China is in the process of introducing a digital version of its yuan currency. Photo: iStock

China is in the process of setting up a sovereign digital currency, which will function like cash. The nation has made significant progress in the development of the currency, piloting systems in Shenzhen and Suzhou at the end of 2019 and beginning of 2020, Seeking Alpha reported. Although it has not been stated when the currency will be more widely rolled out, it will likely be one of the first sovereign digital currencies to hit the global economy, and will likely play a major role in aiding the expansion of fintech in China. Despite its benefits, a number of misconceptions have arisen that threaten to sour public opinion on the innovation. We discuss the benefits and misconceptions in what follows.

China’s digital currency is to be issued in a manner similar to cash, being sent from the central banks to banks, which can issue the digital currency to customers. The digital currency will be ultimately distributed to users and businesses through digital wallets registered with the commercial banks. In this way, the digital currency system will not dramatically reduce the role of banks in China’s economy, as some have feared.

The development of the new currency system appears to be reaching a more mature stage. The central bank has announced that the top level design of its digital currency is complete. At present, China is working to ensure stability, security and control in the system. To hone these qualities, the currency entered a testing stage at the end of 2019 in applications including those in transportation, education, and health care. For the test, the central bank has partnered with seven state-owned banks and telecoms – the Industrial and Commercial Bank of China, Bank of China, China Construction Bank and the Agricultural Bank of China, China Telecom, China Mobile and China Unicom.

Improved traceability

China’s digital currency will be more traceable than cash, and can make the process of cross-border transactions easier, particularly because individual banks and fintech firms will build up their own technology ecosystems around the currency. Some of these systems will use the blockchain to track funds, while others will use more traditional methods. This will encourage the use of technology among not only financial firms, but also among individuals, who will need to register for a digital wallet in order to use the digital currency.

Already, China has a very high use of digital payments. The two dominant payment systems, Alipay and WeChatpay, are ubiquitous throughout China. Alipay boasted 900 million users in 2018, and WeChatpay had over a billion. As a result, China’s use of digital currency should not be difficult for citizens to use, and is likely to even further expand use of digital wallets.

China’s sovereign digital currency has been viewed by some as a direct response to Facebook’s Libra. Although China’s digital currency has been under research for a longer period than Libra, Libra’s development might have sped up China’s testing of its sovereign currency. Libra may challenge China’s digital currency because it is unlikely to include the RMB as part of its underlying assets, and could reduce China’s monetary authority and control over cross-border payments. What is more, regulators have viewed Libra as potential conduit for money laundering. However, Zhu Min, a former deputy governor at the People’s Bank of China, believes that China should reconsider its response to Libra and take a central part in the global regulation of the cryptocurrency.

Sanctions evasion

We note that there is some misinformation about China’s digital currency in the media. The first mistaken concept is that China’s digital currency will promote evasion of economic sanctions. The second is that the digital currency will promote money laundering. Third is that the digital currency will replace the US dollar as a reserve currency.

First the US has raised concerns about China’s potential use of digital currency in helping American adversaries to skirt sanctions. Some observers have suggested that China could, for example, help to fund North Korea’s development of long-range missiles through its use of the digital RMB. The digital currency is now being examined as a potential US national security concern.

Second, Mu Changchun, head of the People’s Bank of China’s digital currency research institute, told a conference in Singapore. “We know the demand from the general public is to keep anonymity by using paper money and coins … we will give those people who demand it anonymity in their transactions.” This statement has provoked fears that China’s dcep will be easily used for money laundering.

To speak to the first and second points, China’s digital currency will be used in a way similar to cash, in that it will be issued by the central bank in a way similar to that of cash, but ownership through digital wallets will track to whom the funds are transferred. This will allow authorities to trace the trajectory of issued currency, whether overseas to North Korea or to possible criminals in China. While some daily digital currency transactions may not be flagged for potential illegal activity, given a well-rounded supervisory framework, sanctions evasion or money laundering likely would send an alert to Chinese authorities.

We note that Mu Changchun added to his statement above, “But at the same time we will keep the balance between the ‘controllable anonymity’ and anti-money laundering, CTF [counter terrorist financing], and also tax issues, online gambling and any electronic criminal activities.”

Reserve currency?

Third, concern has been expressed that China’s digital currency will replace the dollar as a global reserve currency. At present, this is impossible, as China maintains controls on its capital account. In order to promote the RMB to reserve currency status, China would have to lift these controls that effectively insulate China’s economy from rapid inflows or outflows of funds and allow freer movement of its exchange rate. Otherwise, countries will be unwilling to hold large amounts of the RMB if it does not reflect true market conditions. It seems likely that the digital currency will make holding RMB more attractive to some external users, especially if complementary applications are created that greatly increase efficiency and transparency. Still, the currency will by no means upset the reserve currency status of the US dollar, or even the euro or yen.

China’s sovereign digital currency will improve the nation’s competitiveness in the digital currency arena, which at present is wide open. As a first mover, China can ensure that no other digital currency can beat it to the punch, at least within its own borders. This innovation should be viewed as a positive step for China, and not as a threat to the rest of the world. Other nations would do well to come up with their own sovereign digital currencies in order to improve use of financial technology and maintain competitiveness themselves.

Also read: Why China’s digital yuan is ‘a dictator’s dream’