This article was written by Rocky Lee, Stanley Zhou, Andrew Fei.
China's central bank – the People's Bank of China (PBOC) – has successfully completed a trial of a blockchain-based digital currency prototype system, taking it one step closer to becoming one of the first major central banks to issue its own digital currency. The PBOC also plans to officially launch a digital currency research institute. In light of these recent developments, this article explores the digitization of China's currency, the Renminbi (RMB) and its implications.
In recent years, RMB internationalization has become a hot topic in finance circles and beyond. As China emerges to become a global leader in financial technology (fintech), the digitization of the RMB puts it one step ahead of other global currencies.
This not so discreet upgrade of China's domestic and cross-border RMB payment systems can have global implications as it not only significantly accelerates the internationalization of the RMB but will have far reaching implications for global commerce, other virtual currencies, regulatory compliance and cross-border payment platforms.
China's Digital Economy
China has over 730 million internet users[1], more than the U.S.[2] and Europe Union[3] combined. To put this in perspective, one in five internet users in the world is Chinese. And we expect to see further internet penetration in China. Right now, slightly over half of China's population has internet access,[4] compared to nearly 90% in the United States.[5]
For those 730 million (and increasing) Chinese internet users, online payments, e-commerce and digital financial transactions have become ubiquitous and modern China is fast becoming a cashless society. Interestingly China has done this by leap-frogging the plastic credit card with China trailing far behind the U.S. on credit card issued and usage on a per capita basis.
China's online and mobile payments totaled 2172.6 trillion RMB (USD 315.69 trillion) in 2015, up 53% from the previous year. [6] In 2016, Alibaba's Singles Day shopping festival (which took place on 11 November) generated over US$17.8 billion of online sales in just 24 hours, with 82% of those sales completed on mobile devices.[7]
On the policy front, China's economic blueprint for the next five years – the 13th Five Year Plan – is littered with references to and action items centered around the digital economy, ranging from Internet Plus to big data, fintech, 5G technology and the internet of things (IOT).[8] In October 2016, China's Ministry of Industry and Information Technology (MIIT) published the country's first official whitepaper on blockchain technology.[9] The whitepaper identified finance (including digital currencies) as one of the first areas of application for blockchain. Furthermore the whitepaper explored the use of blockchain technology in the areas of manufacturing, communications, health, education, IOT, social welfare, entertainment philanthropy as well as culture. And in January 2017, the first China Fintech Innovation Conference was held in Beijing. [10] The conference was attended by senior officials from the PBOC, China's financial regulators and major Chinese financial institutions.[11]
Against the backdrop of China's vast and rapidly growing digital economy, it is not difficult to imagine the emergence of RMB as a major digital currency.
Steps Taken by the PBOC
In as early as 2014, the PBOC established a research team dedicated to exploring the issuance of digital currency and related technological, operational and legal issues, the impact of digital currencies on existing economic and financial systems, and the relationship between digital legal tender and privately-issued digital currencies.[12]
In January 2016, the PBOC announced that it was exploring the prospect of issuing its own digital currency in the "near future".[13] The PBOC noted that a digital currency can reduce the high costs associated with issuing and circulating traditional paper currencies; improve the convenience and transparency of economic transactions; reduce the occurrence of money laundering, tax evasion and other unlawful acts; enhance the PBOC's oversight of money supply and currency circulation; and improve financial inclusiveness. [14] According to the PBOC, the issuance and circulation of digital currencies would also help China build an entirely new financial infrastructure, further improve China's payment systems and enhance the efficiency of payments and settlements.[15]
In September 2016, various departments within the PBOC published a series of working papers on digital currency, which analyzed and discussed topics such as developmental path, prototype conception, choice of underlying technology, impact on monetary policy and key legal issues. [16]The working papers represent the furthering of interim consensus amongst the PBOC departments and helped establish a basis for the future issuance of digital currency.
