All You Need to Know about China’s Central Bank Digital Currency (CBDC)


November 2, 2020

Officially approved by the State Council since July 2020, the Central Bank of China has been organizing market institutions to carry out research and development of the Central bank's digital currency (CBDC).

In a fully digital world, the implementation of digital finance, a new technology, is bound to bring innovation to the existing financial system. Today, when mobile payment has been deeply integrated into our daily life, we may have many questions about the necessity of a new digital currency. For example, what exactly is a central bank digital currency (CBDC)? How is it different from cryptocurrencies represented like Bitcoin? How is it different from WeChat and Alipay? Will it replace paper currency? Faced with these questions, it is necessary to do a comprehensive and in-depth analysis.

First, let's review Bitcoin

The iconic application of cryptocurrencies is Bitcoin. Bitcoin is a decentralized cryptocurrency system proposed by Satoshi Nakamoto, a special currency system that utilizes computational power to generate virtual currency without relying on an authoritative currency institution to issue it. The Bitcoin system is built on and a mature application of blockchain technology.

With the operation of the Bitcoin open-source network, as of November 2020, the market value of bitcoin circulation has exceeded 160.4 billion USD, making it the most successful application of the decentralized blockchain technology. The maturity of Bitcoin also drives the gradual expansion of decentralized cooperation mode, which has been applied in a variety of scenarios (such as equity verification, trust guarantee, digital notarization, etc.), solves the pain point of trust in the development of the Internet, and brings new possibilities for the future of the Internet.

Now, what's CBDC?

The Central Bank digital currency (CBDC), on the other hand, can be seen as a digital renminbi, a legal cryptographic currency issued by the state. The most fundamental difference between CBDC and Bitcoin is the different issuing mechanism -- the issuer of Bitcoin is not a country, but an electronic form of currency. CBDC and Bitcoin can be used for real goods and services transactions, while Alipay and mobile banking are payment methods based on electronic accounts, which are essentially the digital form of existing legal tender.

The economic and financial implications behind these two different digital currencies are also completely different. Central bank digital currency (CBDC) is helpful to improve the effectiveness of the monetary policy, optimize the payment function of central bank money, and improve the status of central bank money.

Two-tier frame central bank digital currency (CBDC) = bank account system + cryptocurrency wallet

China's central bank digital currency uses a two-layer framework that combines the original bank account system with the accounting system based on the digital money wallet. In the bitcoin cryptocurrency system, the currency is separate from the legal tender system and the bank account system, a separation that makes it somewhat harder for users to manage. In order to solve this problem, the central bank introduced the wallet property of digital currency on the basis of the original traditional account system of commercial banks in the design of CBDC and created a two-layer framework structure that supports an account to manage both the existing electronic currency and digital currency.

More about China's Digital RMB

Basic properties: Digital currency ≠ blockchain

The biggest foundation of the central bank's digital currency is the endorsement of national sovereignty, which is no different from the RMB cash paper currency in nature

Talking about Digital Currency cannot avoid blockchain. The full English name of Digital Currency is Digital Currency Electronic Payment or DCEP. In fact, the concept of digital cash was proposed many years ago, long before the blockchain. However, it was not until the emergence of Bitcoin as a "decentralized digital currency" that the popular misconception that "blockchain = bitcoin = digital currency" came into being.

But in fact, neither the concept nor the implementation of digital currency does exist and does not need to be tied to the blockchain. The blockchain is just a means to realize the decentralized digital currency, and Bitcoin is the representative of this kind of digital asset.

The main function of blockchain is to store data. Any data that needs to be saved can be written to and read from the blockchain, so it is a database. Anyone can set up a server to join the blockchain network, so it is a distributed database with no central node. Because each user uses the block header to calculate the hash, and every block header contains a block of data, so the hash changes are "lead a body", unless the mastery of the entire network more than 51% of the workforce is likely to change at the same time, in a short time so blockchain have to center, trade openness, traceability, and tamper-resistant features.

Offline payments and anonymity are the biggest challenges

The fundamental difference between the two is that the central bank's digital currency is a currency and bitcoin is an asset. The central bank's digital currency is endorsed and issued by the central bank's credit. It is the M0 with the highest value as cash, and its credit subject is the central bank. When money is deposited in a demand account at a bank, the subject of credit becomes a bank and its credit rating is lowered to M1. If it is then bound to WeChat or Alipay, a loan relationship with WeChat or Alipay will be formed, and the credit rating will be further reduced to M2.

It can be seen that the central bank's digital currency has the highest credit rating, which means that in law, institutions or individuals have the right to refuse WeChat or Alipay payment during transactions, but cannot refuse to be paid by the central bank's digital currency, because the central bank's digital currency, like cash, is a standard national sovereign currency protected by the law.

Bitcoin is precisely an asset created by the calculation of hashing (mining) without credit endorsement from any national central bank or commercial bank, which is also the root cause of its volatile price.