Digitalizing the Yuan: The Future of Money

In today’s fast evolving payment environment, China is moving towards a complete digitalization of money. In 2016 alone, nearly $24 trillion of total Chinese consumer expenditures were made through mobile-payment platforms. Now, China accounts for 42% of global e-commerce, boasts 11 times more mobile payments than the United States per year, incubates some of the most innovative fintech companies and is on the precipice of breaking new grounds as it prepares for the release of a digital version of its renminbi currency.

China’s Digital Currency Plan

Since 2014, China’s central bank has been working on a project called “DC/EP”, their Digital Currency/Electronic Payments initiative. After six years of research by a team at their central bank, government officials have hinted on its soon release. Mu Changchun, deputy director of the new sovereign digital currency recently commented on the digital currency as “close to being out.” Speculations on exactly when the release will happen range from as close as November to in the next couple of years.

Although a plan of how the sovereign digital currency will be implemented has not been revealed, some details can be deduced from various government announcements. Thus it will not be used for speculation or require the backing of a basket of currencies. He emphasizes that retail banks and fintech companies will continue to manage customer deposits the same way in order to minimize the initial disruption to China’s existing financial systems. Yi Gang, the governor of the People’s Bank of China, has said the plan is not to create a new currency like bitcoin or Facebook’s Libra project. Instead, China hopes to digitize the yuan and phase out cash. Ultimately, the Chinese government emphasizes the new digital currency is intended to provide a streamlined way for banks to settle payments.

China’s Current Use of Digital Payments

China is already well on its way to being a cashless society. Chinese citizens often exclusively use their smartphones to make payments and are extremely familiar with scanning QR codes to transfer money. A 2017 study by Ipsos identified that 40% of the Chinese population regularly carry less than 100RMB or $16 USD. A trip to China would reveal the extent to which digital payments dominate consumer transactions as small businesses such as taxi services and street-food stands now exclusively accept mobile payments. This is because e-payments are instant and reduce transfer costs. For businesses, it also reduces the risk of receiving fake bills. Currently, the mobile-payment industry in China is dominated by Alibaba and Tenpay who own a combined 90 percent of mobile-payment market share. These companies have created massive e- commerce, finance and social media “ecosystems.” Because of this, Chinese citizens are all extremely familiar with how to use digital payments, making China the perfect market to experiment with a digital currency.

Why is the Chinese Government interested in a digital Yuan?

In the internet era, issuing its own digital currency would allow the government to retain control of money supply and monitor capital distribution. It would also prevent the central bank of China from losing market share to fintech companies and would make it easier to execute monetary policy. The country sees any digital currency or payment service that is not under its control a potential threat to the country’s financial security. Historically, Beijing has outlawed the trading of bitcoin and other digital tokens due to the uncontrollable nature of the currencies and the potential for digital tokens to be used for money laundering. Mu Changchun has identified the incentive for the Chinese government to move into digital currency despite the maturity of electronic payment methods to “protect monetary sovereignty and legal currency status,” as a reaction to the release of the Facebook stablecoin Libra. A digital currency would provide “all the benefits of a central bank-backed asset, as well as the convenience and security of wireless, electronic payments. However, it would also allow the government to fully track all purchase transactions which the Chinese Government argues, would allow it to better respond and crack down on money laundering, illegal gambling and terrorist financing.

What implications does this have for Chinese citizens?

There are still 200 million citizens in China who are unbanked, meaning they are without access to financial services and cut off from the larger economy. However, digital currencies alongside other innovations in payment systems could broaden access to the financial system for these unbanked citizens. These citizens are typically found in rural areas so new technologies make it easier for money to transfer hands because money transfer is not restricted by geographical barriers and distances. Mu Changchun has also promised that the digital currency can be accessed without internet connection which significantly lowers the barriers for citizens to participate in the greater economy.

Digitizing the yuan could also present an opportunity to create a nationwide credit score system that China’s financial system currently lacks. Historically, Chinese fintechs have filled in the role of serving small businesses who do not have a credit score but if all payments could be recorded, the central bank would be able to review and analyze small-business data in real time to determine creditworthiness. Furthermore, the bank would be able to collect the digital assets and data of these small businesses to be used as collateral instead of traditional tangible assets.

However, the plan by the Chinese Government to release its own digital currency raises many privacy concerns. A digital trail of every purchase or money transfer will give the central bank, and by extension the Chinese Government, an exclusive and complete datalog of everyone’s transactions. It is speculated that the digital currency will be supported using a ‘private permissioned’ form of blockchain which is not supported by a decentralized database and the central bank will be able to control and access the database. This would give the Chinese government unprecedented knowledge on its citizens activities. However, Mu Changchun has both promised to ensure “anonymity in transactions”, while also clamping down on illicit transactions through monitoring money flow. But these two objectives seem to be contradictory — and the bank hasn’t explained how it will balance the two.

Movements in other countries

China is not alone in its venture into digital currency. 24 countries including the Central Banks in Canada, Singapore and Switzerland are also conducting research into their own digital currency and a few countries have already released their own cryptocurrencies. However, despite the advantages of instantaneous transactions, increased efficiency and reduced operating costs, many countries are cautious about the implications a datalog of all user transactions would have on citizen privacy.

Ultimately, I believe that over time, digital currencies will move to replace physical banknotes and coins. Despite the issues with privacy and security, the myriad of applications and benefits for governments, small-businesses and individuals cannot be understated. With China at the spearhead of the technological and societal change needed to support the rise of digital payments. Imagine a society where instead of carrying a wallet and pulling out coins, cash and cards to make purchases, all transactions are made by scanning a code on your phone or tapping a machine to transfer money from a central bank. China will likely be the first to issue sovereign digital currency, but it will certainly not be the last.