On the evening of October 8，2020，the Shenzhen Municipal People's Government announced that it would cooperate with the People's Bank of China (PBOC) in the trial operation of the central bank digital currency in the city's Luohu district. The digital currency，provisionally called DC/EP，was issued to local residents in the form of gift packets (known as "red packets" in Chinese) worth 200 yuan each. A total of 10 million yuan worth of these were distributed to 50,000 residents by means of a lottery. The program was funded by the Luohu district government.

In order to participate in the lottery residents needed to register their cell phone numbers and ID card numbers on the "i_Shenzhen" platform. Lottery winners needed to download the app "DC/EP" as per instructions sent by mobile phone short messaging service. They then had to activate the "DC/EP wallet" with a selected bank (any of four major state banks - Industrial and Commercial Bank，Agricultural Bank of China，Bank of China and China Construction Bank) and set a password to receive the 200 yuan of DC/EP. The red packets received could be used with 3,389 merchants included in the DC/EP system transformation program in the Luohu district. There was no spending threshold and each red packet could be used for multiple transactions. If the balance in the wallet was insufficient for a purchase，the user could bind the wallet to a bank account and recharge it，but the balance could not transferred to any other wallet or back to the user's own bank account. The red packets were valid from 18:00 hours on October 12 to 24:00 hours on October 18. Any amount not used at the end of trial period was to be recovered by the DC/EP system.

According to data collected over the period，a total of 47,573 people received the gift packets，accounting for 95.15% of the winners. There were 62,677 transactions with a total of 8.76 million yuan. Some winners of the lottery also recharged their DC/EP wallets，with the total recharge amount reaching of 901,000 yuan.

This was the first trial use of the DC/EP. Previously，there had been much speculation about how a central bank digital currency would work，but now there is much more clarity. The demonstration，though successful，also revealed some technical problems that may appear in the actual implementation of DC/EP.

DC/EP is Digital Legal Tender

DC/EP is also referred to as "digital renminbi," emphasizing the fact that it is another form of the sovereign currency. This will prevent people from mistakenly concluding that it is another currency outside the existing monetary system.

Like renminbi notes，DC/EP is also legal tender，and thus payment of any public or private debt within China with DC/EP cannot be refused by any entity or individual eligible to receive it. Since DC/EP will be included in the renminbi monetary aggregates for centralized management，it will not have a major impact on the formulation and implementation of monetary policy.

DC/EP is envisioned as a replacement for M0，the narrowest definition of money supply，or cash in circulation，though it is not entirely the equivalent of cash.

The PBOC has explicitly stated that DC/EP will be positioned to replace M0，or some part of the cash in circulation. The digital currency will not be interest-bearing. It must comply with laws and regulations related to cash management such as the Law of the People's Bank of China and the Regulation of the People's Republic of China on the Administration of Renminbi，and also those on large-value cash management，anti-money laundering and anti-terrorist financing. However，being positioned as a replacement for some portion of the narrowly defined money supply does not mean DC/EP will only have the functions of physical renminbi cash.

From the phone screenshots of the Luohu DC/EP gift packets received and the "DC/EP wallets" used at various banks，we can see that the amounts ranged from 200.00 yuan to the smallest amount of 0.01 yuan towards the end of the trial period. This rebutted early speculation that DC/EP would have different face values and note numbers in order to aid the  PBOC in keeping track of all transactions.

In fact，the digital currency could only be presented in figures (accurate to the smallest currency unit) instead of units with different fixed face values. Otherwise，people would have had to make change during actual transactions. The PBOC was already able to track the receipt and payment of every DC/EP transaction，so there was no need for additional tracking.

The DC/EP wallet at each bank has a uniform appearance – similar to that of paper notes and containing elements like the national emblem，the People's Bank of China label，and the portrait of Mao Zedong (though there are minor differences in color). The goal is to highlight the official status of this digital currency. However，this also increases operating costs，because DC/EP，despite being positioned as a replacement for M0，is actually used through the account-based "DC/EP wallet," that is，a special deposit account opened at an operating agency. Therefore，an identification of "DC/EP wallet" will suffice.

Centralized Management of DC/EP

The PBOC has emphasized four key points in the management of DC/EP. First，it will conduct overall management on the DC/EP quota and formulate consistent business，technical，security and application codes and standards.

Second，it will conduct centralized management of DC/EP information，retain all transaction information and records，monitor and analyze the exchange and circulation of DC/EP to improve the PBOC’s currency issuance system in the digital era.

Third，it will conduct overall management of DC/EP wallets. Provided that there is a unified authentication system and an anti-counterfeiting function for DC/EP，based on the principle of two-tier operation，the PBOC will jointly build and share an ecological wallet platform with designated operating agencies and at the same time allow these agencies to develop their own visual design and features.

Fourth，the PBOC will build out the infrastructure to issue DC/EP and achieve the circulation of the digital currency across different operating agencies so that this currency will circulate in a stable and orderly manner.

