Lazard Insights
Beyond Cash: China Pulls Central Banks
into the Digital Currency Race
Aristotel Kondili, Director, Portfolio Manager/Analyst
Summary
• China’s digital currency could be a significant
step in the movement of the Chinese economy
toward a cashless society.
• The world’s major central banks, although
behind the People’s Bank of China (PBoC), will
likely introduce digital currencies designed to
meet their own objectives over the next several
years.
• With digital currency, the PBoC can gain insight
into consumer behavior and the full scope of
economic activity, including illegal transactions,
potentially leading to better policy decisions.
• Central bank digital currencies should help
improve financial inclusion in China and
eventually globally, leading to a reduction in the
informal economy.
Lazard Insights is an ongoing series designed to share value-
added insights from Lazard’s thought leaders around the
world and is not specific to any Lazard product or service.
This paper is published in conjunction with a presentation
featuring the author. The original recording can be accessed
via www.lazardassetmanagement.com/insights.
The now ubiquitous Bitcoin and a number of other
cryptocurrencies are creating a decentralized, alternative global
financial system. For many investors, the rise of alternative
currencies represents an opportunity for speculation and raises
interesting long-term questions: Will cash go extinct—and when?
Central banks, however, are looking well beyond this. The
potential for currency to become decentralized over time could
interfere with their ability to achieve their core goals: price
stability (controlling inflation) and maximum employment, which
combined can lead to healthy economic growth. If a significant
portion of the population were to use alternative currencies,
monetary policy—from easing financial conditions in a recession
to raising the policy rate to fight inflation—could lose much of its
effectiveness, which has implications for everyone.
Hoping to push back against the competition, central banks
are investigating what it would take to launch their own digital
currencies—centralized, backed by equivalent assets, and
supported by the power of sovereign governments.
The People’s Bank of China (PBoC) has firmly taken the lead. It
tested a central bank digital currency (CBDC) with commercial
banks in China last year, and we expect it will officially launch
its digital currency soon. Other central banks have published

research, done policy work, and floated initial proposals, but
progress toward an actual digital currency has been very slow.
Nevertheless, spurred by China’s progress, other major central
banks will almost certainly introduce their own digital currencies
in the coming years.
Why Would a Central Bank Want a
Digital Currency?
In a recent Bank of International Settlements (BIS) study, almost
all major developed markets central banks, including the European
Central Bank (ECB) and the US Federal Reserve, shared their
plans for and views on digital currencies. The study found that
some 80% of central banks are investigating digitalization and
about half have progressed past the conceptual stage.
The report also found that the primary driver for central banks is
to enable broad access to central bank money: In places where cash
usage is in decline, local banking networks may shrink accordingly,
leaving households and businesses at risk of losing access to risk-
free central bank money. Some central bankers consider it an
obligation to provide this access to the public; a CBDC would
serve as a digital bank note, fulfilling this obligation.
Central banks’ second motivation is to retain and even enhance
the impact of monetary policy, according to the BIS report.
If a significant portion of a population uses money that is not
denominated in the sovereign currency, central banks’ ability
to support financial stability may be limited. Digital currencies
backed by large private institutions with deep pockets are of
particular concern. Facebook’s Libra, for example, is a digital asset
built by Facebook and powered by a new Facebook-created version
of blockchain. Easy access to private stablecoin like Libra, which is
backed by reserves and designed to maintain price stability, could
potentially undermine the role of a national currency, and worse,
undermine confidence in it (Exhibit 1).
With their own digital currencies, central banks see a possible
path to retaining the strength of their sovereign currencies. For
one thing, digital payments should be safer and more efficient
than cash. But also, electronic transactions can provide the central
banks with real-time information on consumer and business
spending—specifically prices—something they lack now. Seeing
transactions as they are happening could help the banks more
accurately target monetary policy to achieve their objectives,
especially on inflation.
2
Digital Currency Primer
Q: What is a central bank digital currency (CBDC)?
CBDC is a digital payment instrument, denominated in the
national unit of account, or currency. It is a direct liability
of the central bank. This new form of digitized sovereign
currency will be equal to physical cash or reserves held at
the central bank.
Q: How does it differ from cryptocurrencies, such as
Bitcoin, or stablecoin, such as Facebook’s Libra?
Bitcoin is not issued by a central bank or typically considered
legal tender; it is not a liability of any institution, and it is not
backed by assets. Its value often fluctuates with extreme
volatility. Corporate digital currency projects, such as Libra,
are backed by corporations, such as Facebook. These
currencies are typically backed by an asset reserve of the
corporation and can be less risky than cryptocurrencies as a
means of payment.
Q: How would a CBDC work at the retail level?
CBDC would constitute the first digitized form of central
bank money that the general public could own. People
would have accounts of the digitized fiat currency with the
central bank or hold CBDC on mobile devices, prepaid cards,
or other forms of digital wallets.
Q: What are the main benefits for people who use
CBDCs?
Using China as an example, in regions with low-to-no
access to banking services, such as regular credit, cash
still plays an important role. Digital currency issued by
the central bank could bring much of this “underbanked”
population into the financial system, and theoretically
everyone would be able to have access to digital money
and the associated financial services that this would make
possible. (continued on next page)
 3

