China’s Digital Currency (Bloomberg Quick Take, Washington Post September 2019)

The People’s Bank of China is poised to become the first major central bank to issue a digital version of
its currency, the yuan, seeking to keep up with -- and control of -- a rapidly digitizing economy. Unlike
cryptocurrencies such as Bitcoin, though, dealing in the digital yuan won’t have any presumption of total
anonymity, and its value will be as stable as the physical yuan, which will be sticking around too. Some
questions remain, including the impact on commercial banks as well as Big Tech companies such as Ant
Financial and Tencent Holdings Ltd. that already offer payment services. Behind China’s rush is a desire
to manage technological change on its own terms. As one PBOC official put it, currency isn’t only an
economic issue, it’s also about sovereignty.

1. What’s the plan?

Not all the details are out, but according to new patents registered by the PBOC and official speeches, it
could work something like this: Consumers and businesses would download a digital wallet on their
mobile phone and load the digital cash from their account at a commercial bank -- similar to going to an
ATM. They then use that like cash to make and receive payments with anyone else who also has a digital
wallet.

2. Aren’t most transactions already electronic?

Yes. China is increasingly a cashless society. Even street-food sellers in small towns will prefer to use a
mobile payment app than make actual change. In the first quarter of 2019, such apps handled 59 trillion
yuan ($8.3 trillion) of transactions in China, up 15% from a year earlier, according to research firm
Analysys. Ant Financial’s Alipay handled almost half of that, followed by Tencent’s WeChat Pay with a
third. The PBOC says all non-cash transactions (which also includes such things as credit, debit and
stored-value cards, bank transfers and checks) totaled 3.8 quadrillion yuan in 2018. The trend is hardly
unique to China: A central bank survey in Sweden found that only 13% of people in 2018 paid for their
most-recent purchase in cash, down from 39% in 2010.

3. So why is the PBOC doing this?

There are important regulatory and political considerations. Having the ability to track money
electronically as it changes hands would be useful in combating money laundering and other illegal
activities. The project was started by former PBOC Governor Zhou Xiaochuan, who retired in March
2018. He wanted to protect China from having to some day adopt a standard, like Bitcoin, designed and
controlled by others. Facebook Inc.’s push to introduce its own digital coin, called Libra, in 2020 may be
speeding things up, as it could end up strengthening the dollar’s dominance -- and weakening China’s
capital controls. As the head of the PBOC’s research bureau, Wang Xin, put it in July, that could have
“economic, financial and even international political consequences.”

4. Is it a cryptocurrency?

Probably not. When we say cryptocurrency, we usually mean an offering such as Bitcoin that uses
decentralized, online ledgers known as blockchain to verify and record transactions. It and others such
as Ethereum support anonymous transfers without the need for a middleman -- or a central bank. The
wild volatility in their value, however, makes them ill-suited for use as a means of payment. Libra will
also be a cryptocurrency, but a so-called stablecoin, 100% backed by a basket of securities and real-life
currencies such as the dollar, euro, pound and yen. Because those don’t fluctuate much, Libra’s value
should be steady as well. Initially at least, Libra will be run by private companies including Facebook,
Visa and Uber. The PBOC will, of course, back the digital yuan, making the currency the opposite of
decentralized. It’s also not certain that it will use blockchain, either.

5. Why not use existing coins?

China banned cryptocurrency exchanges and so-called initial coin offerings in 2017 amid a broad effort
to cleanse risk from its financial system and clamp down on so-called shadow banking. They can still be
traded, but through a slower, more restrictive process. Digital currencies also could provide a way to
move money out of China, potentially adding to capital outflows that would undermine the yuan’s value.
Even though Libra isn’t out yet, Chinese officials have called for oversight by monetary authorities.
(Facebook’s website is banned in China, but many Chinese access it via a work-around called a virtual
private network, or VPN.)

6. Why not use blockchain?

The PBOC has considered it, but researchers have expressed doubts about whether the technology
would be able to support a large volume of simultaneous transactions. China’s annual Singles’ Day
shopping gala in 2018 had payment demand peaking at 92,771 transactions per second, far above what
Bitcoin’s blockchain could support, according to another central bank official, Mu Changchun.

7. How about privacy?

The bank wants to “strike a balance” between anonymity and the need to crack down on financial
crimes, Mu said, but it’s unclear what that means. The PBOC has said that user information won’t be
completely exposed to banks. But user identities will likely be tied to individual wallets, giving
authorities another window into people’s lives. PBOC Deputy Governor Fan Yifei suggested in an article
in 2018 that banks may need to submit daily information on transactions and that there could be caps
on transactions by individuals.

8. When’s it coming?

Soon, it seems. Mu said in August that the digital cash is “close to being out.” The PBOC has been
looking into a digital currency since at least 2014, and it’s been recruiting staff for a dedicated institute.
Research and innovation regarding digital currencies was mentioned in the grand plan to make
Shenzhen, the technology hub next to Hong Kong, into a world-class city by 2025.

9. Will people use it?

It’s hard to say. The PBOC’s digital wallet is just a wallet, at least for now, whereas the incumbents
Alipay and WeChat Pay are deeply embedded in a whole world of social media, e-commerce, ride-
hailing, bill-paying, investments and other functions. Da Hongfei, the Shanghai-based founder of open-
sourced blockchain platform Neo, said he can’t see why the general public would choose the PBOC’s
digital currency over something as handy as Alipay.

10. How will banks be affected?

Mainly in bookkeeping. Digital cash would have to be kept separate from regular savings, because it
represents money in actual circulation (known in central banking parlance as M0), not the so-called
demand deposits (M1) which banks use to lend out again to companies and households. Commercial
lenders would deposit 100% worth of reserves at the central bank in exchange for digital currency,
which it then distributes to retail users. The two-tier system also reduces the burden on the PBOC to
perform due diligence, revamp IT systems and answer client requests.

11. Any economic impact?

Probably not immediately. As the PBOC’s digital money is designed to replace cash, it won’t have a big
impact on the broad money supply, and thereby its affect on monetary policy will likely be neutral. If the
digital currency is widely accepted and people are encouraged to hold more cash, bank deposits could
decline, but the impact will be manageable, according to a 2018 article from the PBOC’s digital currency
research institute. In a more distant future, the central bank might use digital currency to help steer the
economy. Patent filings made public in October 2018 described a currency that would require banks
making loans to input details about borrowers and interest rates before funds could be transferred. That
could allow the PBOC to more proactively control bank lending and direct funding where it deems
appropriate. Furthermore, should there be a need for China to turn to an unconventional monetary
policy toolkit, digitized currency would allow it to apply negative rates even for people holding digital
cash.

12. What are other central banks doing?

Uruguay has done a pilot program, called e-Peso, that was praised by the International Monetary Fund.
Venezuela has a controversial offering called the petro, and Sweden’s Riksbank is exploring an e-krona.
Last month, Bank of England Governor Mark Carney called for Libra-like reserve currency to end the
dollar’s dominance. An anonymous survey by the Bank for International Settlements in early 2019
showed most of the global central banks are participating in theoretical and conceptual research.