Since DC/EP is still centrally managed，it may not require the use of blockchain technologies like Bitcoin or Ethereum. However，some restrictive clauses can be added to the DC/EP operating system to keep it automatically controlled by way of "smart contracts."

Two-Tier Operation

DC/EP will still be operated under the "central bank-commercial bank" two-tier model. The PBOC will select well-capitalized and technologically advanced commercial banks as its designated operating agencies. They will open different types of DC/EP wallets (usually with four types of restrictions such as different wallet balance requirements，single transaction limits，daily transaction numbers and annual transaction limits) for customers based on how well the customer information is identified. They need to provide DC/EP conversion services and the designated operating agencies will cooperate with other commercial banks and institutions to jointly provide such DC/EP circulation services.

In the trial operation of DC/EP in Shenzhen，the lottery winners needed to download the PBOC's app "DC/EP" and then activate the "DC/EP wallet" of the selected bank (there were only four banks participating in the trial operation，but in the future，users will probably be given more choices). Here，mobile phones have become an important carrier for digital wallets and a QR code has become a critical component. The operating logic behind it may be as follows:

Firstly，the "DC/EP wallets" opened by banks for customers are linked to the PBOC's app "DC/EP." Through this app，the PBOC will obtain the information of all DC/EP holders，including their names，ID numbers and mobile phone numbers. It will then establish a memorandum account for each holder (including merchants，business entities and financial institutions among others participating in the program) on the DC/EP platform. That forms a "centralized DC/EP account system" for the public. This will help the PBOC fully collect all transaction information of DC/EP exchanges and circulation and enable it to conduct necessary monitoring and analysis.

Secondly，designated operating agencies also need to download the PBOC's app DC/EP and open accounts with the central bank，so that the PBOC will become the real payment and clearing center for the currency and ensure interconnection among all operating agencies.

Finally，the information of each DC/EP transaction must also be sent to the PBOC so that the central bank can retain all transaction information. The DC/EP wallet operating agency can obtain the information related only to its own wallets. If the DC/EP wallets receiving and paying DC/EP belong to different operating agencies，each agency will not be able to obtain all information of both sides of the transactions. This demonstrates the "limited anonymity" of DC/EP.

This might be the most important change in the operation of DC/EP. The PBOC，rather than the operating agency，shall play the leading role.

Judging from the trial operation in Shenzhen，digital wallets and mobile phones will be the important carriers of DC/EP，and a QR code will be the main payment method. The so-called offline NFC (near-field communication) payment will not be the most important feature that distinguishes DC/EP from other general mobile renminbi payment tools，because NFC is in fact a small-value payment method designed for emergency scenarios and cannot be widely applied unconditionally. When communication conditions permit，the information of NFC payments still needs to be sent to the operating agencies and the PBOC as soon as possible to adjust the records in relevant wallets and memorandum accounts. Without the support of a third-party account system，there will be great risks in the NFC payments through such hardware such as mobile phones. This is also an important reason why NFC technology has not been applied widely despite its early development. Therefore，there is no need to highlight the NFC function of DC/EP.

Initially a Domestic Currency

Judging from the trial operation in Shenzhen，the PBOC's DC/EP system has not yet been opened to offshore areas such as Hong Kong and Macao. In this case，it will not affect the internationalization of the renminbi and its international payments and settlements system. If，in the future，DC/EP is to have an impact on the internationalization of the renminbi and its international payments and settlements system，the PBOC's DC/EP system app must be opened to overseas areas. DC/EP must also have internationally competitive advantages in operational efficiency，cost and payment and settlement security. It also relies on liquidity，security，and profitability of DC/EP itself. Meeting these requirements may take time.

Will the digital currency have a major impact on the existing payment and settlement system?

The PBOC does not provide DC/EP exchange or payment and settlement services directly to the public. It also has stated that “to ensure that DC/EP is widely available without causing major impacts on the existing financial market，all commercial banks and non-bank payment agencies must fully play their active roles to arouse the enthusiasm and creativity of all parties in the market and maintain the stability of the financial system." However，unlike renminbi，DC/EP is operated and settled mainly by the PBOC and completely free of charge，so it may cause a major impact on the existing payment and settlement system.

For DC/EP，the most important operating node is the PBOC's app，which means that the central bank is the only real payment and settlement center for the digital currency. The DC/EP wallets opened by various operating agencies are effectively a derivative system of the central bank app. Since the payment and settlement of DC/EP is free，this will result in a number of problems. If DC/EP is intended to be merely a replacement for cash，the impact will not be great. But as DC/EP and the non-digital renminbi and their payment and settlement systems will coexist for a long term，this may cause some new problems in the operation and management of the renminbi. If DC/EP is no longer used solely as a replacement for cash，but also extended to other applications like financial services，including loans and other extensive receipt and payment services，then it will not only have significant impacts on the market positions and profit models of non-bank payment agencies like Alipay and Tenpay，but also greatly affect bank cards and related industries as it does not need to be bound with bank accounts and bank cards.

