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China’s Digital Currency: Kicking off a Horse Race

Cross-Interview with Éric Chaney and Viviana Zhu

China’s Digital Currency: Kicking off a Horse Race
 Eric Chaney
Senior Fellow - Economy
 Viviana Zhu
China analyst, former Research Fellow, Institut Montaigne’s Asia Program

In many countries, the retreat of cash in daily uses has led to new digital forms of money. As we have seen, the private sector has been grasping the opportunities provided by the decreasing demand for cash. Paypal, Alibay, PayTM, Bitcoin, etc. are all products of the digital economy. However, concerns over the solutions provided by the private sector have led to the question: should the role of the state be limited to regulation or go beyond with a more active role?

China has clearly taken the second path, with its "Digital Currency Electronic Payment (DCEP)" project led by its central bank, the People’s Bank of China (PBOC). How does the Chinese digital currency work and what are its global implications? Eric Chaney, Economic Advisor to Institut Montaigne, and Viviana Zhu, Policy Officer at Institut Montaigne, address the issue.

China will be the first large country to launch a government sponsored digital currency. Concretely, how is this going to work? Is China’s digital currency push part of its surveillance need/desire?

Viviana Zhu 

PBOC had an early start in the study of a government-backed digital currency. The DCEP project has been launched in 2014. In 2017, the digital currency research institute at the PBOC was established to focus on the issue. The central bank only revealed the status of the digital currency study to the public last summer. The move is officially explained by the need to protect China’s sovereign currency and against the current and potential form of digital forms of money. The other factor, underlined by Huang Yiping, director of the Digital Finance Research Center of Peking University, is indeed the birth of Libra, which served as an "alert". In short, China has to "plan ahead of the rain 未雨绸缪".

Not surprisingly, DCEP uses a centralized management model, but the interesting part is its two-pronged operation system. It means that the PBOC will issue the digital currency to commercial institutions, which will be in charge of the actual distribution. This model, on the one hand, provides an extra layer of guarantee compared to other cryptocurrencies in the market, because it is backed by the central bank. On the other hand, it allows the effective use of available resources (including human resources) and technology in the market, which can serve as a way to diversify risk.

According to Mu Changchun, head of the PBOC established in 2017, the planned digital currency has the same characteristics as physical cash. This means that payment with the digital currency cannot be refused, no interest will be offered for the digital currency stored in consumers’ e-wallets, and its value equals to that of China’s legal tender, RMB. Different from the other digital forms of money provided by the private sector, the DCEP belongs to the stable coin genus and is a liability for the central bank. The technology to be used remains unclear, but President Xi Jinping’s endorsement of blockchain research and innovation, during a Politburo study session in October, was interpreted as a signal that the DCEP will be based on a weak form –i.e. centralized versus decentralized—of blockchain. Nevertheless, the official statement stresses that PBOC is open to all options, provided that they can process 300,000 transactions per second. What is also open, is the timeline of the project.

As a substitute for physical cash, no account is needed for the use of the digital currency. A charged phone with your e-wallet is all you need to make the transaction happen. No internet connection is required. Although how one’s e-wallet will be obtained or issued is not clear, some restrictions on its anonymity have already been outlined. There will be a transaction limit on one’s e-wallet, and the more personal information you feed into your e-wallet, the higher the limit gets to. For instance, adding your ID number to your e-wallet will raise your transaction cap, and linking your bank account to it will increase it further. 

"Controllable anonymity 可控匿名" is what has been promised to the users of DCEP, while the exact meaning those terms entail is confusing. In short, any transaction may be traced if the government needs to. Daily transactions are anonymized, but if the system identifies suspicious activity, the user can be identified with the help of algorithms designed to extract hidden information from big data. In other words, the level of anonymity will be decided by the government, thus "controllable". Hence, in contrast with what has been promised, the official digital currency will not be a substitute for the physical currency, which use does not require any personal information.

"Controllable anonymity 可控匿名" is what has been promised to the users of DCEP, while the exact meaning those terms entail is confusing.

Note that the concept per se is not new, while still IMF managing director, Christine Lagarde, in her November 2018 speech, strongly opposed the idea of anonymous digital currencies, which she qualified as "a bonanza for criminals". In the case of China, what raises concerns is its loose regulatory framework that leaves space for Chinese authority to navigate through.

Whether this new digital currency will be transformed into a mean of surveillance, or whether the main driver for its construction is the political project to extend the surveillance state even further, is yet to be seen. However, what can be said is that the current design of the digital currency favors a system, which allows for more control over its citizens.

