Wednesday, March 9, 2016

Interview with PBOC (China) Governor Zhou Xiaochuan

Here is an excellent Q&A style interview with the head of the Peoples Bank of China (PBOC) Zhou Xiaochuan. This interview covers a lot of ground including a very interesting exchange on a future digital yuan China is working on. Below are some selected questions and answers from the interview related to a digital yuan concept. 

Click here to read the full interview.


The digital yuan
The PBOC held a seminar on digital currency on January 20, saying that the central bank will try to launch its own digital currency as soon as possible. What are the considerations behind this?
The PBOC has studied digital currencies for a long time. History shows that currency has evolved abreast of technological advances and development of economic activities. The evolution from early-stage physical currency and commodity currency to the later credit currency was a result adapting to the development of commercial society. Paper money, as the last generation currency, lacks high-tech support, and it is an irresistible trend that paper money will be replaced by new products and new technologies with greater security and lower costs. With the rapid development of the Internet and the significant changes in the global payment systems, it is necessary to establish the issuance and circulation system of digital currency, which will help build the financial infrastructure and improve the quality and efficiency of the economy.
How can a digital currency replace paper money? There are several ideas. One is to make digital currency anonymous, like paper money which is transacted anonymously, and this anonymity will determine the technology. But paper money is not designed to be anonymous. It is anonymous because no real-name technology can ensure the convenience of a large amount of small-value transactions. Some people assume that it would be better for digital currency to be transacted anonymously in the future because the government may fail to protect people's privacy regarding wealth and the use of wealth, which should definitely be protected.
From the central bank's perspective, a digital currency should be designed in a way that can best protect people's privacy, but we also need to pay attention to social security and social order. We need to keep some necessary investigative instruments readily available to deal with criminal activities. A balance needs to be struck between protecting privacy and cracking down on illegal activities. Different preferences between these two motives will lead to different technological orientations for digital currency.
What is the central bank's thinking on the issuance and management of a digital currency? Will it be different from the digital currency in the market right now?
Many countries around the world acknowledge that the digital or electronic currency issuance framework led by central banks might be different from the current private sector practice.
There are several principles underlying the central bank digital currency issuance framework. The first is convenience and security. Second, as mentioned earlier, a balance needs to be struck between protecting privacy and maintaining social order and cracking down on illegal activities, especially preserving necessary tools to fight money laundering and terrorism financing activities. Third, it should be conducive to the efficient operation and transmission of monetary policies. Fourth, the control over monetary sovereignty should be maintained. Digital currency can be converted freely but its convertibility will also be controlled. We think, therefore, as a legal tender, digital currency must be issued by the central bank. The issuance, circulation and transaction of digital currency will follow the same management principles of traditional currency.
Is there any timetable for the launch of digital currency? Will a digital currency replace paper money?
We do not have a timetable yet. China has the world's largest population and is a huge economy. It will only take several months for a small country to replace an old version of paper money with a new one. But it has taken about 10 years for China to do the same thing. So a digital currency will co-exist with cash for quite a long time before it finally replaces cash. The cost for cash transactions will gradually increase in the later stages. For instance, banks do not charge any fees for counting large amounts of coins now, but in the future they may charge their clients for the service. With the transaction costs of paper money rising, people will be motivated to opt more for digital money. But digital currency and cash will coexist for a long time.
Do we still need monetary policies once we have digital currency? How will monetary policies be implemented against such a background?
We think we still need to adjust the money creation mechanism and money supply. At the current stage, the central bank's major goal of issuing digital currency is to replace the physical cash so as to lower the costs of issuing and circulating traditional paper money and to improve the convenience. The central bank will fully consider the current monetary policy framework, money supply and creation mechanism and monetary policy transmission channels in designing digital currency.
The current practice of cash issuance and withdrawal is based on the "central bank-commercial banks" binary system. The issuance and operation of digital currency should still be based on such a system, but delivery and storage methods will change: money will be delivered electronically instead of physically, and money will be stored in cloud computation space instead of the central bank's treasuries and commercial banks' vaults. The security and efficiency of issuing and withdrawing digital currency will be significantly improved in the end.
What anti-forgery measures will be taken for the digital currency? For example, how to avoid the "51-percent attack" security loophole in bitcoins?
From a practical perspective, we should make the anti-counterfeiting knowledge of paper money easy to understand for the consumers. But fundamentally these key anti-forgery technologies are national secrets. It is the same thing with digital currency issued by the central bank. We will use many information technologies including cryptographic algorithms to make sure that the digital currency cannot be counterfeited. Technologies will be upgraded in the future. We will take that into consideration and bring in the development idea of long-term evolution from the beginning.
As for the hotly debated "51-percent attack," it is more about bitcoins. Bitcoins do not involve a central bank. For a digital currency controlled by the central bank, a combination of technological measures, institutional design as well as laws and regulations will be applied to ensure the security of its operation system. This differs from bitcoins at the very start.
Block chain technology has recently attracted lots of attention. Has the central bank considered using block chain technology for its digital currency?
The technologies of a digital currency can be divided into two types: account-based and non-account-based. These two technologies can coexist by being applied to different layers. Block chain is one option. It is non-account-based and non-counterfeiting, and features distributed ledgers. If a digital currency wants to emphasize privacy protection, block chain technology is a good choice. The PBOC has spent a lot of time and energy researching on the application of block chain technology. But so far block chains have consumed too many resources, including both computation and storage resources, and cannot handle the current transaction volume. We need to wait and see whether this problem can be solved in the future.
Besides block chain technology, the PBOC's digital currency research team has made in-depth studies on digital currency related technologies such as mobile payment, trusted and controllable cloud computation, cryptographic algorithm and secure chip. We will cooperate with the financial industry and science and technology community to continue researches on all kinds of innovative technologies, to improve the technical framework for issuing and circulating digital currency, and to fully predict, timely react to and effectively address risks that may emerge during the application. To that end, the PBOC welcomes the support, participation and contribution from all related parties so that the research can bear fruits.

My added comment:

Please note the statement in bold and underlined above where they state that "so far block chains have consumed too many resources, including both computation and storage resources, and cannot handle the current transaction volume. We need to wait and see whether this problem can be solved."

This is exactly the problem identified by our expert here who wrote this two part article for the blog last summer.

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