- “[A central bank’s digital currency is] a huge database using the hash function, chain technology. There’s no distributed ledger portal.”
- “[The People’s Bank of China] have been working on CBDC for about four years now.”
- “One of the areas where I really think blockchain could help is on trade finance. When I say trade finance is basically like small entrepreneurs. […] If you have blockchain technology that brings transparency and validation across, that will help the working [class?] quite a bit, and also help the banking system to invest in some profitable project.”
- “CBDC brings more brings more flexibility [on monetary policy] to the central banks.”
- “If Beijing still doesn’t allow us to innovate [on cryptocurrency], we are lagging behind for the next 200 years. We’re back into the Opium War. […] [Beijing doesn’t] want to lag behind the frontiers of technology, but all of a sudden, there’s a brand new idea [of cryptocurrency and Facebook’s Libra] that also seems to be getting support from other parts, not just these Chinese crypto people, but also from the USA.”
- “I think Beijing is hoping that Hong Kong will catch up [on ICOs]. […] The payment, or the exchanges, cryptoassets, cryptocurrency, investing, etc, is on the Hong Kong side. The chain innovation of the trade finance […] is basically the supply chain. There’s a lot, a lot of [those] projects in China.”
- “The government could play some role with well-intended [blockchain] ideas etc. One example I know of is that Tianjin Port is initiating some kind of trade finance project.”
Listen to the podcast version
Just earlier this month, China announced that it intends to launch its own cryptocurrency, specifically one that is backed by the People’s Bank of China (PBoC) after four to five years of research. Many deemed that this is a response to Libra, a cryptocurrency project spearheaded by Facebook, as central banks around the world have expressed their concerns about the lack of central bank oversight for this specific project.
But what exactly has been going on with PBoC’s cryptocurrency — and other blockchain projects, for that matter — throughout their research period? In order to find out, our Editor-in-Chief Angie Lau sat down with Professor He Zhiguo from the University of Chicago Booth School of Business to unpack this issue from the inside.
According to Professor He, the PBoC has been exploring the idea of central bank digital currency (CBDC) for the past four years, taking into account what a monetary authority can and should do to regulate the digital asset. He believes that blockchain’s greatest impact in China is in trade finance, helping small-medium enterprises and preventing fraud.
China’s agenda to internationalize the RMB was also brought up in the conversation, but Professor He disagrees that this is linked to PBoC’s motives to create digital currency. Rather, Professor He believes that China sees blockchain as an emerging technology that they want to be in the frontiers of. Drawing from his experiences in talking to retired regulators and attending Alibaba’s open research institute events, he noted that Chinese blockchain enthusiasts are very supportive of exploring blockchain but are still in the process of figuring out how to best regulate this asset for the nation and beyond.
Angie Lau: Central Bank Digital Currency — or CBDC. From Beijing to London, … the world’s top central banks are now, if not working on it, talking about the need for a digital alternative to fiat currency… in other words, money. As part of Forkast.News ongoing coverage, we sat down with Professor He Zhiguo, Fuji Bank and Heller Professor of Finance at the University of Chicago Booth School of Business.
A fascinating and candid look at PBoC’s plans in China, here it is:
Professor He: CBDC. That’s the central bank digital currency. That term is used everywhere. It’s widely accepted by the Fed etc. A lot of central banks are thinking about this. The fundamental economics reason behind it is that they understand there’s a lot of good part of having a digitalized assets where you can trace where you’re coming from where you go, and make the settlement the super quick. To some extent, you can think about it like WeChat or Alipay — it’s very similar.
Angie Lau: So the PBoC is drafting the white paper right now.
Professor He: We’re working on it already.
Angie Lau: Yes. We know [that there are discussions] in terms of what the high level themes are. What do you know of it?
Professor He: I know how we’ll do it.
Angie Lau: How will the PBoC do it?
Professor He: When I say I know how they do it, I meant like in terms of the implementation, a little bit of the technical side of it. Fundamentally, you would think that it’s actually not that hard to because it’s basically in a centralized database.
Every time I mention CBDC, my colleagues at UChicago will immediately tell me it’s not blockchain. I actually agree. The essence of blockchain will be multi-party maintaining. Everybody comes in to check…
Angie Lau: Decentralized. It’s not going to be decentralized. It’s going to be very centralized.
Professor He: CBDC is CB.
It’s a huge database using the hash function, chain technology. There’s no distributed ledger portal.
