China’s digital yuan sets the standard for central bank digital currencies

Any UK cit­i­zen or busi­ness can choose to be a pay­ment anar­chist. Peo­ple can ignore the fiat cur­ren­cy and request pay­ments for goods or ser­vices in what­ev­er form they like: cowrie shells, cab­bages or Bit­coin.

What they can’t do is require that mon­e­tary debts be paid in cowrie shells, cab­bages or Bit­coin. If cred­i­tors don’t accept legal ten­der, they can’t sue for non-pay­ment. 

That might not sound momen­tous, but it is a big anchor for the val­ue of a fiat cur­ren­cy. Legal ten­der is also a lia­bil­i­ty of the cen­tral bank. Com­mer­cial banks cre­ate most of the mon­ey peo­ple use, but trust in the state stands behind it. The exis­tence of legal ten­der is what makes mon­ey, mon­ey. That is: a store of val­ue, a unit of account and the medi­um of exchange. 

I’m inclined to put cryp­tocur­ren­cies in the same brack­et as tulips. That is, with the excep­tion of cen­tral bank dig­i­tal cur­ren­cies

By that def­i­n­i­tion, pri­vate cryp­to assets can’t be mon­ey, despite — and much to the hor­ror of the Inter­na­tion­al Mon­e­tary Fund (IMF) — El Salvador’s deci­sion to make bit­coin legal ten­der. Bit­coin is backed only by spec­u­la­tion and by the argu­ment (or hope) that cur­ren­cies can do with­out finan­cial inter­me­di­aries and state over­sight. But wild swings in the val­u­a­tion of fash­ion­able assets are noth­ing new, of course.

“I’m inclined to put cryp­tocur­ren­cies in the same brack­et as tulips,” says Charles Tay­lor, a Vis­it­ing Schol­ar at GW Law School and a for­mer deputy comp­trol­ler of the cur­ren­cy in the US. “[That is] with the excep­tion of cen­tral bank dig­i­tal cur­ren­cies.” 

The only major econ­o­my that has already launched a CBDC is Chi­na, which unveiled tri­als of the e‑CNY at the end of 2021. But oth­ers aren’t far behind. A 2021 sur­vey by The Bank for Inter­na­tion­al Set­tle­ments found that 86% of cen­tral banks were “active­ly research­ing the poten­tial” of CBD­Cs.

What China is doing

The e‑CNY aims to be retail “dig­i­tal cash” and it is ful­ly backed by the People’s Bank of Chi­na (PBoC). Choos­ing to replace cash and not bank accounts is an impor­tant step. It ensures that com­mer­cial banks won’t be dis­in­ter­me­di­at­ed, and it spares the PBoC a major headache: offer­ing con­sumer accounts and decid­ing who gets to bor­row what. 

Chi­na has decid­ed that inter­est can only be paid on bank deposits, not on the e‑CNY itself. Banks are also the only insti­tu­tions that can con­vert e‑CNY into deposits and pay it out again as cash. 

But why has Chi­na launched the dig­i­tal yuan while oth­er major economies are still car­ry­ing out con­sul­ta­tions and tri­als? 

“To cater to its population’s needs as peo­ple use cash less and less,” says Dr Sara Hsu, asso­ciate pro­fes­sor of sup­ply chain man­age­ment at the Uni­ver­si­ty of Ten­nessee, Knoxville, and the author of China’s Fin­tech Explo­sion. 

Hsu points out that because of the wide­spread use of Ali­pay and WeChat­Pay, which link peo­ple’s bank accounts to a dig­i­tal wal­let, Chi­na is already close to being cash­less and many places no longer accept notes and coins. 

“In addi­tion, Chi­na has been opposed to decen­tralised dig­i­tal cur­ren­cies, such as Bit­coin [which was banned last year], and this is its answer to cryp­to,” she adds.

Chi­na is not the only juris­dic­tion that has an uneasy rela­tion­ship with cryp­tocur­ren­cies. Facebook’s Diem dig­i­tal cur­ren­cy project was stopped short part­ly because of US reg­u­la­to­ry objec­tions. 

Huge pri­vate plat­forms where the major­i­ty of peo­ple live their eco­nom­ic lives – as many as one bil­lion Chi­nese peo­ple do so on Ali­pay – are, arguably, a threat to mon­e­tary sta­bil­i­ty if the trans­ac­tions use a pri­vate cryp­to asset.

Big Tech cut down to size

There is like­ly anoth­er fac­tor in China’s move to a CBDC: data. Before the crack­down, around 10% of China’s con­sumer loans were made through Alipay’s app. The state-owned banks com­plained Ali­pay had an unfair advan­tage thanks to low­er costs of cap­i­tal and lighter reg­u­la­tions.

