The legal framework for China's digital currency was published by People's Bank of China (PBOC) in October 2020 through the PRC Law of PBOC (Amended Draft for Public Opinion) (the Draft). The Draft, once enacted, will legalize a digital form of renminbi (RMB) as an alternative legal tender in Mainland China.
PBOC, as the issuer of Digital Currency Electronic Payment (DC/EP), will adopt a "one currency, two bank libraries and three centers" structure (DC/EP Structure) to manage, record, and analyze DC/EP and DC/EP-based transactions. Distributed ledger technology (DLT) might be one technology used for such DC/EP structure, but the exact role of DLT remains unclear at this point as the DC/EP structure is not decentralized. As a result, the DC/EP user can only enjoy limited anonymity as DC/EP is technically traceable. PBOC will also adopt a two-tier DC/EP distribution system: first being distributed to banks and other designated financial institutions (including payment institution) and then further being distributed by such intermediaries to the end users.
What is DC/EP?
The PBOC-backed sovereign digital currency is referred to by PBOC as the "Digital Currency Electronic Payment" or, commonly referred to, "DC/EP". The PBOC has determined that DC/EP will be accepted as a form of RMB, convertible with paper currency and coins at a rate of one to one. This means that DC/EP will inherit the same characteristics of physical cash and coins, in the sense that: (i) it has unlimited liability, (ii) it does not generate interest, (iii) it must be accepted as a form of payment; and (iv) it undertakes no social or administrative function other than to serve as a form of legal tender (i.e. unit of value, medium of exchange, method of payment and store of value).
How does the DC/EP work?
According to media reports on the testing of DC/EP in pilot cities, comments taken from speeches by PBOC officials and the revealed China Construction Bank's online user terms for DC/EP (though which was invalidated within a day):
- DC/EP will operate through a mobile application linking the user's DC/EP wallet to a bank account (DC/EP App Wallet) or a hardware storing DC/EP (in Shanghai trial, such hardware is in the form of a smart card-like device with a small embedded screen in the corner of the card displaying the account balance, amount of purchase and the number remaining users of offline payments) – (DC/EP Hardware Wallet). DC/EP App Wallet users may convert RMB from the linked bank account, on a one to one basis, into DC/EP, which is then stored in the user’s DC/EP wallet. DC/EP Hardware Wallet user may store DC/EP via NFC technology and spend DC/EP near participating point-of-sale terminals. Merchants will download the same DC/EP app or to their cashless payment systems and maintain a DC/EP wallet or to obtain the DC/EP Hardware Wallet storing DC/EP issued through the counter or electronical channels of the bank.
- DC/EP transaction can be done through the function of "touch and touch" via NFC technology, online transfer, or "sub-wallet push" which enables spending of DC/EP in online scenarios (e.g. users who want to spend DC/EP on their mobile JD.com (a popular PRC e-commerce platform) app need to tap DC/EP wallets to enable a JD sub-wallet push and after that they will find a DC/EP payment option available on their mobile JD.com app.
- There are four types of wallets, each with different transaction limits:
- The first type of wallet is within the maximum of RMB50,000 per payment, a daily limit of RMB100,000, and annual limit of RMB500,000.
- The second type of wallet is within the maximum of RMB5,000 per payment, a daily limit of RMB10,000, and annual limit of RMB300,000.
- The third type of wallet is within the maximum of RMB2,000 per payment, a daily limit of RMB2,000, and annual limit of RMB50,000.
- The fourth type of wallet is within the maximum of RMB500 per payment, a daily limit of RMB1,000, and annual limit of RMB10,000.
The aforesaid transaction limits were revealed by China Construction Bank's open trial of DC/EP in its app on 29 August 2020, the details of which were withdrawn within half a day. Such wallet classification structure is very similar to the current PRC regulation on classification of bank accounts (account opened online rather than over the counter is most restrictive regarding its the maximum amount for per payment, daily limit and annual limit and withdrawal of cash etc.). However, the transaction limit on DC/EP wallet may vary from place to place. For example, in the first public test of DC/EP in Shenzhen, the DC/EP wallet is within the maximum of RMB2,000 per payment, daily limit of RMB5,000, and annual limit of RMB50,000.