Angie Lau: What is going to be baked into the digital asset from the PBoC? How would it technically function?
Professor He: Oh, it’s very simple. Think about it. This is why I think that monetary economics is a very deep part of economics. Money is something that everybody touched, but normal people will not understand what’s going on behind the money. In some sense, central banks of every country are just doing the accounting system. When you think about it, what does this piece of paper really represent? It’s a means that you can use to pay your tax. That’s the fundamental reason why people think this is a useful thing. You often say, that piece of paper is useful because other people accept it. But you’re going to ask why other people accept it? Then you’re going to get to the next round. In the end, it’s because the government is saying that this is the thing that could be useful to pay me back.
So this is the so-called fiscal theory of monetary economic audit. Why do I want to mention it? I’m saying that it’s very simple to create something called digital or cash. There’s no difference, like paper-based cash. Think about it. You must have a lot of deposits. Most of the deposits, or your wealth, is some number recorded somewhere. That’s it.
So as long as the central bank has a technology that convinced everybody that the number they recorded is correct, you’re going to be happy about it.
Angie Lau: And frankly, the Chinese population has already been functioning this way for the past decade. That’s fintech. We hear stories of even in the street, beggars taking WeChat payments.
Professor He: There’s some differences with the technology. With the current WeChat technology, you cannot bring all these banks together to do the real-time setup with digital assets.
Angie Lau: It’s still an inefficient system. Which brings us to what a central bank-backed digital asset is going to [do]. So the PBoC is going to issue a digital asset. So suddenly…
Professor He: Think about it. CBDC do not even to issue… They don’t even need to back it. Suppose today I have a circulation of a paper-based cash–
Angie Lau: –and switch it to digital currency.
Professor He: Yeah.
Angie Lau: As an outsider, do I have to purchase the digital currency to participate in China?
Professor He: You use your cash to purchase that.
Angie Lau: So I use my cash, my fiat. U.S. dollars, HK dollars, I’m going to use my Euro.
Professor He: They’re gonna tear it out.
Angie Lau: And then I’m going to give them that cash. But suddenly, I am within the domestic ecosystem. If I want to take it out, it’s still in the system, right? Can I take it out? Can I take it out of the country?
Professor He: You are touching on another important part.
Angie Lau: Capital controls.
Professor He: Yes, the liberals are trying to do by capital control etc. But let’s just think about what PBoC is trying to implement with CBDC. The implementation is very simple. That’s why they have been working on it for about four years now. They’ve been dreaming of it for many years. You need to be careful because it’s so huge, there’s a big impact. In some sense, thinking about it is easy, but the implementation is hard. The benefit is that the way you’re doing it is the cash becomes digital. Once it becomes digital, you have a digital signature there so that you can send and [the transaction is] being recorded in the chat.
I want to mention it because… suppose a lot of blockchain developers would like to innovate on that chain. They don’t need to they have their own coin to use that chain. So anybody who could innovate on the business ideas and say, “Today I have a much better idea over sharing my services, such as my nanny.” That a bad idea. I’m not sure if it’s a good idea to share nannies but let’s say they want to share something. So you come up with this idea and develop it. And you might say you need an incentive. Okay. So we just pay digitally.
Angie Lau: So instead of your own cryptocurrency, you tap into that currency. But you’re still developing smart contracts, you’re still developing your own chain, your own ecosystem that then [the cryptocurrency will then] flood into. That brings us back to your role as an economist, being a student of the economy, and understanding the fabric of China. How does this help China internationalize its RMB?
How does this help China with shadow banking or its debt pile? These are the things that economically, China is very specific about. That’s why the PBoC exists. That’s why we see the clamp down in ICOs, because there is 1.4 billion people, and the economy needs to be healthy for China. How is the PBoC going to achieve all of those things with a central bank-backed digital asset?
Professor He: I’m a macroeconomist with a financial side. I also have several papers on financial market reform on China. The debt problem, obviously, is one thing. People in general, myself included, like to link things together or make up conspiracy type of ideas. When the PBoC is trying to work on CBDC, I know for a fact that they were not thinking to the extent of what you’re talking about. However, I do think that it has a positive effect on that.
Let me just explain that. I think China’s economic engine–or my wishful thinking–is for it to not come in from the big bank. Ten years ago, the local government made infrastructure investment, and did other big things.
Angie Lau: China spent the world out of the global financial crisis.
Professor He: I have a paper on that. Everybody knew it.
