Abstract: Institutional arrangements for the e-CNY should consider four aspects, i.e. the form of circulation, the relationship between the central bank and commercial banks, the role of operators, and the management of digital wallets, in order to promote both convenience and safety.
Currency is not only a universal equivalent for payment and settlement; nor is it gold, silver, copper, paper, ledger symbols, electronic digits, encryption codes or other matters serving as a means of exchange. Instead, it’s an entire set of institutions and systems underpinning payment and settlement, including an issuance framework and a series of management rules and policy tools.
Currency serves as a convenient means of payment, which is its most explicit function. Such convenience and safety it provides, while partly owed to the special properties of the materials used, are essentially a result of the implicit institutional arrangements behind it. A currency, a certain material or a technology is not necessarily good just because it’s fast and convenient. Likewise, currency issuance and circulation systems are good only when they facilitate the smooth circulation of money, the central bank’s management of the money in circulation, the implementation and transmission of monetary policy, and a level playing field.
The e-CNY has made great headways, opening more consistent channels for individual payment across scenarios and introducing many innovations. Trial programs at this front have succeeded, and new improvements and innovations can be delivered gradually later. After the official launch of the e-CNY, I believe market participants will keep exploring new application scenarios under proper institutional frameworks.
Trial programs going forward may enter a harder, yet most critical, pre-launch phase of institution building. As of now, there have been no concrete institutional arrangements as to e-CNY issuance except for the concept of a “two-tiered operation system”, and operators are putting it into practice in different ways in trial programs. The trials will undoubtedly provide experience and basis for the design of a sound institutional system for the e-CNY. This article, based on observations of the trials, envisages several possible modes for the issuance of the digital currency.
I. FORM OF CIRCULATION
To start with, the e-CNY will adopt a two-tiered operation system whereby, similar to paper money, it is issued first by the central bank to commercial banks, and then provided by the commercial banks to the general public. But a question would come up: should commercial banks provide the e-CNY via one or several channels?
Most of the paper money today is put in circulation when individuals or organizations withdraw it from their deposits. It also enters circulation via the direct issuance of loans which incurs no management cost associated with either institution or infrastructure building. Recently, the city of Suzhou has rolled out a trial where banks issue loans directly with the e-CNY, and the results still remain to be seen. If we only look at it as a scenario, then the e-CNY should be able to work just as well as paper money, theoretically. But against the digital economy boom, we may have to think about the necessity of this move based on the trial results.
We need to think about the implications for businesses, commercial banks and the central bank if we issue loans directly with the e-CNY.
Commercial banks will have to invest in infrastructure and maintenance, and manage risk exposures that arise as more channels open.
Businesses regard currency not only as a means of payment, a measurement of value, a medium for circulation and a storage of value, but also “funds” and a tool for financial management, and so they pay more attention to the efficiency, safety and liquidity of the currency than to convenience. There are three ways for a business to obtain loans:
? Loans are first credited to its deposit account before paid out on a transaction-by-transaction basis;
? Loans are issued in cash or e-CNY and then paid out on a transaction-by-transaction basis, with the outstanding amount credited to its bank account;
? The obtained cash or e-CNY is credited to its bank deposit account before paid out in accordance with operation needs on a transaction-by-transaction basis.
These ways provide about the same level of efficiency. Businesses can choose among them at their own discretion.
In the trial programs, most borrowers have chosen to credit the e-CNY loans in their bank deposit accounts. Since the conversion of these deposits into the e-CNY and payments with the e-CNY are both free of charge, businesses have started to withdraw the digital currency from their accounts for payment purposes. This is typically out of cost benefit considerations and of course also owed to increased convenience in comparison with payment in cash, but businesses don’t really care about the difference in efficiency between e-CNY payments and bank transfers.
From the central bank’s point of view, smooth circulation of currency in payment and settlement is an important target of a central bank as the currency issuer, but the cost incurred by currency issuance and management of its circulation as well as potential implications for monetary policy of various forms of circulation are all important matters to consider. To balance these goals, sometimes it would be better to restrict some of the circulation forms.
Reducing the use of paper money and coins is an important motivation driving the PBC’s attempt to issue the e-CNY. There were discussions around 2000 about providing individual check settlement services, out of considerations that as income grew, cash issuance was in constant expansion incurring increasingly higher cost of management, which couldn’t be addressed just by elevating the face value of the currency. Individual checks can reduce the costs incurred by paper money issuance and circulation, while channeling a large amount of the cash in circulation toward bank deposits. But this plan was scrapped because of the rise of bank cards and electronic payments.
In retrospect, this was a wise decision that could avoid unnecessary infrastructure investment since bank card and electronic payment tools, especially third-party payment platforms, could reduce cash issuance and circulation without any need for paper money of bigger face value so that bank deposit accounts can absorb more currency.
