What is behind China’s digital currency aspirations?

The PBoC sees CBDC as a means of riding the wave of digitisation, and potentially challenging the US dollar’s dominance, writes Hui Feng
The renminbi could soon be going digital

A former high-ranking Chinese official, Huang Qifan, announced in October that China may well be the first country to issue a digital sovereign currency. Chinese president Xi Jinping’s recent public endorsement of blockchain technology has further sent the nation into a frenzy of digital encryption. Stocks, even those of remote relevance to the blockchain concept, soared in value during the trading day. Local governments rushed to announce new sponsored programmes supporting the technology. Chinese social media was awash with introductory pieces on blockchain. Beijing stepped in to tell investors to show restraint.

The government’s high-profile embrace of blockchain technology begs an important question. After all, only the internet and artificial intelligence have been endorsed by China’s paramount leaders before. It is even more puzzling given the fact that, only months ago, in June this year, the People’s Bank of China (PBoC) issued a statement announcing that it “would block access to all domestic and foreign cryptocurrency exchanges and [initial coin offering] websites” and clamp down on “all cryptocurrency trading with a ban on foreign exchanges”.

If you can’t beat them, join them

Indeed, Beijing worried about the potential risks of crypto assets when they first emerged. Chinese finance has been under tight control by the government for decades, and the initial rampant speculation on a range of crypto assets, especially bitcoin, posed a serious challenge to the regulatory authorities, including the PBoC. In particular, the popularity of bitcoins in China coincided with its slowing economy, rising inflation and the financial turmoil of China’s stock market meltdown between 2015 and 2016. Bitcoin trading had been an important channel for capital flight, as the PBoC and State Administration of Foreign Exchange tightened up control of capital outflows. In fact, China quickly became the capital of the crypto ecosystem, accounting for about 90% of trading volumes on some estimates and hosting two-thirds of bitcoin mining operations as well as an array of trading platforms.

The PBoC’s heavy-handed approach to regulation since September 2017 only modestly tamed the crypto market. At the same time, the explosive development of e-commerce and the associated third-party digital payment platforms in China, such as Alipay and Wechat Pay, have also seen China become the vanguard of internet-based fintech. This prompted a rethink on the part of the authorities on crypto assets as well. As it turns out, the new strategy is, ‘if you can’t beat them, join them’. That is, if the digitisation of finance is an unavoidable trend, a more sensible response would be to ride the wave proactively rather than being washed away. In this case, China should develop a digital sovereign currency rather than being forced to accept a decentralised, transnational currency (such as libra) that is beyond its control and regulation.

Huang’s view, in this regard, is representative of China’s perspective that non-sovereign digital currencies are doomed to fail. As he remarked: “The basis of the issuance [of these private currencies] cannot be guaranteed, the value of the currency cannot be stabilised and it is difficult to truly form social wealth. I do not believe that libra will succeed.”

A digital renminbi, on the other hand, has unique benefits for China. On top of the country’s state-of-the-art domestic payment networks, it could help further reduce transaction costs and make payment and settlement faster, safer and more secure.

China could also weaponise digital renminbi in challenging the global status of the US dollar. The internationalisation of the renminbi has lost steam since 2016 due to heightened restrictions over capital flows. China thus hopes that digitising its currency will renew the momentum by establishing a digital cross-border settlement and liquidation system that is independent of the Swift network. The latter has been one of the cornerstones of the infrastructural power of the US dollar, but is seen as “outdated, inefficient and costly” by China, according to Huang. Even Mark Carney, governor of the Bank of England, agrees that a digital currency, private or state-run, could counterbalance the dollar in the global monetary system – though he envisages one backed by a basket of national digital currencies.

The PBoC has also put forward an interesting proposition with regard to the utility of a digital currency toward monetary policy. As Sun Xuefeng, director-general of the PBoC’s research institute put it, “In the long run, due to the lower natural interest rate, monetary authorities can incorporate negative interest rate policies into the normal monetary policy toolbox”. According to PBoC officials, this could be done by the central bank charging administration fees to commercial banks as distributors.

A recent study by the Bank for International Settlements reveals that about 70% of 63 central banks surveyed has been undertaking relevant research on central bank digital currency (CBDC), though most projects are still in the concept phase.

First mover

Despite its concern over the risky side of blockchains and crypto assets in relation to speculation and fraud, the PBoC has been open-minded and arguably the best prepared in developing its own digital currency in competition with other non-state players in the arena. It established a digital currency research group back in 2014 and issued a series of reports on feasibility and prototype design in 2015. An internal greenlight was given in early 2016 to develop China’s own CBDC.

Subsequently, PBoC staff experimented with the application of the CBDC in real-time, real-life scenarios on a digital banknote trading platform in collaboration with several domestic banks and financial institutions in Shanghai. These pilots led to the establishment of the Digital Currency Research Institute (DCRI) within the PBoC in June 2017. The DCRI teamed up with local governments and institutions in Shenzhen and Nanjing to further develop the technology and application in 2018. The PBoC conducted a closed test of the system in September 2019, which means China’s CBDC is right on the cusp of being rolled out.

As a key component of the financial infrastructure in the internet age, a digital renminbi will help China capitalise on the technology to foster economic growth. At the same time, the PBoC will also be in uncharted waters, with likely unforeseen political and technical challenges, if it remains the global pioneer in issuing CBDCs. Whether this will be marked as success or failure, it will help boost the bank’s prominence in the global central bank community.

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