Promise of virtual money

Central bank digital currencies would transform the global monetary and financial systems

From big data, artificial intelligence to cryptography, rapid advances in financial technologies are generating a dazzling array of new financial products and services, changing how we make payments, manage our wealth and process financial information. The world may now be approaching a historic turning point where the basic forms of money are reshaped.

The 2008 global financial crisis and the subsequent unconventional monetary policies cast doubts on the credibility of existing fiat currencies and their supporting banking institutions. The erosion of trust in the current global monetary environment has stimulated the rapid development of private cryptocurrencies. Applying blockchain technologies, cryptocurrencies enable decentralized transactions and payment clearing with anonymity. They can reduce transaction costs and strengthen data security and privacy. More than 1,000 cryptocurrencies of various types have mushroomed around the world.

However, operating outside regulated financial intermediaries and the monetary supervision of central banks, cryptocurrencies are intrinsically risky and prone to illicit activities such as money laundering. With extremely volatile pricing, crypto assets are not yet able to fulfill the core functions of money as a unit of account and store of value. Their use as a medium of exchange remains limited as well.

Despite these weaknesses, the underlying financial technologies for cryptocurrencies are rapidly evolving. It is possible that more sophisticated forms of cryptocurrencies will emerge in the future, eventually challenging the dominance of fiat currencies and traditional financial institutions. As Christine Lagarde, former managing director of the International Monetary Fund, pointed out, the best response for central banks to such potential competition would be to run effective monetary policy while being open to fresh ideas and new demands as economies evolve.

In this context, central banks issuing digital currencies would be an important financial innovation. While taking advantage of new digital financial technologies, a central bank digital currency would be issued by the state and backed and regulated by the public authorities. With similar benefits in reducing transaction costs and fostering financial inclusion, they still operate under the supervision and safeguards of central banks and can prevent illicit activities with the stronger capability of the central bank to track transactions.

Many central banks have started to explore the possibility of developing digital currencies. A survey conducted by the Bank of International Settlements last year shows that some 70 percent of the responding central banks were engaged in or would soon start digital currency work. As early as 2014, China started research on the feasibility of introducing a central bank digital currency while strengthening regulations on cryptocurrencies. The central banks of countries including Canada, the United Kingdom, Japan, Sweden and Switzerland as well as the European Central Bank have joined forces this January to assess the potential cases for central bank digital currencies in their home jurisdictions.

The development of a central bank digital currency is open to different designs. The most viable designs will likely be based on an effective public-private partnership which combines private sector innovation and flexibility with public sector supervision and authority. In China, digital currency experiments build the highly innovative private sector internet and mobile payment ecosystems. During the past decade, driven by private sector innovations, China has achieved phenomenal success in digitalizing its payment systems to improve connectivity and enhance financial inclusion. According to the People's Bank of China, China's central bank, over 82 percent of adults in China made payments by digital means in 2018, with around 72 percent of adults in rural areas doing so. Most Chinese consumers are now well accustomed to scanning QR codes to complete transactions.

The new central bank digital currency in China will not replace deposits held in bank accounts and balances held in private sector platforms such as Alipay and WeChat Pay, but it will provide a more efficient way for banks and platforms to settle payments than the existing clearing system. Starting with pilot programs, the planned digital currency infrastructure will further upgrade the technical efficiency and regulatory effectiveness of China's existing payment ecosystems. With stronger security and compliance standards, it will enhance the regulator's capability to monitor the flow of funds and fight against illicit activities.

If the trials of the central bank digital currency prove successful, money in its new incarnation will transform the financial system, enabling safer, more convenient and trustworthy transactions for domestic economies. Moreover, if countries widely launch central bank digital currencies in the future, it will likely have profound impacts on how international transactions are settled as well, rendering the global monetary system less dependent on US-dollar clearing. At the forefront of digital innovations, China's digital currency experiments will undoubtedly contribute new public products and experience to this global transformation.