China is rolling out its central bank digital currency (CBDC), the most radical change in money since the Chinese introduced paper money 1,000 years ago. Some 270 million Chinese have already downloaded the CBDC digital wallet from banks and private payment providers.
The back end of the system is provided by the central People’s Bank of China (PBOC), which is deploying a massive system ultimately able to process millions of transactions per second.
The digital yuan (e-CNY) is part of China’s new Digital Currency Electronic Payment (DCEP) system, a network that will ultimately replace physical cash.
Digital money gives the Chinese government new tools to manage the economy. If farmers in western China are confronted with floods, the government can send money for emergency supplies directly to the digital wallets of farmers. Digital money is immediate and flexible: It can be programmed so that it can only be used for the purchase of a certain commodity. The government can also give the money an expiration date.
Users can choose from four types of e-wallets with varying balance and payment limits and different sign-up requirements. The entree-level Type 4 wallet requires only a cellphone number and has a maximum balance of is 10,000 yuan (US$1,575). The maximum single payment is 2,000 yuan, and the daily maximum is 5,000 yuan. Higher balance and spending limits require personal identification with a bank.
Eight million merchants, including Western franchises like McDonald’s and Starbucks, have signed up for the e-CNY. Entry costs are zero, as are transactions. Merchants don’t have to install new equipment but can simply print out a QR code and display it at the checkout counter. Customers scan the code, enter the amount on the phone, and press “pay.” Early this year, China launched iPhone and Android apps for its digital currency.
The Chinese show little concern for privacy issues. They point out that the e-CNY doesn’t give the government any power it doesn’t already have. Records of financial activities from private payment platforms or commercial bank-issued credit cards can already be seized by the government if it has probable cause for malfeasance.
David Li of the Shenzhen Open Innovation Lab points out that China’s DCEP will also provide access to banking services for a large segment of the population that is “unbanked.” In China, 20% of the population is unbanked.
Central bankers in the rest of the world are keenly watching the e-CNY rollout, studying not only its technical and legal aspects but also its potential impact on the global financial system.
The US has obvious reasons for concern. The dollar has been the world’s reserve currency since the 1940s and played a key role in postwar reconstruction. But in recent years, the US has debased its currency by printing trillions of dollars. It has also used the dollar for geopolitical reasons by excluding its adversaries from the dollar system. This had led to growing calls for an end to the dominance of the US dollar.
China is arguably the only country with the financial clout to lead a movement to break the dollar hegemony. The Chinese government has repeatedly said the digital yuan is not meant to replace the US dollar. That may technically be true but is at best only half the story. China has bilateral currency-swap agreements with dozens of countries. Their main purpose is to bypass the dollar system.
This month, China and France announced a cross-border interbank payment system that will help with the internationalization of the yuan. It will also provide an opportunity for the eurozone to reduce its reliance on the US dollar.
Under the agreement, France would first accept the yuan as a payment currency to carry cross-border settlement and investment and then add the yuan to its reserve-currency list. The agreement may set an example for other countries in the eurozone to accept the yuan as a reserve currency.
A joint venture between SWIFT and China’s department responsible for the digital yuan is exploring the international use of e-CNY.
The e-CNY will affect both domestic and international businesses, especially companies with a presence in China or routinely transact with Chinese businesses. It will affect everything from product offerings to business practices. China’s Digital Currency Research Institute has filed more than 80 patents for digital money technology.
The patents shed light on how China may regulate CBDC supply using an algorithm based on certain triggers, such as loan interest rates and economic triggers. The central bank can, for instance, issue inactive digital currencies to a financial institution, activating the currency only after the financial institution meets certain criteria.
The e-CNY is being readied for international payments. A Chinese state-owned bank and steel company Baowa have established a partnership to create a trading platform that could support cross-border transactions. The two companies have signed a strategic cooperation agreement with the Australian payment processor Airwallex, which could open up future integration of the e-CNY overseas.
The PCOB is exploring digital-currency cross-border payments with central banks in Thailand, the United Arab Emirates and Hong Kong. Countries participating in the Belt and Road Initiative are likely to be next.
All indications are that China plans gradually to internationalize the yuan, using both its economic power and first-moving advantage in digital payment infrastructure. China is likely to be the key architect of a new payment system that presupposes the full digitization of all money. Given the inclinations and priorities of the Chinese government, the playing field for currency traders, speculators, and tax havens will gradually diminish.
CBDCs are also likely to seal the fate of Bitcoin and other cryptocurrencies, at least as payment currencies. Ironically, Bitcoin was conceived as an alternative to fiat currencies, but concerns about the rapid growth of private cryptocurrencies are said to have motivated the Chinese government to roll out its digital currency quickly.
The notorious volatility of cryptos made their use as a medium of exchange always unlikely. CBDCs will reduce them to speculative virtual assets with considerable opportunity cost unless ways are found to deploy the more than $2 trillion stored in idle crypto wallets for the common good.