China’s digital currency could be the future of money – but does it threaten global stability?

0

China is making promising strides in testing its yuan digital currency. It announced the success of a pilot project in Suzhou City, near Shanghai, in eastern China, which involved 181,000 consumers between May 1st.

This was part of a larger test by the People’s Bank of China that has targeted 500,000 consumers in 11 regions of China since April. For those entitled, there is a simple app to download that gives them a wallet. Use it to shop at thousands of participating stores and receive discounts.

The latest digital currency experiment in Suzhou was hailed as a success.
ImageinChina Limited / Alamy

The digital yuan is a version of the normal Chinese currency that runs on a blockchain, the tamper-proof online ledger technology that powers digital coins like Bitcoin and Ethereum. However, this blockchain is approved, i.e. the Volksbank decides who is allowed to use it.

The most recent test round is ten times the size of the original round from autumn 2020. China is also testing the digital yuan across borders between Hong Kong and neighboring Shenzhen and is developing a platform to make the currency internationally sustainable, including Thailand, the United Arab Emirates and the United Arab Emirates International Settlements Bank.

Every step forward increases the chances that China will become the first country to put its currency entirely on an approved blockchain. No date has been announced, but a national rollout seems likely within the next 12 months, most likely in staggered phases.

In contrast, western central banks such as the Federal Reserve, the Bank of England, and to a lesser extent the European Central Bank, are moving more slowly in what are known as central bank digital currencies (CBDCs). They worry about things like data protection when all transactions are publicly visible on the blockchain and the impact on retail banks.

However, a digital yuan raises profound questions about global financial stability. The question for the other major economies of the world is how to respond.

Advantages of digital currencies

The digital yuan already has legal tender status. Payments with it differ fundamentally from those on payment platforms such as Alipay or WeChat (or PayPal in the West). Such services can process transactions for customers very quickly, but behind the scenes there are ledgers of a large number of transactions between the banks of the buyers and sellers and often intermediary banks that process hours or even days later.

The digital yuan bypasses the need for these banks. Unlike these payment alternatives, there are no service fees, and in theory the payment speed can be even faster.

Someone is holding a smartphone and using the WeChat app to make a payment
Paid apps like WeChat will soon look clunky.
A ming

Unlike cryptocurrencies like Bitcoin, the currency is also supported by a government. This means that issuing the digital yuan is the same as issuing cash in circulation, which makes it just as secure. It gives the government better control over the supply of money because unlike cash, officials can see all of the transactions that are going on at any given time.

Three dangers

Many central banks have dealt with the development of digital currencies. Some like Japan and South Korea are not far from the Chinese. The EU is signaling that a digital euro could be four or five years away.

There are several dangers to the stragglers. The first concerns international payments. Most transactions between different currencies currently use the US dollar as an intermediary via the international banking protocol SWIFT. This means significant demand for the US dollar, which brings benefits such as cheaper US government borrowing. For example, in 2019 China alone exported $ 134 billion (£ 96 billion) in goods.

Digital yuan transactions do not require SWIFT or the dollar, which affects the use of dollars in international trade. Up to 120 countries have China as their largest trading partner, and many are questioning dollar billing as it increases the unnecessary financial risk of adverse exchange rate movements. China says it is not trying to replace the dollar with the digital yuan and that the “goal is to give the market choice” on how to conduct international transactions.

Chinese writing and drawing by multiple people on pink paper.
Song dynasty banknote, circa 11th century.
Wikimedia

A second danger is that if central banks fail to meet the demand for digital money, market forces will do so. Paper money was invented in China during the Song Dynasty in the 11th century. But it quickly becomes superfluous. Contactless credit cards have become ubiquitous during the pandemic. Digital money is even better because it costs less.

Third, countries that do not adopt digital currencies could find their central banks losing control of monetary policy to cryptocurrencies – be it decentralized initiatives like Bitcoin or centralized ones like Facebook’s upcoming Diem currency. In other words, if these non-government coins are widely used for payment purposes, it will be harder for central banks to control their economies by setting interest rates or changing the money supply. Of course, it is possible to ban cryptocurrencies, but this gets in the way of progress and all the benefits that they bring.

The digital yuan is taking place amid heightened tensions between China and the US and Europe. This clearly makes it a worrying time to give China’s first mover advantage an edge over these new breed of currencies.

Incidentally, sanctions like those recently imposed on Chinese officials for human rights concerns will be much easier to circumvent when and when the digital yuan is in operation. As a result, calls for sanctions against the currency could emerge, raising numerous sustainability and consequence questions that could be discussed on other occasions.

However, given how much is at stake, it is vital that the US, EU and UK urgently start testing their own digital currencies. Blockchain is reinventing the way we make payments and the risks of being left behind are too great to ignore.

Leave A Reply

Your email address will not be published.