Zhou Xiaochuan Clarifies Three Major Misunderstandings About Digital Currency at Wudaokou (Full Speech Attached)

This article is sourced from Tencent Finance.

On May 22, Zhou Xiaochuan, Honorary Dean of Tsinghua University’s Wudaokou School of Finance and former Governor of the Central Bank, delivered a keynote speech on "Digital Currency and Electronic Payment Systems" at the "2021 Tsinghua Wudaokou Global Financial Forum."

In his speech, Zhou Xiaochuan first clarified three misconceptions about digital currency: First, that China's digital currency aims to replace the dollar's status as a reserve currency and its role as an international payment currency; second, that digital currency is closely linked to the internationalization of the renminbi; and third, that DECP and e-CNY intend to replace the current role of third-party payment systems.

"The purpose and direction of digital currency design do not aim to replace the dollar's status as a reserve currency and its role as an international payment currency; digital currency helps enhance the status of the renminbi and its cross-border use, but the internationalization of the renminbi depends more on institutional and policy choices, and more on the progress of reform and opening up, rather than on technological factors; DECP is a dual-layer system, developed collaboratively by commercial banks, telecommunications operators, and several major third-party payment institutions, all of whom are in the same boat," Zhou Xiaochuan stated.

Zhou Xiaochuan also expressed his views on controllable anonymity in digital currency, believing that payment systems must strike a balance between protecting privacy and combating money laundering, terrorism, drug trafficking, and cross-border gambling.

"The concept of controllable anonymity proposed by China's DECP is not a mathematically precise point, but it means finding a balance between protecting privacy and combating money laundering and drug trafficking. Everyone can further study where this balance lies, but we should not deliberately belittle or attack the progress of DECP in this matter."

The following is the full text of Zhou Xiaochuan's speech:

Distinguished guests and representatives, good morning! I am very pleased to participate in this Tsinghua Wudaokou Global Financial Forum. I just listened to very important speeches by President Qiu Yong and Dean Zhang Xiaohui. This year marks the 110th anniversary of Tsinghua University, and national leaders have personally given important instructions on the development of Tsinghua University, expressing high expectations. In this context, Tsinghua University’s Wudaokou School of Finance and the global financial forum it hosts are becoming better and better. Today, I would like to discuss an academic issue, specifically "Digital Currency and Electronic Payment Systems."

This topic has been discussed a lot recently, and it has indeed received clear attention from the Central Committee of the Communist Party and the State Council, being included in the "14th Five-Year Plan" to actively explore development pilot promotion. However, I have seen many media reports and comments on this issue and found that there are still many concepts that need further clarification, and some directional issues still need exploration.

Although China has entered the R&D and pilot phase of DC/EP, there are still many aspects of this issue that require discussion, so I take this opportunity to communicate with everyone, and I feel it is also an issue of international interest.

Of course, I am currently in a position as an observer, and I have a certain distance from some specific issues in the R&D and pilot process, so my observations may not be very accurate. I would like to discuss this topic with everyone.

First, some discussions by the media, especially foreign media, may lead to certain misunderstandings. As I mentioned earlier, in the past few years, we have had many discussions about these basic concepts, but it does not mean that everyone has reached a consensus or that everyone has a deep understanding of this issue.

For example, a common statement from foreign media is that China's DC/EP or e-CNY, no matter how it develops, cannot replace the dollar's dominant position internationally. I think this statement itself is not quite correct because the development of DECP is primarily based on the modernization of the domestic payment system, keeping pace with the digital economy and the internet era, improving efficiency, and reducing costs, especially serving the retail payment system. The original design purpose and direction did not aim to replace the dollar's status as a reserve currency and its role as an international payment currency.

Another statement often made by foreign media is closely linking the R&D and pilot of digital currency with the internationalization of the renminbi, believing that digital currency does not significantly help the internationalization of the renminbi or that it cannot achieve the internationalization of the renminbi.

