Digital Renminbi: A Fiat Coin to Make M0 Great Again

Dovey Wan is a partner at Primitive Ventures, a crypto asset investment fund.

Contrary to what many think, China does not oppose blockchain technology.

Rather, it takes issue with bitcoin and other privately issued cryptocurrencies, which it fears may facilitate financial fraud and capital flight. The People’s Bank of China (PBOC) has, in fact, had an initiative for issuing a blockchain-based digital renminbi (RMB) since 2014. The project has already generated 71 patents and has initiated a trial operation for an interbank digital check and billing platform.

If successful, this digital RMB project could expand the central bank’s influence over both the domestic and international economy. It has broad implications for the geopolitics of money and for the future of private cryptocurrencies such as bitcoin. To understand the PBOC’s motives, we must first distinguish between the digitalization of fiat currency and digital fiat currency. They are not the same thing. Each has a very different impact on the money supply and on the power balance between central banks and commercial banks.

The digitization of currency, which stems from the advent of electronic payment/clearance and mature interbank IT systems, allows commercial banks to more efficiently and independently generate the credit flows that expand broad
money supply, or M2. By contrast, digital fiat currency, enabled by blockchain technology, affects the base currency measure known as M0.

Traditionally, central banks directly control base money creation/destruction but have only indirect power over the broader, credit flow-driven monetary supply. Now, with digital fiat currency, they have the potential to bypass commercial banks and regain control of currency creation/supply end to end, thereby structurally centralizing their power in policymaking.

The PBOC’s interest in this solution comes as highly advanced digital payment systems like Alipay and WeChat have created a cashless and cardless economy. This is a form of currency digitalization, built upon a network of commercial bank accounts, operating at the M2 level of money supply.

By contrast, a digital RMB would be integrated into M0, thus restoring control and influence to the PBOC. As the Vice President of PBOC Fan Yifei put it in a public interview: “With the help of technology innovation, we can gradually transit into issuance and circulation of digital RMB and impose effective supervision of in the private sector.”

High M2 supply and massive shadow banking

From 2007 to 2017, China’s M2 supply grew from 40 trillion RMB to 170 trillion RMB ($25.5 trillion), with an average annual growth rate of 15%, far outpacing the 10 percent nominal GDP growth rate over the same period. This massive expansion is largely due to the excessive issuance of commercial bank loans, primarily for real estate development, local governments’ infrastructure projects, and state-owned enterprises.

It has led to a highly leveraged banking system and left a huge debt risk hanging over the Chinese economy.

What’s more, the measurement of M2 underestimates the real currency growth rate in China due to shadow banking. High-yield “wealth management products” and structural deposits offered by banks, as well as internet financing such as P2P lending, make up a separate financial industry that’s worth 70 trillion RMB.

Wealth management products alone have grown from a 0.5 trillion RMB industry in 2007 to a whopping 30 trillion in 2017. These are not counted as M2 and are often hard to track due to their being hidden from bank balance sheets, making it even harder for the PBOC to manage the Chinese economic cycle. Current attempts to address the problem largely consist of more stringent reporting and regulation, but this merely chases behind the problem rather than stamping it out.

To get ahead of it requires a new financial system altogether. That’s what’s intended with the Digital RMB, a project that’s conceived of as a means of reasserting monetary control in the interests of financial stability.

Design methodology

While the PBOC is still considering different possibilities for network design, it seems likely to be a permissioned network in which nodes are controlled by the PBOC and major Chinese banks. This suggests transactions will be visible to the banks and government, but not to the public.

According to Yao Qian, the head of PBOC Digital Currency Research Center, the designated PBOC digital currency system has a few key elements:

• A PBOC-managed private cloud as the IT infrastructure
• A database on the private cloud to allow the PBOC to exercise full control over monetary issuance and ledger management
• A reserve database accessible by commercial banks, which can either reside on the PBOC private cloud or on banks’ own private cloud
• A digital RMB wallet client, published and maintained by the PBOC that’s used by all entities and individual
• A verification center where the PBOC can manage institutional and user identity information
• A registration center which records the registration of currency ownership and keeps the ledger of digital currency generation, circulation, and inventory management
• A big data analysis center used for anti-money laundering, payment behavior analysis, and analysis of regulatory signals.

