Translation: Liu Bin
Collaborators: Zhaoyun De
Source: Didi Technology Information
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Editor's Note: The original title was "Central Bank Digital Currency and Future Payment and Settlement System"
When considering the issuance of digital currency by the central bank, it is necessary to pay attention to "three constants" and "three changes" regarding the payment and settlement system and currency.
I want to thank everyone for attending today's "Future Payments Forum".
Recent private sector initiatives (including stablecoins) have shown that customers need convenient, fast and efficient payment methods. To meet this demand, the central bank should work with the private sector and continue to improve the payment and settlement infrastructure it provides. In this regard, the question of whether the central bank should issue digital currency (CBDC) has become an important issue.
When we look at the future of Japan's payment and settlement infrastructure, in a digital society, it is important to consider in what form central banks should provide central bank funding and how to improve private sector payment services. These two issues are closely related and should not be studied separately. I sincerely hope that we can have a fruitful exchange of opinions, as there are so many experts here on the Future Payments forum today.
When addressing these issues, it is important to explore how IT innovation and private-sector planning can impact payment and settlement systems and currency architecture. Before starting our discussion, let me first talk about "what will remain the same" and "what will change" in the foreseeable future.
Central Bank should pay attention to the "three constants" in the process of digital currency issuance
With regard to payment and settlement systems and currencies, three things will not change or should not change.
First, the basic structure of the currency will remain unchanged. There are two forms of currency: token-based or account-based. Token-based currency is a form of currency where the value of the currency is stored locally in some medium. Cash and electronic money issued by Japanese transportation companies are examples. The types of media (i.e. paper and electronic devices) that store monetary value vary, but the basic architecture remains the same, that is, payments are made by transferring the monetary value stored in the medium. At the same time, when an issuer receives a value transfer instruction from a payer, it debits and credits the receiver's account lender from the payer's debit, and an account-based monetary value transfer occurs. A typical example of an account-based currency is a bank deposit. Payers can send bank transfer instructions to their banks in a variety of ways (such as through bank teller counters, online banking, credit and debit cards), but the basic structure remains the same. Non-bank payment service providers (NBPSP), which today lead the expansion of Japan's cashless society, also issue account-based currencies. Users send value transfer instructions to their account via their smartphone for payment. Future payment services will likely evolve based on one of two forms: token-based currency or account-based currency.
Second, the two-tier currency system will remain unchanged. This is something that should not be changed and should be maintained. The currency provided by the central bank in the two-tier system consists of cash and central bank deposits, and private banks provide deposits through credit creation based on the central bank's currency. Under the two-tier system, financial resources are effectively allocated through privately led programs, and the system has the advantage of taking full advantage of private sector innovation in payment services. In fact, currencies issued by NBPSP (such as fintech companies), whether token-based or account-based, are generated through the equivalent conversion of cash or bank deposits. The presence of a large number of private currency issuers will maintain a competitive advantage in providing new and efficient payment methods and financial services in general.
Third, the basic role of the central bank will remain unchanged. Even if the use of banknotes continues to decrease and the Japanese economy enters a cashless society, the Bank of Japan will implement monetary policy under the two-tier currency system by controlling the central bank's current account (ie digital currency) and act as a "last lender." Facing challenges, such as the complexity of currency transmission channels or the difficulty of mastering currency. However, these challenges are not new to us. Regardless of the changes in the environment surrounding payment services and currencies with the development of IT innovation, the central bank will basically maintain its responsibility and ability to maintain monetary and financial stability.
"Three changes" to be noticed in the process of central bank digital currency issuance
In contrast, how will payment and settlement systems evolve with IT innovation? Now, I want to talk about three things that will change.
First, cashless payments will grow steadily in retail payments. In fact, except in special circumstances such as Sweden, the cash balances of major advanced economies have been increasing. In Japan, the number of people using cashless payments seems to have increased since the government launched the "Consumer Credit Reward Program Using Cashless Payments" in October 2019. However, at the same time, the amount of outstanding cash in circulation has also increased by 2% per year. The preference for cash remains surprising. Having said that, as new services emerge and people learn more about their convenience, in the long run, progress towards a cashless society will not be hindered.
Second, the diversification of payment service providers is likely to continue. The latest developments in a cashless society seem to be dominated by NBPSPs (such as large high-tech hi-tech companies, fintech companies, retailers, and transportation companies) rather than banks. For example, digital currency issued by money transfer service providers commonly known as "XYZ Pay" and issuers of prepaid payment instruments such as retailers and transportation companies is different from traditional cash and bank deposits Use seems to be expanding. The diversity of payment service providers can have various impacts on financial regulations and the operation of payment and settlement systems operated or managed by central banks and the private sector.
Third, money and data will become more closely linked. Many NBPSPs provide convenient cashless payment services. Their purpose is not only to improve customer convenience, but also to expand their ecosystem through network effects by enticing customers to use other related services provided by NBPSP. This strategy is called "Data Network Activity (DNA)." In the past, shopping with payment, in other words, the exchange of a certain amount of economic value with currency. Today, it also means exchanging relevant data about who, when, where, and what. In some cases, the data exchanged can be data that has just seen online advertising but has not purchased anything. Therefore, as we explore the future of payment and settlement systems, it becomes particularly important to discuss issues related to the protection and effective use of personal data.
