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What is China's Digital Yuan Cryptocurrency? How Does the Chinese Digital Currency Work?

Editor, TRANSFIN.
Apr 14, 2021 3:16 PM 6 min read
Editorial

A digital payments revolution is gathering pace in China.

If all goes according to Beijing’s plan, the first national digital currency by a major economy could be launched before February 2022.

What is China’s Digital Yuan Experiment?

In 2014, even as cryptocurrencies like Bitcoin were becoming popular, China’s central bank set up an internal group to study the feasibility of a state-backed digital currency of its own. They named it the electronic yuan (eCNY).

Last year, China’s experiment moved out of research rooms into large-scale testing. In four cities - Shenzhen, Suzhou, Xiongan and Chengdu - trial participants were chosen via lottery and given 200 eCNY ($31) each by authorities. The idea was to give people money to spend at a variety of retail stores and judge if they found it convenient and adaptable.

Since then, the trial has expanded to bigger cities like Beijing and Shanghai. While the government has not given an official launch date, they reportedly want to roll out eCNY to the general public before the 2022 Winter Olympics, which is scheduled to be held in China.

 

How Does the Digital Yuan Work?

As a state-backed cryptocurrency, eCNY was inspired by the likes of Bitcoin and Ethereum, but it differs in its (1) lack of user anonymity, (2) central bank-controlled centralisation and (3) the absence of blockchain technology. The money is stored in your mobile phone (this is where it’s similar to mobile money). Moreover, these transactions can take place even without an internet connection.

As for how you can pay using digital renminbi, the process is similar to typical digital payments - you pay either by scanning the retailer’s QR code or producing a QR code on your phone for the retailer to scan.

 

Why is China Eager to Roll Out a National Cryptocurrency?

The impending rise of the digital yuan can have significant ramifications.

 

One: Within China

It would help the government keep the country’s huge tech conglomerates in check. The hegemony of payments apps like Alipay and WeChat Pay (which combined have a user base of 1.9 billion) vis-a-vis state-owned banks would be threatened by eCNY.

Already, these companies are reeling under increasing regulatory oversight from Beijing, with the Ant Group being cajoled to restructure itself as a holding company and Alibaba imposed with a record $2.8bn fine. Widespread adoption of the digital yuan would take away value from the private-sector payments tsars and hurt the clout of their mammoth parent companies.

Then there’s government control. Given that eCNY is issued by the People’s Bank of China, every transaction made would be tracked and recorded by the state. This would not only provide the Chinese Communist Party (CCP) with an invaluable treasure trove of data that could help them study and predict consumer behaviour, but would also give the Party yet another tool to monitor its citizens with.

It also heralds an objectively unhealthy level of state involvement in a citizen’s personal finances. China’s notorious Social Credit System tracks citizens’ credit scores, spending patterns and even behaviour and “trustworthiness”. Combine this with a central bank digital currency (CBDC) and suddenly the government has the power to make it impossible for you to access your money, let alone spend it, if it thinks you are spending too much, risk falling into debt...or posted something mildly critical of Xi Jingping on Weibo. You get the idea.

 

Two: On an international level

The rise of eCNY may pose a serious challenge to the US dollar’s preeminent place in global finance. Cryptocurrencies are easier for cross-border transactions, are simpler to use for poor countries, and convenient if you’re trying to escape US sanctions (such as on Chinese friends like North Korea, Iran and Venezuela or Chinese companies and individuals accused of aiding and abetting genocide in Xiniang).

Fun Fact: Ironically, some of the first retail partners that jumped on Beijing’s bandwagon for the ongoing eCNY trials were American companies like McDonald’s, Subway and Starbucks.

China doesn’t mince words about its ambitions to disrupt the global financial system, which it sees as skewed in favour of the West, an unfair remnant of Bretton Woods and World War Two and not representative of the realities of the 21st century.

The ambitions are also borne out of geopolitical considerations. The same way China (correctly) predicted a boom in demand for solar panels and electric cars and thus preemptively positioned itself as a renewable energy behemoth early on and benefited from the same, it opines that CBDCs will become commonplace in the near-term. Issuing the first such currency gives the country a lucrative headstart and the opportunity to set global technical standards. The early bird gets the worm, as they say.

FYI: The People’s Bank has already filed more than 100 patent applications related to digital currencies.

China’s push for a digital renminbi may also have been accelerated by a fear of foreign digital currencies (like Facebook’s Libra) and other stablecoins (like the dollar-backed Tether). Just like India, China too is an earnest believer in the pursuit of Atma Nirbhar-ness!

 

Will the Yuan Be Able to Replace the Dollar?

All said and done, dethroning the dollar is easier said than done. 88% of international foreign-exchange trades are dollar-based; only 4% is in yuan. The dollar’s dominance is intrinsically tied to America’s soft power and the size of its economy, both of which have remained the steering wheels of international finance for decades, despite occasional challenges by upstarts like the Euro, Japan and China.

The yuan, on the other hand, is a force to be reckoned with only within China and in some parts of its backyard. Its presence on the global stage has been constricted by America’s apprehensions about Beijing but also (if not more so) by the CCP’s penchant for surveillance, totalitarianism and human rights violations. Not to mention its activities in the South China Sea, accusations of corporate spying, and alleged violations of trade and IPR laws.

So unless China fixes its image problem, the digital renminbi will face crippling reluctance in foreign markets. (But this is a tall order in itself because China has an image problem of being looked at as a neo-imperialist rule-breaking genocide-accused bully because it has an actual problem of being a neo-imperialist rule-breaking genocide-accused bully.) 

 

The Spectre of State-Backed Crypto

If it sounds oxymoronic, it’s because it sort of is. State-backed digital currencies invalidate a basic tenet of crypto - that of separation of money and state. Instead of doing away with centralisation and control, they make the state an integral player within the system. The currency is issued by the state, regulated by the state, and derives its legitimacy from the state. So in its most basic form, a CBDC is merely fiat currency on a mobile.

Now, China is not alone in all this CBDC fervour. The Bahamas has already issued its version - the sand dollar - into circulation. The EU wants to launch a digital euro by 2025. The Bank of England is mulling a digital pound. Sweden is conducting trials of a digital krona. An Indian Government committee has proposed a ban on private cryptocurrencies but the creation of an RBI-backed one.

All in all, over the last 12 months, more than 60 countries have experimented with national digital currencies, up from just over 40 a year earlier.

FYI: Rather uncharacteristically, the US has dragged its feet on the issue of CBDCs. The Fed’s Jerome Powell had said that America would prefer to “get it right than to be first”. But with eCNY knocking, Washington seems to have woken up from its slumber. Last week, Treasury Secretary Janet Yellen hinted that the US might pursue the issue more proactively, saying a digital dollar was “absolutely worth looking at” because it “could result in faster, safer and cheaper payments”.

 

Why Pursue CBDCs At All?

The motivations behind CBDCs are two-pronged. One, they encourage cashless payments, which are faster, cheaper, more efficient, easier to track, and less susceptible to counterfeiting. For poorer countries, fintech also offers a route for the unbanked to embrace the formal economy. And two, CBDCs help retain government control over the monetary system at a time when it is threatened by “private” cryptocurrencies and stablecoins.

But the motivations aren’t merely economic in nature. With China poised to become a digital currency leader even as the West struggles to keep up, state-backed national cryptocurrencies might very well be the next arena for the escalating superpower rivalry.

FIN.
 

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