I believe that the modernization and digitization of the renminbi payment system will help enhance the status of the renminbi and increase its cross-border use to a certain extent, but it will not be a huge help. The internationalization of the renminbi depends more on institutional and policy choices, and more on the progress of China's reform and opening up, rather than on technological factors.

Another argument is that the People's Bank of China is promoting DECP and e-CNY to replace the current role of third-party payment systems, which I think is also a misconception. The People's Bank of China has clearly stated that the DECP plan is a dual-layer system, and the entire R&D team is organized by the People's Bank, involving major commercial banks, including ICBC, ABC, and others, as well as telecommunications operators and several major third-party payment institutions, all participating in the R&D based on their previous work, aiming for an upgraded new level.

Everyone is in the same boat, and of course, people in the same boat may sometimes have different opinions and may have disputes on some issues, but after all, they are in the same boat. It is not as some people say, as if there is an internal struggle over who will replace whom.

A few days ago, I happened to watch a movie about playing volleyball. I want to give an example. How do volleyball players train? To increase the power of attacks and spikes, athletes need to train their muscles.

As a result, some people might see this training and start making sarcastic comments, saying, "Your muscles are well-trained, but no matter how you train, if you want to compete in weightlifting and win, you have no chance." The team says, "We never intended to participate in weightlifting competitions, so don't bring up such irrelevant matters." Moreover, the current volleyball playing style emphasizes back-row attacks, jumping from beyond the three-meter line.

When training for back-row attacks, some might say that the coach and setter are deliberately belittling the attacks of the second and fourth positions, focusing solely on training back-row attacks. Such provocation is meaningless because, in a team, everyone hopes to have scoring opportunities when the first pass is good, and frankly, volleyball competitions often award the best spiker to whoever has more opportunities to score. Therefore, internal disputes sometimes occur, which is normal, but after all, they are a team, and everyone needs to cooperate to make progress together.

I use this example to illustrate that some unfounded concepts or statements actually lack understanding of the R&D plans and pilots, and they can easily lead to the idea of "the grass is greener on the other side." It is clear that the plan has been proposed and is already in the process of system construction and piloting; one should not expect to excel in volleyball while also aiming to win championships in other sports, as this may be problematic.

Another issue is the discussion about controllable anonymity. In fact, payment systems must strike a balance between protecting privacy and combating money laundering, terrorism, drug trafficking, and cross-border gambling. On one hand, privacy must be guaranteed, while on the other hand, necessary monitoring must be implemented for certain activities. Therefore, if viewed from two angles, some may stand on the left and say you are not protecting privacy enough, while others on the right may say you are condoning money laundering and drug trafficking.

Thus, there must be a balance point in the middle, but this balance point can be chosen to lean slightly left or slightly right. The concept of controllable anonymity proposed by China's DECP is not a mathematically precise point, but it expresses the idea of finding a balance between protecting privacy and combating money laundering and drug trafficking. Everyone can further study where this balance lies, but we should not deliberately belittle or attack the progress of DECP in this matter.

Another question is whether the issuance rights of digital currency require special legislation, etc. I will also say a few words about this later, as there are many conceptual aspects that need to be explored.

In summary, amidst the media and various discussions and voices, we still need to enhance communication and discussions in this area, so that society, including all aspects globally, can have a clearer understanding of the progress and development of digital currency, as well as a better understanding of China's DECP and e-CNY.

The second aspect I want to discuss is about the modernization of payment systems, specifically which key points to focus on.

First, we say that digital currency has many different emphases from a global perspective. Some focus on improving the efficiency of retail systems, some emphasize wholesale transactions, and some focus on whether exchanges and financial markets can adopt new payment and settlement systems. Some people say that with so much global trade, including goods and services trade, whether trade can be more convenient.

When Facebook initially promoted Libra, it felt that cross-border remittances were inconvenient and could not improve the convenience of cross-border remittances. Some individuals also mentioned the convenience of cross-border investment, so there are multiple areas that may have development prospects. I want to discuss what issues we should focus on.

