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What’s next for China’s digital currency?

China’s government has struggled to find uses for e-CNY inside of China. Now, it's hoping to use it to challenge the US-dominated international financial system.

August 3, 2023
the e-CNY extends out over the ocean from a bank on a landmass the shape of China
Stephanie Arnett/MITTR | Envato

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China’s digital yuan was seemingly born out of a desire to centralize a payment system dominated by the tech companies Alibaba and Tencent. According to its central bank, the digital currency, also known as the e-CNY, is both a risk-free alternative to these commercial platforms and a replacement for physical cash, which is becoming obsolete. 

Almost three years into the pilot, though, it seems the government is still struggling to find compelling applications for it, and adoption has been minimal. Now the goal may be shifting, or at least broadening. China appears to be charging ahead with plans to use the e-CNY outside its borders, for international trade. 

If it’s successful, it could challenge the US dollar’s position as the world’s dominant reserve currency—and in the process shake up the global geopolitical order.  

The (public) rationale

From the outside looking in, it is impossible to fully ascertain the government’s plans for the e-CNY. Though the People’s Bank of China (PBOC) has not been shy about its central bank digital currency (CBDC) project, it has revealed few specific details about how the e-CNY actually works—or how it ultimately intends to use it.

One thing we do know is that it’s been a long time in the making. 

While Alibaba and Tencent launched their digital payment systems in 2004 and 2005 respectively, China began researching digital currency technology in 2014 and launched a research institute devoted to the concept in 2016, hoping to create a centralized alternative. Then in 2019, after Meta (then called Facebook) proposed its own global digital currency, PBOC officials expressed concern that the coin, called Libra, might undermine the monetary sovereignty of China’s currency, the yuan. The next year it started the e-CNY pilot phase, which is still ongoing.

According to Mu Changchun, director general of the PBOC’s Digital Currency Institute, the e-CNY project has three main goals: to improve the efficiency of the central bank’s payment system, provide a backup for the retail payment system, and “enhance financial inclusion.”

“Now we can provide 24/7 services to the general public,” he said during a talk he gave via Zoom for an event hosted last year by the Atlantic Council, a foreign policy think tank in Washington, DC. Mu added that the e-CNY will broaden access to the PBOC’s payment system—extending it to, among others, more private-sector firms, including fintech companies and telecom operators.

Mu said e-CNY will also serve as a necessary backup to the popular mobile payment apps Alipay and WeChat Pay, which dominate China’s daily retail transactions. Most people in China don’t use cash or credit cards but rely on their phones to buy things, so these commercial platforms have become “significantly important financial infrastructure,” Mu said. If something ever goes wrong with them, “that will bring a very significant negative impact to the financial stability of China,” he said.

On top of that, between 10% and 20% of people in China don’t have bank accounts and can’t access the commercial financial system, said Mu. Visitors to China from other countries also often have difficulty participating in the mobile-dominated payment system, where many vendors no longer take cash or even cards. They could use e-CNY instead, according to Mu. 

It’s possible to access e-CNY through commercial bank apps, but it’s also possible through an app run by the PBOC. The PBOC’s choice to connect directly with retail customers through its app is remarkable, because central banks typically deal only with other banks.

“Managed anonymity”

China is at the forefront of an increasingly global push to adopt CBDCsMore than 100 countries around the world are exploring possible CBDC designs, and a big question they are wrestling with is how directly the central bank should be involved versus letting the currency be run by private-sector intermediaries. For example, to prevent money laundering and other financial crimes, traditional banks require users to verify their identities. Most central banks don’t want to have to do this kind of admin for millions of people, says Ananya Kumar, an associate director for digital currency research at the Atlantic Council.

But the PBOC’s desire to do just that explains why some civil liberties activists oppose the idea of CBDCs. Around the world, retail transactions are going cashless, and if cash becomes obsolete, governments will use CBDCs as tools for surveillance and control, argues Alex Gladstein, chief strategy officer at the Human Rights Foundation. 

“The Chinese government wants more control over payments,” says Gladstein. Though it already has a firm grip on the two commercial payment giants, direct control and oversight over a digital currency would provide much better data and the power to deny people access, he says. 

The PBOC, on the other hand, says the e-CNY will protect people’s privacy thanks to a policy that it calls “managed anonymity.” In short, it’s possible to get an e-CNY account using only a mobile number. Balances for these accounts are capped. In his talk last year, Mu said the cap was 10,000 yuan (around $1,400 at the time of this writing) and that users of such software wallets can spend up to 2,000 yuan per transaction and 5,000 yuan per day. 

Mu dismissed the idea that the government could determine users’ real identities from the mobile numbers. China’s new Personal Information Protection Law will prevent telecom operators from sharing identifying information with the central bank or other e-CNY operators, he said.