Some might wonder why blockchain or distributed ledger technology (DLT) is needed at all if nodes are not highly decentralized. The answer is that a blockchain model offers a better coordination paradigm compared to traditional currency supply management, which is heavily dependent on bookkeeping. Blockchain’s tamper-proof nature and private-key cryptography prevent false transactions and counterfeiting, while also making it much easier for the PBOC to manage the circulation flow.

Domestic impacts and beyond

The issuance of a digital RMB will not only make cash and coinage obsolete (which is already happening in China), but also make commercial banks and M2 easier to control. It means the PBOC can more effectively control and regulate an
overextended debt market. Thanks to blockchain’s traceability and programmability, it will become much more difficult to hide banking products and services from balance sheets.

This also allows for easier execution and more accurate assessment of monetary policy, and makes the measurement of currency supply, circulation speed, currency multipliers, and distribution much more accurate. PBOC can write rules at the code level regarding where digital RMB can and cannot flow to. If it wants to cool down the housing market, for example, it can simply set a program preventing digital RMB from entering the real estate sector.

As for policing individuals, a person’s spending history and assets balance are immediately evident on the blockchain, making it much easier to accurately assess creditworthiness, detect money laundering, and prevent tax evasion and capital flight. This is, of course, is likely to strengthen privacy advocates’ already mounting criticisms of China’s social credit score model, It’s not clear that such criticism is having any influence over the government’s thinking on such matters, however.

A digital RMB could even strengthen China’s influence overseas. If the One Belt One Road initiative succeeds, a digital, borderless, stable currency could facilitate international trade among its 60-plus member countries. This, coupled with the fact that China is the biggest creditor to Venezuela and it holds over 14 percent of African countries’ sovereign debt, would position it to offer a digital RMB as the next reserve currency of emerging-market economies.

This would require those countries to confer to China some degree of influence over their monetary conditions. Would they prefer that to their current dependency on the U.S. Federal Reserve’s dollar?

It’s an open question. But it will be highly synergetic with China’s rigorous effort of de-dollarization: reducing US dollar asset in both its foreign exchange reserve, largely increasing its gold reserve and selling off US Treasury debt. Either way, these moves could increase tensions between US and China and might even force the U.S. to pursue a similar digital model for the dollar.

We still have a little time before such questions become pressing. Even so, change is coming. According to people working on this initiative, adoption will come with a great deal of observation and adjustment over the course of 10 years or more, with experiments in various use cases starting in “special economic zones” like the city of Shenzhen. Eventually, the plan is to use incentives such as increasing the transaction cost of cash to push people towards using digital currency.

Cash is expected to disappear almost entirely.

The next question is: what does this mean for private, decentralized cryptocurrencies such as bitcoin?

It may seem incongruous that blockchain technology, initially introduced under the ethos of censorship-resistance, is now being used by central banks to further centralize their financial power. But from the perspective of the Chinese government, it’s not hard to see why. Over the long term, a digital RMB has the potential to make global trade more efficient and money laundering more difficult.

Yet, given worldwide concern over surveillance by centralized institutions – both public and private – and the perennial risk that monetary policy mismanagement could foster a currency collapse akin to the Venezuelan bolivar, there’s no reason to believe such programs will kill private cryptocurrencies. On the contrary, it could boost demand for them. Anonymous, non-sovereign currencies like bitcoin or privacy coins become increasingly important in an environment where government money is closely surveilled and controlled.

What’s more, a programmable fiat digital currency could provide a seamless fiat-to-crypto on-ramp. Ironically, projects such as China’s, in which governments aim to concentrate control over money, could foster greater competition from private systems of money such as bitcoin.

Yuan and dollar image via Shutterstock