Overall, the modernization of payment systems is a step forward over a period of time, and this step is generally quite significant, providing enough motivation for everyone. For example, like the updates of mobile phones, some manufacturers release a new version every few months, but from the user's perspective, if I just bought my phone and it still works, the performance hasn't changed much. Therefore, it must feel like this step is significant enough before considering an upgrade; especially small steps or minor improvements may not provide enough motivation to change systems. Thus, we should evaluate the magnitude of the step based on the differentiation of the gap.

How to assess this step? One is to look at the system's functions, how efficient it is, and how it performs. The second is to look at costs, whether costs can be reduced; efficiency compared to cost is the cost-effectiveness ratio.

Additionally, we must consider the likelihood of errors in this system, as the financial system involves stability and confidence, and the probability of errors is of great concern. It is also difficult to avoid errors entirely; there will be small probabilities of errors, and after an error occurs, whether it can be corrected. For example, if a payment is made incorrectly, can it be refunded, can losses be stopped? There is also a concept in credit cards called chargeback, which allows one to recover the money. Furthermore, from a performance perspective, how strong is the system's risk control capability?

Sometimes, from a technical development perspective, there is a strong desire to use a particular technology, but from the perspective of the financial system, the emphasis on stability, risk control, error probability, and error correction capability may be higher than from a purely technical perspective.

Looking at these aspects, China places considerable emphasis on the retail system, and this step can be quite significant. China is a society that uses cash relatively more, but globally, it is not particularly outstanding.

I estimate that even in developed countries where credit cards are widely used, there will still be a sense that with the emergence of the internet, especially mobile internet, this step is worth taking.

Moreover, this is also a customer demand; customers do not want overly complex and diverse payment methods. They hope that with the advent of mobile phones, mobile internet can become a mainstream retail payment method. Therefore, this step also saves significant costs, and the motivation to move forward is considerable.

From a wholesale perspective, some countries are now working on CBDC. From my personal observation, China's e-CNY is not a complete CBDC, but it can certainly be discussed within the broader topic of CBDC, as it has its own characteristics.

One type of CBDC primarily focuses on the wholesale system. Most ordinary people and non-financial system individuals do not understand the wholesale aspects of the payment system; they do not know how the underlying clearing system works, nor do they understand how bank clearing and settlement work. They may not know whether this system currently has poor efficiency, whether it makes mistakes, whether costs are too high, or whether banks charge excessive fees that are indirectly passed on to other bank customers.

With the development of technology, the wholesale system also has great potential for further improvement. However, currently, there is not much room for significant improvement in efficiency and cost, and even if improvements are made, they may not be very noticeable, and society may not feel much impact. Overall, we believe that attention should also be given to the wholesale aspect, but this step seems to be limited to a relatively small one.

As for exchanges, the operation of all systems in exchanges is still very good, except for individual cases, especially due to high-frequency trading, which has led to situations like the flash crash in the UK. Overall, the operation is still quite good.

Although the entire system of exchanges, including the so-called price priority and time priority automatic matching system, as well as the subsequent securities registration and settlement systems, incurs considerable costs, the calls for improvement in this area are not high. If everyone wants to reduce trading costs, it may be more about reducing stamp duties, as stamp duties are more concerning than the costs of technical systems.

Additionally, it is not necessarily better for trading settlements to be faster. Over the years, there has been much discussion about whether the exchange's technical system has the capability to provide T+0, allowing same-day turnaround trading and more high-frequency trading.

However, market participants have raised certain doubts and challenges regarding this, as faster is not always better. The entire payment system, including the exchange system, may potentially achieve real-time full-amount trading systems in the future, but real-time full-amount trading systems are not necessarily a good choice applicable to all links.

This is why the ISDA Derivatives Trading Association repeatedly advocates for netting settlement, as it is more beneficial for market participants' risk control, while also reducing the economic capital required for each real-time full-amount transaction and the so-called risk measurement. From the perspective of the exchange system, it is not the case that faster and more real-time full-amount trading is better. Therefore, this also involves the question of how much room there is for this step to be taken.

