Cryptocurrencies, China's sovereign digital currency (DCEP) and the US dollar system

Introduction (Michael A. Peters)

The Central Bank of China is testing its Digital Currency Electronic Payment (DCEP) in the cities of Shenzhen, Suzhou, Chengdu and Xunan with the involvement of four large state-owned banks in the issuing of the digital asset including, the Agricultural Bank of China, Industrial and Commercial Bank of China, Bank of China and China Construction Bank. China’s DCEP could be launched as early as next year. Already mobile transactions accounted for four of every five payments in China during 2019 and the Chinese population habitually use Alibaba’s Alipay and Tencent’s WeChat Pay as a preferred method of payment. As Karen Yeung (2020) indicates: ‘The digital yuan is part of the most liquid form of money supply that includes notes and coins in circulation in the society, known as M0, but in a digital form. It is issued and backed by the country’s central bank.’¹ By adding a new layer of digital traceable cash with transactions made online through mobile phones through a ‘touch and touch’ facility that requires only two mobile phones to touch without the internet, the digital Yuan system is ready to digitize China’s existing monetary base rather than develop a new currency such as Bitcoin but make no mistake it has the potential to revolutionise China’s currency system and perhaps later with further refinements China's new digital currency system has the power to change the monetary and the international monetary system and to challenge the US dollar as the premier reserve currency of the world (Huang, 2020).

DCEP is one of latest FinTech developments, technology-enabled innovation in financial services that include the application of cloud computing and Big Data analytics to the finance economy and to the process of financialization. One review divides FinTech technologies into the following broad classes:

Distributed ledger technology (DLT) and blockchain:

• crypto-currencies;

• Application Programming Interfaces (API);

• Big Data and Artificial Intelligence (AI);

• digital platforms encompassing peer-to-peer (P2P) activities; and

• other developments (Fujii-Rajani, 2018).

The report focuses on the basic operation, application and understanding of these technologies and concludes:

FinTech has the potential to change the landscape of the financial sector by introducing new products and services, new business models and more competition for incumbents. This has the potential to enhance financial sector efficiency, but it also raises questions about financial sector stability.

The emergence of FinTech creates new market opportunities that could benefit consumers, improve financial system resilience and might even lead to more efficient regulation. https://www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2018/rbb2018-81-12

But FinTech also ‘creates new risks which pose new challenges’ for regulators encouraging ‘fragmentation of the value chain of activities’ of a firm and has

the potential to unbundle banking into its core functions of settling payments, performing maturity transformation, sharing risk, and allocating capital. It could undermine the position of incumbents through a loss of business, or reduced access to information or liquidity, and lead to the emergence of new systemically important players. https://www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2018/rbb2018-81-12

Alex Axelrod (2020) commenting on ‘How National Digital Currencies Will Change Our Lives’ remarks that the COVID-19 pandemic ‘has accelerated cryptocurrency’s exit process from the marginal state, and has firmly pushed it front and center into many more people’s consciousness than ever before.’ He suggests that the global economy requires ‘a payment instrument’ that ‘can make payments quickly, inexpensively and without unnecessary intermediaries, such as Visa or Mastercard’. As well as China other countries also are working on similar schemes.

The World Bank Group’s (2020) report ‘Payment aspects of financial inclusion in the fintech era’ from the Committee on Payments and Market Infrastructures emphasizes a balance of challenges and opportunities:

Fintech can be leveraged to improve the design of transaction accounts and payment products, make them ubiquitously accessible, enhance user experience and awareness, and achieve efficiency gains and lower market entry barriers. At the same time, these benefits come with certain risks in terms of operational and cyber resilience, the protection of customer funds, data protection and privacy, digital exclusion and market concentration (Executive summary, p. 2)

The report also makes clear that a fifth of world banks are likely to introduce DCEP systems within the next five or so years.