Significantly, in late 2016, it was reported that the PBOC successfully completed a trial of a blockchain-based trading platform for digital bank acceptance bills.[17] The issuance and settlement of a digital currency issued by the PBOC were also tested on this platform. The PBOC's digital legal tender prototype system – "Demo" – could also be launched as soon as this year.[18]
Digital Legal Tender
The PBOC Vice Governor Mr. FAN Yifei has drawn a distinction between digital legal tender issued by central banks, on the one hand, and privately-issued digital currencies on the other.[19] He noted that the shortcomings of privately-issued digital currencies include volatility, limited creditworthiness and limited acceptance. Accordingly, he argues it is critical for central banks to issue digital legal tender because it would be backed by sovereign credit and can be used in both online and offline transactions with greater scope, convenience and security.[20]
Impact on Bitcoins
The PBOC has issued rules and regulations in an attempt to regulate digital currencies and its exchanges.
Regulations promulgated by the PBOC and other Chinese regulators classify Bitcoin as a virtual good that does not have the same legal status or features (such as mandatory acceptance) as legal tender and should not be used as a currency. [21]
The PBOC's preference for central bank issued digital legal tender can be seen in Chinese regulators' recent crackdown on the usage and exchange of Bitcoin, a privately-issued digital currency.[22] Over the past 6 months, RMB exchanges represented nearly 98% of all Bitcoin transactions around the world.[23]
In early January 2017, PBOC's Shanghai headquarters and the Shanghai Municipal Finance Office met with executives from a Chinese Bitcoin exchange, reminding them about potential risks and requiring them to strictly comply with relevant laws and regulations.[24]
In late January 2017, PBOC's operations management department and the Beijing Municipal Bureau of Finance conducted on-site inspections of Beijing-based Bitcoin exchanges and decided to conduct further reviews focusing on anti-money laundering, foreign exchange management, payments and settlements as well as information and financial security. [25]
In February 2017, PBOC's operations management department met with nine Beijing-based Bitcoin exchanges, warning them that serious violations of anti-money laundering, foreign exchange management, tax or payments and settlements laws and regulations may result in closure of a Bitcoin exchange.[26] In response, several Chinese Bitcoin exchanges announced that they will suspend withdrawals of the virtual currency. [27]
Operational Model
Vice Governor Fan has identified two alternative models for issuing digital legal tender.[28] First, the central bank can directly supply digital legal tender to the public, and oversee all related issuance, circulation and maintenance services. Second, the central bank can issue digital legal tender to commercial banks, which would then provide deposit and withdrawal services to the public. The second approach is the model used for issuing and circulating paper legal tender.
Vice Governor Fan has stated that the PBOC is inclined to use the second model because using the existing model would make it easier for digital legal tender to gradually replace paper money. [29]This approach would also encourage commercial banks to actively participate in the issuance and circulation of digital legal tender, which results in appropriate risk sharing, fosters innovation, and better serves the public and the real economy. Indeed, the PBOC's recent trial of its digital currency on the digital bank acceptance bills platform involved major State-owned and privately-owned commercial banks in China.
Key Issues
In their working papers, the PBOC departments argue that it is important to carefully consider the following key issues relating to the design and creation of digital legal tender in China:
Mandatory Acceptance of Legal Tender: The Regulation on the Administration of RMB ("RMB Regulation") provides that no entity or individual may reject the RMB as payment for any public or private debt within the People's Republic of China. Digital lender tender issued by the PBOC is expected to enjoy the same legal status as physical RMB. But at the same time, digital legal tender is unique because its acceptance may require special electronic equipment and networks. This has given rise to some views that the mandatory acceptance provision in the RMB Regulation should be conditional until the recipient has actual capacity to accept digital legal tender. A working paper written by the deputy director general of PBOC's legal department argues that the authority and legal stability of legal tender means its mandatory acceptance should not be subject to this type of general condition.[30] Instead, the PBOC is now leading efforts to amend the RMB regulation to improve the inclusiveness of legal tender and to grant specific exemptions from the mandatory acceptance of digital legal tender in certain limited circumstances.
