Douglas Arner：Building Better Monetary and Payment Systems:Central Bank Digital Currencies

About the Speaker:

Douglas Arner，the Kerry Holdings Professor in Law at the University of Hong Kong and an expert on financial regulation, particularly the intersection between law, finance and technology.

The Speech:

Thanks Jenny and your team. I am glad to be here today.

2020 was dominated by Covid-19, but we are also seeing this rapid trend of digitization, in particular, digitization of finance.  

When we think about what is happening in the context of central bank digital currencies today, what we’re seeing is the result of a long-term process. We can think of finance and technology as being co-evolutionary. We think of the earliest histories of settled civilizations. We can think of some of the earliest evolutions from the standpoint of technology. We can think of writing. We can think of minting of coins later in time. We can think about paper money. We can think about bills of exchange. We can think about checks. We can think about electronic payments. All of these are a process of long-term co-evolution between money, finance and technology. 

I think this process has accelerated quite dramatically over the last 50 years. We think of the period from the 1970s up to the present, a process of digitization of finance, all aspects of finance around the world and that process of digitization sets the groundwork for datafication, the application of ever increasingly sophisticated analytics to those ever larger stores of digital data. And it is really this long-term process that we are seeing reflected in central bank digital currency. 

So what I mean by that? The long-term evolution, often we think of a focus on decentralized aspects. We think about blockchain. We think about digital assets. But in reality many of these processes are in the context of centralized technologies, centralized stores, centralized databases. And when we look at payment systems, when we think about central bank digital currencies, more often than not there is just as much role of centralized technologies as there is of decentralized technologies. I think the key point to take away here is that whenever we are thinking about money payments and finance, there is a technological horizon and money payments and finance are always evolving with that technological horizon. 

Think about 70s, 80s, 90s, really the beginning of the 2000s. Perhaps the biggest trend was in the context of digitization on centralized systems, things like RTGS systems, real time gross settlement systems, or mobile money systems of the sort that have become so powerful in China and across the world, and more recently the advent of an increasing range of FPS, what we call fast payment systems that essentially bring together real time payments across an economy. And much of what we are seeing in the context of today’s money and payment resolution is actually the result of that long-term evolutionary process in centralized technologies, but at the same time from around 2009, we began to see the advent or the expression of blockchain and the development of decentralized technologies and decentralized financial instruments and payment structures. 

Now if we think about the early evolution of, say Bitcoin or other cryptocurrencies, what I think we have seen as the reality is that none of those instruments have become widely accepted as monetary and payment instruments. Generally speaking, we’re seeing them used in economies where there are not better functioning alternatives, but also from the standpoint of investment as opposed to from the standpoint of actual payments. And that I think is an important aspect. 

When we think about the future development of blockchain, one of the constraints around blockchain systems has been the lack of an effective monetary and payment instrument. And we’ve seen the evolution beginning from around 2014 or so, a variety of what are called stable coins. Stable coins are digital assets which are linked to fiat currencies, and essentially what they do is they try to provide a link to the stability of a fiat currency, which can then be embedded into blockchain systems. But there have been lots of concerns around these instruments, things like Tether and others, and questions about just how stable and viable they really are. 

But I think much changed in 2019. If we think about monetary history, mid-2019 is an important historical date when Facebook releases its proposal for Libra, the first so-called global stable coin. What Libra represented was really the idea of a big tech company, a gigantic tech company releasing its own digital currency to operate across its own electronic payment system. And when we think about, particularly the Libra 1.0 proposal, this was something that was immediately seen as a potential challenge in a way that Bitcoin and crypto currencies and stable coins had never been. In other words, that because of the scale of Facebook and its global reach, particularly in developing countries around the world, it was seen that this proposal had the potential to very much challenge sovereign currencies. 

And as a result, we get a very strong response from international regulators, in particular trying to figure out ways to essentially bring Libra and its related payments systems within to the global regulatory framework. And we’ve seen particular attention from the G20 and the Financial Stability Board, as well as a range of individual countries and regulators to constrain that proposal and essentially bring it into the regulatory system.

