This article is a part of EqualOcean's 'Blockchain, China's Story' report. Read more about it or download the sample and check out the contents.

The People's Bank of China (PBoC) – the central bank of the country – has taken the lead in researching blockchain technology and has been preparing to issue its own digital currency since 2014.

In the past five years, the Digital Currency Research Institute of PBoC has investigated the possibility of a national digital currency from the aspects of  'top-layer design,' operating system, technology roadmaps and other components, defining these jointly with several commercial banks.

In August 2019, Mu Changchun – Deputy Director of the Payment and Settlement Department of PBoC – noted during the third China Finance 40 (CF40) Yichun Forum that China's national digital currency, which will be named Digital Currency Electronic Payment (DCEP), is ready to go.

With Mr.Mu is appointed as Director of the Digital Currency Research Institute of PBoC concurrently in September 2019, suggesting an acceleration in launching DCEP.

So far, China is expected to be the first country to launch a national digital currency.

The main properties and mechanisms of DCEP

Positioning as the replacement of M0

This implies that DCEP inherits the same characteristics as physical cash (banknotes and coins), in the sense that it does not pay interest, is a central bank liability, i.e., with unlimited legal tender, and has certain anonymity.

Adopt a two-tier operation delivery system

PBoC serves as the upper layer (issuance layer), which provides credit guarantee for the digital fiat currency issued. Meanwhile, the commercial banks compose the lower layer (distribution layer) in the system, where they have to pay 100% full reserves in issuing DCEP to the public, to ensure that the PBoC does not over-issue.

Compared to a single-tier system, in which PBoC directly issues DCEP to the public, this two-tier system will not change the existing currency placement system and binary account structure – thus it does not squeeze out the deposits in commercial banks, and contributes to the stability of the entire financial system.

Technology neutral

Though it is clear that commercial banks are free to adopt blockchain in the distribution of DCEP, whether this emerging technology will also be employed in the issuance layer is somewhat uncertain, based on the available information at present.

Regarding the issue, there are currently three official statements with considerably different attitudes:

Neutral: Yi Gang, Governor of PBoC, commented that the central bank will not preset specific technical routes in developing DCEP. Both blockchain technology and existing electronic payment solutions are under consideration, and the final decision can be made through fair market competition.

Will not adopt: According to Mr. Mu, as the target application scenario of DCEP is retail, which tends to have high concurrency – therefore, this requires the underlying system to be capable of supporting at least 300,000 Transactions per Second (TPS). It is apparent that blockchain technology cannot realize this at the moment, therefore, PBoC itself is not adopting blockchain technology in issuing DCEP.

Will adopt: Huang Qifan – Deputy Director of National People's Congress Financial and Economic Affairs Committee – described DCEP as 'blockchain-based' during the first Bund Finance Summit in late October. As this remark was given after the time that Mr. Mu made his explanation, the question of whether DCEP would adopt blockchain in the issuance layer loomed over the issue.

Similarities and differences between DCEP and other mainstream digital currencies

At present, five typical schemes have appeared in the digital currency field, where the main differences lie in the characteristics of the lead organization and the relation with physical fiat currency.

For the DCEP, its position of M0 substitution, and its emphasis on serving as a medium of exchange rather than a unit of account and a store of value – as depicted in its name – are important features.

How may blockchain technology take a role in the DCEP operating system?

From the patent applications of four institutions affiliated to PBoC – Institute of Digital Currency Research Institute of PBoC, Institute of printing technology of PBoC, and two subsidiaries of Zhong Chao Credit Card Industry Development, namely Hangzhou Blockchain Technology Research Institute and Beijing Smart Card Research Institute – we could take a look at how blockchain is involved in DCEP:

Digital wallet address management based on blockchain

Blockchain technology supports the business process of digital wallet address management, primarily through smart contracts.

First, the transaction request is verified based on the digital wallet address of the transferor. If the verification is approved, then it updates the digital wallet address and saves it to the smart contract, such that subsequent transactions can be conducted based on the new address.

After the original digital wallet address is updated, its binding relationship with the identity information of the transferor is cut off forcibly. Therefore, even if the original address is tracked by outsiders, it cannot be used to view the private information corresponding to the identity of the transferor, which effectively protects the privacy of the users.

Transaction information supervision based on blockchain

The blockchain-based transaction information supervision process mainly adopts the encryption function of the technology.

First, the transaction information of digital currency is obtained from the blockchain, including information of the supervisor, information of a particular user (start with the first user) and the encrypted data.

With the initial private key of the supervisor and the initial private key of the user, then the shared secret password of the user is generated through the symmetric key algorithm.

After this, using the shared secret to decrypt the encrypted data, so that the crypto transaction details between the supervisor account and a particular user can be obtained.

In this case, transaction information can be kept confidential from the irrelevant parties on the blockchain.

Digital bill and currency transaction based on blockchain

The blockchain-based digital bill and currency transaction processes leverage the characteristics of the technology of decentralization and immutability, to realize disintermediation in value transfer, to control credit risks and to lower down the auditing expense in the market.

A bottom line

In the past ten years, the active exploration and promotion of Chinese Internet juggernauts like Alibaba and Tencent and the friendly attitude of policymakers have put forward China's mobile payment industry into the forefront of the world.

At present, with the movements of PBoC in the development of a national digital currency, DCEP, we see the open mind and positive actions of Chinese regulators in digital financing.

Undoubtedly, the issuance of DCEP will fundamentally reshape the digital economy and financial system in the country, which will help to facilitate further development of fintech companies in China.

As for blockchain, although the issue of whether it will be employed in the 'top-tier design' of DCEP still leaves a question mark, the fact that this emerging technology will be adopted in the distribution layer by at least some of the commercial banks is certain.

Finally the fact that blockchain has been taken into full consideration by PBoC in investigating the technical base of DCEP has already inspired a great feel-good factor in the industry.

At the same time, from the story of DCEP, we can also discover that practical matters like TPS it can process are still the main factors restricting the practical application of blockchain.