A full analysis of DC/EP
By DR.Zou Chuanwei, the Chief Economist of HashKey Group
The PBoC has no official document to elaborate systematically on DC/EP design. Several high-level officials, including former governor ZHOU Xiaochuan and current governor YI Gang, have discussed DC/EP in their public speeches and writings. After combing and comparing information from those public channels, I believe DC/EP should have the following key characteristics：
1.The aim of DC/EP is to replace M0.
DC/EP is backed 1:1 by deposit reserves, it doesn’t gernerate interest, and undertakes no social or administrative functions other than the four functions of money, i.e. unit of value, medium of exchange, method of payment and store of value.
To ensure that the issuance and redemption of DC/EP don’t impact the aggregate amount of central bank money, there is an equivalent exchange mechanism between deposit reserves and DC/EP.
In issuance operations, the PBoC reduces deposit reserves and issues the same amount of DC/EP. In redemption operations, the PBoC increases deposit reserves and destroys the same amount of DC/EP.
In redemption operations, the PBoC increases deposit reserves and destroys the same amount of DC/EP.
2. The circulation of DC/EP follows the traditional 2-tier system of the central bank and commercial banks.
The PBoC issues DC/EP to commercial banks in a wholesale approach. Commercial banks then distribute DC/EP to the public for retail use. The PBoC works with commercial banks to ensure the normal operation of DC/EP.
3. DC/EP takes the form of an encrypted numeric string representing a specific amount of money and guaranteed by the PBoC.
It contains a serial number, amount, owner and issuing bank signatures etc. The serial number is a unique identification and unrepeatable and can be used as an index of DC/EP. DC/EP is programmable and can incorporate any user-defined executable script.
4. The registration center and verification centers of DC/EP.
The registration center records all DC/EPs and corresponding owners. It also records all DC/EP transactions, including the whole life cycle of issuance, circulation, and redemption. It is basically a digital coinage center and built in a traditional centralized approach. The certification center plays an important role in the “controlled anonymity” of DC/EP. For example, PKI (Public Key Infrastructure) can be used for authentication of financial institutions or high-end users, while IBC (Identity Based Cryptography) can be used for authentication of low-end users.
5.Loose account coupling and centralized management model
DC/EP transactions almost do not rely on accounts so DC/EP can circulate as easily as cash and can achieve “controlled anonymity”. “Controlled anonymity” means that DC/EP only discloses transaction information to the PBoC. Without the permission of DC/EP users, even if commercial banks and merchants work together, they still can’t discover the true identity of DC/EP users or trace their transaction history. DC/EP can expand the use of RMB abroad and promote RMB internationalization. In contrast, bank cards and Internet payment follow the “tight account coupling” model.
6. Distributed ledger technology (DLT) is not used in the registration center
In DC/EP, DLT may be used to verify the authenticity of DC/EP, providing an Internet website for external inquiries. It thus functions like an online DC/EP verification machine. This design brings two benefits. On the one hand, the registration center is securely isolated from external attacks, while DLT improves verification efficiency. On the other hand, DC/EP transactions are not processed by DLT, thus avoiding the efficiency bottleneck of DLT.
7.System independence.
DC/EP is universally flexible. It can be transacted in all kinds of payment methods, channels and platforms and is compatible with existing financial infrastructures. In theory, whatever payment network boundary can bank deposits and electronic money reach, DC/EP can reach too.
The Design of DC/EP
Judging from the above information, I think DC/EP does not use blockchain.Although DC/EP is not token inside blockchain, it shares the following features with token: No “double spending”, anonymity, unforgeability, security, transferability, divisibility and programmability etc. Therefore, DC/EP still belongs to the token model rather than the account model. At the core of DC/EP is its registration center. This center is managed by the PBoC in a centralized approach and does not need to run any consensus algorithm. So, it can be highly efficient. In DC/EP, blockchain may be used in the online verification system, therefore taking a supporting role.
Based on the DC/EP prototype system, I make the following inference on the design of DC/EP:
DC/EP uses a centralized ledger based on the UTXO model
This centralized ledger is embodied in the DC/EP registration center. Of course, like DLT, this centralized ledger can be structured via Hash functions and Merkel trees. But that will not make much difference because it is managed by the PBoC. More importantly, the credibility of the PBoC is significantly higher than that of commercial banks and other private institutions, so it is unnecessary to introduce DLT as a decentralized trust mechanism. I consider the centralized ledger based on the UTXO model as a “degraded” blockchain with only one node.
DC/EP wallets
User need to have DC/EP wallets to own and use DC/EP. At the core of DC/EP wallets is a pair of public and private keys. The public key is also the address where the digital representation of RMB is stored. Users can see the addresses of other users, but don’t necessarily know the true identity of address owners. The corresponding relationship between addresses and user identity is known only by the PBoC through a KYC process. But KYC can be far from a strong real-name system.
DC/EP transactions
Users can initiate address-to-address transactions with their private keys. Unlike on-chain token transactions which are first broadcast to a peer-to-peer network, then packaged by miners into blocks and become blockchain consensus, DC/EP transactions are processed directly by the PBoC in the centralized ledger.
DC/EP’s Impacts on Payment
Figure 5 shows flow of funds in DC/EP:
Figure 6 shows DC/EP’s impacts on the balance sheets of the central bank, commercial banks and users.
I study the scenarios of DC/EP issuance and redemption on the wholesale side, and DC/EP deposit and withdrawal on the retail side.
In Figure 6, drr stands for deposit reserve ratio. The middle of Figure 6 shows the scenario when the PBoC issues A units of DC/EP to a commercial bank, the deposit reserve falls by A (A<0 indicates redemption). The right side of Figure 6 shows the scenario when a user withdraws B units of DC/EP, his deposits in the commercial bank fall by B (B<0 indicates DC/EP deposit).
