OKEx Research: The future development of digital currency from the perspective of currency evolution

OKEx Research: The Future Development of Digital Currency from the Perspective of Monetary Evolution

Source: Ou Yi & NBSP; OKEx Research

Abstract:Digital Currency can be thought of as a virtual Currency based on node networks and Digital cryptography algorithms. Decentralized digital currencies have no issuer, so no one or institution can control their issuance, such as Bitcoin, Ethereum, etc. Since the number of algorithm solutions is determined, the total amount of digital currency is fixed, thus eliminating the possibility of inflation. The transaction process of digital currency is secure enough because it requires the approval of various nodes in the network. Centralized digital currencies refer to currencies with issuing entities, such as the digital RMB issued by the central bank and Facebook's Libra.

This paper studies the nature of currency, the historical changes of currency carriers and the historical changes of currency issuers to gradually complete the unification, aiming to explore whether digital currency has the three elements of currency, whether it can gradually replace cash to realize the digital revolution, and the problems still existing in digital currency at present.

Key words:Digital currency, monetary history

货币载体的历史变化 

1.货币的本质

As is known to all, in the history of traditional money, people believed that the essence of money was a measure of value. Its most basic function was to serve as a medium of exchange and a store of value, and its fundamental purpose was to organize production activities and become a link to maintain production relations. But with the coordinated development of productivity and production relations, the nature of monetary explain certain improvement happened naturally, we can see that the nature of the currency has evolved in order to form a human social mechanism, its core is the trust, the trust is the mistrust of the parties in the middle (currency) of trust. We all now have a new consensus on money that offers a solution to the problem of lack of trust.

Secondly, the nature of money is also an accounting currency, or a unit of measure, whose value fluctuates with the national fiscal policy, monetary policy and other economic means as well as changes in domestic and foreign situations. The value of a good unit of measurement must be relatively stable. Therefore, in the course of history, money always needs a set of mechanisms to ensure the stability of its value. This mechanism has been developed in a comprehensive way, including core infrastructure construction such as payment and settlement system, credit creation system and financial supervision.

Third, money essentially embodies the credit relationship mentioned in the opening document. Money is both a debt or liability of the issuer and a credit or claim of the holder. So money affects assets and liabilities in both directions and can be recorded by changes in both ends.

Finally, the trust is negotiable. Money, if it is to be used in circulation, must be represented by symbols, a system of accounting to record its value and its transfers, and to settle all kinds of credit relationships.

For a digital currency to replace fiat money, it needs to meet three of these elements. In the long run, digital currencies will need a whole set of mechanisms to ensure their value stability and thus function as a unit of account, and this set of mechanisms will most likely be provided by central banks, for reasons we will discuss later.

2.货币载体的变化

Historically, money carriers followed the transition from metal money to bank notes to fiat money. At first, the appearance of metal money greatly facilitated the exchange and accelerated the development of economy and society. However, with the increase of transaction frequency and the expansion of transaction scope, the cost of carrying, transporting, delivering and clearing metal money in large quantities is getting higher and higher, which is difficult to meet the needs of economic development. Therefore, merchants keep separate accounts, and at the end of a period, the two parties check the accounts, offset the transactions with each other, and settle the balance in currency. This currency receipt is called a bill of exchange, and the merchant who handles it is called a bank or a bill number. With the gradual improvement of the acceptance of bills of exchange in the bill number, in order to facilitate circulation, bills of exchange began to transform into pre-printed denominations (divided into different grades), indicating the drawer and promise to pay at sight, adding anti-counterfeiting verification marks, but not limited to the holder of bills of exchange, which made it evolved into "paper money".

Changes in money carriers explain the need for liquidity and trustworthiness. This evolution follows Gresham's Law, which states that bad money drives out good money. The original money was tied to the value of metals like gold, silver, and copper. As transactions went on, notes and paper money, which had no real value, were artificially endowed with value and successfully replaced the metal money, backed by the trust of the intermediary party.

Ideally, a digital currency would be issued by a third party that everyone trusts, or by a decentralized system with strong technology. This kind of digital currency can be said to be the account number itself directly into money, money carrier from tangible to intangible.

