Responding to the rise of cryptocurrencies: How China is developing its own digital currency
China is rapidly developing a Renminbi (RMB) digital currency that promises to rival the proliferation of cryptocurrencies, turn China into a cashless society, and eventually give the authorities full control over financial transactions.
By Philipp Heuermann & Thaddeus Jahn
With its 730 million internet users, online payments and digital financial transactions processed through applications such as Alipay and WeChat have already become commonplace in China’s urban daily life. The Chinese Communist Party’s Thirteenth Five-Year Plan (2016–2020) underscores the attention that the government pays to the future of the digital realm in facilitating financial transactions. As such, the plan features an entire section dedicated to digital economy issues such as 5G technology, big data and the Internet of Things (IOT).
Meanwhile, blockchain-based cryptocurrencies such as bitcoin have experienced a boom in China. This has triggered both a strong regulatory response as well as interest in exploiting blockchain technology to the government’s advantage. As the popularity of cryptocurrency trading soared, the Chinese authorities — increasingly concerned about large-scale capital flight — have found it frustratingly difficult to control or monitor financial outflows. With more than 96% of the global bitcoin trading volume denominated in Chinese RMB in January 2017, the Chinese government has followed a two-fold approach to counter the threat emanating from cryptocurrencies such as bitcoin.
1. Regulating China’s Cryptocurrency Exchanges
Firstly, the Chinese government has begun imposing stricter controls and regulating intermediary bitcoin exchange platforms. The crackdown on digital currency exchanges began in January 2017 when the People’s Bank of China (PBoC) announced that it was investigating the role of cryptocurrencies in facilitating capital flight. This included the creation of a task force to inspect exchanges and ensure they were enforcing anti-money laundering regulations. In a move to weed out speculative trading and disincentivize capital outflows through bitcoin, the PBoC further demanded the imposition of trading fees. Subsequently, China’s three largest exchanges levied trading fees of 0.2% for both buy and sell trades from late January 2017 onwards. Following the implementation of exchange controls and the introduction of trading fees by the Chinese authorities, the total volume of bitcoin trading denominated in Chinese RMB plummeted from a total share of 96% on January 1, 2017, to a mere share of 9% on March 1, 2017. This is partly because the introduction of the trading fee has significantly reduced automated trading, as arbitrage trading via automatic trading software became less profitable. The pressure exerted by the PBoC on China’s bitcoin landscape has granted the government a previously unseen degree of leverage over cryptocurrency trading within the country.
2. Developing an RMB Digital Currency
In the long-run, the Chinese government has a far more ambitious plan to regulate the country’s cryptocurrency landscape. The authorities have already announced their intention of establishing China’s very own RMB digital currency that would in turn give the government full control and oversight over financial transactions. In 2016, China’s Ministry of Industry and Information Technology (MIIT) published the country’s first official whitepaper on blockchain technology that highlighted its potential to serve as the basis for China’s efforts to move towards a cashless society. Furthermore, in June 2017, the PBoC opened the “PBoC Digital Currency Institute”, a cryptocurrency research lab that is tasked with actively developing prototypes related to blockchain-backed digital currency. While there is no precise timetable for the nation-wide rollout of such a digital currency, the Chinese government is currently testing the technology.
From a governmental perspective, a digital currency provides unprecedented capabilities to control and monitor financial transactions. Not only will it allow the authorities full control over financial flows, but could also enable the PBoC to trace transactions and collect complete and authentic data in real-time to compile indicators of monetary policy. This would provide it with previously unavailable information about the economy, and — in all likelihood — become a vital tool in China’s implementation of a “social credit system” to track and evaluate the behavior of individuals. In addition, an RMB digital currency would make economic transactions more transparent, limit illicit activities such as money laundering and tax evasion, and reduce the high costs that come with the printing and circulation of physical fiat currency.
Unfortunately, the process of phasing out paper money will almost certainly lead to an exacerbation of social inequality. The reality is that the digital form of money disfavors segments of society with limited internet access such as rural dwellers and those with lower levels of income. Due to the ongoing economic transitions in China, the government is likely to take a cautious step-by-step approach towards launching the RMB digital currency. The desire to minimize risks and maintain stability will mean that digital legal tender will be introduced incrementally and only when major risks have been excluded. As such, it can be expected that both paper and digital tender will coexist for some time, notwithstanding the question whether the central bank would directly supply digital legal tender to the public, or whether commercial banks would serve as an intermediary through which financial transactions are carried out. Nonetheless, the PBoC and, more generally, the Chinese Communist Party (CCP) are, without question, determined to implement highly complex systems in a rapid manner.
In the end, from a strictly Western perspective, the advent of digital currencies raises deeper philosophical questions about the degree of government control in modern societies. Cryptocurrencies emerged as an intrinsically libertarian concept that would allow individuals to perform anonymous financial transactions without the need for a central authority. Given the potential emergence of a state-issued digital currency in China, however, there is a touch of irony in the fact that similar blockchain technology could soon allow governments to effectively monitor even the simplest financial transactions of its citizens — consequently turning a libertarian utopia into an Orwellian dystopia.
Philipp Heuermann and Thaddeus Jahn are both ‘Double MSc International Affairs’ candidates at Peking University and The London School of Economics and Political Science (LSE). This article draws from the findings of a research project on “Cryptocurrencies & Capital Flight in China”, which was conducted by the two authors at Peking University in Spring 2017.