The aurthor of this article is Chief Economist of Wanxiang Blockchain.

Recently, both Libra and DC/EP (Digital Currency/Electronic Payment) of the People’s Bank of China (PBoC) have drawn lots of attention worldwide. There have been lots of discussion from various angels. This article studies Libra and DC/EP from a new perspective, i.e. blockchain as a financial infrastructure (BaaFI). It consists of 4 parts. Part Ⅰ introduces BaaFI and discusses two models of financial infrastructures, i.e. the account model and the token model. Part Ⅱ briefly evaluates the risk and regulation of Libra. Part Ⅲ studies DC/EP in great details. Part Ⅳ is a brief summary.

Ⅰ. Blockchain as a Financial Infrastructure (BaaFI)

There exist two models of financial infrastructures. The first is the account model, which is represented by the 2-tier bank account system. The second is the token model, which is made possible by blockchain and related technologies. Those two models are quite different from each other but both can record financial assets and transactions. Under lots of circumstances, they complement as well as substitute for each other.

Ⅰ.1. The Account Model

The best-known and most studied example of the account model is the 2-tier bank account system, which consists of a central bank and commercial banks. Individuals, enterprises, and government departments open deposit accounts in commercial banks. Commercial banks open deposit reserve accounts in the central bank. Fiat money, no matter it is M0 or M2, exists on the liability side of the central bank and commercial banks. M0 is the central bank’s liabilities, among which cash is its liability to the public, and deposit reserve is its liability to commercial banks. Deposits are commercial banks’ liabilities to individuals, enterprises, and government departments. In a modern economy, cash is only a very small portion of total money supply. All layers of money except cash, especially deposit reserve and deposits, exist in a digital form.

Cash is anonymous and accessible to all. Cash transactions also have a unique feature. As long as both the sender and the receiver are sure of the authenticity of cash, cash transactions can be settled without any third-party trusted institution. This is similar to token transactions which will be discussed later.

Bank transfers and remittances are conducted through bank accounts. If both the sender and the receiver have deposit accounts with the same bank, transfers between them only require the bank to credit the receiver’s account and debit the sender’s account. If the sender and the receiver have deposit accounts with different banks, transfers between them, besides requiring the two banks to adjust the sender’s and the receiver’s accounts respectively, will also lead to transfers between the two banks, which are settled through their deposit reserve accounts with the central bank.

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Figure 1: Cross-border Payments

(This figure is adopted from Bank of Canada, Bank of England, Monetary Authority of Singapore, 2018, “Cross-Border Interbank Payments and Settlements”.This figure is adopted from Bank of Canada, Bank of England, Monetary Authority of Singapore, 2018, “Cross-Border Interbank Payments and Settlements”.)

Cross-border payments under the account model are more complicated (Figure 1). Let’s suppose 2 countries, A and B, with their respective currencies. Both countries have established payment systems for their currencies [For example, HVPS (High Value Payment System), BEPS (Bulk Electronic Payment System), and CIPS (Cross-Border Interbank Payment System) in China, and Fedwire (Federal Electronic Funds Transfer System) and CHIPS (Clearing House Interbank Payment System) in US.]. There are two people, Alice and Bob. Alice is a resident of country A. She has a deposit account denominated in currency A with bank A1 of country A. Bob is a resident of country B. He has a deposit account denominated in currency B with bank B2 of country B. Suppose Alice wants to pay Bob a certain amount of money. However, bank A1 and bank B2 have no direct business relationship. That is where correspondent banks become necessary.

Suppose bank A2 of country A and bank B1 of country B have direct business relationship with each other. As correspondent banks, they will act as a bridge between bank A1 and bank B2. Cross-border payments are performed as follows. First, in country A, Alice transfers money from bank A1 to bank A2, which is supported by the payment system of currency A. Next, bank A2 transfer money to bank B1. Correspondent banks open deposit accounts with each other. For example, from bank A2’s perspective, its account with bank B1 is called the nostro account and denominated in currency B. Bank B1’s account with bank A2 is called the vostro account and denominated in currency A. Transactions between correspondent banks are settled through the nostro and vostro accounts. Finally, in country B, bank B1 transfers money to Bob’s account with bank B2.