Exhibit 1
Digital Currency Primer (continued) Comparing Major Digital Currencies
Digital Renminbi Libra Bitcoin

¥
Q: What are the benefits for central banks and
governments?
Digital currency would allow broader visibility of money
flows in the ecosystem. Some policymakers have
expressed concern that alternative currencies could Central bank
Type digital currency Stablecoin Cryptocurrency
displace the domestic currency in an economy and create
People’s Bank Facebook/Libra Decentralized
significant risks to financial stability and monetary policy. Issuer of China Association network
The goal for the People’s Bank of China (PBoC) is to gain Pilot launched in
Status April 2020 In development In use since 2009
transparency and control on money supply and capital
Primary Consumer Consumer
flows. Additionally, China has a long-standing aim to Usage purchases purchases Speculation
internationalize its currency. The digital renminbi may help
Value Identical to Pegged to multiple
with this initiative, making it easier for consumers and Determination Renminbi currencies Market

businesses in some other countries to use its national Blockchain

currency.
Q: Switching to digital currency will be a big change for
many consumers, but how will it be different for central
banks?
Central banks today move and store large amounts
of money electronically, so from a purely logistical
perspective, digital currency would be similar. In fact,
the expense of issuing and managing cash falls mainly
to commercial banks, businesses, and households. For
central banks, the differences with digital currency lie in
the direct link to end users—through the electronic trail
of transactions and possibly through direct accounts with
consumers. For example, currently central banks are
aware of how much money is in circulation, but they do
not know where it is stored and by whom. Central banks
are also missing out on information about everyday cash
transactions and spending that could potentially help them
assess monetary policy more accurately.
China’s Initiative: How a Central Bank
Digital Currency Works
China was the first to heed the wake-up call from alternative
currencies. The PBoC has been working on its digital currency/
electronic payment (DC/EP) since 2014 but released few details
until last year, when it began testing in various cities, including
Shenzhen. The DC/EP is a digital alternative to bank notes and
therefore both a component of the country’s liquid money supply
Usage Limited usage Centralized Decentralized
As of 31 December 2020
Source: China Power
(M0) and a direct liability of the central bank. In other words,
the DC/EP will constitute a third form of central bank money,
alongside physical cash and reserves.
The structure of the program is fairly straightforward. The PBoC
will issue DC/EPs to commercial banks against cash or reserves
deposited at the central bank. The banks, in turn, will issue DC/
EPs to the general public. The public users will download digital
wallets to store their DC/EP funds, and the wallets will generate a
code that can be scanned to make purchases at payment terminals.
Because the DC/EP is designed to replace cash in circulation,
commercial banks will have a role in distributing the digital
currency to users, meaning that the PBoC will not disintermediate
them for now. Banks must deposit exactly the same amount with
the PBoC as the DC/EPs they distribute. So unlike alternative
currencies—which can be very volatile—the value of one DC/EP
will always be 1 renminbi (Exhibit 2).
While the structure seems simple enough, the technology will not
be. In replacing cash, the underlying system needs to be resilient,
available at all times, flexible, secure, and private. Given the
Chinese government’s prioritization of digital currency, its features
are likely to be superior to third-party payment systems. For
one, as a direct liability of the PBOC, the DC/EP will enjoy the
backing of the government, while other digital payment systems
carry the default risk of their corporate parents, even if that risk is
low. In addition, with support from the government, the PBOC
has the ability to ensure the DC/EP is more widely used than
 4