Some commentators have suggested that the Chinese digital currency system is more about control over the cash economy than a progressive decentralization first promised by visions of the introduction of cryptocurrencies. Wired’s Barclay Bram (2020) indicates the original techno-utopian vision:

Bitcoin, which was released into the world by the mysterious Satoshi Nakamoto in 2009, is based on a techno-utopian vision of a decentralised global currency that would provide anonymity and security, while allowing users to subvert the established financial system and its gatekeepers. Underpinning this technology is the blockchain.

https://www.wired.co.uk/article/china-digital-currency-crypto

There are likely to be several fundamental differences between Bitcoin and the Chinese system because the blockchain ledger will be controlled by the government rather than distributed across the system giving government unprecedented control over the cash economy. The impetus has been as Mu of the Central Bank expressed it ‘to protect our monetary sovereignty and legal currency status’.² Yet ‘The biggest, and possibly the most important, objective of e-RMB could be a shot in the arm to RMB internationalisation which has stalled since the China–US trade war started two years ago.’³ One of the major implications is whether the current US–China tensions will spread to a FinTech race and the weaponization of currency wars.

FinTech as rapidly growing aspect of the wider process of financialization since the computerization of financial markets and the automation of equity markets since the 1980s raises some important questions of how quickly information technology has transformed financial trading, electronic banking and finance investment (Currie & Lagoarde-Segot, 2017). FinTech has the potential to mediate and shape markets through innovation especially in periods of crisis. It has the capacity to further enhance access to credit—to create credit-driven economies—providing instantaneous credit ratings on individuals, firms and countries and the rise of ‘digital financialization’ with fears of ‘an infrastructure that harvests citizens’ data, which companies can monetise and governments can use for political surveillance’ (Jain & Gabor, 2020). The collapse of the Bretton Woods system in 1971 opened the way for financial globalization reorganizing finance and the economy to provide easier access to world financial markets with the consequence some argue of effectively undermining sustainable growth and full employment.⁴ As part of this critique from political economy critics emphasize of financialization of value and the financialization of life that is taken to historically new technological levels by FinTech (Mader et al., 2020). Yet FinTech in China also has the potential to create a more inclusive digital financial system, establish an open banking system, and provide greater financial security.⁵

DCEP and RMB internationalization: A step towards relieving the global dollar trap (Benjamin Green)

According to Sebastian Mara, at BNY Mellon investment management, during times when there is less willingness to lend in safe-haven currencies like the US dollar, risk-off environments (such as those created by global pandemics) lead to greater demand for US dollars. Moreover, shock and uncertainty have led to risk aversion within key funding markets that have exacerbated dollar shortages within the international monetary system (IMS) (‘The FX of Covid-19’, 2020). Within the framework of an international dollar shortage, the age of Covid-19 has represented a boon to China’s decades long efforts to avoid the ‘dollar-trap’ on its quest towards RMB internationalization. Predicting that Covid-19 could increase both ‘yuan denominated cross-border trade’ and the pace of RMB ‘internationalization’, Tu Yongshong, deputy director of China’s International Monetary Institute at Renmin University stated that, China can offset dollar shortages by offering Yuan liquidity to the global market through ‘increased overseas investment, imports and offshore Yuan deposits, and cross-border lending’ (‘Chinese Yuan’s Share’ …, 2020). While recent disruptions may prove expeditious for these aims, the goal of currency liberalization within China, albeit within an extremely measured framework, can be traced as far back as Deng Xiaoping’s policy of opening up and reform in 1978. However, it is within the post-2008 financial crisis era that the IMS has witnessed a true surge in the Chinese government’s efforts to ‘internationalize’ its currency (RMB) (Chey, 2013). Specifically, since the upending of the IMS by the global financial crisis of 2008, which highlighted the critical flaws inherent to an overreliance on the USD as a keystone currency, China has sought to foment a crucial shift away from what Eswar Prasad has labeled a ‘dollar-centric global financial system’ (Anstey, 2020). As Covid-19 continues to signal waves of volatility within the global foreign exchange (FX) market, threatening global financial safety within a dire climate of international cooperation, China’s continued efforts to internationalize the RMB must be seen as an overwhelmingly welcome development to the IMS. With this in mind, the recent development and trial implementation of China’s DCEP within four domestic markets marks a significant step towards the intended goal of RMB internationalization as a means to hedge against the currency risk inherent to dollar hegemony within the IMS (Gjoza, 2018).