I want to emphasize two points in cross-border payments. First, correspondent banks use SWIFT (Society for Worldwide Interbank Financial Telecommunication) to communicate with each other. SWIFT is an interbank messaging system that processes information flow in cross-border transactions. However, flow of funds in cross-border payments are processed through bank accounts, especially those of correspondent banks. Therefore, information flow and flow of funds are separate. Second, many people think that SWIFT is main cause of high cost and low efficiency of cross-border payments. However, that is not necessarily true. The network of correspondent banks and compliance checks in every step of money movement make cross-border payments less efficient. But according to a study of the McKinsey & Company in 2016, the main contributor of cost in cross-border payments is liquidity locked in the nostro and vostro accounts of correspondent banks. Correspondent banks have to keep extra money in those accounts, which could have been used to generate higher returns. As a result, they have to charge users higher fees to cover the opportunity cost.

Ⅰ.2. The Token Model

Mainstream blockchain systems, no matter they are public or consortium chains, and no matter their script languages have Turing completeness and support smart contracts or not, can all be summarized by the token model (Figure 2).

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Figure 2: The Token Model

Tokens, smart contracts, and consensus algorithms all exist inside the boundary of consensus. There exists an inseparable relationship between tokens and smart contracts. Consensus algorithms ensure the trustless environment inside the boundary of consensus. There are two types of interactions across the boundary of blockchain. First, outside information is written into blockchain by Oracle mechanisms. Second, the representative relationship between tokens and off-chain assets, as well as trade between them. Blockchain as a financial infrastructure (BaaFI) is to use tokens to represent off-chain assets. The following features of blockchain and tokens are key to understand BaaFI (Table 1).

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Table 1: Blockchain as a Financial Infrastructure (BaaFI)

First, different addresses inside blockchain correspond to different users, which is similar to bank accounts. Cryptographic technologies such as ECDSA (Elliptic Curve Digital Signature Algorithm) and Hash functions ensure the anonymity of addresses. For any address, only the person with the right private key can own and spend tokens in that address, which is similar to the passcode of a bank account.

Second, Tokens are essentially state variables defined inside blockchain. Tokens defined by the same rule are homogeneous and can be divided into smaller units. The number of tokens in a address is similar to the balance of a bank account. Although blockchain’s distributed ledger technology (DLT) is stored and updated by a group of miners or verification nodes, DLT maintains consistent in this decentralized arrangement. That is why blockchain is used in post-trade settlement to simplify custodian network and streamline transaction process.

Third, tokens can be transferred between different addresses, which is similar to bank transfers. Token transactions do not change the total number of tokens. That is, while the transferred-out address loses 1 unit of token, the transferred-in address gains 1 unit of token at the same time. Confirmation of token transactions and update of DLT are completed simultaneously, which means there is no settlement risk. Besides, DLT and confirmed transactions are public and tamper resistant.

Forth, consensus algorithms, such as the Nakamoto consensus, and blockchain’s tamper resistant feature make “double spending” impossible.

Fifth, since blockchain runs on the Internet, token transactions are cross-border by nature. That is why blockchain is used in cross-border payment.

Tokens exist as a piece of computer code and have no intrinsic value. Tokens derive their value from off-chain assets they are linked to. Linking tokens to off-chain assets is a legal as well as economic problem. A centralized trusted institution (thereafter “issuance institution”) is indispensable in this process (Table 2).

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Table 2: Linking Tokens to Off-chain Assets

The issuance institution follows 3 rules in linking tokens to off-chain assets. The first rule is “1: 1 issuance”: Tokens are backed 1: 1 by the underlying assets. The second rule is “1:1 two-way exchange”: The issuance institution guarantees a 1:1 two-way exchange between tokens and underlying assets. Whenever a user gives the issuance institution 1 unit of asset, the issuance institution will issue 1 token to the user, and vice versa. The third rule is credibility: The issuance institution must be regularly audited by a third party and fully disclose information to demonstrate the authenticity and adequacy of the underlying assets.