Angie Lau: I’ve been reporting on the story, it feels like, for ten years, but this is what happened. But also now China’s paying the price for rescuing the global economy right now.
Professor He: Exactly, but we don’t get the reward. We–when I say we, I’m referring to the fact that I’m a Chinese citizen. I think that a lot of times, the Chinese economic policies does some unintended good things to the world but, again, also very bad, unintended consequences that were only brought by us. So it’s related to this debt problem and all these things. I think the ultimate economic engine and what’s very healthy compared to the U.S. is consumption. I see a really, really good trend in the past five years. How is this related to CBDC, blockchain, and all the things? We need really, really fundamental innovations on the small, consumer-based business models. One of the areas where I really think blockchain could help is on trade finance. When I say trade finance, it’s basically like small entrepreneurs. They want to do business, but oftentimes, we know that doing business needs interim financing, but in a world where we’re still lagging a bit behind for the law system and infrastructure… If you have blockchain technology that brings transparency and validation across, that will help the working class quite a bit, and also help the banking system to invest in some profitable project.
Angie Lau: Economically, China has been experimenting with a lot of these techniques. So is it injecting dollars to state-owned companies that then trickle down?
Professor He: RMB. Injecting money. I know when you say dollars you mean RMB.
Angie Lau: Exactly, injecting RMB, Yuan, I mean money. Injecting RMB, into state-owned agencies, corporations, that then hopefully trickle down to SMEs (small medium sized-businesses)–which did not happen, so then there was a conflict there. And then shifting policy and encouraging banks to inject RMB and support local businesses. It’s almost like playing whack-a-mole. Once you address a problem, another problem comes up. How does a PBoC digital asset soothe the policies? Can it help?
Professor He: First of all, let me just clarify. I personally do not think in the sense that the trickling down is totally ineffective. Let me give you one example. You could have a negative side or a positive side. There’s a housing center in China. The biggest economic engine–in terms of not only the housing, wealth etc, that’s a separate thing–but a lot of wage income, improvement in living standards, and also, if you’re wealthy, [that improvement] goes to tourism, etc. Those improvements to the living quality are thanks to the housing sector, because the housing sector is so important in bringing all the industries up. If you need to make the house better, you need to install the [better] lights…
That’s really the biggest multiplier to the economy. I do not agree with you saying that initially, we pumped [money] into this SOEs (state-owned enterprises) and then stop there. That’s not true. It’s just the nature of the housing sector, which is the biggest investment in the past 10 years.
Angie Lau: So the central bank’s role is very much creating the business cycle of a natural economy and minimizing that. So we often hear hard landing, soft landing. Every central bank wants a soft landing. And technically they don’t want a landing. That, in a sense, is a fundamental economic problem, because at some point, the cycle must move naturally. That’s one way.
So what central banks do–not just the PBoC, but the ECB and the Fed–they use monetary policies to shift the gear on the economy. How does the digital asset help bake in this policy? Like how would a central bank be able to do that?
Professor He: A little bit of continuation just because this answers your question too is that there are two parts of it. I was hoping that with the CBDC introduction, at least you could kind of jump-start or help this chain to be applicable to trade finance, small SME transactions, etc. That part is kind of the real part. The underside of it is called monetary policy. That’s actually linked to other advocates for the CBDC in the Western world. It’s the fact that people realize that the traditional monetary policy, has lost its power, its effectiveness.
Angie Lau: We’re in negative yield right now.
Professor He: Yes, because of negative yield. But do you understand why the negative yield is on the bond? Just because cash. The presence of cash makes the negative yield not possible. Suppose I’m telling you, your yield becomes -10%. What you’re going to do is take your money out from the bank. Which means that just that the effective interest rate is still kind of zero, or died away. If in the end there’s no cash, monetary policy could be way more effective, because they could put -50. So that’s the one the biggest advocating reasons of the Western central banks. They would like to experiment with this digital currency, this CBDC, a central bank.
Angie Lau: Helped me understand that. -50 yield is possible with digital currency.
Professor He: It’s possible because it’s just accounting. So think about a world where we do not have cash. Suppose you’re living and there’s a no cash. Which means that all your money is written in the central bank’s account. You have an account with some money there, let’s say HK$500. The central bank can have a monetary policy saying that starting from now on every day, or every year, that the interest rate is, is -50%. What are you going to do? That’s minus 50%.
Angie Lau: That doesn’t sound like a good thing.
