The Impact of Digital Currency on the Traditional Financial System

The emergence of private digital currencies such as Bitcoin have attracted the attention of central banks，and related technologies – such as blockchain and smart contracts – have been of even greater interest. But private digital currencies have some serious drawbacks，among them volatility and their use by criminals for illegal activities such as money laundering and tax evasion. This has posed a significant challenge to central banks as they try to protect their sovereign currencies and make use of new and promising technologies. Central banks realize that in the era of digitization，only through legal digital currencies can their market positions be protected and their legal tender status defended from private digital currencies. With successive reports on Central Bank Digital Currency (CBDC) released by the Bank for International Settlements (BIS) jointly with the European Central Bank，the Bank of Japan，and five other major central banks，legal digital currencies have once again become a major talking point. The successful pilot program for digital currency in Shenzhen has added to the pressure for a policy response. This article looks at the possible impacts of digital currencies on the traditional financial and monetary system.

Impact I: Improved Financial Efficiency

At present，there are mainly two types of central bank digital currencies – retail CBDC and wholesale CDBC. Both of them can improve the efficiency of the financial system，but the principles behind them and the extent of the improvements are quite different.

Retail CBDC can improve the efficiency of the financial system by direct and indirect means.

One of the direct effects is that there is good potential for the upgrading of the financial infrastructure. Credit cards are still the major form of payments in most countries – except China – these days，and retail CBDC will improve financial efficiency in the following ways. First，the use of CBDC will promote the upgrading of payment facilities and the optimizing of payment "scenarios," improve the efficiency of payment and settlement in the retail sector overall and enhance the consumer experience. The range of participants in payment scenarios will be expanded. In the digital age of the "Internet of Things," retail participants are no longer limited to consumers，but instead could include accounts，the carrier in the Internet of Things，which，in a large number，constitute the basic element of the Internet of Things in the digital age，and help maximize the functions of digital currencies. Additionally，the form of transaction can be expanded from "people-to-people" to "people-to-things" and even "things-to-things." Smart contracts play an important role in promoting efficiency in the transaction process. And the popularization of CBDC will decrease the use and circulation of banknotes，in turn reducing the cost of banknote transportation and storage，as well as security at financial institutions.

As to the indirect effects，the quality of information acquired by financial institutions can be improved through the collection and processing of big data. With the use and circulation of retail CBDC，big data with multiple dimensions will be obtained in these various payment scenarios. And in the information-centered financial institutions，scenario-based transaction data is highly valued.

Financial institutions can take advantage of the big data generated by CBDC to process operational information of the supply chain and business operations of corporate customers before extending loans.  Technologies such as cloud computing and artificial intelligence (AI) can be utilized to improve the speed and quality of information analysis and reduce the information asymmetry between banks and enterprises. This can help small and micro businesses acquire necessary financial support，thereby promoting the development of inclusive finance. The flow of loans can be monitored by financial institutions through CBDC data，and in turn reduce the risk of loan defaults. And for individual customers，financial institutions can make use of the big data obtained from CBDC to accurately profile their customers. This will let them better determine the creditworthiness and repayment reliability of their customers. The improvement of information quality therefore helps improve the operating efficiency of the macro financial system.

Central banks that look to employ wholesale CBDC mainly focus on the feasibility of constructing an efficient settlement platform in the interbank market based on blockchain technology. Through wholesale CBDC，the existing high-value clearing system can be greatly improved，and this is mainly reflected in "efficiency raising and cost cutting."

Improved efficiency stems from promoting the efficiency of settlements for larger trades by using CBDC，through which there is real time transaction service 24 hours a day，seven days a week. At present，interbank and cross-border transactions in many countries or regions are not settled in real time，and the efficiency of funds is reduced due to unilateral delays in delivery or transaction delays. The Monetary Authority of Singapore tested cross time zone transactions based on digital currencies，and initially realized real-time transactions anytime of the day. It will optimize cross-border transactions (including international interbank transfers and cross-border settlements) and will handle transactions in countries with different working hours.

Cost cutting is mainly reflected in reducing the cost of cross-border payments through CBDC. The cross-border payment is an important application of CBDC. And the digital currencies，by means of the underlying blockchain technology dramatically enhance the efficiency of cross-border payments. In 2018，Ant Financial took the lead in testing cross-border payments using GCash，the private digital currency in the Philippines. According to the results of the test，the digital currencies based on a distributed ledger have changed the original remittance mode in which layer-by-layer approval and confirmation are required when making transactions. Using distributed ledger technology，all business nodes of the chain can be synchronously confirmed in real time once a remittance is initiated. This shortens the time of cross-border remittance from days to seconds，and greatly improves the efficiency of the cross-border settlement.

In traditional cross-border payments，a rem