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Digital yuan will not drive internationalisation of the RMB

By Paul Golden

06:36, 18 October 2021

China map made of digital blockchain grid on a black background with binary code
China map made of digital blockchain grid on a black background with binary code - Photo: Shutterstock

In July, the People’s Bank of China (PBOC) set out a white paper in which it said it would explore the possibilities of using its experimental central bank digital currency (CBDC), the digital yuan or e-CNY. 

One of the three stated objectives in the paper was to “explore the improvement of cross-border payments”. This exploration is far from theoretical. While the e-CNY is being road-tested in major Chinese cities such as Shenzhen, Beijing and Shanghai, the upcoming 2022 Beijing Winter Olympics will give the PBOC the opportunity to likely see its first international use. 

So is the e-CNY aimed at a global or local audience?

Emily Jin, research assistant for the energy, economics and security programme at the Center for a New American Security says it is both. 

Emily Jin of the Center for a New American Security Center for a New American Security research assistant for the energy, economics and security programme Emily Jin - Photo: Emily Jin

A China-wide test

She refers to an all-of-Chinese-society mobilisation to test and use the digital yuan with the government at every level (central, provincial, municipal) launching pilots aimed at broadening domestic adoption of the digital yuan and other schemes targeting state-owned enterprises.

“We can describe the current stage as ‘domestic implementation’ and the next might be called ‘international dissemination or application’,” she says. “For example, one Chinese state-owned bank has established a partnership with Baowu, a state-owned steel enterprise, to create a trade platform that could support cross-border transactions. 

The same partnership also signed a strategic cooperation agreement with Australian payment processor Airwallex, which could open up future integration of the e-CNY overseas.”

Digital yuan privacy concerns

The next step domestically is to build up the front end infrastructure that would allow users to make payments in digital yuan, such as installing and upgrading point of sales machines, says Bao Linghao, analyst at investment advisory firm Trivium China.

China’s administrative structure means it is uniquely positioned to make a CBDC work by hardwiring the digital yuan into all commercial transactions. It would be a lot harder for governments in the US or UK, for example, to demand that merchants in those countries no longer accept cash as a form of payment and only use digital currency.

But those same administrative advantages linked to implementing the e-CNY also act as barriers to its international use. Privacy being a key issue according to Steve Ehrlich, CEO of US cryptocurrency broker Voyager.

Voyager CEO Steve EhrlichVoyager CEO Steve Ehrlich - Photo: Voyager

China's crypto crackdown

“China will use its CBDC to help strengthen the country’s financial security and increase financial surveillance on its citizens,” he explains. “The digital yuan is currently not blockchain-based as it has only borrowed certain concepts from blockchain technology, so it lacks the element of anonymity and enables the government to track and monitor all transactions.”

Another sign of the digital yuan’s domestic focus is the series of measures taken by the Chinese government against digital currency use so far in 2021. In mid-September the PBOC (along with a number of other state organisations) issued a notice referring to virtual currency-related activities as illegal and stating that provision of services by overseas virtual currency exchanges to Chinese residents was also off limits.

The notice also stated that financial institutions and non-bank payment institutions should not provide services for virtual currency-related activities and that internet companies should not promote such services.

BTC China - down but not out

Chinese firms took immediate action. Domestic digital currency exchange Huobi initially barred new Chinese users then quickly announced that it was exiting the country altogether, while e-commerce giant Alibaba banned the sale of cryptocurrency mining equipment on its website.  

These actions are just the latest in a long line of moves designed to suppress cryptocurrency activity. 

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However, in a recent interview on the Wharton Business Daily radio show, Kevin Werbach, Wharton professor of legal studies and business ethics observed that the extent to which large holders of cryptocurrency in China are still transacting overseas through virtual private networks and in other ways is hard to know.

Preparing for the 20th Party Congress

He also made the point that despite earlier crackdowns on cryptocurrency trading, a number of exchanges were founded in China, largely operated by mainland Chinese citizens, nominally offshore, and not doing business with China were still huge participants in the market.

Clearly it would be nigh on impossible to control the use of cryptocurrency in a decentralised and fragmented financial technology market where government oversight did not reach deeply into the private sector. But the level of centralised control in China makes it realistic for the country’s government to exert control over cryptocurrency use within its borders.

In fact, Jin describes cryptocurrency regulation as simply one piece of the larger regulatory effort as China builds up to its 20th National Party Congress in October 2022.

Taking power from the people 

Bao agrees that it is not possible to completely cut off cryptocurrency transactions any more than it is possible to stop Chinese citizens from using Facebook or Google. “But that is not to say the recent ban is ineffective,” he adds. “Some major crypto exchanges have been pressured to stop serving Chinese citizens.”

Complete government control cancels out cryptocurrency’s original intent, states Ehrlich. “It was made for the people, and for China to ban it means taking away power from the people,” he says. 

While China has been promoting the use of RMB internationally for more than a decade, the focus of its CBDC programme is much closer to home according to Aaron Klein, an economic studies fellow at research group the Brookings Institution.

Brookings Institution economic studies fellow Aaron KleinBrookings Institution economic studies fellow Aaron Klein - Photo: Brookings Institution

Retail payment disintermediation fears 

“This movement is driven largely by the leapfrog of retail payments that occurred when WeChat and AliPay disintermediated the banking system,” he says. “It is common in the West to assume that the goal of innovation is to spread it globally, but I am not so sure that is what China is trying to do with its new payment system.”

Bao suggests RMB internationalisation is more dependent on China's currency policies than the underlying technology and remains a hard sell when the currency itself is not even freely convertible.

In order for RMB to become more attractive, China would have to truly open up its capital account - letting capital in and out without restrictions - and also not artificially depreciate its currency to make its exports more appealing. As long as it is unwilling to make these two moves, the RMB will not be able to significantly internationalise even if the digital RMB is successfully implemented domestically.

CBDC cannot drive internationalisation

“China’s CBDC will not help RMB internationalisation because there are more structural forces that drive the international adoption of a currency and the RMB lacks appeal compared to the US dollar, the euro and the yen because it is just not as safe an asset,” says Jin.

This point was explicitly conceded in the PBOC’s July white paper. 

“The internationalization of a currency is a natural result of market selection. The international status of a country’s currency depends on its economic fundamentals and the depth, efficiency and openness of its financial markets. Therefore, though technically ready for cross-border use, e-CNY is still designed mainly for domestic retail payments at present.”

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