Li Lihui: A digital currency regulation system should be formulated as soon as possible and be wary that the US is in a position to approve Libra
On January 13, 2020, Li Lihui, a member of the Finance and Economics Committee of the 12th National People's Congress and former Governor of the Bank of China, delivered a keynote speech at the “Future of Digital Currency” seminar and “Digital Currency - Reading Book for Leading Cadres” held by the Peking University Digital Finance Research Center, Peking University National Development Research Institute, and People's Daily Press. Li Lihui gave an updated and detailed summary of the central bank's digital currency issuance methods, technology routes, and future prospects. In addition, he also expressed his views on the economic reasons for the growth of virtual currencies and the advantages associated with Libra. The following is a wonderful summary of the contents of Golden Finance's speech.
Talk about digital currencies
When talking about digital currencies, he said whether digital currency will restructure our monetary system, including our Chinese monetary system, and even the global monetary system, I think this is a very important question. I call all forms that use digital technology digital currency, and I roughly divide digital currency into three categories. All fiat digital currencies in the first category, or central bank digital currencies. The second category is like Bitcoin and Ether. They call it virtual currency, and some also call it some kind of asset. The third category classifies it as a digital currency of a trusted institution. If it is further derived on the basis of the digital currency of a trusted institution, it may be derived from the digital currency of a trusted institution into a global digital currency.
Regarding some specific forms of digital currency, he believes that the focus of attention should be on high concurrency and high reliability. Digital currencies with legal status, national sovereignty endorsement, and issuer responsibility are called legal digital currencies. Their essence is still a legal digital currency and payment instrument. Since 2014, central banks in many countries have announced the launch of digital currency research and development, but technologies that may be applied to digital currencies, including consensus mechanisms, distributed ledgers, blockchain, encryption algorithms, etc., are currently unable to meet the high concurrency requirements of retail businesses in mega-markets. I think it's mainly because technological bottlenecks have not been broken through, so the world is still in the process of weighing choices, and no choice has been made yet.
Despite this, central banks in many countries have basically reached a general consensus, and the IMF has also recently released some reports. The reports indicate that central banks in many countries are of the opinion that digital currencies have potential benefits.
First, it can save the cost of cash circulation, especially in remote and large regions, and in scenarios such as cross-border retail payments, fiat digital currency can effectively reduce the cost of cash flow, and also help prevent counterfeit money.
Second, it is possible to strengthen the public nature of the future society and promote facilitation finance. They believe that fiat digital currencies can provide the public with highly secure and highly liquid tools. Commercial bank accounts are no longer required, and commercial banks are no longer required as payment intermediaries.
Third, fiat digital currencies can provide end-to-end reliable payment tools for digital asset transactions, blockchain smart contracts, keys, etc., and automatically execute asset transfers in accordance with agreed commercial terms and applicable laws.
Fourth, it is possible to strengthen the transmission mechanism of monetary policy, especially during the long-term economic recession. We use the form of fiat digital currency, which may be more convenient to implement special monetary policies such as negative interest rates. Further research is needed on this. Under the fiat digital currency system, what problems will we encounter when implementing a negative interest rate policy may require further research.
At the same time, the central bank also believes that fiat digital currencies also have some potential risks and problems. Li Lihui made a three-point summary based on the opinions discussed by some experts.
First, it may weaken the initial creditworthiness and profitability of commercial banks. Fiat digital currencies can be issued in two ways. One is indirect issuance. The central bank issues currency to the public through commercial banks, which is the same as our current issuance model. There is another type. Due to the special nature of the fiat digital currency structure, fiat digital currencies are issued directly to the public. No matter what form of central bank is under the fiat digital currency structure, it can absorb public deposits. There will be a problem. Public deposits may flow from commercial banks to central banks. In this way, commercial banks will be forced to raise interest rates to obtain funds to retain customers, and commercial banks' costs will increase.
Second, it may be more likely to promote systemic financial risks. In particular, when an economic crisis or financial crisis occurs, commercial banks with lower trust levels may experience a shortage of digital currencies that are difficult to control and cause a chain reaction. Everyone knows that under the traditional money issuance system, it's cash. If a bank goes wrong, as long as the big banks support the past, this kind of crowding can easily be prevented. As long as fiat digital currency deposits meet the conditions and it is easy to withdraw the deposit, it will cause a payment crisis at a certain bank, and causing a chain reaction may promote systemic financial risks.