Exhibit 2 Exhibit 3
Volatility: Cryptocurrency Bitcoin vs. Fiat Currencies and Gold Nearly 85% of Chinese Payments Are Digital
30D Volatility (%) (Millions)
140 1,000

105 750

70 500

35 250

0 0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 2019
2015 2016 2017 2018 2019 2020
Bitcoin Gold Euro Chinese renminbi Number of Internet Users Number of Mobile Internet Users
Number of Online Payment Users Number of Mobile Payment Users
As of 31 December 2020
The 30-day price volatility equals the annualized standard deviation of the relative price
change for the 30 most recent trading days’ closing price, expressed as a percentage. (%)
Source: Lazard, Bloomberg 90
Payments as % of online users

60
competing digital currencies. For example, all online and offline
merchants could be required to accept the DC/EP; also, the DC/ Payments as % of mobile users
EP could be enabled with near field communication (NFC)— 30
contactless communication between electronic devices like
smartphones—a more reliable technology for transactions than the 0
Internet, which third-party payment firms use. 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

As of 31 December 2019
China’s Many Motivations Source: CNNIC

China’s digital payment ecosystem is already one of the most

advanced in the world. Mobile chat and payment apps in China
now have hundreds of millions of active users and provide
them with access to a wide spectrum of financial services—from
payments to savings products. In fact, approximately 85% of
transactions in the country originate with some sort of digital
payment, up from 54% in 2012—meaning only 15% of
transactions currently involve cash (Exhibit 3).
So why is China so eager to launch its own digital currency? Like
other central banks, the PBoC is concerned about the potential for
alternative currencies to undermine the national currency, but it
has other, unique objectives as well.
First, even though China has granted third-party payment licenses
to more than 270 companies, the online payments market has
been dominated by the top two players: Alibaba’s AliPay with
a 52% market share and Tencent’s TenPay with a 37% market
share. Each has the potential to rapidly establish a dominant
position by leveraging its large user base and network. Therein lies
a major motivation for the PBoC: to challenge this duopoly and
prevent a monopoly from developing. It is noteworthy that of all
central banks considering digitalization, only China’s has cited this
as an objective.
That said, another goal for the PBOC should not be underestimated:
financial inclusion for the “underbanked” portion of the population,
who have little access to credit and still use cash to a large extent. A
survey by the World Bank in 2017 found that Asia has the largest
percentage of the unbanked adult population globally at 49%,
followed by Africa at 25%. The two countries with the largest
populations, China and India, have 12% and 11% of the global
unbanked population, respectively. Bringing more people in
underdeveloped areas into the financial system could not only benefit
them but also reduce the informal economy in China, allowing the
government to see the full scope of economic activity.
Unlike cash transactions, digital money will leave an electronic
trail. Therefore, the PBoC will be able to establish the locations
and, if needed, the parties involved in transactions, which could
help the PBOC uncover illegal activity, including capital flight.
China does not allow free cross-border capital movements, and
capital flight happens frequently, creating a substantial challenge
 5

Exhibit 4 Exhibit 5
Chinese Cross-Border Payments Are Near an All-Time High Chinese Renminbi Has Become a Slightly Larger Component
of Global Currency Reserves
(%) ($M)
42 -100,000 World Currency Composition of Official Foreign Exchange Reserves
100

