The digital renminbi has the dual characteristics of the linked exchange rate system and the indirect CBDC.
Title of original text: “Looking at Digital RMB from the Linked Exchange Rate System”
Author: Zou Chuanwei, Chief Economist of Wanxiang Blockchain
Digital Renminbi (eCNY) has the characteristics of a linked exchange rate system and an indirect central bank digital currency.
Explanation of Digital RMB
On November 27th, Zhou Xiaochuan, the former governor of the People’s Bank of China, expounded his vision for the digital renminbi at a series of seminars on “Digital Financial Innovation and New Patterns of Economic Development” at the Digital Finance Research Center of Peking University. The main points are as follows.
First, the digital RMB follows the principle of two-tier operation. The first tier is the People’s Bank of China, and the second tier is commercial banks, telecom operators and leading non-bank payment institutions.
Second, the digital renminbi is different from the central bank digital currency (CBDC) that is generally considered. Whether a CBDC is wholesale or retail, it is a liability of the central bank, and the digital renminbi does not necessarily constitute a claim for users against the People’s Bank of China (Claim). The second-tier institutions licensed by the People’s Bank of China have the ownership of digital RMB and related technologies and systems.
Third, the People’s Bank of China supports the value of the digital renminbi (or endorses the value of the digital renminbi) through the supervision of second-tier institutions, as well as the issuance preparation and capital adequacy requirements. The relationship between the People’s Bank of China and the second-tier institutions is not a simple wholesale and retail relationship.
Fourth, the second-tier organization is responsible for KYC (“Know Your User”), anti-money laundering and other compliance reviews and data privacy protection for digital RMB users. Digital RMB data is backed up by the People’s Bank of China.
Fifth, the responsibilities of the People’s Bank of China in the digital renminbi mainly include: supervising and ensuring the stability of the digital renminbi value, focusing on payment and settlement infrastructure, promoting interoperability and switching facilities between different payment products, and Prepare emergency and emergency alternative plans.
Introduction to the Linked Exchange Rate System
Zhou Xiaochuan pointed out in his speech that the digital renminbi has borrowed from Hong Kong’s currency issuance system to a certain extent, that is, the linked exchange rate system.
The linked exchange rate system is essentially a currency board system. Under this system, the flow and stock of the base currency are supported by sufficient foreign exchange reserves. In other words, changes in the base currency must be consistent with changes in foreign exchange reserves (calculated at a fixed exchange rate). The Currency Board has made a clear commitment to convert the local currency into a reserve currency at a specified fixed exchange rate.
Hong Kong has implemented the linked exchange rate system since October 17, 1983. The goal is to maintain the exchange rate of the Hong Kong dollar against the US dollar in the foreign exchange market at about 7.80 Hong Kong dollars to 1 US dollar.
In Hong Kong, the base currency is mainly composed of four parts: first, the certificate of indebtedness, which is used to support banknotes issued by note-issuing banks; second, the circulating banknotes and coins issued by the Hong Kong SAR government; third, the aggregate balance, which refers to licensed The bank’s settlement balance in the Hong Kong Monetary Authority (the transactions between licensed banks and the Hong Kong Monetary Authority); fourth, the exchange fund bills and bonds are issued by the Hong Kong Monetary Authority on behalf of the Hong Kong Special Administrative Region Government.
Most of Hong Kong’s banknotes are issued by three note-issuing banks including HSBC, Standard Chartered Bank and Bank of China Hong Kong. When issuing banknotes, note-issuing banks must submit the equivalent of US dollars to the Hong Kong Monetary Authority at an exchange rate of 7.80 Hong Kong dollars to 1 US dollar to purchase certificates of indebtedness as support for issuing banknotes. These US dollars are held by the Exchange Fund. On the contrary, when the paper money is recycled, the Hong Kong Monetary Authority will redeem the certificate of indebtedness, and the note-issuing bank will collect the equivalent dollar from the Exchange Fund.
The banknotes and coins issued by the Hong Kong Special Administrative Region Government through the Hong Kong Monetary Authority are stored and distributed to the public by correspondent banks. Transactions between the Hong Kong Monetary Authority and the correspondent bank are also settled in US dollars at an exchange rate of 7.80 Hong Kong dollars to 1 US dollar.
On May 18, 2005, the Hong Kong Monetary Authority expanded the floating space of the exchange rate of the Hong Kong dollar against the US dollar to 7.75 Hong Kong dollars to 7.85 Hong Kong dollars per US dollar, and made three reforms to the linked exchange rate system: First, the introduction of strong exchange guarantees, namely When the Hong Kong dollar is under pressure to appreciate, promise to buy U.S. dollars from a licensed bank at an exchange rate of 7.75 Hong Kong dollars to 1 U.S. dollar; second, adjust the weaker exchange guarantee to 7.85 Hong Kong dollars to 1 U.S. dollar, that is, when the Hong Kong dollar is under pressure to depreciate, promise Will sell U.S. dollars to licensed banks at an exchange rate of 7.85 Hong Kong dollars to 1 U.S. dollar; third, within the conversion range set by the strong and weak convertibility guarantee exchange rates, you can choose an operating mechanism that conforms to the currency board system. Market operations.
The linked exchange rate system is also implemented in my country’s Macau region. The Macau Pataca is linked to the Hong Kong dollar. Banco Nacional and Bank of China Macau are the note-issuing banks of Macau Patacas, with a 50% note-issuing quota. The note-issuing bank must deliver the equivalent value of Hong Kong dollars to the Macau Monetary Authority at a fixed exchange rate of 1.03 patacas to 1 Hong Kong dollar in exchange for an interest-free certificate of indebtedness as the statutory reserve for issuing notes.