Third, under the fiat digital currency structure, the central bank has more direct power or a more absolute position to regulate the money market. Li Lihui believes that in the case of fiat digital currencies, the central bank's balance sheet is likely to expand drastically. The basic understanding mentioned earlier is that central banks in various countries have a relatively common understanding, and Chinese experts need to further discuss and study these issues.
China's market is far larger than other countries, and digital currencies are even more important to China. Li Lihui believes that the introduction of China's fiat digital currency may have a certain degree of transition. Special attention may be paid to inheritance and substitution, maintaining the current operating mechanism of the money market and the transmission mechanism of monetary policy, and gradually replacing traditional monetary instruments and payment instruments.
Here is Li Lihui's summary and interpretation of some of the reports and statements made by central bank officials last year.
First, they will choose an indirect distribution model and adopt a two-tier operation and distribution system. I mentioned fiat digital currency. It can choose either a model directly issued by the central bank to the public, or an indirect distribution model from the central bank to the commercial bank to the public. Looking at the current situation in China, I think there is still a relatively large possibility of using an indirect distribution model. It maintains a two-tier operation and investment mechanism. The first benefit is that there is no need to rebuild financial infrastructure, which is conducive to saving investment. Second, there is no need to restructure the currency issuance and management pattern, which is beneficial to risk management. Third, there is no need to connect currency issuance models with different characteristics, which is conducive to stabilizing the market. If the distribution model is different, the two operating systems must be linked. We choose this indirect distribution model, which is consistent with the traditional system. In this way, we can stabilize our market. This is probably the first possibility.
The second possibility is to adhere to central bank management, or central bank centralized management model, while adopting a parallel technical route. I myself think China is a very large country, and even if we issue fiat digital currency, we cannot adopt a decentralized or multi-center management model; we should maintain the current centralized management model. The main goal is to guarantee the reliability of the currency transmission mechanism and ensure the efficiency of currency regulation. At the same time, because the current blockchain technology I just mentioned cannot meet the high concurrency requirements of retail businesses in mega-markets, we should maintain technology neutrality, not rely on a single technology, and not rely on a single blockchain technology. There is also a greater possibility. For example, adopt a horse racing mechanism and have some designated agencies carry out research and development to see what the market needs more, and at the same time decide which technical route can be taken better then.
Third, use a “loose account combination” method to replace the currency in circulation and replace M0. We all have WeChat and Alipay on our hands. Our Alipay and WeChat Pay are linked to one or two of our bank accounts, including debit cards, as well as individual debit cards. In such a state, we must go through a bank to transfer value. Even though WeChat and Alipay do not require a cryptographic code for payment, they must transfer value through a bank account. Currently, bank account management is a strict real-name management system, so under the current circumstances, it is impossible for us to use WeChat Pay or Alipay to make anonymous payments. However, fiat digital currency may use a method of loosely combining accounts and adding a digital wallet. The technical officials in the design think that it is possible to separate bank accounts to achieve end-to-end value transfer, which can reduce the transaction process's dependence on financial intermediaries and achieve controlled anonymous payments. It is controllable and can be controlled by the central bank. For example, if you pay 5,000 yuan, you can pay anonymously; if it exceeds 5,000 yuan, you may not be anonymous. If large payments are made within a short period of time, even if the amount of each payment is very small, they may be placed on the monitoring list. I think this kind of controlled anonymous payment is easy to achieve in the form of digital currency.
Also, our so-called fiat digital currency in China or the central bank's digital currency option is to replace M0, cash in circulation. This is not the same as the digital currencies of financial institutions introduced by our other countries. Digital currencies of financial institutions such as those introduced in the US do not focus on replacing cash in circulation, but instead of financial transactions, clearing between financial institutions is M1 or even M2.
Let's discuss a very important issue here. Now our WeChat Pay and Alipay digital technology have built a platform for payment and lifestyle services linked by trust links. However, the fiat digital currency in our design can theoretically be removed from the network and achieve value transfer without the bank. This is an advantage of fiat digital currency compared to WeChat Pay and Alipay. However, I think whether fiat digital currency can actually replace traditional forms of currency, replace emerging electronic payment instruments, and become the main form of currency and the main payment instrument will ultimately be decided by the market. The conditions for this choice are whether it will be more convenient, whether the cost of circulation will be lower, and whether the public will be happy to accept it, thus forming an economic scale with commercial value.
