Chinese Crypto? More Likely, Just RMB Payments
It seems likely that Forbes has misunderstood. The initiative in China is more likely to be a payment system without crypto or blockchain.
Forbes released an article on 27 Aug, citing official sources, claiming that China’s central bank, the People’s Bank of China (PBoC), will issue a ‘cryptocurrency’, together with a payment network. The initiative is being referred to as Digital Currency/Electronic Payments (DC/EP). Participants will include the largest banks in China, and Alibaba and Tencent, the technology giants that operate the large online and mobile payments platforms Alipay and WeChat Pay, among other services.
For reasons explained below, I agree with Michel Rauchs on this — I think Forbes has misunderstood the information they have received. It is likely that there will be nothing crypto-related or even blockchain-related about DC/EP, and that DC/EP will just be a fiat currency renminbi payment network. It’s definitely not a cryptocurrency to start, because it will be linked to the renminbi.
At Finteum, we believe that blockchain-based fiat-linked digital currency has the potential to enable more efficient large-value interbank payments, and we will make some exciting announcements on that in the coming weeks, but our solution won’t look anything like DC/EP.
All views in this article are on my own and based on public sources.
Why is DC/EP Significant News in Banking?
It would be highly unusual if PBoC included non-banks Alibaba and Tencent as direct participants in a banking clearing network. It is more likely that DC/EP will be a low-value, deferred net settlement payment network akin to Faster Payments in the UK, which is open to both banks and other organizations that are licensed and regulated as e-money institutions. However, the inclusion of Alibaba and Tencent in the DC/EP initiative does cement their power in the financial system in China. Alibaba’s Ant Financial already has a larger consumer loan book than the second largest commercial bank in China.
The second interesting aspect of DC/EP is the international plan for the network. Mu Changchun is quoted in the Forbes article, saying
“the central bank’s digital currency can be circulated as easily as cash, which is conducive to the circulation and internationalization of the renminbi”.
DC/EP will be an interesting development in the international development of the currency, for reasons I explain below.
How Do Digital Payments Work in China Today?
China has been quite far ahead of Western countries in the adoption of digital and mobile payment technology. According to SP Global, in China, 90% of adult Internet users use WeChat Pay, 94% use Alipay, and 86% use both. Comparatively, in the US, Venmo has 40m users, which is only about 16% of the adult population, or 12% of the total population. In the UK, 48% of adults use mobile banking, which is still a lot lower proportionately than China. Some parts of China are even replacing the QR codes that are widely used for mobile payments with facial recognition. Mobile payment transaction volumes in China are estimated by Ipsos to be RMB153trn (GBP17.5trn), covering 10.4trn transactions, which represents about 10 times the value and 5,000 times the volume of Faster Payments in the UK.
Is There a Facebook Connection?
According to Forbes, this development from PBoC is unrelated to Facebook’s Libra initiative. It is notable that Facebook, the largest social network in the world, has made forays into payments, like Facebook Credits, but hasn’t been successful yet. Facebook is battling data privacy issues and, as a result, it is facing skepticism and challenge on its digital currency. Contrastingly, in China, Alibaba launched Alipay and Tencent launched WeChat Pay. Both have been incredibly successful. Alibaba and Tencent are not facing the same level of scrutiny on data privacy as Facebook. The Chinese government, through PBoC, is supporting them to launch DC/EP. There are clearly different approaches between the US and China when it comes to big tech and such companies’ role in financial services.
An important aspect of the move by PBoC is how it will play out in international geopolitics, and whether the US will react, especially given the ongoing trade war between the two countries. Mark Carney also pointed out last week at Jackson Hole that it is possible the renminbi will replace the US dollar to become the global reserve currency. The fact that DC/EP could support the internationalization of the renminbi is the most interesting aspect of this news.
How Does China’s Fiat Currency Work?
Renminbi is a somewhat complicated currency. The renminbi unit of account is the yuan. It can be expressed in speech as “how much renminbi do you have — how many yuan”, which is the equivalent of saying “how much sterling do you have — how many pounds”.
Renminbi has three currency symbols — RMB, CNY, and CNH. Fundamentally, all three refer to the renminbi. RMB is an overarching currency code for renminbi and could refer to either onshore or offshore money. However, onshore vs. offshore is an important distinction.
CNY refers to onshore RMB issued by PBoC, meaning that it is subject to currency controls from PBoC, including a 2% band limit on fluctuations each day.
CNH refers to offshore RMB that was originally associated with Hong Kong (hence the ‘H’). Sometimes there are large price swings between CNY and CNH — allegedly up to 10%.
Confusingly, BIS publishes a triennial FX survey and refers to the currency as CNY, but they include CNH in the reporting. SWIFT’s RMB tracker also refers to international payments in CNY, which is similarly confusing, but let’s try not to get stuck in the details.
Why Create Digital Renminbi?
The commercial bank, Bank of China, and Tencent have been partnering on blockchain and Artificial Intelligence (AI) for a while now. So it is possible that China has developed DC/EP as an incredibly advanced blockchain-based solution, but it’s unlikely. There are a few possible reasons why they would create DC/EP, some of which are alluded to in the Forbes article, but none requires blockchain:
1. Maybe the reason for including Alibaba and Tencent in the DC/EP network is to discourage them from following Facebook and launching a payments network outside the banking system, though it seems unlikely Alibaba and Tencent would do so. No blockchain needed to do that either way.