Professor He: It’s a good thing in the sense that the point of negative interest rate is to push you to spend. If you spend, you pay some housing money.
Angie Lau: So you’re saying it creates a deflationary aspect to the average person having wealth that they want to buy things in so triggering an inflationary effect.
Professor He: That’s exactly monetary policy. Pushing up the transaction [volume], making sales for every product, etc. That’s exactly what monetary policy does. There’s nothing mysterious. It’s just as that initially, we have a monetary policy that has a natural rate of 5%.
Angie Lau: What if I don’t want to participate in that? What if I want to independently say, I don’t necessarily… so what am I gonna do? I guess I’ll shift to different assets?
Professor He: Everybody else’s wealth will shrink, let’s say, by the same rate. You won’t care.
Angie Lau: The classic accounting principle of balancing your books, how does that…?
Professor He: It doesn’t matter.
Angie Lau: It doesn’t matter.
Professor He: It doesn’t matter. It’s just accounting. The wealth from today to tomorrow. But if you think about it, it’s just the way that the central banks are stimulating the economy. The central banks would like to stimulate the economy to encourage people to either spend or invest.
Angie Lau: So now I kind of understand the policy that exists out of China. Because if this is ultimately the goal, mining doesn’t make any sense. Because mining actually creates liquidity outside the system. So that is an industry that doesn’t make sense for this policy goal.
Professor He: These are very different things. You don’t need to mine for the CBDC itself.
Angie Lau: Right. I guess I’m trying to understand why the Chinese government would shut down mining.
Professor He: They shut down cryptocurrency.
Angie Lau: They shut down cryptocurrency; they shut down mining. So they’re going to support outside cryptocurrency.
Professor He: I think this logic has its own truth in the sense that typically a central bank would not would like to have a payment system outside the central bank itself. That’s very typical.
Angie Lau: It’s not just China. Europe talks about it in the exact same way. America talks about it in the exact same way.
Professor He: Often times the reason or excuse they quote is on privacy, anti-money laundering, KYC, etc. That’s always there. I do not think that it’s connected as much. I firmly believe that it’s not connected so much to monetary policy. The monetary policy that you were talking about is just you asking what’s good about the CBDC. On the monetary policy side, it brings more flexibility to the central banks.
Angie Lau: So that actually helps the ultimate goal, which is the internationalization of the RMB. If you can capital control your domestic economy of 1.4 billion people, that’s a lot… Capital flight is not necessarily something that the Chinese government wants. Certainly not what any country wants.
So we’ve seen the financial and economic policies that have been put in place. Let’s get to that point where you have that capital control, so you have that pot of wealth that you can now get to your next goal of internationalizing the RMB? Help me get there and understand for our audience. It makes a stronger and easier path to internationalization?
Professor He: I would say it helps a little bit, but it doesn’t solve the fundamental issue.
Angie Lau: What’s the fundamental issue?
Professor He: The fundamental issue is that people do not worry that there’s some capital control. Once they have the CBDC, they can easily control it. That doesn’t solve the core problem that you want to control the flow. It’s making things easier to control, so in that sense, it’s the negative side of the internationalization of the RMB. I can stand here and talk a lot about the internationalization of the RMB, but I do not think that this type of innovation will do anything or will have any effect. If anything, it’s probably on the negative side of it because once you have this book where you basically can program it…
Angie Lau: People are incentivized in a different way. When Facebook announced the Libra project what was China’s response?
Professor He: It’s so interesting to me that when you say China, you could say Beijing or those cryptocurrency people. I’ve seen way more analysis of Libra. At that time, I was at the Luohan Academy (an open research institute initiated by the Alibaba Group) meeting Alibaba about these things. I have friend circles on this side [China] –朋友圈–and that side [U.S.]. The articles or the comments coming from the China side is way more than the U.S. side.
Angie Lau: What was it? What was the context, the tone? Were they supportive?
Professor He: Supportive, for obvious reasons. They’re saying that they’re doing true innovation. And if Beijing still doesn’t allow us to innovate, we are lagging behind for the next 200 years. We’re back into the Opium War. These types of tones.
Angie Lau: And on the Beijing side?
Professor He: Beijing was a bit uneasy. They don’t want to think about the day three years ago that the former regulator was asking me. They don’t want to lag behind the frontiers of technology, but all of a sudden, there’s a brand new idea that also seems to be getting support from other parts, not just these Chinese crypto people, but also from the U.S. side. So they worry that indeed that we need to catch up a lot.
