GUANGZHOU, China – Without a doubt, China is leading the world in the development of a national digital currency, a project it has been working on since 2014.
The People’s Bank of China (PBOC) has led work on the digital yuan, the so-called central bank digital currency (CBDC) that aims to replace some of the cash in circulation.
There is already real world evidence in the world’s second largest economy. This is what we know so far about the digital yuan or its official name: electronic payment in digital currency (DCEP).
What is the digital yuan?
It is effectively a way for the central bank to digitize banknotes and coins in circulation. The Chinese market is already well advanced in cashless payments. The digital yuan would be a way to speed up this process.
It will be legal tender in China and no interest will be paid.
“Cash usage is declining. Eventually, cash will be replaced by something in digital format. This is one of the big engines behind it,” Yan Xiao, leader of the digital commerce project, told CNBC of the World Economic Forum.
Why is it introduced?
Fan Yifei, deputy governor of the PBOC, said last year that there is an “urgent need to digitize cash and currency,” as production and storage of these is currently expensive. In an article in the state-backed publication Yicai Global, Fan said that cash and coins are not easy to use, are easy to counterfeit, and because of their anonymity, could be used for illicit purposes.
The PBOC sees other advantages for the digital yuan.
In a separate article, Fan outlined how a CBDC could make payments more efficient and improve the transmission of monetary policy. Fan also argues that a digital yuan could help financial stability through a “controllable anonymity” system. This is where payments would be anonymous to some extent, but data analysis tools could help the central bank capture illegal activities.
Another reason for the PBOC’s efforts could be to increase competition in the payments space and reduce systemic risk. China’s digital payments field is dominated by Alipay, which is run by Ant Group, a subsidiary of Alibaba, and WeChat Pay, run by Internet giant Tencent.
“The existing system is owned by private companies. If Alipay or WeChat pay in bankruptcy, which is extremely unlikely, it creates a systematic risk,” Linghao Bao, an analyst at Trivium China, told CNBC. “The main reason for them (the PBOC) to do this is to level the playing field. Another reason is perhaps to create a new platform payment system that increases efficiency.”
How will the digital yuan work?
The issue has two aspects: distribution and, finally, how it will be spent.
The distribution will be done through a system called two levels. This means that the PBOC will distribute the digital yuan to commercial banks. Commercial banks will be responsible for putting the currency in the hands of consumers. This could include services that allow consumers to exchange their currencies and cash for digital yuan.
China has already donated millions of dollars worth of digital currency in real tests in several cities, including Shenzhen, Chengdu and Suzhou. This means that the local government distributes a certain amount of yuan through a lottery. Users usually have to download a standalone app to receive the currency. JD.com, one of China’s leading e-commerce agents, participated in the test and allowed customers to buy items with the digital yuan.
A man has 100 RMB notes with the Chinese flag in the background.
Sheldon Cooper | Images SOUP | LightRocket using Getty Images
At this time, it is unclear how users could retain and spend digital yuan when deployed across the country. The most popular form of mobile payment in China is based on so-called fast response codes (QR). Users can display this barcode on their Alipay or WeChat app in a store and the merchant will scan it.
Xiao from WEF says commercial banks are likely to be able to integrate similar functionality into their applications. And that Alipay and WeChat Pay can have a section of their applications dedicated to the digital yuan. Meanwhile, smartphone makers could also create digital yuan wallets for their devices.
“It will be interesting to see how the phone companies take the opportunity to become a payments player in the market,” Xiao said.
The PBOC fan also said that commercial banks already have the infrastructure to distribute the digital yuan and it is better that they do so instead of the central bank.
“Building an independent system would be a huge waste of these existing resources,” he said.
So, is it designed to compete with the tech giants?
In a way, it’s designed to increase competition with Alipay and WeChat Pay, but not to completely replace them.
“My way of looking at it is that the digital yuan is not a direct competitor to Alipay or WeChat Pay, but a new platform that allows other players to compete with WeChat and Alipay,” said Bao of Trivium China. “They could be commercial banks or other payment companies.”
The PBOC fan also said the proposed two-tier model could help “avoid disintermediation in the financial sector” because the central bank will not compete with commercial banks.
Is the digital yuan like bitcoin?
No, Bitcoin is the so-called decentralized cryptocurrency. This means that it is not controlled by any central authority like a central bank, unlike the digital yuan that the PBOC will issue.
Bitcoin is also based on a technology known as blockchain. At this time it is not clear what kind of technical composition the digital yuan would have.
Proponents of bitcoin also promote the anonymity of the digital currency.
A PBOC fan said the digital yuan would have “controllable anonymity.” This would imply those operating digital yuan portfolios to disclose transactions to the PBOC as the “only third party”. Users would have a “loose account docking,” which means their current bank account isn’t necessarily closely related to their digital yuan account.
It could be based on a phone number, according to Xiao of WEF.
The PBOC says agencies operating digital yuan services should “submit transaction data to the central bank through timely asynchronous transmission.” This would allow the PBOC to “keep track of the data needed” to crack down on money laundering and criminal offenses.
Some commentators have expressed concern, however, that the digital yuan could be used to increase citizen surveillance.
Renminbi internationalization
China has been pushing for the internationalization of the yuan and some commentators have seen the digital yuan as a way to do so.
But today, digital currency has a national focus and international use “is not the immediate priority,” according to Bao of Trivium China.
But the PBOC has begun to lay the groundwork for digital currency to be used in cross-border transactions. Last month, the PBOC joined central banks in Thailand, the United Arab Emirates and Hong Kong to explore a cross-border digital currency payment project together.