How does the Chinese initiative fit within the global eco system of crypto / digital currencies?

Eric Chaney

While cryptocurrencies and tokens based on various blockchain technologies have left central banks and regulators skeptical and pondering whether these financial innovations should be considered as pseudo-currencies, commodities or financial assets, the Libra project triggered a knee-jerk reaction from officials, central bankers as well as elected bodies such as the US Congress. The G7 commissioned a report on "global multicurrencies stablecoins" (a fig leave for Libra), by a committee chaired by ECB board member Benoit Coeuré. Made public in October 2019, the report is not closing the door to global stable coins but has set the regulatory bar quite high. As for garden variety stable coins (mono-currency), the report mentions nine areas of concerns, from governance to money laundering, market integrity, data privacy or tax compliance. And for global stable coins (multi-currency), it mentions four additional risks, including monetary policy and financial stability, no less!

This unanimous call to arms by central bankers and other officials, has thrown buckets of cold water on the Libra project. Testifying in front of the House Financial Services Committee on October 23, Mark Zuckerberg back pedaled as much as possible, indicating for instance that, in a first stage, Libra could be backed with US dollars assets only and that he would comply with whatever regulation comes. Yet, it seems clear to me that the Libra association, even after having suffered from high profile defections –Visa, MasterCard and eBay—is not throwing the towel and is ready to recalibrate the project in order to keep it going, although with a less ambitious and, probably, delayed agenda.This is a boon for the central banks which have already made public that they were considering the possibility of issuing Central Bank Digital Currency (CBDC, renamed DCEP by China’s PBoC), the Bank of England, the Swedish Riksbank and the Peoples’ Bank of China being at the forefront.

That China is taking the lead is quite indicative: it shows that Chinese authorities are worried by the emergence of uncontrolled substitutes for the legal tender that is the renminbi but also by the potentiality of Libra becoming a global contender for all sovereign currencies but the US dollar, which was supposed to take 50% of its underlying assets.

Chinese authorities are worried by the emergence of uncontrolled substitutes for the legal tender that is the renminbi.

Chinese authorities seem to have seized a unique opportunity, both on the defense side  - against cryptocurrencies including Libra - and the offensive side, by allowing its own technology giants (Alibaba, Tencent…) to gain traction in the digital currency battleground.

As for the other central banks planning to experiment CDBCs, the Chinese initiative is probably seen as a godsend: issuing a government-backed digital currency will certainly make the headlines but it is hardly a fundamental game-changer. On the other hand, it is a path full of booby-traps that they will be happy to observe from the outside. Overall, the Chinese initiative, if implemented, will accelerate the issuance of government-backed digital currencies in other constituencies, including the euro area, in my view.

Two US lawmakers have recently called for a US digital dollar managed by the Fed. Are we going to see another confrontation between the US and China, this time on the digital currency battlefield?

Eric Chaney

First of all, the US dollar is and will remain for the foreseeable future the world currency, no matter how hard euro-area or Chinese leaders try to challenge its dominant position. There are very objective reasons for that: a global currency must be backed by a large, deep and highly liquid pool of safe assets (government bonds) and must be free to cross borders. The euro area lacks the former quality and will lack it until the peoples of the countries composing the monetary union decide on their own will to move towards a political (and thus fiscal) union. That may or may not happen, but I would bet that if it does, it will be in the distant future. As for China, opening its borders to the free movement of capital is a necessary condition to make the renminbi a world currency. As the recent past has shown over and over again, as soon as Chinese authorities open up their capital borders, even marginally, wealthy Chinese rush to save their assets abroad, something Xi Jinping cannot tolerate. It is therefore very unlikely that Chinese capital borders will fully open up any time soon, which implies that the renminbi is no candidate to challenge the US dollar. Another consequence of the dominant position of the US dollar is that American policy makers have little incentive to take the risks associated with issuing a digital dollar. A digital Swedish krona is one thing — it matters almost only for domestic use — a digital US dollar is a totally different ball game.

Second, the technology battle between China, the US and other constituencies, Europe in particular, but not only, cannot but intensify in the coming years. Digital currencies are just one of the fields where the battle will take place. Knowing that the US is likely to be reluctant to enter the digital currency world, Chinese authorities may infer that they have a card to play, not to make the renminbi a genuine global currency, but to cover the technological ground left by the US, at least within its own sphere of influence and perhaps even farther.

Last, I do not see why the euro area should remain in the back seat. Once China has dealt with its digital currency teething troubles, the ECB should be smart enough to issue its very own digital euro, provided of course that it is backed by its owners.


Copyrigth : ROBYN BECK / AFP

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