Under those 3 rules, 1 unit of token represents 1 unit of underlying asset. If there is a secondary market for tokens, token price may deviate from asset value, but arbitrage will make them converge. If those 3 rules are not strictly followed, arbitrage will not have perfect effect and token price will be decoupled from asset value.

Ⅰ.3. A Comparison between the Account Model and the Token Model

Ⅰ.3.1. Difference in Transaction Performance

Token transactions do not rely on any centralized trusted institution. Transaction confirmation and DLT update occur simultaneously so there is no settlement risk. However, because of the existence of hard forks, many types of blockchain can only ensure settlement finality in a probabilistic sense. Blockchain is also constrained by the “impossibility trinity”: No blockchain system can achieve accuracy, efficiency, and decentralization at the same time. In particular, the higher its degree of decentralization, the lower its efficiency.

In contrast, in the account model, centralized and trusted institutions such as banks play an indispensable role in confirming transactions and updating ledgers. It is hard to eliminate counterparty risk and settlement risk. But the account model can guarantee settlement finality. Being not subject to the “impossibility trinity”, the account model can achieve very high efficiency.

Ⅰ.3.2. Difference in Openness and Privacy Protection

Data management and privacy protection have increasingly become an important policy issue and can significantly impact the future of online business models.

Theoretically speaking, blockchain is open to all. Anyone who can generate a pair of public and private keys can own an address in blockchain. Addresses are anonymous. It is almost impossible to discover the true identity of address owners. The number of tokens in addresses and confirmed transactions in blockchain are open to all and tamper resistant. The anonymity feature helps protect the privacy of address owners but increases the difficulty in enforcing regulation such as KYC (“know your customers”), AML (anti-money laundering), and CFT (counter-terrorism financing).

In contrast, accounts generally require prior approval to open and therefore can be highly selective. Particularly, financial accounts such as deposit accounts and third-party payment accounts must follow strict KYC requirements. It is relatively easy to infer information about account owners from the names of financial accounts. But the balance of financial accounts is only visible to those with authorization.

If we expand our horizons from financial accounts to other types of accounts such as social network accounts and e-commerce accounts, it is straightforward to see that accounts are inevitable associated with user identification. Accounts record the behaviors of their owners in various scenarios and make consumer profiling possible. Consumer profiling then helps technical companies to engage in targeted advertising and online lending. However, in the account model, the collection and use of users’ behavioral information can easily evolve into privacy infringement. Personal information is difficult to protect but easy to use without prior authorization. Information collected from a line of business can be used in another line of business. Organizations holding personal information may be attacked, leading to information leakage. Those problems faced by the account model do not apply to the token model.

Ⅰ.3.3. Complement and Substitute Effects

In many use cases, the token model can substitute for the account model. The most prominent example is the comparison between stable coin and third-party payment (Figure 3).

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Figure 3: Stable Coin and Third-party Payment

For stable coin, I use USDC as a representative. USDC is a US dollar stable coin. It is backed 1:1 by US dollar reserve. Any institution that follows the USDC agreement and meets compliance requirements can become a USDC issuer. USDC issuers must keep US dollar reserve provided by users in a bank covered by the FDIC. USDC transactions between users are essentially token transactions inside blockchain. When users redeem USDC, USDC issuers destroy a number of USDC and transfer an equivalent amount of US dollar from the custodian bank to users’ deposit accounts.

In third-party payment, after users refill, third-party payment institutions deposit users’ funds into custodian accounts with banks[3] and credit users’ third-party payment accounts. The balance of third-party payment accounts is essentially an IOU (I owe you). Transactions between users of the same third-party payment institution only involve the adjustment of their third-party payment accounts (i.e. IOU transactions) and do not impact custodian accounts in banks. When users withdraw, third-party payment institutions transfer money from custodian accounts to users’ personal bank accounts.