2. As far as I can tell, Alipay performs its own deferred net settlement on T+1 and so does WeChat Pay. DC/EP could be an internationally available, periodic deferred net settlement system operated by PBoC. This would make DC/EP similar to Faster Payments in the UK, which is operated by pay.uk and supported by the Bank of England (BoE). Faster Payments has 3 daily settlement cycles. No blockchain needed for that.
3. The PBoC and the government in China might want to gather more data on payments, including international CNH payments. No blockchain needed.
4. Perhaps hey have built DC/EP as a very efficient payment technology, because they need one. According to the Forbes article, on the busiest shopping day in China last year, there were 92,771 transactions per second. The DC/EP system can allegedly handle 300,000 payments per second. That is incredibly fast and makes it unlikely that DC/EP is a distributed system, or that it involves blockchain. Visa claims it can handle up to 56,000 but it rarely goes over 1,700. It is hard to say whether distributed computing or blockchain is involved without seeing the details, but it seems unlikely.
How Do Fiat Renminbi Payments Work Internationally?
China used to have strict currency controls, which have been rapidly relaxed over the last decade. Renminbi used to be thought of as a non-deliverable forward (NDF) currency, meaning if two parties agreed to exchange RMB for USD at a future date, they would only pay the profit or loss in USD and not the principal amounts. Counterparts do not actually exchange any RMB in a USD/RMB NDF trade.
However, deliverable forwards (where CNH is actually exchanged between counterparts) for CNH were introduced in the last decade and, according to the Bank for International Settlement (BIS), their volume reached $16.4bn by 2016, about 1.5 times the NDF volume. So in practice, RMB is no longer an NDF currency, though there is still an NDF market. Interestingly, the deliverable forwards volume was ten times greater in 2016 in CNH compared with CNY, implying that onshore there may not be very significant volumes being executed for hedging currency risk. BIS is due to issue a new triennial report later this year. Also, RMB was included in the IMF SDR basket in 2016, which was another step towards internationalization.
What International Fiat Renminbi Infrastructure Exists?
The PBoC has established RMB Bilateral Swap Agreements with over 30 international central banks. For the UK, the PBoC and BoE established a line for RMB200bn (which was since increased to RMB350bn and renewed in Nov 2018 for 3 years). The purpose of these lines is for international central banks to facilitate access to CNH liquidity for eligible institutions in their respective jurisdictions. So, if a UK-based CNH clearing bank needs CNH and can’t raise it in the interbank market, they can request it from BoE and if BoE doesn’t have it in reserve, BoE can obtain CNH from PBoC by transferring GBP to PBoC’s GBP account.
There are also over 30 international CNH commercial clearing banks that facilitate the clearing of CNH payments for other commercial banks in their jurisdictions. Until 2018, only offshore branches of Chinese banks had authorization from PBoC as international clearing banks. In Feb 2018 JP Morgan became the first non-Chinese CNH clearing bank, receiving approval from PBoC to clear CNH in the US. So, technically, now it’s possible for a US bank to have a CNH account (nostro) with JP Morgan in the US. In Jun 2019 MUFG became the second foreign clearing bank, for clearing CNH in Japan.
The Cross-Border Interbank Payment System (CIPS) is an international interbank CNH payment system, backed by PBoC. It was launched in 2015 to enable cross-border CNH transfers and it uses SWIFT messaging standards. Initially, CIPS enabled real-time gross settlement (RTGS) only. It connected international banks to China’s domestic RTGS, which is called the High-Value Payment System (HVPS). HVPS is one of the several PBoC payment systems that are collectively referred to as the China National Advanced Payment System (CNAPS). CIPS Phase 2 was launched in 2018 and extends settlement access and adds hybrid settlement, so it’s no longer RTGS only. The hybrid settlement is similar to RTGS but also has some liquidity-saving features that are comparable to the liquidity savings mechanism in the European Central Bank (ECB) Target2 system. CIPS processed RMB26trn (GBP3trn) of payments in 2018 and has 31 direct participants in China and 861 indirect participants internationally (including some that are subject to US sanctions, interestingly).
Establishing this infrastructure over the last decade has been important as a step towards RMB adoption outside China. However, there is still a long way to go before CNH becomes a broadly used international currency. As of July 2019, SWIFT reported that only 1.8% of international payments were in CNH. CNH is also not yet a CLS currency.
How Will International Renminbi Payments Work in the Future?
The Forbes source said that PBoC hopes DC/EP will eventually be made available internationally through relationships with international correspondent banks.
Historically, creating an Alipay or WeChat Pay account required having a bank account in China. It seems unlikely that will still be the case in a couple of years. It seems likely that foreign clearing banks will enable individuals and companies outside China to open CNH accounts, and that it will be possible to link these to Alipay and WeChat Pay accounts. An example benefit is that people internationally would have easy access to the vast array of services on Alibaba’s Taobao marketplace. International adoption will be interesting to watch, recognizing the possibility that transaction information would be visible to the government in China.
It also seems likely, or at least possible, that payments from individuals’ Alipay and WeChat Pay accounts will be executed using the new DC/EP system, rather than over another network. However, it seems unlikely that DC/EP will use blockchain.