Retail central bank digital currency classification
Another perspective to understand the digital renminbi is the retail CBDC analysis framework proposed by the Bank for International Settlements (BIS) research report “Retail CBDC Technology” in March this year.
BIS proposes two key dimensions of retail CBDC: first, CBDC as the legal framework for claim rights; second, the role of central banks and intermediaries in payment. BIS proposes the concept of direct, indirect and hybrid CBDC.
Direct CBDC is the right of users to claim the central bank. The central bank processes retail payments, records the ownership information of the direct CBDC, and updates it based on transaction conditions. KYC can be implemented by central banks or intermediaries. Direct CBDC is the simplest in design, but it places high requirements on the reliability, speed and efficiency of the payment system. In addition, the central bank directly faces retail users and scenarios, which may also affect user experience and market promotion.
Indirect CBDC is a user’s claim to intermediary institutions (BIS is called “CBDC Bank”), based on the issuance of CBDC Bank’s reserve assets in the central bank. Reserve assets can be “real CBDC” or other types of central bank currency. CBDC banks implement KYC and process retail payments. The central bank only handles wholesale transactions. The indirect CBDC reduces the pressure on the central bank to directly face retail users and scenarios, and has little impact on the current central bank-commercial bank double-layer structure, but the central bank needs to “penetrate” the CBDC bank to grasp the indirect type held by users CBDC information.
Hybrid CBDC is the right of users to claim the central bank. CBDC payment service institutions implement KYC on users and process retail payments. The central bank regularly records the hybrid CBDC information held by users. Hybrid CBDC does not enter the balance sheet of payment service institutions and has good mobility. If a payment service institution goes wrong, the central bank can easily transfer its users to another payment service institution.
Digital RMB has dual characteristics
In my opinion, the digital RMB has the characteristics of a linked exchange rate system and an indirect CBDC.
The People’s Bank of China has selected commercial banks with strong capital and technology capabilities as the designated operating institutions to take the lead in providing digital RMB exchange services. The designated operating institution will be similar to a note-issuing bank under the linked exchange rate system, or a CBDC bank in an indirect CBDC.
The digital renminbi is issued based on the deposit reserve of the designated operating institution in the People’s Bank of China. This part of the deposit reserve is similar to foreign exchange reserves under the linked exchange rate system. The deposit reserve used to support the issuance of digital renminbi will no longer be included in the assessment of the deposit reserve of designated operating institutions by the People’s Bank of China. Designated operating institutions can obtain the “Certificate of Preparation” or “Comfort Letter” (Expression by Zhou Xiaochuan) issued by the People’s Bank of China. This kind of “preparation certificate” or “comfort letter” will be similar to the certificate of indebtedness of the Hong Kong Monetary Authority and has the status of the currency of the central bank.
Although digital renminbi is a legal currency in digital form and positioned as cash in circulation (M0), it will be “branded” (such as a digital signature) by a designated operating institution.
Not only that, the designated operating agency has ownership of the digital renminbi. The digital renminbi will be similar to the Hong Kong dollar banknotes issued by three note-issuing banks including HSBC, Standard Chartered Bank and Bank of China Hong Kong, while the renminbi banknotes and coins issued by the People’s Bank of China will be similar to the banknotes and coins issued by the Hong Kong Special Administrative Region Government through the Hong Kong Monetary Authority. According to the revised draft of the People’s Bank of China Law, the digital RMB, as a digital form of RMB, will have the same value characteristics and legal compensation as the physical form of RMB.
Renminbi banknotes and coins are the user’s right to claim the People’s Bank of China, and the digital renminbi does not necessarily constitute the user’s right to claim the People’s Bank of China. Therefore, in RMB banknotes and coins, the relationship between the People’s Bank of China and commercial banks is wholesale and retail, while in digital RMB, the relationship between the People’s Bank of China and designated operating institutions surpasses the relationship between wholesale and retail. This arrangement provides flexibility for digital renminbi exchange services led by designated operating agencies and for the promotion and application of digital renminbi. Designated operating institutions need to follow the unified management of digital renminbi quotas by the People’s Bank of China.
The People’s Bank of China coordinates the management of digital RMB wallets. Digital RMB retail payments are handled by designated operating agencies. The wholesale payment link involved in digital renminbi is handled by the People’s Bank of China. Therefore, the digital renminbi is similar to indirect CBDC in the payment and settlement process. In this way, the People’s Bank of China does not need to provide real-time full settlement for retail users and scenarios, which can effectively alleviate the pressure that the People’s Bank of China faces in digital RMB settlement.
Although the digital renminbi does not necessarily constitute a user’s right to claim the People’s Bank of China, the interconnection of digital renminbi redeemed by different designated operating institutions is crucial to the order of currency circulation. The People’s Bank of China mainly guarantees this through three aspects.
The first is the interconnection of value characteristics. The People’s Bank of China ensures that the value of digital renminbi is stable and equivalent to each other through the supervision of designated operating institutions, as well as requirements for issuance preparation and capital adequacy. According to the statement of President Zhou Xiaochuan, the degree of protection of the digital renminbi can be different in the “Provision Certificate” or “Comfort Letter”. In the case of a slightly lower degree of protection, the People’s Bank of China will implement stricter capital adequacy and liquidity supervision on designated operating institutions.
The second is the interconnection of circulation links. By improving the payment and settlement infrastructure, the People’s Bank of China can easily circulate the digital renminbi across different designated operating institutions and wallets. Users can also easily switch digital renminbi services between different designated operating institutions and wallets.
The third is the interconnection supported by credit. The People’s Bank of China provides emergency and emergency alternative plans for extreme situations such as runs on designated operating institutions or problems with withdrawals. According to President Zhou Xiaochuan’s statement, “The responsibilities of the central bank vary according to different design schemes.”
