The steady progress of China’s digital currency

China has accepted the digital yuan, known as the e-CNY, as payment. People have used it for shopping, dining, personal finance and business uses such as paying taxes and employees.  Still it is early days as the use of the e-CNY in pilot programs is a drop in the ocean compared with the volume of commerce conducted using China’s other two dominant mobile payment systems.

To bridge that gap, a large amount of future investment in technology will be required.  No matter what form the e-CNY takes, a currency has three main functions: as a store of value, a unit of account and a medium of exchange.  By definition, for consumers, the most basic function is as a medium of exchange or payment.  In fact, the e-CNY has the same valuation as the RMB.  Unlike many other currencies, the RMB is a fixed exchange rate currency rather than a free-floating currency whose value is determined by the market.

The value of the RMB is pegged to currency baskets, such as the China Foreign Exchange Trade System RMB Index, which includes a number of advanced market currencies, including the US dollar and the euro. Readers ask - what is the state of play of digital currencies in Asia-notably China?   

A bit of background helps as China has in 2017, banned cryptocurrency exchanges and so-called initial coin offerings amid a broad effort to reduce risk to its financial system and clamp down on so-called shadow banking.

Recently, digital currencies were branded as an easy platform to move money out of China, potentially adding to capital outflows that would undermine the yuan’s value. The currency chart in 2022 shows a more relaxed picture. In fact, officials from the People’s Bank of China have hinted in recent weeks that the nation testing the launch of a digital version of its currency, the renminbi, to replace physical cash for consumer payments.

As of May 31 this year, the cumulative number of digital renminbi transactions in the pilot areas of 15 provinces and cities was about 264 million, with an amount of about 83 billion yuan, and the number of merchant stores supporting digital renminbi payment reached 4.567 million.

The People’s Bank of China has been developing the digital yuan, a so-called central bank digital currency that aims to replace some of the cash in circulation. China has already concluded real-world trials for the digital currency in a number of cities including Shenzhen, Chengdu and Suzhou. Needless to mention that the Chinese market is already very advanced in cashless payments.

The digital yuan would be a legitimate way to speed that process up. It will be legal tender in China and no interest will be paid on it. In the retail sector, the use of cash is decreasing.

Eventually cash will be entirely replaced by something in digital format. WeChat Pay will soon have a section of their apps dedicated to digital yuan. Meanwhile, smartphone makers could also create digital yuan wallets for their devices.  One may question - why is the China central bank venturing in such a digital currency today when its own electronic payment methods are so developed.

The answer is that the new platform will vastly enhance the control of monetary sovereignty and legal currency status in China.  It is an understatement to say that to date electronic payment methods are already ubiquitous in China.

Popular mobile payment apps, handle vast amounts of payments per quarter, are quickly eliminating cash transactions. How will the new platform work. Consumers and businesses would download a digital wallet onto their mobile phone and top it with money from their account at a commercial bank.

This is similar to going to an ATM.  They then use that money - dubbed Digital Currency Electronic Payment, or DCEP - like cash to make and receive payments directly with anyone else who also has a digital wallet.  Despite the unknowns, recent public comments by central bank officials have shed some light on the motivation behind the project.

China’s digital currency would strengthen the Communist People’s republic resolve to improve its controls against the proliferation of anonymous payments thereby fighting money laundering.  This creates an advantage since the new digital tokens could be used even without an internet connection as it is blockchain controlled.

Back to China’s potential new venture, one notes how trials have been held in a handful of cities and tests have started with some e-wallets and online apps, albeit slowed down due to the Covid-19 pandemic with its penchant for social distancing.  Such Covid-19 restrictions have on the contrary ushered a new sense of urgency.

Unlike cryptocurrencies such as Bitcoin, dealing in the digital yuan won’t have any presumption of anonymity, and its value will be as stable as the physical yuan, which will be circulating around too. Behind China’s rush is a desire to manage technological change on its own terms.

In the near future, consumers may use prepaid funds in digital wallets to buy wealth management products, and banks may provide loans and other financing for merchants. To increase public acceptance of the e-CNY, the central bank currently does not charge fees to banks and other operating institutions for the conversion and circulation of the digital yuan, and institutions do not charge customers for conversion.

To guarantee the anonymity of the digital yuan, authorities plan to improve regulations, including establishing a mechanism to regulate the use of customer information so that operating institutions will be able to apply for access to user information only for risk analysis and monitoring when illegal transactions are suspected.   

Quoting The Economist, it argues that China’s technocrats aspire to build a payments system that is easier for its trading partners to use and harder for America to block.

They might also hope that such a system could make the yuan more influential abroad, without compromising China’s capital controls at home.