1.2.1 Changes in European currency carriers

The modern paper money in Europe originated from bank notes, and the British gold store notes were the forerunner of the modern European paper money. We know that before the ninth century, Babylonian camel caravans used clay notes as acceptance documents with interest to prevent gold and silver loans from being hijacked in transit. These were similar to the expensive money in Tang China, but they were not paper money in the modern sense. 16th century to the 17th century, for reasons of safety factor, the British government is located the tower of London as businessmen to the perfect place to store gold and silver, but in 1646, Charles I put 130000 pounds of gold and silver confiscated as military behavior let people no longer trust, have turned to credit good folk store, store of deposit receipt is called a "store coupons, store coupons can be instead of gold and silver currency in circulation, and to pay for. However, due to the lack of norms and the desire for interest, the British government stopped paying after the outbreak of the Anglo-Dutch War in 1670, and the era of gold shops ended. In 1694, British merchants further improved the regulation and established the Bank of England in the form of a company, and obtained the charter to issue 1.2 million pounds of bank notes. From then on, the modern paper money -- bank notes appeared in Europe.

Paper money on the Continent is closely associated with John Law. John Law was born in Edinburgh, England, into a family of bankers, and had a wealth of knowledge of money and the banking system since childhood. But after his father's death, he relied on his mastery of mathematics to become addicted to gambling, and in 1694 was even jailed for shooting a rival in love. He was later sent to Europe. During the escape, he further research on finance and trade, successively in Amsterdam and the Netherlands have accumulated lots of experience, then he keenly observed, such as France and other countries of paper currency resisting most economic depression, the introduction of the paper currency of England and the Netherlands, by contrast, the paper currency of irreplaceability let John law gradually became the "bank note" loyal fans.

In 1705, John lowe put together their ideas into the theory of currency and trade, and to the national currency supply proposal ", in his book, he urged to establish a national bank, and called for the state bank should complement each other with state-owned enterprises, the former master the country's financial, the latter control state business, so as to realize the state of the currency and trade monopoly, monopoly profits are feedback state Treasury debt.

This was not an easy idea until King Louis XIV's extravagance caused the government to run up huge debts. In these circumstances, the shortage of precious metals undoubtedly resulted in a sharp decline in the metal money in circulation, and France's ailing finances gave Lowe hope. In 1715, John lowe has persuaded the French king Louis xiv and the duke of Orleans, John law in Paris next year (Banque Generale) established the general bank, the bank shall have the right to issue bank notes and participate in the royal revenue management, and notes can be converted into COINS, this is the first time the French private Banks massive issue paper currency. In 1717, John Law persuaded the French crown that all taxes must be paid in bank notes. Until 1718, under the strong advocate of John Law, the bank was nationalized and turned into the first central bank in France, which marked the shift of France from coinage to paper money. Later, the UK and other countries joined the paper money camp one after another, and paper money was widely spread in Europe.

1.2.2 Changes in US currency carriers

In the early 17th century, England established its first colonies in the Chesapeake Bay and New England on the Atlantic coast of North America. By the 18th century, there were finally 13 colonies in North America. Because the colonists carried few coinage and no gold or silver deposits were found every week, there was a severe shortage of actual coinage, a situation exacerbated by a persistent trade deficit. The colonists used five main forms of money for this purpose. (See Table 1)

Table 1 & have spent Five forms of currency in colonial North America

Table 2 & have spent Non-paper money is disappearing

Colonial America's earliest note issue is credit vouchers issued by Massachusetts colony in 1690, to pay for expeditionary force field, the credit voucher is between guarantee short-term bills issued by the tax and pure credit currency between a form of currency, the authorities admitted that in the future but payment in gold and silver, can be used to pay taxes, can be used as a method of currency. Other colonies followed suit, either to finance their military efforts or to collect taxes, but because they would only accept payment in the future, the paper currency soon began to depreciate until Parliament banned the issue of legal indemnity money altogether in 1764.

The next revolution took place during the American War of Independence. The central government, the Continental Congress, was an assembly of state leaders and had no power to levy taxes. In this case, military financing depended on borrowing or printing money. Both Thomas Paine and Alexander Hamilton supported borrowing. They believed that "no nation should be free of debt, and the national debt is a form of national cohesion." Benjamin Franklin was a strong supporter of paper money. Eventually, the Congress decided to issue paper money because the war was uncertain, the Congress had no guarantees, it was risky to borrow money from them, and the colonies didn't have enough money to lend. At the same time state authorities were forced to use credit notes to fund the operation of the war machine. With the mass issuance of paper money, the value of the continental note continued to depreciate from 1776. In 1781, the cost of printing a dollar continental note was even higher than the value of the currency, but with the war going on, the Continental Congress had to continue to rely on paper money. After the victory of the Revolutionary War, the Constitution of the United States explicitly gave the Union the power to mint money and regulate its value. The states had no right to mint money or issue paper money.