Next, let’s look at international trade, which is actually the main content of cross-border payments, including goods trade and services trade. However, as outsiders imagine, it is easy to think that international trade can be as simple as when we go to a store to buy something, paying cash and receiving goods directly.

In reality, most international trade involves a certain volume and is much more complex. First, most goods, aside from bulk cargo, are transported in containers, which hold many items and involve various specifications and details that need to be specified in contracts, requiring extensive prior communication.

More importantly, it involves transportation, warehousing, and insurance. What are the risks in the transportation process? Will there be losses during transportation? What about the warehousing process? Will items spoil inside? All these factors lead to a series of additional services, which also involve finance.

From a payment perspective, cross-border payments involve exchange rates and currency choices. In addition, exporters need trade financing; once goods are shipped, they must wait for the other party to receive and inspect the goods before payment. This distance means that production has already started, so trade financing is necessary. A typical tool for trade financing in the past has been letter of credit financing; after opening a letter of credit, financing can be obtained, allowing the next round of production to borrow money from the bank. This financial service must also be included as an important component.

Moreover, many small and medium-sized enterprises engage in international trade, crossing countries and sometimes even continents, and they often do not know each other well. Some people may know each other but do not know each other’s backgrounds, so they inevitably need to find a bank; a company in Country A seeks a familiar bank, where it has an account, and a company in Country B also finds a familiar bank. The banks establish correspondent banking relationships, which, in addition to making payments, actually build a trust relationship, helping establish connections between enterprises.

This entire system, while complex, has been criticized for potentially low efficiency and room for improvement. However, it is not as some people imagine, where buying something in a store is as simple as handing over cash and receiving goods. One must also consider the reasons behind this complexity; transforming this system is not as easy as simply replacing it with digital currency. This step may require more functional considerations and an examination of what opportunities exist for upgrades.

Another issue is remittances. Cross-border remittances indeed have high costs, and some banks charge excessively for cross-border remittances. However, the main obstacles to cross-border remittances are significant. Facebook identified the hot topic of cross-border remittances and proposed using Libra for this purpose, and to gain acceptance from more countries, it recognized that many countries would worry about dollarization, so it proposed a basket of currencies.

However, it did not anticipate that the concept of a basket of currencies had been discussed internationally for many years, with everyone trying to figure out how to construct an international monetary system from various angles. Thus, this is not a simple matter. After a year of attempts, it was found that achieving a basket of currencies was very difficult, so it transitioned from Libra to Diem, focusing solely on the dollar.

Cross-border remittances face both technical difficulties and challenges in policy formulation, especially concerning remittances from cross-border laborers to their families, involving developed and developing countries. Although remittances between developed countries, despite having currencies like the dollar, yen, and euro, are relatively efficient and not too costly, costs are much higher for developing countries, and there are often delays. Therefore, this presents an opportunity for improvement, but it cannot be solved solely by technical systems.

It relies on solutions in institutional and policy aspects, especially concerning exchange rate systems and foreign exchange management. Some countries have foreign exchange controls. Many young people may not know that before China's reform and opening up, many overseas Chinese would send money home, possibly in dollars or yen, but they could not access it; they had to exchange it for renminbi, and the exchange rates at that time were very unreasonable. What if they received less? They would have to give additional remittance vouchers.

Although China has long passed through these stages of reform and opening up, many other developing countries still face similar issues, and they indeed worry about the risks brought by dollarization.

Therefore, when we choose to utilize digitalization and the internet to improve the modernization of payment systems and take a step forward, we must consider which direction allows for a more significant step and more noticeable effects.

At the same time, we should not expect to achieve everything at once, claiming that we have created a system that can boastfully solve retail payments, wholesale systems, and completely transform exchange systems, trade settlements, remittances, and all issues. I think this is unrealistic. Therefore, if such choices are made and R&D and pilot projects are conducted, there must be determination not to look at other mountains while neglecting one's own.