But it has to be said that in addition that launch or the proposal to launch Libra spurred efforts of central banks, and the idea that what Libra in some ways highlighted was that the technology was there to build better payments and monetary systems, and that spurred central banks from their own standpoint to move forward. And the thing that moved beyond Libra was really 2020. If we think of covid-19, it has driven digitization. It has driven electronic payments. And that combination, in particular the need to get financial resources to large populations in lockdowns all over the world, has driven a lot of efforts by central banks from the standpoint of developing monetary systems. When we think about central banks, really central banks have three primary functions. One can even extends this to four. The first is monetary policy, monetary support policy which is designed to support wider economic and societal development. 

But core to monetary policy is the idea of monetary stability and what this means is that a monetary instrument is a core role of the central bank. A stable monetary instrument provides a fundamental public good to support economic and societal function and that of course means that central banks are continually looking at how they can provide a better monetary instrument as a foundation to support their role across the economy and society. We think of central bank’s second role. It’s around financial stability, which is both about supporting development, but in particular it is about preventing financial crises and around integrity and many aspects of these all come together from the standpoint of payments. 

Payments enable that monetary instrument to be used. Many of our biggest financial stability risks are through the payment system. Payments are core to the positive functioning of the financial system in supporting wider governmental objectives. And so when we think about central banks, central banks have spent a very long period of time. Fedwire in the United States actually had its advent at the beginning of the 20th century. If we think of Swift, the global payment messaging system Swift dates from the early 1970s. If we think of major RTGS systems across major economies, these have been developing over the past 50 years. 

If we think of the EUROCORE project, is the target to wholesale payment system. And as a result, central banks have a great deal of familiarity with electronic payments and electronic payment systems likewise central banks from the standpoint of their position in terms of responsibility for monetary stability. One core aspect of that is monetary technology. It’s not only payment systems, but it’s also about things like preventing forgery. In other words, if we think of the technology embedded in a banknote today, it is a very sophisticated range of polymers and other sorts of technologies that make it difficult to forge, to create fake currencies. Central banks are constantly investigating this. And certainly we can see in the context particularly, People’s Bank of China, as well as the European Central Bank, Bank of England, Monetary Authority of Singapore, Swedish Central Bank, Bank of Canada, all of these institutions for a variety of reasons began looking at blockchain technology as a potential technology to use in the context of money and payment systems from really the early part of the 2010s.

But by the late part of the 2010s, almost all of the central banks had come to the conclusion that while blockchain was interesting, it didn’t necessarily surpass centralized technologies from the standpoint of speed and safety, in particular, which are often the core aspects of central bank objectives. But the Libra proposal really changed this and it changed the way that central banks were looking at these sorts of technologies.

And I think what we can say is that in particular from the context of China, it had a very important incentive impact in terms of speeding up what had been a long-term process. Looking at using technologies to enhance payments and what I think we can see is that in addition to Libra, in addition to covid-19, the progress in rolling out of DCEP of e-CNY is likewise having a major incentive impact on central banks around the world not least because China is the largest trading partner for more countries around the world than any other country. 

And what that means is that from the standpoint of monetary and payment interactions for essentially every country in the world. Whatever sort of system China is using has a big role from the standpoint of their own trade, monetary and financial interactions with China. And so what we started to see across 2020 was a pretty dramatic acceleration in CBDC projects around the world. And I think what we’re going to see across 2021 is a continued focus on that. And if I were to say what is probably going to be the most important, it’s going to be the other major economies. And certainly the EU launched a major announcement, mainly a study in October 2020, looking at not only a digital finance strategy, but also the possibility of creating a digital Euro, and really for many of the same reasons that China has been looking at e-CNY, essentially needs to provide a secure monetary and payment system for digital environments with their blockchain or otherwise, needs to compete with potential private sector competitors, questions about the use of AML or sanctions regimes at the international level impact, questions around usability of the dollar and dollar-based systems and certainly the advent of possible geopolitical competitors like the e-CNY. 