After the first bank of the United States, the bank of North America, came to the period of the second bank of the United States, President Jackson because of dissatisfaction with a third of the shares in the bank for foreign holdings, the state bank of exclusion and monopoly on domestic and international exchange, etc., strongly opposed the bill, I believe "hard currency", which makes the second bank of the United States eventually collapse settlement in 1841, the U.S. central bank process was suspended. It was not until 1846 that Congress approved the creation of an independent Treasury system to store government funds in a system of treasuries or sub-treasuries composed of customs offices and mints throughout the country. This system was the main regulator of the U.S. monetary and banking system until the establishment of the Federal Reserve System in 1913.

In 1861, it was against a similar background, the American Civil War. The Union soldiers needed a national currency to stop the chaos created by thousands of bank notes. In February the next year, congress passed the then finance minister chase's proposal, by the method of compensation act, the act of authorization of the Ministry of Finance issued $150 million United States Treasury note, which is "green paper", and announced its law countervail currency, can be used to pay, but can't change the gold and silver, cannot be used to pay taxes and government bond yields. It is the first paper currency issued by the United States. It is a credit currency that is issued and circulated completely on the basis of national credit and performs monetary functions.

1.2.3 Historical changes of banknotes such as jiaozi in China

China's paper money appeared in the Northern Song Dynasty, the peak of feudalism, nearly 700 years before Europe and the United States. During the Tang and Song dynasties, Sichuan and Shu were characterized by complex terrain and developed trade. The medium of exchange was still iron money with low price and heavy price, which was extremely inconvenient. This was the direct reason for the emergence of jiaozi. From the point of view of nature is more, the song dynasty COINS outflows, "money shortage" serious, military and administrative expense, the fiscal deficit, Europe and the United States and the appearance of opportunity, but beyond that, when China is highly centralized autocracy of feudal state, is directly by the government to the new medium of exchange (jiaozi) forced promotion, which makes China's notes (jiaozi, etc.) not only have the economic functions of money, also have the political function of currency.

We can see that both European and American continent and notes of the birth of Chinese civilization and continuation, is based on circulating medium, the government-led, a vast of money market more stable, and always accompanied by strong political and military color, the government hopes by the issue of paper money to support government spending and the huge military spending. However, when China Jiaozi came into being, China was still an agricultural society emphasizing agriculture and suppressing commerce. Its economic level was far lower than that of Europe and the United States in the 17th and 18th centuries, where cities arose and commerce developed rapidly. It lacked a stable material basis, and the relationship between commodity production and commodity currency was not healthy. Let alone under the feudal rule, "hand in business" can make notes to mere fiscal plunder tool at any time, the credit business and credit institutions is weak, the notes should be deviated from the economic functions, and prefer to "political function", as a result, stable and healthy development of credit institutions and credit system and credit currency necessary condition.

II. Historical changes of currency issuers

2.1 Transition of money issuers from private money to central bank money

Coinage power is regarded as the fundamental factor to show the power of the government, through which the government shows its supreme power. In the early days, the government did not undertake the task of making money. Instead, it guaranteed the weight and quality of the materials used as money -- gold, silver, and copper -- and marked their true value. At this stage, private enterprises do not have the ability to provide sound coinage, and providing a uniform, easily identifiable coinage technology has been a major challenge. At the same time, the government found that minting money by itself was not only beneficial to society, but also could extract the expenses used to cover the minting costs, thus increasing its revenue. After seizing the coinage power, we can say that almost all the local governments abuse the trust of the people and cheat the people. This is reflected in the fact that when people take metal blocks to the government's furnace to mint money, the government forces to keep some of them. Two smaller coins indicating the same value are recolonized in a gold bank after the withdrawal of coins from circulation.

During the Middle Ages, the contraction of trade led to a decline in the amount of money in circulation. In order to restore trade, European monarchs competed to reduce the weight and quality of coinage. Eventually, the advent of paper money gave the government an even cheaper way to cheat its people, and the government used brutal means to force this bad money on them.

The government had a monopoly on the issue of paper money, which greatly contributed to the growth of government power. We assume that if the government has the power to create any amount of money it wants and make people accept it, it will help the government defend its power. In recent years, the government has expanded largely because it has been able to print money to finance its deficits. We believe, therefore, that the government should issue money within the limits approved by the people, or this power will be taken away.

