How China Is Closing In on Its Own Digital Currency: QuickTake

(Bloomberg) -- While there’s no launch date yet, the People’s Bank of China is likely to be the first major central bank to issue a digital version of its currency, the yuan, seeking to keep up with -- and control of -- a rapidly digitizing economy. Trials and tests are underway in several cities, with the Covid-19 pandemic and need for social distancing adding fresh impetus. Unlike cryptocurrencies such as Bitcoin, the digital yuan won’t have any presumption of anonymity and its value will be as stable as the physical yuan, which will be sticking around too. Behind China’s rush is a desire to manage technological change on its own terms. As one PBOC official put it, currency isn’t only an economic issue, it’s also about sovereignty.

1. What’s the plan?

Not all the details are out, but according to patents registered by the PBOC and pilot trials, it could work something like this: Consumers and businesses would download a so-called e-wallet onto their mobile phone and fill it with money from their account at a commercial bank, similar to going to an ATM. They then use that money -- dubbed e-CNY -- like cash to make and receive payments directly with anyone else who also has an e-wallet.

2. Where and how is it being tested?

The PBOC gave the green light in 2019 for e-CNY to be tested in four cities including Chengdu and Shenzhen as well as the 2022 Winter Olympics venues in Beijing and Zhangjiakou. The list grew to 11 cities and provinces in 2020 including Shanghai, and PBOC deputy governor Li Bo said in April this year that more trials could be rolled out. Selected users are allowed to convert between cash and digital money, check account balances and make payments and remittances. In trials in Suzhou last year, some government employees received digital transport subsidies, and McDonald’s in Xiong’an was accepting it for payments. Didi Chuxing, China’s biggest ride-hailing company, also participated in some trials, as did food-delivery giant Meituan Dianping and streaming platform Bilibili Inc. E-commerce firm JD.com used the digital currency to pay some of its employees this year. The central bank started testing cross-border use with the Hong Kong Monetary Authority in 2021, and has done additional testing with Thailand, the United Arab Emirates and Hong Kong in something called the “Multiple Central Bank Digital Currency (m-CBDC) Bridge Project.”

3. When is it coming?

No word. The PBOC’s Li said there’s still much work to be done to expand the trials, construct an ecosystem in which the currency can be used and think about regulation and legislation. Last year, PBOC Governor Yi Gang called the trials just part of “regular research work,” dialing back expectations. The inclusion of the venues for the Winter Olympics suggested 2022 as a possible target. Digital currency innovation was also mentioned in the Communist Party’s grand plan to make Shenzhen, the technology hub next to Hong Kong, into a world-class city by 2025.

4. Aren’t most transactions already electronic?

Yes. China is increasingly a cashless society. Even street-food sellers in small towns prefer to be paid via a mobile-payment app like Ant Group Co.’s Alipay and Tencent Holdings’ WeChat Pay rather than cash. More than 72 trillion yuan ($11 trillion) of transactions in China were processed via these payment systems in the last quarter of 2020, according to research firm Analysys. The latest central bank figures show 85% of adults used electronic modes of payment in 2019. The trend is hardly unique to China: A central bank survey in Sweden found that only 9% of people paid for their most-recent purchase in cash in 2020, down from 39% in 2010.

5. Will people use it?

It’s hard to say. So far the trials have had a muted reception as customers complain that they struggle to find stores that accept the e-CNY, and that the e-wallet doesn’t offer as wide a range of services as the commercial payment apps do. The PBOC’s e-wallet limits users to making payments for some retail services, whereas Alipay and WeChat Pay are deeply embedded in a whole world of social media, e-commerce, ride-hailing, bill-paying, investments and other functions.

6. Does China want to supplant the tech giants?

It says no. Ant and Tencent, which together occupy over 90% of the mobile-payment market, are under more regulatory pressure these days, from anti-trust probes to control over data. But Mu Changchun, head of the PBOC’s digital currency research institute, said in March that the digital yuan will co-exist with the two payment platforms and provide a backup, since their dominance in the market creates financial stability risks. Bloomberg Intelligence estimates the digital yuan could grab a 9% market share by 2025.

7. So why is the PBOC doing this?

The PBOC’s Mu says China is defending its monetary sovereignty, enhancing the efficiency of its payments systems and promoting financial inclusion. The e-yuan project was started by former central bank Governor Zhou Xiaochuan, who wanted to protect China from having to some day adopt a standard, like Bitcoin, designed and controlled by others. Having the ability to track money electronically as it changes hands would also be useful in combating money laundering and other illegal activities. Other factors may have sped things up, including worries about handling cash during the pandemic as well as a cryptocurrency project backed by Facebook Inc. -- first called Libra, now named Diem. Assuming it goes ahead, Diem could end up increasing the dollar’s dominance and weaken China’s capital controls. As the head of the PBOC’s research bureau, Wang Xin, put it, that could have “economic, financial and even international political consequences.”