Talk about virtual currency
Let's discuss virtual currency next. I myself think we have many different views on virtual currency. I myself think the focus should be on decentralization and its speculative nature. In fact, everyone knows that virtual currency is not supported by physical assets, and there is not enough trust and endorsement. Businesses include so-called stablecoins launched by small financial institutions. To what extent are their physical assets supported? Nor is there a trustworthy global accounting firm to conduct an audit, and its trust is questionable. Since virtual currency doesn't have enough trust, endorsement, and assets, why has it continued to grow over the years? This is actually a question we want to ask. I myself think there are economic reasons for this; I have summarized two aspects.
First, virtual currency has a living ground. It exists in public blockchain communities or virtual communities structured with public blockchain technology. First, it has a governance mechanism that passes through the network. Second, there is an incentive mechanism for issuing virtual currency, so in these virtual decentralized public chain communities, virtual currency is an equivalent and payment tool recognized by participants, and it is also a proof of their work contribution.
Second, virtual currency is in demand in the market. Virtual currency can be anonymous and can cross borders. It is difficult to control because of its characteristics, it may become a tool for illegal flow and investment of funds. There is a large dark web market in the world, drug trading and porn trading. No one can say for sure how large such a market is now. What does it need in a market like this? What is needed are payment instruments and monetary instruments that can be trusted underground and are difficult to control above ground. So I think some virtual currencies like Bitcoin are adapted to the transaction and payment needs of underground markets such as dark web markets.
Let's further discuss where will virtual currency go? I think it has two big issues. The first is its technical flaw. The virtual currency we just mentioned survives and develops under the decentralized public blockchain architecture. Under such an architecture, its entire network is verified through ultra-high data synchronization, and the operating capabilities of each node also need to be balanced. Until now, neither Bitcoin, the best developed, nor Ethereum, which later took the lead, could solve the problems of transaction efficiency and large-scale application.
Second, there are economic problems or economic shortcomings. It is too speculative because it lacks sufficient physical assets to support and trust. In 2018, the lowest price of Bitcoin was 3,158 US dollars per virtual currency, and the highest price at the beginning of the year was more than 1,700 US dollars. There was an 84% drop between the lowest price and the highest price. On the other hand, the total market value of various virtual currencies in the world fell by 87% in 2018. Many of us Chinese participated in speculative Bitcoin virtual currency transactions, and it should be said that most of us lost money. Why is that? Let's take a look at Bitcoin. If you further analyze the Bitcoin account structure, you'll find that about 40% of its bitcoins are controlled by about 1,000 accounts, and 1,000 accounts are easy to speculate on. In May and June of the first half of last year, we in China were a good Bitcoin investor and technical expert. He suffered huge losses due to Bitcoin, and finally chose the path of suicide.
I myself think this part is very speculative. There are two problems. One is that it is a large-scale problem, and it is still not possible to achieve it; the other is that it is too speculative. Because of these two reasons, I myself feel that it is still difficult for virtual currency to enter popular transactions and life scenarios. China strictly controls and strictly supervises such so-called virtual currency transactions. By the end of last year, we had 173 virtual currency trading and financing platforms in China, all of which had withdrawn without risk. I think this is absolutely necessary.
Now let's discuss digital currencies from trusted institutions around the world. Regarding global digital currencies, special attention should be paid to their suprerogatives and superbanks. As mentioned earlier, fiat digital currencies can be trusted because of their statutory status and endorsement of national sovereignty. The digital currency of any other institution must have these qualities in order to be trustworthy. I have classified them into five aspects.
First, trust endorsements from institutions trusted by the public; second, customer size with commercial value; third, efficient and reliable financial transaction and payment platforms; fourth, auditable financial asset support; and fifth, market access with administrative licenses.
Talk about Libra
Everyone also has some research on Libra. Libra has some potential advantages. There are 21 co-founding institutions, so trust and endorsement is enough. Second, the existing customer base of this 20 or so founding institutions deducts at least 2 billion dollars of repetition. I just mentioned that our WeChat Pay and Alipay are over 1 billion; they are not an independent monetary system. Our Alipay and WeChat Pay customer groups are basically domestic, and there are very few foreign ones. You probably don't know that we have so many online platforms in China now. Which platform has the most customers in the world? It should be Douyin. Douyin probably has at least 200 to 300 million overseas customers, and maybe it is still growing fast. Nowadays, there are few global customers for other payment-related things, but Facebook dominates having global customers, which is a very important advantage for them.