The notes were issued by a number of private banks and gradually consolidated into the central bank. In the case of digital currency, the digital currency that is currently issued by many private individuals but can actually become money will eventually be issued by central banks and become a centralized digital currency. A decentralized digital currency like Bitcoin could evolve into an investment product (today's digital currency is not really money).

2.1.1 Uniform monetary authority for the Bank of England

From the second half of the 17th century until the 1920s, various types of bank notes were in circulation, with Bank of England notes dominating in the London area. In 1826, the British Parliament passed the Banking Partnership Act, which indicated that the Bank of England had the sole privilege of issuing joint-stock bank notes within 65 miles of London, but private banks in London could still issue bank notes. The Bank of England was allowed to set up branches in various parts of Britain. After the passage of the Act, some small private banks in Britain merged into joint-stock banks, and joint-stock commercial banks developed rapidly and issued their own bank notes. At this time, Bank of England notes, bank notes issued by private banks and joint-stock bank notes appeared in the British money market.

It was not until the early part of the 20th century that the Bank of England finally unified its money issuing authority. In 1833, the British Parliament passed a new Act, making Bank of England notes unlimited "legal reimbursement", that is, legal tender, compulsory in circulation, must be accepted, not refused. This made Bank of England notes the first and only bank notes to achieve legal tender status, the legal equivalent of gold. In July 1844, the British Parliament passed the Bank Charter Act. The Act prohibited new banks from issuing bank notes. Banks that had not issued bank notes before 1844 were limited in the amount of bank notes they could issue, and those that had been issued could still be circulated. Any bank issuing notes which has established a branch in London or which has merged with another bank loses its right to issue notes and transfers this right to the Bank of England. With each passing year, most banks in Britain (and only in England and Wales) gradually lost the right to issue notes. By 1921, the Bank of England was the only one with actual authority to issue notes.

Eventually, Bank of England notes became the official credit note in the United Kingdom, where they are still used today. After the outbreak of World War I in 1914, to fund the war effort, the Treasury issued 10 shilling and 1 pound notes to circulate as notes. So after 1921, there were Bank of England notes as well as Treasury notes. In 1928, the British Parliament passed the Currency and Banknotes Act, which legally confirmed the Bank of England as the sole authority to issue the nation's currency. From then on, Bank of England notes became the sole dominant currency in the UK, completing the unification of currency circulation. After Britain left the gold standard in 1931, Bank of England notes became the successor to the gold standard. They became the official bank note (not redeemable, but backed only by government credit) in the United Kingdom, and have continued to be used today. The British monetary system also changed to a system of uncashable credit paper money.

$2.1.2 unification

In 1787, the United States Constitution, which had an epochal significance, was born. It aimed to establish a common market and political union composed of the original 13 colonies, legally guaranteed the free flow of goods and factors of production among the states, and defined and limited the power of the Confederate government. The federal government had no monopoly on the issue of banking licenses and paper money, so in the early days, the banks of each state "took over the hill" and issued their own currency (bank notes), the value of which depended on factors such as the reputation and convenience of the issuing bank.

Throughout history, there have been two attempts to create a federal bank in the United States. It is important to note that banks were not really central banks, but merely institutions dealing with national banking.

Table 3 & have spent Overview of the First Bank and the Second Bank of the United States

Conflicts with state banks hindered the development of the American central banking system, and the Civil War became the new breakthrough point. In order to finance military and political expenses, the Northern states passed the Banking Act from 1863 to 1865, which established the federal banking system as a platform for the new debt trading of the federal government (secondary market). This system can solve the problems of the development of some state banks. In addition, in order to control the risks of banks and ensure the liquidity and solvency of banks, the Act also requires strict supervision and information disclosure on the capital and asset quality of commercial banks, and implements the reserve system. At the same time, the United States established the first banking system supervision agency OOC in history, which was responsible for issuing the national banking license, and the supervision responsibilities of OOC were clear. But the money supply is still inelastic when the economy fluctuates.

After 1865, economic crises occurred frequently. Until 1907, some banks were run due to speculation, and the banking industry was seriously damaged. Eventually Congress asked the National Monetary Committee to review it, and from there, on its proposal, the Federal Reserve was born.