Issuance of the e-CNY should also consider the implications of increased cash in circulation for currency management and monetary policy transmission. Hence, many scenarios should be allowed to choose whether the use of the e-CNY is encouraged or restricted as long as transactions can proceed normally. Thus, whether the direct use of e-CNY should be restricted in lending activities is one of the issues policymakers need to consider in institutional design.
II. RELATIONSHIP BETWEEN THE CENTRAL BANK AND COMMERCIAL BANKS
This is actually about how the PBC issues the e-CNY. Currently, there are still many practical details unclear about the two-tier system. Compared the issuance of paper money, the issuance of e-CNY involves an additional layer of “operators”, based on which we could envisage two different issuance mechanisms: 1) same as paper money, commercial banks receive the e-CNY from or deliver it to the PBC directly; 2) the PBC issues the e-CNY to operators who then give it to commercial banks. Different choices could have different effects and profoundly affect the result of the e-CNY program.
1. The PBC→Commercial Banks
If the PBC directly issues the e-CNY to commercial banks, it would be same as paper money issuance. The question is whether commercial banks and the PBC coordinate in a headquarter-to-headquarter or branch-to-branch manner. Both are feasible given their increasing digital technological capacity. If it’s headquarters to headquarters, commercial bank headquarters will need to put its e-CNY account balance under special management; if it’s branches to branches, the PBC will need to set up a special department to study cross-regional flow of the e-CNY in order to distribute the digital currency properly.
2. The PBC→Operators→Commercial Banks
Two models are possible under this scenario: 1) operators function as the PBC’s e-CNY “vaults” and distribute the e-CNY to commercial banks, who apply to the operators for the e-CNY based on their need and then provide e-CNY services for customers; 2) commercial banks report their clients’ demands for the e-CNY to the operators, and the operators provide the clients directly with the digital currency.
Under the second model, commercial banks do not actually engage in e-CNY transfer, but they provide the data on the transaction and clients’ identities to operators. This could cause problems: 1) commercial banks with the support of operators will enjoy unfair leverage against their competitors absent necessary institutional arrangements; 2) even if proper mechanisms are in place to provide a level playing field, clients will view these two types of banks differently, which still causes unfairness.
III. Operators
A major difference of e-CNY issuance from that of cash is the presence of additional operators. The role an operator can play is not yet clear as e-CNY is still at a pilot stage, with nothing being finalized. What does an operator do? Where are the functional boundaries? How to ensure sustainable operation?
1. What do the operators operate?
There are two potential arrangements about what an operator operates, either both e-CNY and digital wallets, or just digital wallets.
1) E-CNY + digital wallets
There are two ways to operate e-CNY.
First, an operator can act as a vault of the PBC. This kind of agency model is relatively simple, seeing not much profit opportunities.
Second, an operator can provide e-CNY to customers on behalf of commercial banks. This model entails a number of questions. For example, should the service be charged? How much is reasonable? How should prices be determined? Should they be determined by the PBC, or the operator, or through negotiations between the operator and commercial banks? Another question is how to resolve the unequal competition among commercial banks mentioned above? In particular, how to make customers and the public understand the phenomenon that when they wish to exchange e-CNY at the bank where they hold an account, it is the operator, instead of the bank, that provides them with e-CNY? Personally, I don’t approve of this model.
2) Digital wallets
There are two ways to operate digital wallets:
First, an operator can act as a producer and wholesaler of digital wallets and sell them to commercial banks. The latter then distribute digital wallets to their own customers. In this case, relations are rather straightforward.
Second, commercial banks report information of clients who demand digital wallets to their partner operators and the latter will then review and provide clients with digital wallets. This also brings about problems, for example, how to ensure fair competition among commercial banks, and how commercial banks that are not operators can win customers’ trust about their reputation and service capabilities. If clients are required by the operator to have their digital wallets bound with deposit accounts opened by the operator, competition between commercial banks will become even acuter. Further, if operators are allowed to manage clients’ digital wallets, conflicts between themselves, commercial banks and clients will only intensify.
2. Functional boundaries
Regardless of the model of operation, operators have to run the digital wallets. The opening of a digital wallet must be based on a real-name system. The verification and the archiving of customer information can be undertaken by either account opening banks or operators, which should be feasible technically.
If this is yet impractical technically, and customer information must be kept by the operator that provides a digital wallet, that is, the operator becomes the manager and bearer of risks associated with the wallet, the issue of operator’s functional boundary arises. First, an operator can only be a service provider, not a business provider at the same time, which means the operator should not provide commercial banking services in addition to digital wallet services; second, the operator’s system, accounting, data and management must be completely separate from its parent bank.