Online and offline usage: The issuance and circulation of digital legal tender should support both online and offline transactions. To implement this from an operational perspective, different standards, specifications and processes may need to be in place for online and offline use. [31]
Convenience and security: In order to improve efficiency and convenience, it may be necessary to distinguish between large-sum and small-sum transactions and impose different levels of safety and security related measures. [32]
Anti-money laundering (AML): If PBOC issues its own digital legal tender, there would need to be significant changes to the types of entities tasked with carrying out AML compliance obligations. The existing AML regime primarily imposes AML compliance obligations on financial institutions and certain non-financial institutions. However, many transactions involving digital legal tender would be "point-to-point" transactions that do not go through any financial institution and take place outside the traditional financial system. Therefore, regulators would need to identify new entities to carry out AML compliance obligations.[33]
Identity and anonymity: Without doubt identity management can facilitate the oversight of digital legal tender and the detection of money laundering, tax evasion and other unlawful acts. On the other hand, it may disincentive use under certain circumstance, especially for small-sum transactions. The PBOC is considering an approach of requiring only voluntary disclosure of identity for front-end transactions and mandatory use of real identity for back-end management (such as initial account opening) controlled by the central bank to ensure the traceability of digital legal tender.[34]
The PBOC's new digital currency research institute will be exploring these and other operational, technological and legal issues associated with issuing digital legal tender.
Looking Ahead
Issuing digital legal tender can be challenging for any economy, let alone one as large and populous as China's. As the Chinese economy enters the "New Normal" of single digit GDP growth and a period of significant economic transition, maintaining financial, economic, social and political stability are paramount considerations.
Accordingly, Chinese regulators will take a cautious and prudent approach in this area. They will want to ensure every perceivable risk is adequately addressed and all systems are appropriately tested before fully introducing digital legal tender in China. We can also expect to see a step-by-step implementation approach involving further tests and trials, pilot programs that expand in scope over time and an extended transition period during which both digital and paper legal tender are in circulation.
Having said this, China's ability to implement and advance extremely complex systems and solutions in a timely manner should not be underestimated and, as is the case with every other aspect of China's digital economy, there are enormous commercial opportunities associated with the development, issuance and usage of digital legal tender in China.
Digital currencies also have a tendency to transcend national borders. A successful digital RMB can help promote the usage of China's currency in cross-border trade, investment and finance. Eventually, we expect RMB digitalization to be closely intertwined with RMB internationalization and could easily be a significant catalyst for its acceleration. This may mean a cross-border disruption of numerous existing payment platforms such as the ACH and the SWIFT.
If the RMB can successfully become the first sovereign backed digital currency, then we might see a disruption to the very same blockchain-based Bitcoins that started the digital currency revolution. What will become of Bitcoins but for those dark-ally transactions requiring anonymity and secrecy? This is not to say that Bitcoin will no longer serve a purpose but one can argue that many of the virtues expounded by its advocates will one day become available with a sovereign-backed digital currency.
In the meantime, we will continue to keep you updated on key developments in this area.