III. Prospects for the future of digital currency

We have summarized the historical changes of money carriers and money issuers above. It is not difficult to see that the limitations of money carriers, such as the convenience of transactions, portability, transaction fees and other issues, determine that money will inevitably develop in the direction of leaving the carrier. It is an inevitable development process for inferior coins such as digital currency and paper currency to replace good ones such as gold and silver as currency carriers. History has always been strikingly similar, and once there is a consensus on the digitization or virtualization of money, it is inevitable that political games will be played to preserve that consensus and pursue monetary interests. The political class monopolizes the issuance of digital currency and regulates the supply of digital currency, which may become the inevitable process of digital currency. In recent years, the exploration of digital currency by central banks has brought about some new thoughts and practices for the reform of monetary system. These explorations are still a long way off, but they are also full of hope. For decentralized digital currencies, such as Bitcoin, Ethereum, etc., we consider them closer to investment goods than to circulating money.

3.1 Current situation of central bank digital currency

China's digital RMB CBDC is a controllable and anonymous payment tool issued by the People's Bank of China, operated by designated operating institutions and exchanged to the public. It is based on the generalized account system and supports the loose coupling function of bank accounts. It is equivalent to paper notes and coins, and has value characteristics and legal compensation. Compared with Alipay and WeChat, digital RMB has the advantages of dual offline payment, which can satisfy the normal electronic payment demand even when the network signal is not good. Second, it is more secure, because the credit parties behind WeChat and Alipay are Tencent and Alibaba, while the digital yuan is endorsed by the central bank's security system. Third, multi-terminal selection, WeChat and Alipay must have a mobile phone network to complete the payment, and for the people who do not have smart phones, can choose IC card, function machine and other hardware to use digital RMB.

The Monetary Research Institute of the People's Bank of China (PBOC), the Hong Kong Monetary Authority, the Central Bank of Thailand and the Central Bank of the United Arab Emirates (UAE) have jointly launched the M-CBDC Bridge, aiming to explore the application of central bank digital currencies in cross-border payments, the People's Bank of China (PBOC) announced. The project has been supported by the Hong Kong Innovation Centre of the Bank for International Settlements.

The People's Bank of China is piloting the digital currency in four cities -- Shenzhen, Suzhou, Xiongan and Chengdu -- and it will also be tested internally in future Winter Olympics scenarios. On Feb. 6, Beijing gave out digital yuan red envelopes worth 200 yuan each. A total of 40 million yuan in digital red envelopes will be handed out in Chengdu on February 23, according to an official account of WeChat called Chengdu Announcements.

3.2 Problems of digital currency

After the digital currency completely replaces the cash, the central bank can implement the completely negative interest rate monetary policy through the digital system, so that the monetary policy breaks through the ZLB (zero interest rate line). For ordinary people, savings may show a negative growth trend. If people hold paper money, they can take it home and escape negative asset growth if interest rates break zero. However, when digital currency completely replaces paper money, people will have no choice but to face the shrinking of assets.

From the perspective of history, it is not difficult to find that the nature of money has gone beyond the economic property, reflecting a more powerful political property. The obstacles to a future monetary revolution are not economic or technological, but political. Governments often deal with deficits by overprinting money, which leads to inflation and makes people's money less and less valuable. It is not clear whether the political disputes over digital currencies will bring huge volatility to digital currencies.

The real price of the idealized digital currency is absolutely unchanged, which can effectively avoid the threat of inflation and only form a structural relative change with the price of goods and services. Such a currency would be a true stablecoin. However, the realization of this ideal digital currency will break through political obstacles to form consensus, mutual constraints, the establishment of reserve mechanism, payment and settlement mechanism, credit mechanism and other goals. At present, the digital RMB has only digitized the cash and carried out the technical experiment of cross-border payment. It is still difficult to replace the cash with the digital currency.

Literature reference:

1. Liu Zijian, "A Comparative Study on the Production Conditions of Paper Money in East and West", Chinese Coin, April 1994 & NBSP;

2. Wang Zhijun et al., The History of European and American Finance, Nankai University Press, January 2013 & NBSP;

3. Qian Xuening, "The Nature of Money and Digital Currency Analysis", China Financial Journal, December 2019 & NBSP;

4. Friedrich von Hayek, The Demoneticization of Money, New Star Publishing House, August 2007;

5. Gewu Capital,A Monetary History of Britain: The Birth and Unification of Paper Money, June 1, 2019 & NBSP;

6. Zhou Yonglin, "The Future of Digital Currency from the Nature of Money", Central Bank and Money, December 2018 & NBSP;  

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