8. What’s the U.S. reaction?

The Biden administration is stepping up scrutiny of China’s e-CNY ambition, with some officials concerned it could kick off a long-term bid to topple the dollar as the world’s dominant reserve currency. Officials are said to be eager to understand how the digital yuan will be distributed, and whether it could also be used to work around U.S. financial sanctions. In China, policy makers say the e-CNY is intended to build a cheaper, easier domestic payment system, not to give the yuan a bigger global role.

9. Is it a cryptocurrency?

Probably not. When we say cryptocurrency, we usually mean an offering such as Bitcoin that uses decentralized, online ledgers known as blockchain to verify and record transactions. Bitcoin and others such as Ether support anonymous transfers without the need for a middleman -- or a central bank. The wild volatility in their value, however, makes them ill-suited for use as a means of payment. Facebook’s Diem will be a set of cryptocurrencies, but so-called stablecoins, with each backed by a real-life currency such as the dollar, euro or pound. The PBOC will, of course, back the digital yuan, making it the opposite of decentralized. It’s also not certain that it will use blockchain.

10. Why not use existing coins?

China banned cryptocurrency exchanges and so-called initial coin offerings in 2017 amid a broad effort to cleanse risk from its financial system and clamp down on so-called shadow banking. They can still be traded, but through a slower, more restrictive process. Digital currencies also could provide a way to move money out of China, potentially adding to capital outflows that would undermine the yuan’s value. Even though Diem isn’t out yet, Chinese officials have called for oversight by monetary authorities. (Facebook’s website is banned in China, but many Chinese access it via a work-around called a virtual private network, or VPN.)

11. Why not use blockchain?

Researchers have expressed doubts about whether the technology would be able to support a large volume of simultaneous transactions. China’s annual Singles’ Day shopping gala in 2020 had payment demand peaking at 93,500 transactions per second, far above what Bitcoin’s blockchain could support.

12. How about privacy?

The bank wants to “strike a balance” between privacy and the need to crack down on financial crimes, according to Mu. For instance, users with just small daily transactions can open accounts with only their phone numbers and stay relatively anonymous. (An ID is required to activate a phone number in China, so network operators could trace the identity. Mu said they are barred from sharing that information with third parties.) In addition, the PBOC has said that user information won’t be completely exposed to banks. But user identities will likely be tied to individual wallets, giving authorities another window into people’s lives. PBOC Deputy Governor Fan Yifei suggested in an article in 2018 that banks may need to submit daily information on transactions and that there could be caps on transactions by individuals.

13. How will banks be affected?

Mainly in bookkeeping. Digital cash would have to be kept separate from regular savings, because it represents money in actual circulation (known in central banking parlance as M0), not the so-called demand deposits (M1) which banks use to lend out again to companies and households. Commercial lenders would deposit 100% worth of reserves at the central bank in exchange for digital currency, which it then distributes to retail users. The two-tier system also reduces the burden on the PBOC to perform due diligence, revamp IT systems and answer client requests.

14. Any economic impact?

Probably not immediately. As the PBOC’s digital money is designed to replace cash, it won’t have a big impact on the broad money supply, and thereby its effect on monetary policy will likely be neutral. If the digital currency is widely accepted and people are encouraged to hold more cash, bank deposits could decline, but the impact will be manageable, according to a 2018 article from the PBOC’s digital currency research institute. In a more distant future, the central bank might use digital currency to help steer the economy. Patent filings made public in 2018 described a currency that would require banks making loans to input details about borrowers and interest rates before funds could be transferred. That could allow the PBOC to more proactively control bank lending and direct funding where it deems appropriate. Furthermore, should there be a need for China to turn to an unconventional monetary policy toolkit, digitized currency would allow it to apply negative rates even for people holding digital cash.

The Reference Shelf

• QuickTakes examine what other central banks are doing, cryptocurrencies, the end of cash, and what happened to ICOs, Tether and blockchain.
• A close look at how e-CNY could impact global business operating in China
• Facebook’s white paper on Diem, and the PBOC’s thinking on it.
• Bloomberg Opinion’s Andrew Browne on China’s crypto ambitions.
• The PBOC’s deputy governor writing on why central banks should lead the way on digital currencies.
• PBOC official Mu Changchun’s speech on motivations for creating a digital yuan

©2021 Bloomberg L.P.

With assistance from Bloomberg