So I think we can see many commonalities between major economies looking at these sorts of issues. And I think we’re likely to see a range of discussions increasing as well in the United States about the digital dollar. And I think when we think about central bank digital currencies, a number of things to take away. But first there is no single structure. Different governments, different central banks around the world are looking at a range of different systems likewise. As there are different structures, there are different technologies being used. 

Almost no one is looking at a fully decentralized, permissionless digital currency. Almost all of the systems evolve some level if they are distributed ledger structures of permissioned systems, but many systems are in fact fully centralized systems. So we’re seeing a variety of different structures, depending upon the level of development of a given economy, of a given country, its objectives from the standpoint of supporting its economy, its payment systems, its technologies and from the standpoint of what does its existing financial system and existing electronic payment systems look like. 

And so I think as we look forward, we can think about three different big groups. One group are our major economies: China, the EU and the US. And clearly what each of these does has big impacts from the standpoint of their own areas, but also from the standpoint of others interacting with those systems. Our second group is really around developed countries. Most of the rest of the developed world, OECD, G7 countries, these countries are mainly looking at developed financial systems, effective, more or less, payment structures, but trying to figure out how they can use digital currencies to make those systems work better and often dealing with evolution of cashless society to what we’re seeing in Sweden and Canada. 

Within the developed countries, there is a special group, the International financial centers. And one can think of the UK, with London; one can think of Switzerland; one can think of Singapore; one can think of the role of Hong Kong. Each of these financial centers, because of their interconnectivity, the way that they look at central bank digital currencies, particularly from the other major economies, is quite different than other content. And finally from the standpoint of emerging and developing economies, thinking about how they can use technologies to build better monetary and payment systems, to in many cases enable them to leapfrog past existing inefficiencies in their payment systems or in their financial systems. 

And at the international level, a major project from the G20, which is trying to look at how technologies, including central bank digital currencies, can be used to build better cross-border payments systems. So if I was going to add, to sort of summarize, I would say that 2020, because of Libra in 2019, because of Covid in 2020, because of progress with DCEP in China, that was a major transitional year from the standpoint of technology used by central banks, particularly central bank digital currencies. And I think 2021 we would see those projects accelerate, particularly across major economies. 

Thanks very much, Jenny.

Jenny, Founder of BlockGlobe：Thank you. Thank you Professor Douglas. Very excellent speech. Thanks for your sharing. Here I have a brief question and you can maybe spend about two minutes to answer me. Because China is putting forward with China’s central bank digital currency, many people are asking this question: How would China’s central bank digital currency help the internationalization of Chinese RMB? Can you answer me briefly?

Douglas: Yeah. I think it’s very interesting, because I think from 2015 up to 2020, there was a slowing of the RMB internationalization. I think if we look from 2008 up to 2015, this was something where a lot of attention, including here in Hong Kong, was pushed on RMB internationalization. Things probably slowed down a bit from 2015 to 2020. And I think it’s very interesting that if we look at the PDOC’s objectives for its current workplan, RMB internationalization has reappeared in the sort of shortlist of objectives. 

I think if we look at the design of the DCEP system, initially it’s largely focused on the domestic context. And I think that’s significant. But as we think about how that currency system can be used, it has important implications from the standpoint of internationalization. First, if you think of essentially the possibility that the central bank digital currency eventually eliminates all other non-electronic forms so bills and notes eventually go away, where you end up with eventually is a closed monetary system which gives you a very good ability from the standpoint of data tracking to track payments, to see economic activity and the like. But it also gives you a very effective tool from the standpoint of managing capital controls and flows in and out. 

And anyway you look at it, it would be very important from the standpoint of how does this system interact with the rest of the world; How do the valves work that allow flows in but also out of that. And that’s in particular from the standpoint of financial centers. I think as we think about how it could be used from the standpoint of internationalization, I think one thing is very clear. It’s not going to be a permissionless token that can flow to anywhere around the world. Rather it’s a system that is perhaps more likely to be extended in corridors, perhaps along existing central bank swap networks which would then enable access to the system by outsiders via these corridors. So it doesn’t end up being decentralized as it supports internationalization, but as an electronic system, it does support internationalization.