There have been multiple attempts to devise digital cash over the last couple of decades. Eventually, in 2009, Bitcoin succeeded in creating a decentralised, digital form of money. A decade later, global central banks are working on their own experiments to digitise fiat currencies. Central bank digital currencies (CBDCs) can have many positive implications on society, from financial inclusion to decreased illicit activity like fraud and money laundering. In this article, we cover global CBDC efforts and, in particular, China’s Digital Currency Electronic Payment (DCEP) program.
CBDC interest picking up amid Covid-19
While exact numbers are hard to pin down, it’s estimated that less than 10%, perhaps as low as 2%, of all money, is physical cash. Cash is expensive to produce, distribute and store. As most money is already electronic, we are likely on the way to a completely cashless society.
Over the recent years, CBDCs went from obscure experiments to the inevitable reality. Growing digitisation of commerce, the rise of Bitcoin and other cryptocurrencies and Facebook’s attempt to privatise money through its Libra (now Diem) initiative have all played a role. Add Covid-19 to the mix, and the macro backdrop seems perfect for CBDCs.
A recent survey by the Bank for International Settlements (BIS) showed that 80% of the central banks surveyed are actively working on CBDCs. This includes everything from research to technical development, and in some cases, retail or wholesale trials. According to BIS, as of July 2020, three countries have completed a retail CBDC pilot (Ukraine, Ecuador and Uruguay), while six other pilots were ongoing, including in China, Korea and Sweden.
Looking at the majors, the European Central Bank (ECB) recently said that it’s working on a digital euro. The Boston branch of the Federal Reserve has partnered with MIT’s Digital Currency Initiative to actively research and test a digital dollar, and Sweden’s central bank is working with Accenture on its e-krona pilot.
China leads the way
However, when it comes to CBDCs, China is leading the way, on track to be the first major economy to launch one. The People’s Bank of China (PBOC) has been working on digital yuan since 2014, accelerating its efforts in 2019 following Facebook’s Libra announcement. Last year, it revealed plans to conduct extensive trials, in partnership with four major state-owned banks, technology and telecommunications companies. At this stage, the PBOC will issue digital yuan to the participating banks, who will then channel the money to the retail users. During the next phase, companies like Tencent and Alibaba will be serving as an intermediary between the PBOC and the end-user.
Following closed pilot tests in Shenzhen, Chengdu, Suzhou, Xiong’an and some 2022 Winter Olympics locations, the DCEP trials will be expanded to Beijing, Shanghai and other cities. DCEP could end up covering around 400 million people, of 29% of China’s population. Recently, the Hong Kong Monetary Authority (HKMA) announced that it was preparing to test DCEP for cross-border payments, in collaboration with the PBOC.
To date, trials have been conducted in Shenzhen, Suzhou and some smaller Chinese cities. In Shenzhen, the city gave away digital yuan worth a total of RMB 10 million (US$1.5 million) to 50,000 people via a lottery. In Suzhou, some municipal government employees have been receiving their transport subsidies in digital yuan since May. In December, the government in Suzhou gave away RMB 20 million (US$3 million) to 100,000 residents, in the largest DCEP trial to date.
According to a speech by the deputy governor of PBOC on November 2, more than RMB 2 billion (US$299.07 million) digital yuan had been spent in four million separate transactions.
What are China’s plans?
DCEP aims to deliver on several key objectives. If widely used, it can give Chinese government officials better visibility into the flow of capital in the Chinese economy. It also makes anti-money laundering and terrorist financing easier to track. At the same time, digital currency can serve as a monetary policy tool, allowing the PBOC to target monetary policy to different economic or geographic classes. According to Huang Qifan, Chairman of the China International Economic Exchange Centre:
“DCEP can achieve real-time collection of data related to money creation, bookkeeping, etc, providing useful reference for the provision of money and the implementation of monetary policies.”
Digital yuan is also designed to increase financial inclusion in rural areas. It will have NFC-based payment option, which means that payments can be made offline. Furthermore, DCEP will not require that a mobile number is attached to a bank account, which will make the digital yuan available to the currently underbanked population in China.
There’s also a geopolitical angle to DCEP as China has a long-standing desire to promote yuan’s internationalisation and reserve status. Before the RMB Cross-Border Inter-Bank Payments System (CIPS) went live in 2015, China relied on CHIPS or SWIF for cross-border payments and settlement. CHIPS is an American company and SWIFT, while an international organisation, is viewed by China as controlled by the US and its allies. Therefore, to achieve its objective of increased global use of the yuan, China needs its own international payments system.
Is China going after the US dollar?
According to Christian Vondenbusch, Portfolio Manager at Lombard Odier Investment Managers, in China DCEP is viewed as a domestic-first project. However, the Chinese government has put in a lot of effort over the years to elevate the yuan’s stature in the global arena, including its use in international trade and as a reserve currency.
However, at this point, the yuan lags significantly behind the US dollar. According to SWIFT’s monthly RMB tracker, RMB made up just 2% of global payments by value as at the end of November. This was actually below its 2.09% share in November of 2018. At the same time, USD and EUR each accounted for around 37%. If we look at the global central bank reserves, according to the IMF, 60% were held in the US dollar as of September 2020. Euro is the second global currency making up about 20.5% of international reserves. RMB accounts for just over 2%.
At the same time, China has been taking a proactive approach to the internationalisation of the yuan. In 2016, RMB was added to the International Monetary Fund’s Special Drawing Rights basket. China has also appointed yuan-clearing financial institutions in 20+ countries to facilitate yuan swap agreements. Its “Belt and Road Initiative” has been effective in using economic development incentives to promote the yuan’s adoption.
This is where the DCEP could be especially powerful. While 1.7 billion adults around the world don’t have bank accounts, more than 65% of this population has a mobile phone. DCEP doesn’t require a bank account and supports offline transactions. Combining DCEP with the “Belt and Road Initiative” could allow millions of people to bypass traditional financial infrastructure and benefit from digital financial services.
While the US dollar position as the global reserve currency is unlikely to change, the Euro might be more vulnerable. According to dGen, Dutch fintech think tank, the Euro will be overtaken by the digital yuan by 2025, unless Europe develops its own CBDC.
Do CBDCs compete with cryptocurrencies such as Bitcoin?
There are many differences between cryptocurrencies and CBDCs. Both use distributed ledger technology, also known as the blockchain, but that’s where the similarities stop. Cryptocurrencies, for example, use public and permissionless blockchain architecture, while CBDCs operate on private and permissioned blockchains.
Cryptocurrencies are not legal tender and are currently not regulated as currencies at all. In fact, the regulatory landscape varies by country, and many governments are hostile to cryptocurrencies. CBDCs, on the other hand, will be appropriately regulated, comply with all currency requirements and be accepted as legal tender. In China, for instance, the government mandated that all merchants who currently allow digital payments have to accept DCEP.
Most CBDCs will also have programmable functionality, meaning that they can leverage smart contracts to facilitate more complex applications in the future. To that extent, there’s certainly potential to eventually bridge CBDCs with permissionless blockchains.
Overall, cryptocurrencies and CBDCs have very different value propositions and shouldn’t necessarily be compared directly. Instead, they will likely co-exist and together facilitate the transition to the cashless society.
CBDCs are here to stay
It seems inevitable that a variety of CBDCs will be introduced around the world over the next several years. China is currently leading the way, cementing its place as one of the top innovators in fintech and digital banking. While cash remains in circulation, even in China, it is clear that CBDCs will significantly impact the global economic and monetary order.