[1]The 39th China Internet Development Statistics Report, from China Internet Information Center, available at http://www.cac.gov.cn/wxb_pdf/39CNNIC.pdf
[2]TOP 20 COUNTRIES WITHTHE HIGHEST NUMBER OF INTERNET USERS, from Internet World Stats, available at http://www.internetworldstats.com/top20.htm
[3]Internet Usage in the European Union, from Internet World Stats, available at http://www.internetworldstats.com/stats9.htm
[4]The 39th China Internet Development Statistics Report, from China Internet Information Center, available at http://www.cac.gov.cn/wxb_pdf/39CNNIC.pdf
[5]TOP 20 COUNTRIES WITHTHE HIGHEST NUMBER OF INTERNET USERS, from Internet World Stats, available at http://www.internetworldstats.com/top20.htm
[6]China Payment & Clearing Industry Operational Report, from Payment & Clearing Association of China, available at http://www.pcac.org.cn/file/File/1463712430.pdf
[7]Singles' Day Sales Scorecard: A Day In China Now Bigger Than A Year In Brazil, from Forbes, available at http://www.forbes.com/sites/franklavin/2016/11/15/singles-day-scorecard-a-day-in-china-now-bigger-than-a-year-in-brazil/#22c114af29d0
[8]The Thirteenth Five-Year Plan for National Economic and Social Development of the People's Republic of China (中华人民共和国国民经济和社会发展第十三个五年规划纲要), available at http://news.xinhuanet.com/politics/2016lh/2016-03/17/c_1118366322.htm
[9]China Blockchain Technology and Application Development (2016), from China Blockchain Technology and Industry Development Forum, available at http://chainb.com/download/%E5%B7%A5%E4%BF%A1%E9%83%A8-%E4%B8%AD%E5%9B%BD%E5%8C%BA%E5%9D%97%E9%93%BE%E6%8A%80%E6%9C%AF%E5%92%8C%E5%BA%94%E7%94%A8%E5%8F%91%E5%B1%95%E7%99%BD%E7%9A%AE%E4%B9%A61014.pdf
[10]The First China Fintech Innovation Conference and the Tenth China Internet Finance Annual Meeting were held in Beijing, from Xinhua News, available at http://news.xinhuanet.com/city/2017-01/05/c_129433623.htm
[11]he First China Fintech Innovation Conference and the Tenth China Internet Finance Annual Meeting successfully completed, from Internet Society of China, available at http://www.isc.org.cn/zxzx/xhdt/listinfo-34876.html
[12]PBOC Convened a Digital Currency Forum in Beijing, from the People's Bank of China, available at http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3008070/index.html
[13]PBOC Convened a Digital Currency Forum in Beijing, from the People's Bank of China, available at http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3008070/index.html
[14]PBOC Convened a Digital Currency Forum in Beijing, from the People's Bank of China, available at http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3008070/index.html
[15]PBOC Convened a Digital Currency Forum in Beijing, from the People's Bank of China, available at http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3008070/index.html
[16]China Finance No. 17, 2016, available at http://www.cnfinance.cn/
[17]PBOC Successfully Completed a Trial of the Prototype System of Digital Bill Trading Platform, from Caixin, available at http://finance.caixin.com/2017-01-25/101048999.html
[18]The Digital Currency System of PBOC will be Introduced Next Year, from China Economic Times, available at http://www.cet.com.cn/yhpd/yhfb/1879856.shtml
[19] The Theoretical Basis and Structure Choice of China Statutory Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24314.html
[20]The Theoretical Basis and Structure Choice of China Statutory Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24314.html
[21]Notice of PBOC, MIIT, CBRC, CIRC on precaution of Bitcoin risk (中国人民银行 工业和信息化部 中国银行业监督管理委员会 中国证券监督管理委员会 中国保险监督管理委员会关于防范比特币风险的通知), 2013
[22]Statement by PBOC Shanghai Headquarters, available at http://shanghai.pbc.gov.cn/fzhshanghai/113571/3230012/index.html
[23]Bitcoin trading volume, available at http://data.bitcoinity.org/markets/volume/6m?c=c&t=bar
[24]Statement by PBOC Shanghai Headquarters, available at http://shanghai.pbc.gov.cn/fzhshanghai/113571/3230012/index.html
[25]Statement by PBOC operations Office, available at http://beijing.pbc.gov.cn/beijing/132005/3245162/index.html
[26]Statement by PBOC operations Office, available at http://beijing.pbc.gov.cn/beijing/132005/3248926/index.html
[27] Precaution of Illegal Behaviors by Bitcoin, from OKCoin China, available at https://www.okcoin.cn/t-2505271.html
[28]The Theoretical Basis and Structure Choice of China Statutory Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24314.html
[29]The Theoretical Basis and Structure Choice of China Statutory Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24314.html
[30]The Legal Issue of Digital Currency issued by PBOC, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24311.html
[31]The Conception of China Legal Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24313.html
[32]The Conception of China Legal Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24313.html
[33]The Legal Issue of Digital Currency issued by PBOC, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24311.html
[34]The Conception of China Legal Digital Currency, from China Finance, available at http://www.cnfinance.cn/magzi/2016-09/01-24313.html