A detailed accounting of the scope and nature of China’s ongoing DCEP trials first requires the establishment of a suitable framework of ‘RMB internationalization’ within the context of China’s current account. Put simply, a currency may be considered international upon its extensive use as a ‘vehicle currency’ for the settlement of international trade transactions (Liu et al., 2019). Moreover, according to IMF metrics, which established the RMB as a ‘freely usable’ currency in 2015, a currency is considered international when; it is used for the settlement of international transactions; trading volumes in foreign exchange markets; and is in use as an international reserve asset (Maziad et al., 2011). Despite meeting IMF requirements for its status as an SDR currency, political economists continue to cast doubt on whether the RMB actually constitutes a ‘freely usable’ currency. Specifically, China’s authoritarian capitalist economic system – wherein the Central Party inhabits the role of ‘market-maker’ or sole arbiter of market structures (Töpfer, 2018), continues to cast a pall over the future likelihood of RMB supremacy within the IMS. Among the criticisms levelled against the free usability of the RMB are; capital controls, which preserve the value of the RMB but limit investors’ ability to repatriate profit (Kärnfelt, 2020); the privileged access given to Chinese firms within a repressed financial system (Germain & Schwartz, 2017); and central controls on interest rates (within a narrow band), which benefit exporters while keeping the RMB artificially stable and competitive (Gjoza, 2018). To be sure, China has made some cautious steps towards the liberalization of its capital accounts such as; reducing restrictions on cross-border financial transactions; increasing capital outflows, such as developmental projects within the (BRI); and widening the band within which the RMB floats (Saha, 2020; Zenglein & Kärnfelt, 2019). However, as long as China’s government continues to use its role as market-shaper to push forward liberalizing reforms within an ‘expanding system of closed loops that confine capital within a controlled system’, some will continue to view China as ill-equipped to handle the social and political costs of running a keystone international currency (Germain & Schwartz, 2017; Zenglein & Kärnfelt, 2019). Thus, while China’s DCEP signifies a remarkable feat of FinTech which may bolster the short-term international image of RMB as a freely usable DSR currency, the decisive factor in the developing saga of RMB supremacy may partially hinge on the establishment of a more nuanced ‘political’ understanding of China within the fractious political economy of the IMS. Specifically, the demand for RMB as a reserve currency will depend on China’s future economic as well as political choices. Specifically, China must leverage its considerable geopolitical muscle to present DCEP for what it is as – another important step towards the long-term solution of the IMS’ continued ‘dollar-trap’ crisis. As it stands, this process should begin within suffering BRI economies/populations that are starting to weigh the value of holding US-denominated debts against the data privacy issues inherent to a digital currency whose blockchain ledger is held by an authoritarian central government (Huang, 2020).

DCEP’s impact on RMB internationalization (Haiyang (Melissa) Yang)

With its recent phased trial issuance of DCEP, China has reached a milestone achievement – becoming the first central bank in the world to issue cryptocurrency. However, along with this significant contribution to FinTech, the Issuance of DCEP should also be considered as yet another important step towards RMB internationalization. Having begun in earnest in 2009, when the financial crisis-borne liquidity market witnessed China’s cooperative efforts (swapping its currency with countries like South Korea and Argentina) to alleviate a global liquidity shortage, the issuance of DCEP caps a decade of steady progress towards the internationalization of its currency (Hu, 2012). Moreover, a significant milestone was met when, in December 2015, the International Monetary Fund (IMF) announced that the RMB would join the special drawing rights (SDR) basket from October 2016 onwards. This meant that, along with the US dollar, Euro, British Pound and Japanese Yen, the RMB would become only the fifth SDR basket currency in the history of the IMF (Xinhua, 2015). As a measure of internationalization, the Bank of China issued a ‘White Paper On RMB internationalization’ which highlights that in 2019 the scale of RMB cross-border usage reached nearly 20 trillion yuan, exceeding 2009 cross-border usage by 500,000 percent (Bank of China, 2019). These cross-border usage figure highlight a significant increase in RMB acceptance within the international financial market, paving the way for the internationalization of DCEP. It should be clearly stated that DCEP is the product of China’s measured yet active promotion of RMB internationalization. Case in point, as stated by former Central Bank of China Director Zhou Xiao Chuan, ‘RMB internationalization, while a gradual process, entails some big steps.’ DCEP represents not only the ‘next big step’ in RMB internationalization, it will also position China at the vanguard of sovereign digital currencies - presenting a significant opportunity for China to continue its hedge against US dollar hegemony within the IMS.