As can be seen from Figure 6, DC/EP issuance and redemption only change the composition of M0 but keep its aggregate amount unchanged. DC/EP deposit and withdrawal lead to the two-way conversion between commercial bank deposits and DC/EP, which will then lead to the change in deposit reserves.
If we replace DC/EP in Figure 5 and 6 with cash, the two figures exactly show the circulation process of cash. This shows how the PBoC tries to minimize DC/EP’s impacts on the current monetary system.
From Figure 5 and Figure 7, it is easy to see that DC/EP shares lots of similarities with third-party payment after China’s “direct link disconnected” reform. At present, all user funds of third-party payment institutions in China are kept in the PBoC. I think this is already a type of synthetic CBDC based on the account model. If DC/EP does well enough in term of technical efficiency and business development, DC/EP should produce user experiences similar to that of third-party payment. This indicates that DC/EP and third-party payment may compete with each other in the future.
In addition, DC/EP and third-party payment share the following similarities:
•Both are aimed at retail users.
•Both are centrally managed and based on the 2-tier bank account system.
•Both have complex impacts on money supply and money multipliers.
•Neither DC/EP nor third-party payment balance pays interest to users
However, DC/EP are fundamentally different from third-party payment:
· They have very different implications regarding privacy protection. Third-party payment follows the tight account coupling model and is not anonymous. In contrast, DC/EP follows the loose account coupling model and achieves “controlled anonymity”.
· Third-party payment is a payment tool. Only users with the same third-party institution can make direct transfers between themselves. In contrast, DC/EP is a legal tender.
· DC/EP will help the PBoC to monitor flow of funds and enforce regulation such as AML, CFT, and anti-tax evasion. The programmability of DC/EP will lead to innovations in macroeconomic policy. In contrast, third-party payment mainly replaces payment tools such as bank cards and cheques and does not have much significance as macroeconomic policy tool.
DC/EP’s Monetary Impacts
This section analyzes DC/EP’s monetary impacts from three perspectives. First, DC/EP’s implications for monetary policy. Second, DC/EP’s impacts on RMB internationalization. Third, how the private sector can participate the development of DC/EP.
DC/EP’s Implications for Monetary Policy
DC/EP does not pay interest. The PBoC also has no plan to fully replace cash with DC/EP. Therefore, DC/EP will not become a new monetary policy tool. This is quite different from the scenario that CBDC fully replaces cash and pays interest. In that scenario, interest rate of CBDC will be a powerful monetary policy tool, which can transmit directly from central banks to the public and will not be constrained by zero lower bound (ZLB) of nominate interest rate.
Besides, the development of DC/EP, like that of third-party payment, will cause contraction of M2, which indicates the shrink of the commercial bank sector.
DC/EP’s Impacts on RMB Internationalization
DC/EP’s impacts on RMB internationalization are mainly through its impacts on cross-border payments. DC/EP will start a regime shift from the account model to the token model.
Before 2015, there were two main models of RMB cross-border payments, i.e. the correspondent bank model and the clearing bank model. In 2015, the PBoC launched CIPS (Figure 8).
CIPS serves as the “highway” for RMB internationalization, providing clearing and settlement services across time zones for cross-border and offshore RMB transactions. Those methods all follow the account model. To participate, foreign banks need to offer RMB services, and foreign users need to have RMB deposit accounts.
In contrast, DC/EP only requires users to have DC/EP wallets, which is much easier to have than to open RMB deposit accounts. DC/EP transactions are cross-border by nature. So, DC/EP can effectively promote the use of RMB abroad (Figure 9).
However, cross-border payments are only a necessary but not a sufficient condition for RMB internationalization. To be an international currency, RMB should be freely convertible, stable in value, extensively used in international trade, and widely accepted abroad. Besides, China’s financial market should be well regulated, mature and open. China should also forcefully enforce property rights protection.
The Private Sector’s Opportunities in the Development of DC/EP
At the core of DC/EP’s user interface is a pair of public and private keys. However, private keys, unlike traditional passcodes or passwords, are different to remember and manage. I think there will be DC/EP custodian and payment institutions in the future (Figure 10).
They will help users manage their private keys, using a combination of the account model and the token model. Users can send DC/EP to addresses of DC/EP custodian and payment institutions. In return, those institutions will give users a special account balance, which is essentially DC/EP IOU. Users can pay with DC/EP IOU. DC/EP IOU payment system can be highly integrated with current third-party payment system.
Summary
This article introduces the concept of blockchain as a financial infrastructure (BaaFI) and studies Libra and DC/EP from this angle. Furthermore, it provides a unifying framework to understand global stable coins (GSCs) and CBDCs:
•Whether they follow the account model or the token model. In some literature, the token model is also referred to as the value model or the loose account coupling model. If they follow the token model, they also need economic mechanisms to link tokens to off-chain assets.
•Their issuers can be central banks or private institutions. No matter what, they all follow the 3 rules introduced in Section Ⅰ.2.
•Their reserve can be of a single currency or a currency basket. If a currency basket is used, rebalance of the currency basket is a challenging problem.
•Their targets users can be wholesale or retail (i.e. general purpose).
•As pointed out by the G7 Working Group on Stable coins, they all share 3 basic elements: User interface, Issuance and stabilization mechanism, and transfer mechanism.
I use Table 1 to conclude this article. It shows how blockchain is used in different ways in GSCs and CBDCs. In term of both economic mechanism and the underlying technologies, this field will be highly open and flexible. Lots of possibilities remain to be explored and experimented.