Finally, I want to say a few words about the internationalization of the renminbi. I believe that the internationalization of the renminbi is a good topic. As the world's second-largest economy and the largest trading nation, China's currency status should be elevated, and there is indeed potential for improvement, but as mentioned earlier, technological systems will have an impact on this.

In recent years, there has been much development in technology and support, such as the Cross-Border RMB Payment System (CIPS), etc. Can we leverage digital currency and CBDC to take a significant step forward? I believe we should not overestimate the technological factors; it is more about institutional and policy factors, and it remains a matter of reform and opening up, as well as the extent of future choices.

First, whether a currency can be widely accepted may depend on the size of your economy, trade volume, and degree of openness. It is not about compelling international users to make certain choices; customers have the right to choose.

Thus, the broadness of this maneuvering is not just a technical characteristic. A major component is the degree of currency usability. In 2016, the International Monetary Fund included the renminbi in the SDR, partly because the degree of the renminbi's usability had significantly improved, but it is a continuous process with much room for further improvement. However, regardless of how usable it is, attention must still be paid to anti-money laundering functions, preventing tax havens, preventing tax evasion, and preventing drug trafficking, among other issues.

Another aspect is the currency's resilience to shocks. It is well known that countries around the world, at various stages, experience financial crises from time to time. Now everyone knows about the global financial crisis of 2008. However, if you look closely, financial crises occur in various countries every ten or twenty years, so resilience is also very important.

Therefore, we think it is still an institutional factor. In the future, China's reform and opening up may further intensify, leading to clearer choices. This choice also depends on the path of development and the path of reform and opening up, which is a balance of viewpoints. In fact, this viewpoint is also a distribution, just like I mentioned the balance between currency privacy and anti-money laundering; some people believe that the renminbi's usability and convertibility are very good things that should be promoted quickly.

Others believe that this is a very bad thing with significant risks and should be avoided. Ultimately, it may be a normal distribution, with more viewpoints in the middle, and it shifts with the progress of reform and opening up. Therefore, we say that changes in the process of opening up may have more connections with the internationalization of the renminbi, and technological factors are the foundation, which is relatively easier to address.

Including when the financial system is developing CIPS, banks like Bank of China, which have played significant roles in cross-border payments, find that with clear policy systems, utilizing existing technology to develop a system is not too difficult to advance. Of course, we should not underestimate this effort.

At the same time, I want to emphasize that I have always stressed the internationalization of the renminbi. From the perspective of central banks, the currency issued is a liability. Many people think it is an asset. I remember at a very important international conference dinner, a prominent guest commented on the internationalization of the renminbi, saying that in the future, you will be able to issue renminbi globally, which is a significant asset.

I said that this is not correct; from the perspective of the balance sheet, issuing currency is a liability for the central bank. You need to ensure that your liabilities are redeemable, have purchasing power, and are stable. Moreover, when you want to use the currency to achieve a certain function, the central bank must provide convenience and assurance. Therefore, from this perspective, it is a liability, meaning that one should not view the internationalization of the renminbi as merely a way to create an asset out of thin air, but rather consider the commitments and obligations you must undertake from the perspective of the balance sheet.

Thus, the modernization of payment systems, DECP, and e-CNY will primarily enhance cross-border retail use, including usage between travelers and business visits, as well as the increasingly popular retail online shopping, bringing improved experiences, which will also benefit the renminbi. From a broader perspective, to achieve the internationalization of the renminbi in wholesale financial transactions and trade, as well as remittances, continuous progress in policy and institutional aspects is necessary. We believe that future progress in these areas will be a significant step toward substantial progress in the internationalization of the renminbi.

At the same time, I also emphasize that it is a relative matter. The shares of the major currencies internationally indeed have a certain proportion, and they cannot exceed 100 percent; if one increases, another must decrease. Besides how well you perform, it also depends on how well others perform.

I take this opportunity to report on this topic, as well as to provide a small input to the Wudaokou School of Finance and this global financial forum. Please feel free to criticize and correct any inaccuracies in my remarks. Thank you.