But the big plat­forms also had anoth­er advan­tage. Because they had large­ly rel­e­gat­ed com­mer­cial banks to fund­ing pipes, they had vast amounts of data that the state-con­trolled banks did not. 

In 2021, Chi­nese reg­u­la­tors required Ali­pay to spin off its lend­ing busi­ness­es, Hubaei, which offers con­sumer cred­it and Jiebei, which pro­vides small unse­cured loans. With them went the data they gath­ered. 

The Chi­na chief econ­o­mist at Deutsche Bank, Yi Xiong, said in a research note that the design of the e‑CNY gives China’s big banks “an entry point… to break into a busi­ness… cur­rent­ly dom­i­nat­ed by big tech firms,” and that this will sub­stan­tial­ly change the pay­ments sec­tor in Chi­na. 

Hav­ing a dig­i­tal yuan that puts the com­mer­cial banks front and cen­tre in pay­ments, and opens up the sec­tor to new com­peti­tors, is cer­tain­ly a step away from pri­vate Big Tech. But it’s arguably also a step clos­er to “Big State”.

CBDCs and privacy concerns

“Cash is won­der­ful­ly anony­mous and incred­i­bly con­ve­nient,” Tay­lor says. “That anonymi­ty might be a dis­ad­van­tage in an autoc­ra­cy and a rea­son for a coun­try like Chi­na to intro­duce a CBDC.”

Chi­na has said that the e‑CNY will offer “con­trol­lable anonymi­ty”, but what does that mean in prac­tice? “The author­i­ties can see which dig­i­tal wal­let the dig­i­tal yuan is in and dig­i­tal wal­lets are tied to indi­vid­u­als,” says Hsu. 

Author­i­ties will be able to trace trans­ac­tions and car­ry out com­pli­ance checks includ­ing anti-mon­ey laun­der­ing and know your cus­tomer. The user can choose to be anony­mous to coun­ter­par­ties, which some have argued will be a dis­ad­van­tage for online plat­forms. 

CBDCs in international payments

One of the often-cit­ed advan­tages of CBD­Cs is that they could remove fric­tion from the noto­ri­ous­ly scle­rot­ic inter­na­tion­al pay­ments mar­ket. How­ev­er, Tay­lor is not sure that is the case.

“Many of the sug­gest­ed advan­tages of a CBDC in terms of inter­na­tion­al pay­ments may be illu­so­ry,” he says.  He points out that a lot of rents are tak­en out on the course of an inter­na­tion­al pay­ment and that the sys­tem involves nav­i­gat­ing dif­fer­ent time zones, legal his­to­ries and insti­tu­tion­al his­to­ries.

“If I send mon­ey from the US to India, it has to go from a US bank to a bank in India. I’m not sure a CBDC real­ly gets round the insti­tu­tion­al issues,” Tay­lor adds. 

Chal­leng­ing the dollar’s reserve cur­ren­cy sta­tus has also been moot­ed as a rea­son for the e‑CNY. Chi­na is the world’s biggest pro­duc­er of rare earth met­als, which are increas­ing­ly in demand for recharge­able bat­ter­ies and elec­tron­ics, among oth­er things. Could Chi­na move to “de-dol­larise” the trade in rare earths? “It is pos­si­ble,” says Hsu, “but, the dig­i­tal yuan is like cash so that would like­ly take sec­ond place to nor­mal account trans­fers.”

Hsu says it’s also not clear how the dig­i­tal yuan could be tracked cross-bor­der or whether it will be able to col­lect the iden­ti­fi­ca­tion infor­ma­tion of over­seas cit­i­zens.

Tay­lor, too, is scep­ti­cal that the e‑CNY will increase the foot­print of the yuan in
inter­na­tion­al trade. “The inter­na­tion­al dol­lar pay­ments sys­tem is very effi­cient,” says Tay­lor. “The net­work effects in these things are so strong that the con­ven­tions of using the dol­lar, or SWIFT, are very hard to over­turn.”

Do central banks need CBDCs?

“I think that gen­er­al­ly cryp­tocur­ren­cies might make sense where there is great dis­trust of gov­ern­ment insti­tu­tions,” says Tay­lor. “Cen­tral banks in the OECD are gen­er­al­ly trust­ed.”

He also doubts that cen­tral banks will find their hands forced by the increased use of cryp­tocur­ren­cies.

“There are already lots of trans­ac­tions beyond the direct reach of the cen­tral bank, but as long as some com­po­nent is con­trolled and the rela­tion­ship between that and the rest is pre­dictable and doesn’t change rapid­ly, there isn’t real­ly a prob­lem,” he says. 

---