Characteristics of DC/EP
- Ready to use without need to link to any bank account. Like exchanging cash in real life, customers do not need to hold a bank account or a payment account. DC/EP can be transferred as long as users have a mobile phone with a DC/EP App Wallet installed or a Hardware DC/EP Wallet has been obtained from the banks. Unlike Alipay and WeChat Pay where customers must first bind their bank accounts to their payment accounts and each Alipay and WeChat Pay payment must be settled in their bank accounts, DC/EP can be directly transferred and settled without involvement of a commercial bank or a payment institution. For DC/EP App Wallet, the user may still have to link the wallet to his/her bank account in order to top up the wallet or withdraw DC/EP out of the wallet.
- DC/EP system supports offline payments. The function called "touch and touch" enables users to simply tap their cell phones together to make a transfer via NFC technology without cellular network cell phone signals or to tap the Hardware DC/EP Wallet close to the participating point-of-sale terminal without using the phone, leaving no payment record with a third party like an intermediary bank or telecommunication companies. The offline mode intends to make people feel as though they are exchanging cash. However, given all DC/EP transactions will be managed, recorded and analyzed by PBOC, the aforesaid anonymity is relatively limited.
- DC/EP is legal tender. Like cash, merchants must accept DC/EP as legal tender for payment for their goods and services.
- Free or charge, targeting retail transactions with small amounts. Consumers and merchants do not incur any fees for the use of DC/EP. DC/EP is currently limited to small retail transactions and has not been expanded to large volume transactions.
Why PBOC is launching DC/EP?
The PBOC has set out a number of objectives for DC/EP, including the following:
Combat money laundering, gambling, and terrorism financing
The PBOC has stated that a primary goal for DC/EP is to help combat money laundering, illegal gambling, and terrorist finance. Given that DC/EP is of controllable anonymity, the DC/EP Structure technically enables PBOC to monitor and control flows of funds. The traceability of the digital currency enables PBOC to check the identities of users participating in high-value transactions (though the current trial of DC/EP is limited to low value transaction) and, if necessary, to block processing for disqualified users and transactions. Potentially, the DC/EP system could also be linked with the social credit system to assist authorities in identifying citizens who make suspicious or illegal financial transactions.
RMB internationalization
Another goal for DC/EP is to internationalize the RMB by fostering a better cross-border payments and settlements system. Through the DC/EP, it can boost China's role in international trade and payment settlements across the "One Belt, One Road" countries and regions.
International competition in cryptocurrency
The PBOC has also stated its desire to advance China's position in relation to international developments in cryptocurrencies. Noting that the Draft includes provisions that prohibit the issuance and acceptance of other RMB-backed cryptocurrencies.
Capital control
The ability to trace transactions and funds for DC/EP also enables the PBOC to implement capital controls more effectively. China has very strict forex policy and, amid the COVID-19 pandemic, large amounts of state aid and donation funds have been granted to areas which are significantly impacted by the pandemic. DC/EP allows the Chinse government to trace such aid or donation to ensure that funds are transferred to the intended recipients and used for the right purposes. The traceability also enables the Chinese government to gain full control over cross-border capital flows.
A "contactless" model
With COVID-19 pandemic and the need for social distancing, the DC/EP provides for near-contactless transactions whereby users can carry out transactions by simply tapping their phones together.
Smart cities
DC/EP is meant to support smart city initiatives, building on IoT infrastructures and other networks to create a seamless cyber environment for consumers.
Design of DC/EP System
Discussions of DC/EP have begun as early as 2014. In 2016, the Digital Currency Research Institute was founded. Based on public materials released by PBOC, the current framework for DC/EP system is as below:
- DC/EP will be issued based on encryption algorithm, whilst physical cash issuance will be maintained at the initial stage.
- DC/EP will be issued by PBOC and serve as an alternative for the M0 (cash in circulation) but not for M1 (M0 + corporate demand deposits) or M2 (M1 + corporate demand deposits + resident savings deposits + other deposits).
- PBOC will adopt the "one currency, two bank libraries and three centers" structure:
- One currency: DC/EP is a form of RMB, it is a digital token representing a specific amount guaranteed and signed by PBOC.
- Two bank libraries: means that bank libraries for PBOC and commercial banks.
- Three centers: refer to the certification center, registration center, and big data analysis center. The certification center undertakes to manage approved DC/EP institutions and DC/EP users' identity information. The registration center undertakes to record DC/EP and user's identity, complete the user's registration, record the flow of funds, complete DC/EP generation, circulation, inventory verification and extinction process registration. The big data analysis center undertakes to collect and analyze market behavior, for instance, anti-money laundering, payment behavior analysis, supervision and regulation index analysis, etc.
- PBOC's private cloud for digital currency will be the underlying infrastructure used to support the operation of DC/EP; and blockchain technology is expected to be used as one of the underlying designs of DC/EP.
