Is the Digital Yuan the Future of China’s Economy?

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China is on a mission to become the first country to issue a sovereign digital currency, with the development of a digital yuan being a priority for the People’s Bank of China (PBoC). 

The economic powerhouse believes that a shift from traditional financial systems through digitization of money will help steer it to the front of global markets. While the project dubbed Digital Currency Electronic Payment (DCEP) is still shrouded by secrecy; there’s emerging information and steps towards its actualization.

In September 2017, The People’s Republic of China imposed a blanket ban on Initial Coin Offerings (ICOs) and crypto-related activities. Fast forward to April 2020 and the country’s central bank, People’s Bank of China (PBoC), announced that it was rolling out a real-life pilot test of the much anticipated digital yuan on various platforms.

The announcement came just a couple of weeks after China announced the end of lockdown in Wuhan province. Since then there have been lots of activities touching on the digital currency with more players coming on board to embrace the project.

So, why the sudden urgency to accelerate the release of a digital yuan? Could the escalating China-US trade wars be the reason? How has coronavirus affected the development of China’s digital yuan? The following analysis takes a deeper look at the digital currency and tries to make sense of the ambitious project being put forward by the Chinese government. 

China’s digital currency history 

In 2016, the PBoC announced that it was setting up a digital currency research institute to develop a sovereign currency that would be used to supplement the use of cash in China. With the announcement, the idea of a digital yuan was born. However, little was heard about the project until June 2019 when Facebook launched Libra cryptocurrency. 

In a statement published in July 2019, Wang Xin, the director of PBoC research bureau stated that,

“If [Libra] is widely used for payments, cross-border payments in particular, would it be able to function like money and accordingly have a large influence on monetary policy, financial stability and the international monetary system?”

Later that year, China’s president, Xi Jinping,  during a CPC Committee workshop emphasized the need to accelerate the adoption of blockchain in the country. He commented,

“We must take blockchain as an important breakthrough for independent innovation of core technologies, clarify the main directions, increase investment, focus on a number of key technologies, and accelerate the development of blockchain and industrial innovation.”

At the beginning of 2020 during a working conference in Beijing, PBoC reported that the development of a government-backed digital yuan was ‘progressing smoothly. However, information emerged that research on the digital yuan had been postponed due to coronavirus that had by that time started to spread globally. 

According to a publication on 25th February, the pandemic had an effect on the staff working on the digital yuan. It stated, 

“The coronavirus outbreak has led to postponed work resumption in government institutions, including the People’s Bank of China. Policymakers and research staff involved in the DCEP [Digital Currency Electronic Payment] project are no exception, which weighs on the development process.”

Latest developments related to the digital yuan

Following the recovery from the pandemic, things seem back on track for the release of the digital yuan. On August 5th, reports emerged that major commercial banks run by the government would carry out large scale testing of wallets for the digital yuan.

Another notable milestone in the DCEP project was the publication that revealed one of China’s food delivery giants, Meiutan Dianping, would pilot the digital coin. The Taxi-hailing app, Didi Chuxing, also announced the acceptance of a digital yuan on its platform.

In late April 2020, PBoC launched the pilot test for a digital payment system that will run in four Chinese cities; Shenzhen, Suzhou, Chengdu, and Beijing’s satellite city, Xiong’an. The digital currency has also been formally adopted into some government agencies where it’s being used to pay civil servants.

The government also hopes to launch the sovereign coin for use in different venues hosting the 2022 Winter Olympics.

Why does China desperately want a digital currency?

Lately, China has ramped up its efforts to implement a digital financial system in the country. The country’s president, Xi Jinping, called for the acceleration of the adoption of blockchain and artificial intelligence in China. So, why is China pushing for the development and adoption of digital currency?

Technical inevitability

According to a report published by The Bank of International Settlements, 80% of central banks around the world are working on developing digital currencies for their respective countries. The high figure shows that the shift to digital payments is inevitable, and in the next few years, it will become a reality.

A digital yuan will solidify China’s authority in the FinTech space and will give it a much-needed head start in the technology of the future – or at least that’s the idea.

Dollar dominance

According to data from the International Money Fund (IMF), 90% of the world’s foreign exchange reserves are in US Dollars. Reportedly, China holds a large chunk of its forex with the US treasury to a tune of $1.11 trillion, which is only second to Japan.

Through the development of a digital yuan, China is optimistic that it can dethrone the dollar as the world’s strongest currency. The DCEP project is one of the methods that the Asian economic superpower will use to diversify its reliance on the US dollar.

The ‘New Silk Road’

China’s mammoth Belt and Road Initiative, which is dubbed ‘the new silk road’ is picking up serious momentum. Since 2017, BRI projects have received over 1 trillion dollars in funding, which will be spread over the development of infrastructure by member countries.

There’s a lot of money changing hands as a result of the new silk road which involves the dollar. The Deutsche Bank revealed that 75% of the world’s population is affected by BRI in one way or another. With a digital yuan in place, China will have better control over the financial ecosystem of BRI.

Cashless economy

China is no stranger to a cashless financial system, with over 90% of people in large cities using mobile payment platforms Alipay and Tencent’s WeChat Pay.

With the recent pandemic, using cash was a headache and expensive for most economies where central banks had to purify their money. For these two reasons, it’s only viable for the PBoC to shift to a digital economy where cash isn’t king. 

Li Lihui, the former president of Bank of China, stated that the digital yuan could replace cash only if four conditions were met. He stated during a live stream,

“Whether the digital Yuan can become the dominant form of currency and mainstream payment means, depends on whether it has greater efficiency, lower transaction costs, enough economic scale with commercial value, and peoples’ acceptance.”

Digital yuan is not a cryptocurrency

From the word go, China’s central bank emphasized that it had only borrowed heavily from the fundamental concepts of blockchain. The DCEP will apply the concept of traceability and peer-to-peer payments which are vital pillars of decentralized financial transactions.

However, unlike blockchain, PBoC will use ‘loosely coupled account links’ which will allow bank transactions between two DCEP accounts. In such a system, financial intermediaries won’t exist, but the money is still centralized in a way that the government could tamper with it. Therefore, the digital yuan won’t function like Bitcoin or any other cryptocurrency since it will be on a centralized system run by PBoC. 

Challenges to the adoption of a digital yuan

While China’s DCEP project has made tremendous movements towards its final goal, there’s still a lot of hurdles on the way. The biggest challenge will be the collaboration of PBoC with commercial banks to implement the system. There’s also the fact that Alipay and WeChat Pay already have a robust mobile payment structure, which is working fine without a digital currency.

Another challenge, which is also common to most crypto projects, is the mass adoption of a coin. Yes, China’s government has the mandate to disburse the digital yuan to the public, but the question of whether all the stakeholders will embrace it entirely remains to be seen. 

However, there’s a parallel effort by the country’s Digital Currency Research Institute to increase the number of use cases of DCEP.

The future of China’s economy concerning a digital yuan

A digital yuan is an integral part of the realization of China’s $50 trillion new infrastructure plan that seeks to bring financial autonomy to the country. At the moment, the United States Federal Reserve doesn’t see the urgent need for a government-backed digital currency.

Electronic payment systems are the future of FinTech. While some view it as a cyber weapon tool, China believes that it will help the country move into a new era of a global economic takeover.