It must be stated that within its present nascent stage of operation, the impact of DCEP on international cross-border settlement is very limited. According to 2020 May data released by the Global Interbank Financial Communication Association (Swift), US dollar denominated payments accounted for 40.88% of the global payment market, ranking first again, while the Chinese Yuan accounted for merely 1.79% (SWIFT, 2020). This means that the USD remains the world’s most important currency, especially as concerns large-scale international commodity trading. These figures also evince the notion that, the RMB has yet to cement itself as significant keystone reserve currency. Moreover, at present China’s domestic DCEP pilot trials are all based on retail purchases and daily expenses, which mean that, while its aims are undoubtedly international, at present, the scope of DCEP usage will be mainly restricted to Chinese Domestic financial settings. Case in point, the first pilot application scenario in Chengdu has been carried out at one of the city’s biggest retail area - Taiguli, while in Suzhou the trials are based on traffic subsidies paid by the staff of enterprises and institutions (Sichuan News Network, 2020). In yet more trial locations, the Shenzhen government has been paying Party fees for the bank's internal employees, while Xiong'an has held special pilot promotion meetings for DCEP, inviting the participation of retail corporations like Starbucks, JD(Jing Dong), McDonald’s and 19 other well-known merchants (Yueng, 2020). This strategic brand-name selectivity serves an understanding that CCP policymakers intend to utilize the traceability and widespread international presence of ‘well-known brands’ to advertise reform efforts globally, allowing for a form of liberalization which safeguards state control (Töpfer, 2018). In terms of cross-border transactions, DCEP may prove more convenient for Chinese nationals who intend to travel and shop abroad or for foreigners who wish to spend within China, but it may have little impact on large cross-border settlements. With a foundation built on the wide acceptance of non-cash transaction within China, initiated by Alipay and Wechat pay, there is little doubt that the trials of DCEP will lead to an efficient adoption within the domestic market.

Yet another challenge for future DCEP and RMB internationalization lies within the willingness of other nation to accept the RMB. However, in 2019, Bank of China’s ‘White Paper On RMB internationalization’ states that ‘One- belt-one-road’ participants have a strong desire to use the RMB as a cross-border settlement currency. Specifically, about 71% of the enterprises ‘along the way’ state that they have the intention to use or enhance the proportion of cross-border RMB settlement (Bank of China, 2019). This means that the acceptance of the RMB has been gradually emerging within Belt-and-Road countries.

Overall, most scholars are optimistic about the future of DCEP in the long run (Huang, 2019). Similar to how China's Alipay and WeChat pay have changed the means of payment in the world, the emergence of DCEP will introduce a fresh, and ultimately impactful approach to the continued financialization of the international monetary system.

Postscript

A cryptocurrency is a digital currency that is secured by cryptography, which allegedly makes it difficult to counterfeit or double-spend. Most digital currencies are decentralized networks based on blockchain technology and there are some 1600 cryptocurrencies currently active. It is claimed that cryptocurrencies using blockchain technology could replace centralized banking system with a distributed ledger making it easier for developing countries and those without bank accounts to participate in the global digital economy but is also raises the potential for financial crime, money laundering and tax evasion.

China’s DCEP (数字货币) is likely to enhance the cashless society utilizing a centralized blockchain technology. It a ‘One-Coin, Two Addresses, Three Centers’ structure where One-Coin is the DCEP itself, Two Addresses ‘refers to the data centers run by PBoC and the Commercial Bank’ and Three Centers ‘are the newly created Identification Center, Record Center, and Big Data Analytics Center’ (Kong, 2020). It has made huge progress in less than a decade and blockchain has been officially included in China’s 50 Trillion ‘New Infrastructure’ Plan that ‘focuses on new public facilities that serve the needs of new industrialization, including areas of 5 G, ultra-high-voltage power facilities, inter-city transport, vehicle charging stations, big data centers, artificial intelligence and industrial internet’ (Teng, 2020).

Michael A. Peters , Benjamin Green , and Haiyang (Melissa) Yang Faculty of Education, Beijing Normal University, Beijing, China [email protected]

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 https://www.scmp.com/economy/china-economy/article/3083952/what-chinas-cryptocurrency-sovereign-digital-currency-and-why

2 https://www.wired.co.uk/article/china-digital-currency-crypto

3 https://www.ubp.com/en/newsroom/implications-of-chinas-sovereign-digital-currency

4 https://www.ipsnews.net/2020/07/financialization-tackling-virus/

5 http://www.chinabankingnews.com/2020/03/03/de-financialization-of-internet-giants-and-regulatory-sandboxes-amongst-ten-key-trends-for-chinas-fintech-sector/