“Let China Sleep, for when she wakes, she will shake the world,” the famous quote of the French 18th Century statesman Napoleon Bonaparte was indeed prophetic. With the world’s second largest economy’s vision to transform itself by 2025 into a nation with 70% self-sufficiency in high-tech industries, we might very well be on a cusp of another technological revolution or evolution.
China is currently in the middle of escalating tensions with the US and India, spanning into a war of technological powers. This conflict highlights all that’s going on in the backdrop, and makes for a more interesting analysis of one of the world’s most powerful nations.
While most of the developed world’s governments grapple with the implications of technology’s disruption on the financial sector, the Chinese government is advancing full steam ahead in this domain. Spurred on by the competitive threat of Facebook’s Libra project, China has been doubling down on its digital currency project with great urgency; some newsmakers are saying the digital yuan will be launched by 2020 year end, preposing the initial deadline of mid 2021.
So what does this mean for the rest of us? Understanding the digital yuan and how it will shape our world helps us stay informed and abreast of the changes. So let’s start with the basics.
What is the digital yuan?
- The digital yuan will be the digital currency of China – also known as Digital Currency Electronic Payment (DCEP) – is backed by the central bank of China – People’s Bank of China (PBOC). It intends to replace paper money eventually.
- Controlled by the PBOC, it will be integrated with China’s banking system.
How does it work?
- The PBOC will issue digital coins to its network of state-owned banks and payments firms, such as Alipay and WeChat, which will distribute them to individuals and businesses through mobile banking and payments apps. Users will have the ability to make payments with their mobile phones and integrated apps, services and merchants using NFC technology and the internet. What’s impressive is that the DCEP system also supports payment transactions without an internet connection
- While China’s digital yuan will not operate completely on blockchain technology (given the issues with scalability and interoperability with other payment systems), it will be using some of blockchain’s key components such as asymmetric cryptographic and smart contracts.
- Xu Yuan from Peking University’s Digital Finance Research Centre said upon completion of the internal testing, the digital yuan could be gradually expanded for the payment of staff wages at major government departments, administrative institutions, and even state-owned enterprises.
- China has launched trials in 4 cities – Shenzhen, Suzhou, Chengdu and Xiong’an. Now, talks are underway with private companies to expand its test run.
Why did China launch this project?
- Digital yuan is designed to give the Central Bank of China more authority and oversight over transactions since all cash flows in society will be traceable. This move was necessitated because Chinese consumers had bypassed both computers and credit cards to embrace mobile payment apps, which now have large money-market funds investing in high-yielding wealth-management products.
- This accumulation of risks in opaque shadow banking is something China’s central government wants to diminish. Bringing these shadow banking operations out into the open therefore requires an upgrade to traditional lenders in payments who have been left behind.
The digital yuan aims to address this technological gap by allowing authorities to “regulate an overstretched debt market more effectively,” says DBS Group economist Nathan Chow.
- It is also in line with China’s top policy initiative to internationalise the yuan, improve reserve currency status, and to protect the monetary sovereignty of China.
- Apart from these practical reasons, political analysts are saying that China wants to curb the power and influence of the US dollar, which has dominated the world’s economy for almost the whole of the last Century. The USD is the world’s foreign reserve currency as the size and strength of the U.S. economy and the dominance of the U.S. financial markets has been undisputed for decades; 61% of all foreign bank reserves are denominated in U.S. dollars, and nearly 40% of the world’s debt is in dollars.
So maybe it’s about time to shake things up? But it remains to be seen whether and how the digital yuan will be used in the expansion of Chinese economic and strategic influence abroad.
Can the digital yuan usurp the U.S. dollar as the global reserve currency?
- The backbone of the United States’ financial dominance is the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which facilitates messages between banks about payments orders with a network of U.S. correspondent/intermediary banks that execute international payments. (Most cross-border payments—nearly $5 trillion per day—are directed through SWIFT messages, and a significant portion are routed through U.S. correspondent banks.)
- Digital currencies further the goal of avoiding dollar transactions and U.S. financial oversight, since they provide a scalable cross-border mechanism that circumvents the current system.
- Individuals sending or receiving remittances and businesses with large import or export ties to China, for example, could transact in the digital yuan using Alipay, for example.
- China’s current investments into infrastructure with the Belt and Road initiative in many countries presents lots of opportunities for the digital yuan to grow beyond China.
- The PBOC will have a view on all transactions in the digital yuan and potentially, on all transactions in systems using its technology, strengthening its information advantage.
- Ex- US Treasury Secretary Henry Paulson argues that whether the RMB will displace the USD will have little to do with the form of China’s currency and more to do with its economic and political choices, which means that the digital yuan is only as good as the existing RMB regardless of its form if China’s foreign and economic policies remain the same.
- Many economists are also skeptical on the impact the digital yuan could have beyond its borders without official reforms to relax the yuan’s exchange rate convertibility.
- There are many changes to the world order that need to take place for the digital yuan to truly usurp the USD. So the digital yuan is a credible threat at the moment, but not substantial yet.
Where does this leave the rest of the world?
- According to the Bank of International Settlements, 80% of the world’s Central Banks are engaged in or about to start CBDC work. Countries leading the pack include The Bahamas, whose Sand Dollar is currently in the process of live testing with a nationwide launch planned for the end of the year, and Sweden, which has one of the lowest number of bank notes as a percentage of GDP in the world. The e-krona has been testing for some time now with consulting firm Accenture, but Sweden has no plans to be launched yet.
- The U.S. now has a digital dollar project as well, but it’s way behind China’s digital yuan, which is over 5 years in the making.
Thailand has also started doing some research into digital currencies. However, government led projects typically take time.
- Thailand’s Project Inthanon is a collaborative project with the Bank of Thailand (BOT) and commercial banks that aims to explore potential benefits of the Distributed Ledger Technology (DLT) – or blockchain technology – in enhancing Thailand’s financial infrastructure.
- The Inthanon Project is currently in the testing phase with an implementation pilot to develop a prototype payment system for businesses using the Central Bank Digital Currency (CBDC) underway.
- This means that while we still do not know when the ‘e-baht’ will launched or if there will ever be one.
Any government led effort to create an entire new, wholly digitized currency will always be met with some potential skepticism. This is particularly true in China’s case, where the government implements various state owned missions and enterprises. An e-RMB currency will surely mean complete ability to monitor and track transactions, as well as slow down China’s RMB internationalisation.
What else? It could also impact China’s leading e-payment platforms, Alipay and WeChat Pay. The former commands 53% of the payments market share, with WeChat a close second. Although the e-RMB has plans to integrate with the platforms, it surely would not solely exist through third party apps. This is all just hypothetical, however. In the future, it wouldn’t be surprising to see e-RMB redeemable coins on the Alipay app somehow.
- China is way ahead of the game when it comes to CBDC but they are not the only players in the field.
- It is only a matter of time before the US and other nation states catch up with their own CBDCs.
- China’s digital Yuan initiative presents a model for digitising an economy that will hopefully bring educational value to other nations. However, as with most world changing innovations, it will also come with its own set of implications.
- China’s ambitious e-RMB plan may further broaden the tension’s impact by dividing the global economy into currency ‘zones’. It could also serve as a threat to Alipay & WeChat Pay, as they are currently still powered by bank accounts & credit cards.