Distribution of DC/EP
According to PBOC, the distribution of DC/EP will be based on a two-tier system:
- Issuance layer: the top layer is the issuer, PBOC, who provides a guarantee for the DC/EP issued; and
- Distribution layer: commercial banks and certain non-financial institutions comprise the second layer, committing deposit reserves to the PBOC against the DC/EP issued to the public.
Recent developments
As early as April 2020, there have been reports that an internal and closed testing run was done in Suzhou involving the use of DC/EP for payments to civil servants, public transportation services, and energy and supply chain trading. It was reported that Suzhou municipal government employees received 50 percent of their transportation subsidies in May 2020 in DC/EP.
On 14 August 2020 the Ministry of Commerce of People's Republic of China (MOFCOM) officially announced a plan on expansion of DC/EP trials in major cities. The plan is roughly as follows:
- Trial runs will be rolled out in Beijing-Tianjin-Hebei Region in the north; the Yangtze River Delta (mainly covering Shanghai, Zhejiang and Jiangsu province) to the east; and the Guangdong-HK-Macao Greater Bay Area in the south.
- PBOC will formulate implementation policies to ensure the trials run smoothly and safely in the trial cities (i.e. Shenzhen, Suzhou, Chengdu, Xiong'an), and during the 2022 Beijing Winter Olympics (involving Hebei and Heilongjiang).
- The central and western regions can also run trials if they meet certain criteria.
In October 2020, PBOC conducted its first public trial for testing DC/EP in Shenzhen. In this public trial, PBOC handed out around RMB 10 million (approx. US$1.5 million) of the digital currency in "red packets" to 50,000 lottery winners in Shenzhen. Each red packet was valued at up to RMB200 (approx. US$30). These red packets were distributed through iShenzhen, a blockchain-based public services application operated by the Chinese government. Each lottery winner was able to spend the digital currency in over 3,000 merchants, including restaurants, supermarkets, gas stations, metro stations, department stores, and other everyday retail businesses that have installed the necessary DC/EP payment facilities. In the end of 2020, Suzhou launched a new test, where the all Big Six state-owned banks and major online-platform operators (including e-commerce platform JD.com, Groupon and food delivery platform Meituan, video platform Bilibili, and car hailing platform Didi) had participated. In Suzhou test, DC/EP had been widely tested in online scenarios.
Going forward, Yi Gang, PBOC's governor, said that the PBOC was open to collaborating with other monetary authorities in establishing a legal framework for adopting and promoting an international use of DC/EP.
There has not been a clear timeline for the official launch of DC/EP in Mainland China. This is likely to come with amendments to other laws in mainland China to cover a widespread acceptance of DC/EP as legal tender, including the RMB Administration Regulation, banking rules, and other national level rules.
What this means for payments in Hong Kong?
The PBOC and HKMA collaboration paves way for easier cross-border transfers, bringing greater convenience to Hong Kong and Mainland Chinese tourists. This is not the first collaboration between the two on blockchain projects. In 2019, the two signed an agreement to enable PBOC’s trade finance blockchain to interoperate with Hong Kong's eTradeConnect.
In a press release by the Hong Kong government dated 21 October 2020, the Hong Kong government indicated that China’s DC/EP can be applied to cross-border payments, which would greatly promote the mutual connectivity between Mainland and Hong Kong, under the Guangdong-Hong Kong-Macao Greater Bay Area initiative. The HKMA places great importance to the development of fintech in Hong Kong and is determined to enhance Hong Kong’s position as a global hub of offshore RMB business.
Details of the collaboration in Hong Kong have yet to be revealed, however, it is expected that the pilot scheme will lead to the commercialization of DC/EP in Hong Kong, fostering cross-border payments in the Greater Bay Area. Such a step is crucial in reasserting the role of Hong Kong as RMB's largest offshore trading center, and reaffirming Hong Kong's position as an international financial and technology hub.
Apart from mainland China, the HKMA have also been working with the Bank of Thailand on digital currency projects. In 2019, the HKMA and the Bank of Thailand initiated a joint study named "Project Inthanon (Note)-LionRock", which involves trials of cross-border trade payments by using central bank digital currencies and a blockchain platform. The initial project was completed and a distributed ledger technology based on proof-of-concept was developed successfully together with ten participating banks from both places. The research project is currently in its second stage, which will explore specific business applications as well as operability and scalability of the platform to allow participation of more digital currencies.
Authored by Mark Parsons, Tommy Liu, and Shirley Guo.