CBDC discussions by foreign central banks
In this rapidly changing world around payment and settlement systems and the monetary environment, what role and functions is CBDC expected to play? Foreign central bank investigations into issuing central bank CBDCs can be divided into three categories.
First is the situation in Sweden. In Sweden, the reduction in outstanding circulating cash has reached less than 2% of GDP, which is their motivation to explore the possibility of issuing a CBDC. Due to the significant increase in cashless payments, the number of retail stores that accept cash has decreased, and people sometimes have difficulties with daily purchases in cash. In this case, the central bank's goal is to provide everyone with access to central bank funding.
Followed by emerging economies such as Cambodia and the Bahamas. In these economies, the infrastructure related to local currency and payments is still immature, but smartphones have spread across the globe. In this environment, rebuilding payment and settlement systems from scratch is a viable agenda, and it will be easier to adopt the latest technology.
The third is the situation in China. Although the details of the design are not clear, according to the official information released so far, the People's Bank of China (PBoC) clearly aims to issue a CBDC instead of circulating cash. Not only will the People's Bank of China focus on reducing cash processing costs, it will also address counterfeiting risks, as well as prevent money laundering and combat financing of terrorism (AML / CFT).
The situation is different in major advanced economies, including Japan. As mentioned in the aforementioned countries, the demand for CBDC does not necessarily increase. In many advanced economies, the amount of outstanding cash in circulation is still increasing year by year. No new steps are needed to ensure that people can use the central bank's currency. In addition, the currency systems and payment and settlement systems of these economies are operating safely and steadily. They can't simply switch to new technologies, or they really shouldn't. Anti-money laundering / combating the financing of terrorism is an important issue, but the most advanced economies believe that it should first be addressed through regulatory and supervisory measures.
So, in addition to the roles and functions discussed in these situations, what is the expected role and function of the CBDC? To answer this question, it may be useful to review the basic role of currency. In this way, not only the potential benefits of CBDC, but also the various issues that need to be addressed will be exposed.
To support economic activity, you must have a safe, reliable, cheap, and universal payment instrument for all. Most agree that even in a digital society, central banks should play the role of providers of such tools. It is expected that CBDC will play a role in this. I want to share a point of view often expressed by payment service providers.
As mentioned earlier, the entry of new service providers into the payment market is one of the key changes in the field of payment systems. In this sense, ensuring interoperability between private digital currencies is a challenge. For example, payment platforms operated by NBPSP (such as "XYZ Pay") do not necessarily share member merchants. In other words, usually the digital currency issued by NBPSP cannot be accepted by another NBPSP member merchant. Similarly, peer-to-peer (P2P) payments or remittances cannot be performed between payment platforms operated by different NBPSPs.
What role is CBDC expected to play in these circumstances? CBDC can help remove barriers to P2P payments and significantly improve interoperability between different types of private digital currencies. By linking various types of private digital currencies to each other, CBDC can contribute to improving payment efficiency. In fact, CBDC seems to have high expectations in this regard.
However, this matter is not easy. Regarding CBDC, there are many issues that need to be considered comprehensively, including their impact on the payment and settlement system and the entire financial system. As mentioned earlier, although the issuance of the CBDC can facilitate the interconnection of various types of private digital currencies, there may also be a risk of crowding out existing private services such as bank fund transfers. In addition, if the payment costs associated with CBDC are much lower than the payment costs of private payment services, then most merchants will be more willing to accept payments through CBDC rather than through private digital currencies. Central banks can provide services that are cheaper than private entities, because from the perspective of providing public goods, the central bank bears a certain cost, the core infrastructure for payment and settlement. Depending on the design and pricing of core infrastructure, the central bank may suppress private companies and hinder innovation.
In addition, if businesses and individuals prefer to hold CBDC over bank deposits, this will affect the function of banks' funds and financial intermediaries, including bank loans. Therefore, it may change the double currency system itself.
It should also be noted that, as mentioned earlier, with the development of digitization, money and data will become more closely linked. If the central bank issues a CBDC, relevant transaction information will flow into the central bank. Its meaning is not only a matter of protecting personal information, but also of what kind of system design the society needs in order to effectively use such business information for business purposes.
Central banks need to deepen their understanding of the benefits, challenges and risks of issuing a CBDC. In addition, regarding challenges and risks, the central bank needs to consider carefully whether there are effective measures to deal with these challenges and risks. Various problems remain.
When designing future payment and settlement systems, it is important to study how to improve the overall function of the system by considering the interaction between central bank currency and private currency. In the previous example, it was important for the private sector to improve payment interoperability, increase the efficiency of existing payment infrastructure, and eliminate friction in digital currency exchange. For example, to improve interoperability, you can choose to interconnect different payment platforms or NBPSPs to participate in a bank's payment platform.
The questions I just asked are just some examples related to retail payment services. There are various cases and challenges regarding wholesale and cross-border payments. In today's forum, we will hold separate meetings on the three topics of retail, wholesale and cross-border payment. I hope this forum will provide an opportunity to consult experts to discuss the future of payment and settlement systems together. To this end, the Bank of Japan will continue to host the "Future Payment Forum" in the future. In addition, the Bank of Japan has just established a research group on CBDC within the Department of Payments and Settlement Systems and will conduct further research on various issues through information exchange and discussions with Japanese experts and relevant institutions and other central banks.