80
28 -50,000

60

14 0 40

20
0 50,000
2013 2014 2015 2016 2017 2018 2019 2020 0

2020Q1
2020Q2
2020Q3
2018Q1
2018Q2
2018Q3
2018Q4
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4

2019Q1
2019Q2
2019Q3
2019Q4
2017Q1
2017Q2
2017Q3
2017Q4
China BOP Net Error and Omission [RHS, inverted]
Share of CNY Receipts [LHS] Share of CNY Payments [LHS]

As of 31 December 2020 Claims in US dollars Claims in Australian dollars

Source: Lazard, Bloomberg, SAFE Claims in Euro Claims in Canadian dollars
Claims in Chinese renminbi Claims in Swiss francs
Claims in Japanese yen Claims in other currencies
for the PBOC in setting monetary policy. It occurs in various Claims in Pounds sterling Unallocated Reserves
ways, but one of the most common is the manipulation of invoices
As of 30 September 2020
by Chinese companies trading internationally, resulting in Source: Lazard, Currency Composition of Official Foreign Exchange Reserves
transfers of money abroad. The DC/EP electronic trail could help (COFER), International Financial Statistics (IFS)

by capturing information on cross-border fund flows, which are

inherently complex and now near their historical high of around
more common across China’s borders, they could be settled in
40% of total payments and receipts (Exhibit 4). The rise in cross-
renminbi rather than dollars.
border flows in recent years, mostly through capital accounts, is
also associated with the seemingly large errors and omissions in China is expected to offer its trading partners in Africa the
China’s official balance of payments, and these would potentially opportunity to test its DC/EP. Many African countries do not
be reduced. have fully convertible currencies, and mutual trade is frequently
settled in US dollars, which can be expensive. With its strong
Importantly, the PBoC will also be able to use transaction
geopolitical influence in the region, China could aim for African
information in aggregate on an anonymous basis to see trends in
countries to use the DC/EP not only in their trade with China,
the economy as they develop. For example, the central bank could
but also for their own domestic transactions. Extending that
use real-time big data generated by DC/EP transactions to better
further, one could envision China leveraging its Belt and Road
understand consumption and credit growth at the peer-to-peer
Initiative to promote settlement in renminbi, which ultimately,
level. Equipped with aggregated data, China could in the very
if all the pieces fall into place, would give the Chinese currency a
near future operate with a real-time, on-demand monetary/fiscal
bigger role in the international monetary system. Admittedly, such
policy mix, even targeting a specific town, district, or area of the
a transition would likely take place over a long period, though the
country—truly customized monetary policymaking.
technological evolution of the DC/EP should almost certainly
International Ambitions facilitate it.

Most central banks are looking first to design digital currencies Making It Official
for domestic users and domestic payment systems. However,
It has been about a year since China began test-piloting its
China is also interested in the potential for cross-border use, which
CBDC, and the official launch is probably close, in our view. The
would advance the PBoC’s long-term goal of internationalizing
introduction of the DC/EP to the public may be a significant step
the renminbi and ultimately increasing its role as a global reserve
further toward a cashless society in that country. It should allow
currency (Exhibit 5). A large portion of cross-border transactions
China not only to maintain sovereignty over its own currency
with China are currently done in US dollars, in part because of
and public policy but also to compete successfully with alternative
the US currency’s dominant position as the world’s largest reserve
currencies.
currency. However, if cost-efficient peer-to-peer transfers become
 6

China has a number of unique motivations for pursuing a digital
currency now. Still, we expect other major central banks to follow
in the coming years with digital currencies tailored to each central
bank’s objectives and the needs of its population. ECB President
Christine Lagarde recently said the bank hopes to launch a digital
currency within five years, while Fed officials are conducting
studies to determine how digital currency would work best in the
United States.
Defending their sovereign currencies from competition—first
from alternative currencies and perhaps soon from China’s DC/
EP—has pushed developed markets central banks to enter the
digital currency race, albeit with a delayed start. If China reaps the
benefits it hopes for, especially the ability to improve monetary
policy by using real-time data, other central banks may well pick
up the pace.

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Published on 19 February 2021.
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