International Finance

China’s digital yuan could be the future of money


Around thousands of years ago, when the only form of currency the world knew were coins, China invented the paper currency. Come 2021 and the country is again leading the race when it comes to digital currencies. What’s being debated is whether China’s CBDC project has the capability to shake the pillars of American power? Well, one can argue that money has already become virtual ever since credit cards and digital payment apps such as PayPal, Google Pay, WeChat have come very close to eliminating the need for physical currency, but in its essence, those are just ways to move money electronically.

What China is doing is turning the legal tender into a computer code. Cryptocurrencies such as Bitcoin, Dogecoin, and Ethereum have already shown a potential digital future for money, though they exist outside the traditional global financial realm and are yet to become the legal tender. However, China’s version of digital money will be controlled by its central bank and the same body will also issue the new electronic currency. This is expected to give the Chinese government major new tools that will help them monitor both its economy and its people. Additionally, the digital yuan will also cancel out one of bitcoin’s major drawbacks, i.e., anonymity for the user.

China is leading the digital currency race
China is fairly far ahead when it comes to the testing of the digital yuan and has done these tests in several regions in the past year, along with setting up a legal framework for the CBDC with the help of various global finance regulators. Xiong’an is one of the first four regions that debuted China’s CBDC. The Xiong’an branch of the Agricultural Bank of China in Hebei launched its first digital yuan-based hardware wallet which was developed by the Party Working Committee of the Xiong’an New Area and the PBoC’s branch in Shijiazhuang in February 2021. Recently, China took a major step in its central bank digital currency (CBDC) tests by debuting blockchain-enabled salary payments with digital yuan at Xiong’an.

One might ask why there is so much excitement surrounding the Chinese digital yuan? Well, it’s primarily because tokenised money is completely controlled, similar to physical cash. People might use an ATM to draw the amount of money needed from our accounts, but as soon as we do, the bank owes us less and the state owes us more. Similarly, digital cash has been conceptualised the same way. When we transfer money from our savings account to the digital wallet, the commercial bank steps out of the picture and the central bank takes on the role. Tokenised money makes credit risks disappear from settlements and the transactions remain primarily anonymous unless the concerned authority wants to check for money laundering. As predicted by financial experts, the digital yuan might be heading for a soft launch coinciding with the 2022 Beijing Winter Olympics.

The digital dynamism
It goes without saying that China’s bold move hasn’t surprised anyone, especially after it has positioned itself in the market as a nearly cashless society. Back in 2000, there were around 23 million internet users in the country and that number quickly rose up to 900 million in 2020. It is safe to assume that most of the users consume technology primarily with the help of a mobile phone. As a result of this technical boom, China was tasked with building a comparable physical communication infrastructure. This directly resulted in China’s hugely successful e-commerce and online-to-offline platforms, which brought together the two major digital players of the field- Alipay and Tenpay, that developed the WeChat pay service. WeChat pay service allowed an almost hassle-free shopping experience that included everyday transactions like accessing public transport.

Due to the Covid-19 pandemic, businesses around the world continued to digitise and experts predicted that the post-Covid world will see a large amount of commerce processed on social platforms. This is not just a theory as it has already been reflected on the KPI data which is reported by the US and Chinese platform companies.

Previously, the focus was mainly on monthly active users, it quickly shifted to daily commercial transactions. The growing need to conduct transactions on platforms is what is driving demands for digital payment which has given rise to multiple digital payment companies, which has created opportunities for digital currency.

Ever since the need for digital payments has gained momentum, central banks from all over the world started exploring digital currencies. At present, they are being studied by 85 percent of Central Banks. In October, the Bank for International Settlements (BIS) released a report, along with seven other central banks like the European Central Bank, the Bank of England, the US Federal Reserve and the Bank of Japan, where they assessed the feasibility of CBDCs. The report also focused on how digital currencies can co-exist along with cash and other forms of payments and what steps need to be taken so that no harm comes to financial stability.

Other points that the report focused on how to improve financial stability, innovation, and efficiency. Other smaller nations like Sweden and Thailand are staging their own digital currency trials, and the Bahamas have already launched its first digital currency. As the world becomes more digital and commercial transactions shift even more to digital platforms, Digital Currency Electronic Payment (DCEP) potential will continue to increase. At present, the Chinese currency accounts for about 4 percent of global transactions and DCEP definitely has the potential to further innovate the domestic and global commerce for Chinese companies. Additionally, it could also provide safeguards against fraudulent transactions.

CBDC and its impact on China’s business landscape
In recent years, China has moved rapidly in its efforts to become a cashless economy. Thanks to online payment platforms like Alibaba’s Alipay and WeChat Pay which are essentially digital wallets. People of China use them to make payment in stores, pay bills as well as peer-to-peer transfer. China is also a world leader when it comes to the adoption of mobile payments technologies. Studies show that 86 percent of the citizens used mobile payment platforms to buy their stuff in 2019. This was well ahead of Thailand, a country that had the second-highest percentage of mobile payments users. While digital payment has helped advance the Chinese economy, they have placed a lot of money into the hands of a few technology companies. During the fourth quarter of 2019, Alibaba controlled 55.1 percent of the market for mobile payments in China and Tenecet controlled another 38.9 percent.

