China's Digital Currency Launch

The declining relevance of physical cash and arrival of privately issued Crypto Currencies have forced the central banks to rethink the way the money is issued and circulated in the economy. According to the results of the third Bank for International Settlements (BIS) survey on central bank digital currencies (CBDC) (conducted in last quarter of 2020), the share of central banks actively engaging in some form of CBDC work stood at 86%.

China has always been progressive in-terms of experimenting with financial innovations from Quick Response (QR) codes to E-wallets. It has also been engaged in the development of a Central Bank Digital Currency (CBDC) since 2014 and they call it “Digital Currency Electronic Payment (DCEP)”. China launched the pilot testing in the third week of Oct’20 in four cities: Shenzhen, Chengdu, Suzhou and Xiong’an. It was then extended to other cities like Beijing, Shanghai, Guaongdong etc. and included private players like McDonalds and taxi services aggregator DiDi.

The digital currency is pegged 1:1 to the Chinese Renminbi (RMB). The significance of DCEP is that it is designed as a replacement of Reserve Money (M0). It is based on distributed ledger technology (DLT)(on private permissioned network) style protocol using Blockchain & Cryptographic technology, thus cutting back the cost and friction of bank transfers.

The DCEP employs a two-tier structure, with the People’s Bank of China (PBoC) on the top for the issuance of digital currency and four state owned Banks (Agricultural Bank of China, Industrial & Commercial Bank of China, Bank of China and China Construction Bank) as intermediaries for the distribution of digital currency. DCEP is designed to handle peak transaction per second speed of about 2,20,000 to cater for 2 billion users in the first phase. It does not require a bank account tied to the mobile phone and can be used online as well as offline.

The DCEP system promises to have controllable anonymity, but ironically the central bank will have complete visibility of the financial system in real time.  DCEP is designed to record all transnational data including identity of the parties involved, financial trading information like trading elements and respective trading scenarios along with other derivative information. It provides authorities unprecedented oversight and control over financial system.  With passage of time, the DCEP system will create a huge data pool, which can be exploited using Big Data and Artificial Intelligence for economic benefits. With the wider adoption at home, the DCEP system can prove to be a potent tool for authorities in handling money laundering, tax evasion, counterfeit currency and capital flight from the country.

Apart from revolutionising China's financial ecosystem, DCEP would play a crucial role in internationalising the Renminbi (RMB) as a global payment currency. China is currently collaborating with the United Arab Emirates, Hong Kong and Thailand, together with the Bank for International Settlements Innovation Hub in Hong Kong on a “Multiple CBDC Bridge” (m-CBDC Bridge) project to explore using distributed ledger technology to support real-time cross-border payment transactions on a 24/7 basis. The central bank's digital currency research institute and clearing centre have also set up a joint venture with Society for Worldwide Interbank Financial Telecommunications (SWIFT) to explore global use of its CBDC. After becoming the first major economy to launch a CBDC, China has started pushing for global standards on CBDC.

“Global 1-2-3 Logistics Circle”  along with Blockchain based initiatives supported by a DCEP like smart currency system and thriving cross-border eCommerce have potential  to create a frictionless ecosystem for commerce and international flow of Yuan. International acceptance of DCEP would likely solve China’s dollar constraint in funding OBOR projects to some extent and would pose a challenge to dollar dominance in international transactions.  Any substantial market share gain by Chinese Currency in international transaction will have an impact on US ability to impose economic sanctions.

On the domestic front, it will not be difficult to push wider adoption of CBDC, but international acceptance of China’s CBDC will depend on multitude of factors such as currency convertibility, data privacy of international users and response of other central banks, especially in the environment when Covid-19 seems to be changing the global equations. CBDC is in the process of evolution. Economists around the world have divergent view on its implications on monetary policies and role of financial institutions. To what extent it disrupts the existing system will be known only with the time, but it has clearly created uneasiness in Governments and central banks.

(The views expressed in the article are of the author and do not reflect official views.)

REFERENCES

1.             Anton Lucian and Adam James, Dec’19, “China’s Digital Currency Claims to Have 220,000 Transactions-Per-Second”, https://beincrypto.com/chinas-digital-currency-claims-to-have-220000-transactions-per-second/ 

2.             BIS press release, Feb’21, “Central banks of China and United Arab Emirates join digital currency project for cross-border payments”  https://www.bis.org/press/p210223.htm

3.             Codruta Boar and Andreas Wehrli, Jan’21, “ BIS Papers No 114 Ready, steady, go? – Results of the third BIS survey on central bank digital currency”

4.             CSIS, Aug’20,  “How Will a Central Bank Digital Currency Advance China’s Interests?” , https://chinapower.csis.org/china-digital-currency/

5.             Gao Desheng, Feb’21, “China steps up digital currency rollout, deepens cooperation with SWIFT”  https://www.globaltimes.cn/page/202102/1215809.shtml

6.             Michael, Jan’21, “China’s National Digital Currency DCEP / CBDC Overview” https://boxmining.com/dcep/#What_is_DCEP%20https://www.scmp.com/economy/china-economy/article/3043134/chinas-new-digital-currency-isnt-bitcoin-and-%20%20not-speculation 

7.             Samuel Shen, Nov’19, “ China's proposed digital currency more about policing than progress” https://www.reuters.com/article/us-china-markets-digital-currency/chinas-proposed-digital-currency-more-about-policing-than-progress-idINKBN1XB3QP?edition-redirect=in 

8.             Yaya J. Fanusie and Emily Jin, Jan’21, “China’s Digital Currency: Adding Financial Data to Digital Authoritarianism” https://www.jstor.org/stable/resrep28651.7?seq=1#metadata_info_tab_contents

9.             Zoey Zhang, Dec’20, “China’s Digital Yuan: Development Status and Possible Impact for Businesses”  https://www.china-briefing.com/news/chinas-digital-yuan-status-roll-out-impact-businesses/