3. Revenue sources for operators
Operators must have reliable sources of revenue to continuously provide services. If an operator is to act as an agent of the PBC to issue e-CNY to commercial banks, an agency fee can be charged from the PBC; the operator can also obtain interest spread income through the funds in the reserve accounts opened by commercial banks. If an operator acts as a producer and wholesaler of digital wallets, it can charge fees for digital wallet wholesaling and future operation and maintenance fees from commercial banks. If an operator directly provides digital wallet services to clients, and commercial banks only play a role of channeling client resources, then the service of digital wallets and e-CNY has nothing to do with commercial bank accounts, in which case commercial banks have no reason to bear the costs related to digital wallets and can even charge the operator a fee for customer acquisition. In theory, operators can charge digital wallet holders fees, but it may not work in practice.
The operator is an important infrastructure for the issuance and circulation of e-CNY. It requires huge and continuous technical and financial investment, and a sound return arrangement. A more plausible model would be that operators empower commercial banks rather than serving clients directly, and accumulate financial resources for continuous operation through the latter’s consolidated income.
IV. DIGITAL WALLETS
Once a physical wallet is sold to the consumer, it no longer has relations with the producer and seller. Although the producer may have designed many functions for the wallet, it no longer cares or has no right to care about how a consumer uses the wallet. But it is a different story with digital wallets. After customers open digital wallets, the operation and maintenance of digital wallets, and functional upgrades still require services provided by producers. This also brings a series of problems, which need to be resolved through pilot programs so as to ensure a sound institutional arrangement when e-CNY is officially launched.
1. Management of digital wallets
Due to its particularity, digital wallets must be based on a real-name system, which is not just to mark the holder's name, but to establish a corresponding relationship between the holder and the digital wallet in the background. This will inevitably bring about a management problem, that is, the managers of digital wallets are not only digital wallet holders, but also operators that enable customers to open a digital wallet. Under certain models, it may also involve account opening banks.
There is no doubt that holders can freely manage their own digital wallets, but where are the boundaries for the management of operators? Do they have the right to govern the holder's use of digital wallets, including e-CNY in the wallet? What about personal privacy and data security? Now people are rather concerned about these issues. If the operators can restrict or control the consumption behavior and payment behavior of digital wallet holders, then a monopolistic practice of “choosing one from two” once adopted by platform companies in previous years may emerge, giving a painful blow to the issuance and circulation of e-CNY.
From the payment scenarios that have been piloted, digital wallets can be used to make payments to any payable scenario, and in turn, a digital wallet can also accept payments from another digital wallet. Technically speaking, digital wallet holders can withdraw deposits from any of their bank accounts and exchange them for e-CNY, or they can deposit e-CNY in their digital wallets to their deposit accounts. Under such technical conditions, is it still necessary to force customers to bind a deposit account when opening a digital wallet? The digital wallet itself is based on a real-name system, so it does not need to be bound with a deposit account to verify the authenticity. Of course, if customers choose to bind their digital wallets with a deposit account, banks must meet such requirements.
2. Application and management of smart contract technology
An important technology related to e-CNY and digital wallets is programmable technology, namely smart contract technology.
However, this technology also has a number of problems yet to be addressed. First, should we apply smart contract technology to e-CNY, or digital wallets, or bank accounts? Which case is better? When a certain amount of e-CNY is locked by a smart contract, the targeted transaction contract can be safely executed. However, it leads to the question that whether this locked or restricted e-CNY still is a general equivalent. At the same time, when a certain amount of money is locked by a smart contract, it is temporarily withdrawn from circulation and becomes hoarded money. What impact will it have on the issuance and management of currency, as well as the formulation of monetary policy? This is another issue that pilot programs should be especially concerned. If the smart contract is applied to digital wallets, hoarded money will still be a problem. Applying the smart contract technology to bank accounts may be feasible as it is equivalent to using smart contract technology to supervise deposit accounts. In this way, while transaction contracts can be executed, the money can remain in circulation.
The second question is who has the right to write and terminate the program? What procedures are involved in the programming? First, the two parties involved in a transaction will need to program; the second will be the operators and banks related to the e-CNY and digital wallets in transaction. For the payer, that is, the owner of e-CNY, if the currency in hand can be programmed by others, it means that all of their money can be controlled by others. For the payee, it is difficult to guarantee that the transaction contract can be strictly enforced if the payer programs it themselves. If a third party, such as an operator, is allowed to program, strict systems and procedures are required, and a three-party contract needs to be signed on top of the smart contract programmed. In this case, it must be strictly stipulated that the operator has no right to program beyond the entrustment of the payer and the payee. A lack of strict stipulations on the use of programmable technology can cause chaos in the circulation of e-CNY.