Angie Lau: Do you think that actually is helping? Now the projects that are in China, and the teams, and the cryptocurrency?
Professor He: Quite a bit.
Angie Lau: So China is starting to turn around and go, you know what, we gotta help these guys. Is that the sentiment?
Professor He: I think, just not that yet. I was being careful when you asked me will it help a little bit? I would say yes, it will help a bit. ICO is a no, no, still. I think Beijing is hoping that Hong Kong will catch up.
Angie Lau: So let the innovation happen in Hong Kong. But then let the experiment happen, and then do best practices once that has been determined.
Professor He: That’s a little bit unfair. There’s a lot of innovation and practice on the chain side in the mainland. Again, I do not think that as economies, we can separate these payments from the business model. The payment, or the exchanges, cryptoassets, cryptocurrency, investing, etc, is on the Hong Kong side. The chain innovation of the trade finance I was explaining to you earlier is basically the supply chain.
There’s a lot, a lot of projects in China. And they can also get help by having Libra. Libra means they will have a very important technology. It’s progress. Instead of mining, they’re doing proof of stake. That’s another algorithm, and they make it work that people can learn from. So that in that sense, I really like the Libra project. I do have a lot of concern about it, but I think I will vote yes for it. Not only because it brings convenience to the users, but also because there’s some progress in technology.
Angie Lau: For our global audience who’s unclear about what’s happening in China, how would you compare China to the European market, to the American market, when it comes to blockchain projects, innovation, and talent?
Professor He: The advantage of China is the application scenarios. We need it and has a market and more importantly, have the government support. Let me just go one by one.
We need it. As I said, there’s a lot of legal issues in China with fraud, and blockchain is designed to address that. Second is… let me talk about the third first. The third is about government support. One thing that I feel strongly about the application of the blockchain is that blockchain is very relevant or useful for the scenario where you have a multi-party participation, multi party cooperation, and commonly, they maintain the shared database.
And oftentimes, you have this heterogeneous power within these members. In that time, you need a blockchain to set the rules for everyone to abide to. However, for people to come together to agree on something, there needs to be coordination.
Angie Lau: Consensus.
Professor He: Yes. The government could play some role with well-intended ideas etc. One example I know of is that Tianjin Port is initiating some kind of trade finance project. This is one thing.
And the second, after needing government support, that there’s a lot of talent that’s working on these things. I know how much they’re paid–they are well paid.
Angie Lau: The incentive is there. What do we see with blockchain in China next year? One year from now, where do you think we’re going to be?
Professor He: Ah, it’s very hard to predict that. Economists typically don’t do predictions. But it’s not like stock market and prediction. So that’s fine. I was personally hoping that they could get a more well-functioning user case, that’s so-called trade finance.
And on the Hong Kong side, I hope that the regulatory ports can chase the trend, and quickly embrace the possibility of acknowledging the existence of these things.
I want to mention one thing. The U.S. regulations, given the nature of the of the market-driven economy, they typically will not ban it. Unless there’s a clear case that some group of people gets hurt, in which case they have to do some action. Otherwise, you’re gonna do it. Let me watch. However, when you want to get to Facebook… Because Facebook doesn’t have a good history in this type of things.
Angie Lau: It’s got a marketing issue.
Professor He: Yes. Public relations.
Angie Lau: It’s got a public relations issue.
Professor He: Seems like the atmosphere turns others the other way. Usually, it’s fine. But I don’t think that regulators are incentivized to really figure out what’s going on. I want to mention the difference between U.S. and China. In this case, I mentioned that a former regulator from Beijing… He’s retired. But he still takes time to come to me and talk to a lot of people, asking, “What is the state? I want to know.”
Angie Lau: Learn about blockchain, learn about cryptocurrency.
Professor He: I don’t think that will ever happen in the U.S. In a way, regulators also clearly need to learn. If they don’t learn anything, then it’s all jargon words. And everything you say sounds the same. And how do we address that? In that sense, I feel that’s the difference. And I hope that if there’s a very concrete application–healthy ones, good ones–that the economists will see this is as something that doesn’t just benefit you, but benefits the world. Then I think China has a chance in this type of [technology] application.
Angie Lau: What an incredible insight into blockchain in China. Thank you for your expertise. Thank you for your candidness. And I know I learned a lot, including our audience. Thank you very much, professor.
Professor He: Thank you. Thank you, Angie.