Therefore, stable coin and third-party payment share similar structures, except that the former follows the token model and the latter follows the account model.

In other use cases, there is a complementary relationship between the token model and the account model. For example, most USDC transactions take place on crypto exchanges. Users send USDC to crypto exchanges’ addresses and crypto exchanges credit users’ accounts with them. The balance of users’ accounts with crypto exchanges is an IOU too. USDC trades on crypto exchanges are IOU trades. Being not subject to blockchain’s performance bottleneck, IOU trades can be highly efficient.

Ⅰ.3.4. Token Model and Fiat Money

Table 3 classifies the application of the token model in the field of fiat money. My classification is based on 2 dimensions. The first dimension is whether issuers are central banks or private institutions (but they all follow the 3 rules introduced in Section Ⅰ.2). The second dimension is whether target users are wholesale or retail.

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Table 3: Fiat Money and the Token Model

Ⅱ. Libra

There has been lots of discussion about Libra in the past 6 months. In this part, I will focus on the points that are most relevant to this article.

Libra’s operation mechanisms are:

· Economic meaning: Libra is a synthetic currency unit based on a basket of currencies (USD 50%, EUR 18%, JPY 14%, GBP 11% and SGD 7%). Libra price is linked to the weighted average exchange rate of its component. Although Libra does not anchor to any single currency, it will still exhibit low volatility, low inflation, universal acceptance and fungibility.

· Reserve assets: Libra is 100% backed by fiat reserve. Fiat reserve will be held by investment-grade custodians around the world and invested in bank deposits and short-term government bonds. Investment income of fiat reserve will be used to cover system operating costs, ensuring low transaction fees, and pay dividends to early investors (i.e. “Libra Association”). Libra users do not share investment income of fiat reserve.

· Issuance and price stabilization mechanisms: Libra Association will select a certain number of authorized dealers (compliant banks and payment institutions). Authorized dealers can trade directly with fiat reserve.

· Underlying technology: Libra uses a consortium blockchain. Libra plans to recruit 100 verification nodes and support 1000 transactions per second. 100 verification nodes form Libra Association, which is registered as a non-profit organization in Geneva, Switzerland.

· Governance structure: The governing body of Libra Association is its council, which is composed of member representatives with each verification node assigning a representative. All decisions of Libra Association will be made through the council, and major policy or technical decisions require more than two-thirds of the members to vote.

I have the following comments on Libra:

· Libra is a synthetic currency unit based on a currency basket. Like the IMF’s SDR (special drawing rights), Libra is a super-sovereign currency. Libra is 100% backed by fiat reserve. The only way to issue more Libra is to deposit more fiat assets into its reserve. At the issuance stage, it is fair to say that there is no money creation. In the future, will there be Libra deposits and loans and therefore Libra M2? Although Facebook says it has no intention to do so, this possibility can be supported by current technologies and can not be ruled out. If this happens, there will probably be money creation.

· Libra will certainly be a store of value. Currently, other types of stable coin are mainly used on crypto exchanges rather than in people’s everyday life. Will Libra be an effective payment tool (i.e. medium of exchange and unit of account)? It depends on how Facebook and its alliance promote the use of Libra in the real world. I am pretty sure they have enough resources to do so. However, at present, there are no goods or services denominated in Libra and money has a strong network effect. It will take lots of time and effort for Libra to be widely adopted in retail use. One limitation that can not be ignored is the performance of Libra consortium chain.

· Libra can promote financial inclusion. To own and use Libra, users only need to install Calibra wallets on their mobile phones. This is much easier than to open bank accounts. However, the accessibility of Libra also leads to concerns of currency substitution: In countries with unstable political and economic situations, will Libra “crowd out” local currencies? Libra’s possible impacts on currency sovereignty has made it highly controversial around the world.