This is something we need to bear in mind. Does this model where the PBOC directly participates in the payment and settlement of DC/EP conform to the "two-tier operation model" and is this a reasonable arrangement? These questions require further deliberation. Additionally，unlike the receipt and payment of cash，which is mainly between the two sides of the transaction and thus less costly，the operations of DC/EP involve operating agencies and the PBOC，so a wide application of DC/EP would be costly. In this case，is the exchange，payment and settlement of DC/EP all being free of charge sustainable?

A critical feature of this digital currency is that it integrates the currency closely with payments and settlements，which is one of the reasons why the PBOC calls it "DC/EP." As a result，the DC/EP issuing institution can directly provide digital currency deposit，payment and settlement services. This could cause significant impacts on the monetary and financial system and even economic and social stability. Therefore，the international community is keenly interested in how this is system is implemented and taking a cautious stance on the project overall.

The PBOC's plans to launch DC/EP could greatly reduce the costs of renminbi printing，distribution，receipts and payments，custody，as well as the withdrawal and destruction of old notes. It can also enhance the regulatory monitoring of currency receipts，payments and circulation. Moreover，it can also minimize the risks that may be brought by currency reform and thereby make it easier to launch DC/EP. In this process，the PBOC will also accumulate experience in preparation for greater and more comprehensive changes. It can be said that this is a very reasonable choice，and through this process，DC/EP will also take the lead in the field of digital currency.

However，there are still issues to examine in the extent of DC/EP application beyond cash substitution.

What see that with the development of information technology，the proportion of M0 in the monetary aggregates has already been reduced to 4%. This percentage is still declining，and it will be difficult to completely eliminate cash even over a very long time. The financial system will still need to keep enough cash in stock for emergency use. In this case，if DC/EP is only used to replace cash，the input-output ratio will be greatly reduced. Additionally，it will also affect the opening of DC/EP to overseas business and internationalization，resulting in the long-term coexistence of DC/EP and non-digital renminbi as well as maintain overlapping payment and settlement systems.

During the trial operation，there was no restriction on DC/EP being exchanged for anything besides cash. The digital currency could be exchanged or recharged by adding fresh deposits. This also shows that DC/EP is not completely restricted to being a cash substitute. Therefore，in my estimation，the PBOC is likely to directly launch DC/EP as a replacement for M0，but allow it to be converted into deposits and used for making loans. DC/EP should not be restricted to being a replacement for cash but should be expanded to replace all forms of currency and used for all kinds of payments and settlements，including the PBOC’s lending to commercial banks.

Therefore，the options for the DC/EP operating system are as follows:

First，the PBOC's "centralized digital currency account" system should be further consolidated and improved. This system should be open to all DC/EP users，including financial institutions. All these users could download the system and open the "basic DC/EP account" with the PBOC，which will register each DC/EP receipt or payment and show the account balance in real-time. The PBOC will control all receipts and payments of DC/EP and its distribution in real time and be able to conduct  whole-process monitoring of DC/EP. This will greatly improve the accuracy and effectiveness of the PBOC's monetary policies. Of course，the basic account is only for verification and analysis. No other services will be provided and no interest will be accrued.

Secondly，DC/EP may be used for various financial services (including loan issuance) and could replace all forms of currency. However，financial services will still be handled by financial institutions. Business entities and individuals can open DC/EP business accounts with these financial institutions，including commercial banks. The accounts will record the changes in credits and debits and accrue interest. Commercial banks also need to set up credit accounts and deposit accounts (the deposit account may also be combined with the basic account) separately with the PBOC，with the interest accrued separately.

Finally，all business accounts of DC/EP holders must be linked with their basic accounts with the PBOC. When entities or individuals receive or pay DC/EP，their DC/EP wallets must verify each other and generate a business encryption link code. The receiving and paying parties respectively transmit the relevant information and the link code to the PBOC and the operating agencies at the same time. The operating agencies process the transaction based on the information received，adjust the balances in the customers' DC/EP accounts，and send relevant information to the PBOC. The balances in their DC/EP accounts with the PBOC will be adjusted accordingly and the PBOC will adjust the account balances of both parties per the information sent by them after confirming that the business link codes match. The account balances of both agencies will be adjusted according to the information sent after there is confirmation that the link codes match.

In this way，the PBOC will form a "centralized DC/EP account system" for the benefit of the public. The "basic accounts" of DC/EP with the PBOC will coexist and be interlinked with the "business accounts" with financial institutions. This will bring profound changes to the currency system but will not pose a major threat to the existing financial or payment system. Of course，when all user information and currency receipt and payment information is gathered in a central repository – in this case with the PBOC – the system will face stability and big data security challenges. These need to be properly addressed.

If conditions permit，the DC/EP system should also be extended to offshore areas to give it an international presence. It would also enhance the  internationalization of the renminbi and contribute to reform of the international monetary system as well as the global payment and settlement infrastructure. This option should be incorporated into the overall strategic planning for renminbi internationalization.

The author is a former vice governor of Bank of China and chief economist of Shenzhen Neptunus Group