China’s new digital currency is expected to be a tool that the Chinese authorities can keep a track of the technology companies that operate mobile payment platforms. The People’s Bank of China will issue the digital currency to commercial banks, which will then provide DCEP to individuals.

If the Chinese government is able to popularise the use of DCEP, it stands to gain a lot of economic and political benefits. DCEP can also help boost the internationalisation of the renminbi, which is a key long-term goal of China’s leaders. From what we know, Beijing’s plan is that DCEP would eventually replace physical money significantly, which, in turn, will reduce the cost of securing and maintaining physical cash supplies, as it could free up 0.5 percent of China’s GDP. DCEP is expected to work without the need for a bank account or the internet.

This might bring in new sources of economic growth and opportunities for greater financial inclusion. Till 2017, 20 percent of Chinese adults did not own a bank account, something which is required to access many institutional financial services and to use mobile payment platforms. DCEP can open up new opportunities for borrowing, saving, and investing services to individuals who don’t have an account. Additionally, DCEP is expected to attract new users in China’s e-commerce market. In 2020, standing at $21.1 trillion, the Chinese e-commerce market is estimated to be the largest in the world, which is more than twice the size of North America’s combined e-commerce market and more than three times the size of Europe’s.

Can the digital yuan compete with the US dollar?
According to financial experts, China’s move to a digital currency, focusing on blockchain technology, is intended to displace the dollar at some point. At present, 88 percent of the global trade interactions are done in US dollars, followed by the Euro, the Japanese yen, the British pound sterling, the Canadian dollar, the Australian dollar, and the Swiss franc. Only about four percent of the global trade currency uses Chinese currency as a medium of exchange.

Therefore, it is natural for some analysts to argue that the CBDC has no chance to compete with the American dollar as the data clearly shows that the world lacks confidence in the yuan. In order to solve this problem, it looks like China is forging ahead in the direction of implementing digital currency as a major token in order to displace the dollar. Given that China is one of the largest economies in the world, this move will definitely have some implications for the US economy.

Back in 1994, the US currency was made to be the reserve currency for global trade. Ever since the currency has dominated the market as it is relatively stable and easily transferable. One of the primary outcomes of this decision was that the US now could monitor financial transactions and penalise entities that violated global democratic norms. These transactions are monitored through the Society for Worldwide Interbank Financial Telecommunications (SWIFT) in Belgium. It is a messaging platform that keeps an eye on electronic payments between international banks. After the 9/11 attacks, the US has used these sanctions to restrict individuals, companies, or countries from funding terrorists as well as violating human rights norms.

It is a known fact that digital currencies allow direct money transfers between global banks that could theoretically bypass the SWIFT monitoring system and have backing by central banks. An alternative government-backed currency that is directly transferable would allow countries that are sanctioned by the US to buy and sell with China.

The Chinese government is particularly interested in bypassing the SWIFT monitoring system because the list of Chinese politicians, individuals, and companies on the US sanctions list continues to increase. Similarly, China has also sanctioned a large number of US politicians. But since the US dollar is still the global currency for trade, US sanctions are far more consequential than China’s sanctions.

The evolving landscape
The popularity and the demand for virtual currencies is increasing in different sectors, along with crypto and private digital currencies, along with DCEP. The digital yuan already has the legitimacy of a legal tender and the payments made while using it are different from the ones people do use Alipay or WeChat. The services provided by the latter may settle transactions very quickly for customers, but behind the scenes are ledgers of large numbers of transactions between the banks of the buyers that are originally settled hours or even days later.

The digital yuan neutralises the need for these banks, Additionally, there is no need for paying a service fee and in theory, the speed of payments can be even faster. When compared to cryptocurrencies like Bitcoin and the likes, the CBDC is backed by the government, which means its issuing is the same as the issuance of cash in circulation, making it just as secure. It will also give the government a much better grip over the money supply and officials can see all the transactions taking place at any given time.

Finally, it seems likely that in China, many companies will soon start running in an environment where a large number of transactions will be done using the CBDC. It is important for business leaders to keep an eye out to see how these Chinese pilots evolve and how they are adjusting to the adoption of digital currency. Analysts predict that if all goes well, there is a solid chance that over time, the number of individual transactions through DCEP will soon surpass B2B usage.

While there is no denying this, the digital yuan still has a long way to go, but its path seems to be clear as of now. In 2021, China will test digital money among the masses and 2022 could very well mark the digital unveiling of its progress, hopefully at the Beijing Olympic, 2022. Reports suggest that global athletes and event attendees will be using the digital yuan and as the prized Olympians of our world will strive towards winning that coveted gold medal, there might be a bigger global economic prize waiting in full display, for the first time in history.

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