· Libra Association has not disclosed how it plans to manage Libra’s fiat reserve. What will happen if Libra’s fiat reserve adopts an aggressive investment strategy to pursue higher returns? For example, to invest a large percentage of fiat reserve in long term, high risk, and illiquid assets. If there is a large redemption of Libra, there may not be enough liquid assets in fiat reserve to meet redemption. Libra may be forced to liquidate its fiat reserve in a “fire sale” approach. This would further push down asset value and worsen Libra’s liquidity profile or even its solvency. Since Libra has no lender-of-last-resort support from any central bank, a run on Libra will cause systemic risk. Therefore, how Libra manages its fiat reserve should be strictly regulated.

· Libra Association has not disclosed how it plans to rebalance Libra’s currency basket, either. The actual currency composition of Libra’s fiat reserve will deviate from that of its currency basket from time to time. This will lead to complicated arbitrage between Libra and its components and cause Libra to fluctuate.

· Libra’s fiat reserve will be kept in custodian banks with investment grades. However, investment grades do not guarantee no credit risk. What will happen to Libra if one of its custodian banks becomes bankrupt? I think Libra’s custodian banks should meet strict regulatory requirements. If Libra keeps part of its fiat reserve in one or more central banks, Libra will become a kind of synthetic CBDC. I will return to this point in Part Ⅲ.

· Libra will be used cross-border and cross different currencies and financial institutions. It will have complicated impacts on cross-border capital flows and should be regulated accordingly.

Ⅲ. DC/EP

In this part, I will first summarize public information on DC/EP and infer its design. Then I will analyze its impacts on payment and China’s monetary system.

Ⅲ.1. Public Information on DC/EP

On Oct 24th, 2019, Chinese President XI Jinping pointed out that “the application of blockchain technology has been extended to digital finance” in the 18th collective study of the Political Bureau of the CPC Central Committee. The key to understand digital finance is to understand DC/EP of the PBoC.

So far, 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:

· The aim of DC/EP is to replace M0. DC/EP is backed 1:1 by deposit reserves, pays no 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 DC/EP in the same amount. In redemption operations, the PBoC increases deposit reserves and destroys DC/EP in the same amount.

· 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.

· 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.

· The registration center and certification center of DC/EP. The registration center records all DC/EPs and corresponding users. 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.

· “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, even if users, commercial banks and merchants work together, they still cannot discover the true identity of DC/EP users or trace their transaction history. DC/EP users can expand the use of RMB abroad and promote RMB internationalization. In contrast, bank cards and Internet payment follow the “tight account coupling” model.

· 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.

· 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 following figure is adopted from the DC/EP prototype system discussed by YAO Qian, the former head of the Digital Currency Institute of the PBoC (Figure 4).

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Figure 4: The DC/EP Prototype System

Ⅲ.2. The Design of DC/EP

Judging from the above public information, I think DC/EP does not use blockchain in the same way as the Libra. 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 (unspent transaction output) 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 the address owners. The corresponding relationship between addresses and user identity is known only by the PBoC through a KYC (“know your customer”) 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.

Ⅲ.3. DC/EP’s Impacts on Payment

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Figure 5: 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.

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Figure 6: DC/EP’s Balance Sheet Impacts

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 third-party payment. This indicates that DC/EP and third-party payment may compete with each other in the future.

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Figure 7: Third-party Payment after “Direct Link Disconnected”

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 the 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.

Ⅲ.4. 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 in infrastructure building and promotion of DC/EP.

Ⅲ.4.1. 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.

Ⅲ.4.2. 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 model and the clearing 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.

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Figure 8: CIPS

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).

Figure 9: Use of RMB Abroad

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.

Ⅲ.4.2. 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.

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Figure 10: DC/EP Custodian and Payment Institution

Ⅳ. 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, the 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 4 to conclude this article. It shows how blockchain is used in different ways in GSCs and CBDCs. In term of both economic mechanism design and the underlying technologies, this field will be highly open and flexible. Lots of possibilities remain to be explored and experimented.

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Table 4: Different Use of Blockchain

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