Another one is that it uses so-called distributed peer-to-peer architectures and digital wallets, and it also promises to use hard assets to guarantee its value. Libra launched by Facebook clearly states that it is not possible to adopt a decentralized architecture yet; they promise to adopt a decentralized architecture after five years. Most of this stuff is said on Facebook. Can Libra get the market entry threshold for developed countries? I myself think there are still a few major issues to be solved.
First, how efficient and reliable is the technology platform? As I just mentioned, is the multi-center alliance's peer-to-peer network architecture that he is currently using reliable? Can its efficiency meet the requirements of high concurrency? What is the viability and transparency of the operating model of the secondary market? Burning so much money into it, exchanging our money for his Libra coin, how transparent is it, and how viable is it. Third, what exactly is the implementation path of compliance control, and how credible is it.
Actually, I myself think whether Libra can become a global payment and infrastructure, and the key to the global monetary system is in the US. In addition to regulations, Libra has received many questions up to now, including questions from US politicians, politicians, and US government departments. What can impress US politicians and governments outside of regulations should be the country's economic and financial strategy. Last year, Facebook's CEO answered a bunch of questions raised by lawmakers. At this meeting, Facebook's CEO emphasized the four points. The first point is that the Libra they launched doesn't want to create a new sovereign currency; it's just a global payment system, and the US dollar will account for the largest share of its reserves. Second, it would expand America's financial leadership and democratic values around the world. Third, he said that if America does not innovate, America's global financial leadership may be weakened, and there are no guarantees. Fourth, China has surpassed the US in some aspects of technological innovation. Some financial infrastructure, which refers to WeChat Pay and Alipay, is already ahead of the US, and the US must establish a more modern payment infrastructure.
I myself think that if the US were to try to maintain its financial hegemony, it might be possible that the administration and admission of Libra was based on additional restrictive conditions. For example, the share of the US dollar in the sovereign currency anchored by Libra is required to be increased by one to two-thirds, or about 70%, in line with the US dollar's hegemonic position in the world. It is possible to require Libra to comply with US regulations on anti-tax evasion and anti-money laundering.
What should we be more wary of? Global digital currencies may lead to financial disruption. The first is supersovereignty. The status of money as a general equivalent essentially depends on public trust. If weak countries experience greater economic difficulties, sovereign currencies may be replaced by supranational global currencies. In some countries, Bitcoin has replaced their sovereign currency, let alone a super-sovereign global currency. Another is that developed economies' sovereign currencies generally do not withdraw from the currency stage, and are more likely to become anchoring targets for supranational currencies. In this way, the dominant position between sovereign currencies and supranational global currencies may change. Also, I think there is a possibility that there will be several evenly distributed supranational currency systems around the world. Furthermore, supranational currencies in circulation around the world may no longer have clear national labels. For example, Libra is hosted in Switzerland and not in China. What is important is a global commercial application and digital trust recognized by the public.
Second, Superbank, Libra aims to provide a peer-to-peer, end-to-end transaction and transfer platform that can cover every corner of the world, and form a financial infrastructure that can cover every corner of the country. It is likely that it will gradually enter fields such as savings and asset transactions from payment and settlement, and infiltrate the economic lives of ordinary people. It will no longer require third party financial institutions and commercial banks, and may compete comprehensively for the financial industry market. Judging from the above analysis, I think digital currency is likely to restructure our financial model and monetary system. This is a real test and future opportunity.
What should we do? I think digital currency will definitely take a central position in future competition in the global digital economy, so it is very necessary for us in China to urgently study possible ways and implementation plans to issue a global digital currency dominated by China. A global digital currency dominated by China can be dominated by central banks, and I think it can also be dominated by enterprises. We should also need to further improve the specific structure of our country's fiat digital currency. What I introduced earlier is my interpretation of how we can improve these architectures, and I think we need to discuss them further. We should build on the healthy development of digital finance in China, speed up the construction of a digital finance system, speed up the standardization of digital finance, and urgently formulate a digital finance system to supervise the issuance of fiat digital currencies, etc.
Third, digital finance will surely further strengthen financial globalization and economic globalization. We should actively seek our voice and strive for dominance in building a global digital finance system. We should strengthen coordination of international regulations, promote regulatory consensus, and establish uniform standards for the international regulation of digital finance and digital currencies.
The above is Li Lihui's speech, compiled by Golden Finance based on the live speeches of the guests, without personal confirmation.
Source: Golden Finance
