards will be useless and only serve as a terminal account. The money in any payment instrument will be collected quickly to the layered digital account. If a digital account system is encrypted, the encryption of the digital currency would seem redundant. In other words, because of the absence of reliable digital account system, the current digital assets like bitcoin have to encrypt its underlying currency. Also, we could say the same to the cash system. The underlying currency, banknotes, is also encrypted by numbering banknotes and using detectors. In China, since the use of online account like WeChat pay and Alipay, we neither think about whether the money from Joe is genuine or counterfeit nor care how much notes or fractional currencies are involved in the transaction.
Therefore, if digital currency dominates the future, a crypto settlement system is enough without the necessity of encrypting the currency. The advent of the digital currency will end the cash and fractional currency because the digital currency itself is possibly not encrypted and recorded as balance in a crypto account. Therefore, encrypting two layers is enough and a third layer encryption is redundant.
Then, we move to the wallet. China has come to a stage when online payments like WeChat pay and Alipay can be used for online transfer. Bank cards are added to online accounts.
Alipay and WeChat payment are typical hot money wallets. UnionPay's Cloud QuickPass can also be called a hot money wallet. In contrast, payment tools offered by commercial banks are only used occasionally, which tend to make people feel inconvenient. All such payment tools provided by commercial banks could fade out in an era dominated by digital currency and digital payment systems. Some payment phenomena have also arisen in Western countries. For example, Uber can be bound to credit cards, though this does not necessarily turn credit cards into the so called hot money wallets. One major feature of hot money wallet is that transactions can be made immediately, with money coming in and out without delay. The future of payment system could be akin to a “hot money wallet” system shaped by various payment tools such as the current ones including Alipay, UnionPay, and TenPay. In such a system, everyone could have an online digital account. So, it could be a three-tier structure for a payment system in the future, in which the bottom layer is digital currency, the middle layer is digital account, and the top layer is digital identity.
III. Digital currency and super central bank
Now, let us have a look at the possibility of digital currency and super central bank. I think that if cash disappears completely and digital currency further develops, it could end up with two layers - one is the digital account and the other is digital payment system. Only when such a two-tier architecture is completed, can the system become flawless and form a closed loop, which is also a vertical accounting system.
Below is some of my thinking about the features of digital currency and monetary policy in the future:
The first one is that will the zero interest rate bound or liquidity trap still exist? The central bank is fully capable of setting interest rates at will, from negative rates to zero and high rates. So it is possible that the so called liquidity trap will not exist anymore in a future digital currency era. Zero or negative interest rates will become quite normal, if some discriminative measures are used against some account, especially some extremely wealthy account.
Secondly, it is the conditionality of the issuance of digital currency. Let's take a tiny example. Is it necessary to withdraw from quantitative easing? If the central bank sets a circulation period for digital currency at issuance, it may be able to create credit indirectly and the users will have to spend all the currency by the end of the valid period. So while the central bank can only supply money now, it may be able to create credit demand in the future. The tax system, social security system, and social relief system in the future will be highly dependent on such a super central bank. The role of central bank will be very important and unique in the entire national economy with the formation of a digital currency system.
IV. Three visions of digital currency in the future
First, the digital currency and digital payment system still belong to the future, but as our life is becoming even more online-oriented, offline things could disappear eventually or exist in name only.
The second one is associated with Libra which is very important. It has a complete design, from the bottom component to individual accounts and payment, being different from the tokens and bitcoin we see today. Libra has its own traffic, application scenarios, and a closed loop system. If the US permits the use of Libra, could we imagine or even summit proposal to China’s regulators, central banks, or government functional departments that we can allow some of Chinese financial technology companies to try something similar to Libra as China today is also capable of doing so.
Third, legal digital currency is still quite important. According to a study by Peng Wensheng, about 70% of central banks in the world are paying attention to digital currency, about 60% of whom, however, do not see too much necessity and urgency for central bank to issue legal digital currency in the foreseeable future.