One particularly advanced feature of e-CNY is the ability to transfer money between two people using devices that are not connected to the internet. During the Atlantic Council talk, Mu showed a video of people using this offline payment function with smartphones as well as plastic cards with e-ink displays.

Feeling around for a fit

But why should people adopt the e-CNY? It seems the government is still trying to figure that out. The PBOC has been piloting the currency for almost three years, testing a wide variety of potential uses. 

Kumar and her colleagues have documented 30 different test applications, ranging from bank loans to cards that combine e-CNY wallets with other functions. Examples include an “elderly care card,” which integrates health-care information and location data with an emergency service system; a “smart student ID”; and a card that pays e-CNY rewards for using low-carbon transportation. There are also several pilots focused on online commerce in rural areas. And in April, Changshu, a city of 1.5 million people, said it would start paying public employees in e-CNY.

“All kinds of little nooks and crannies of the payment system are getting reached by e-CNY,” says Darrell Duffie, a professor of finance at Stanford’s graduate school of business. 

Still, hardly anyone is using it. Though the system has been tested in 25 cities, and 260 million unique wallets hold a total of 13.61 billion RMB ($1.9 billion), last year e-CNY accounted for only 0.13% of the supply of central bank reserves and cash in circulation. “That’s very small after two years of piloting,” says Duffie. He says the only reason it’s still called a pilot is that it hasn’t taken off.

Officials have said there is no set timetable for the formal launch of the e-CNY, and that the bank is focused on improving the user experience and testing the security and resilience of the network rather than increasing adoption. But some close observers think the government underestimated how hard it would be to create a retail payment network from scratch.

“A lot of the ambition for this project has proven more difficult to achieve than they thought, and the timeline has been longer than people anticipated,” says Martin Chorzempa, a senior fellow at the Peterson Institute for Economics, a think tank in DC. What’s been especially difficult, he says, has been signing up enough merchants and creating a rich enough “ecosystem” to make the e-CNY as useful as established payment methods. 

“The e-CNY has to be as useful as Alipay and WeChat Pay for it to actually have a user base, and right now there really is not a use case,” says Chorzempa, who has written a book about China’s payment system. “People just get a red envelope, they spend it, and they generally don’t open the e-CNY app again,” he says, referring to the electronic icon the government uses when it doles out digital money to pilot participants. Chorzempa speculates that the challenges the PBOC has had in getting traction for the e-CNY inside China may be contributing to its increased focus on international uses. 

And that has put the e-CNY on a collision course with the US dollar.

e-CNY vs. USD

Though the government may be struggling to find compelling applications in China, it may have found one elsewhere, in the form of large cross-border payments between banks. The international payment system, which consists of a network of so-called correspondent banks, can be cumbersome and slow. CBDCs could be faster and more efficient.

For China, there could also be a geopolitical upside: an alternative set of international payment rails that the United States does not control.

Because the dollar is the world’s dominant reserve currency, a country that wants to do business with others typically needs dollars. That means the US can effectively expel an adversary from the global financial system. For example, when Russia invaded Ukraine in early 2022, the US, with help from its allies, imposed sanctions on Russia’s biggest banks that targeted assets and barred them from US-controlled global financial infrastructure, hampering their ability to raise capital.

This geopolitical advantage could be undermined if currencies like the Chinese yuan become more prevalent in global trade, a process that the e-CNY could accelerate. That’s why an e-CNY pilot called Project mBridge is important, says Chorzempa.

The project is a test of infrastructure for a “wholesale” CBDC led by China, which would be used for large-value cross-border transfers between banks, says Chorzempa. “That’s really where you get into actual potential competition with the US dollar,” he says. 

Today, banks typically execute such transactions using what’s called the correspondent banking system. A correspondent bank is a third party that serves as an intermediary between domestic banks in different countries. 

According to the Bank of International Settlements (BIS), however, this system “has not kept pace” with the “rapid growth in global economic integration” that has occurred in recent decades. Correspondent banks duplicate processes and steps, making cross-border payments costly, slow, and operationally complex—with “limited access and low transparency,” according to the BIS. Researchers at the BIS believe that a CBDC-based system could make this system more efficient and cheaper.

That’s part of the BIS’s rationale for working with the PBOC—along with the central banks of Hong Kong, the United Arab Emirates, and Thailand—on Project mBridge. Over the course of six weeks last August and September, 20 commercial banks used a custom blockchain to settle $22 million in cross-border transactions using CBDCs. 

That’s only a “drop in the bucket,” acknowledges the Atlantic Council’s Kumar. Still, it’s important because it’s the first time multiple jurisdictions have settled CBDC transactions, she says: “Not can, not potential—have actually done it.” It’s also a big deal in the context of the ongoing global discussion about “de-dollarization” and the internationalization of other currencies, says Kumar. 

Given the “weaponization of the dollar” via sanctions, China and other countries are trying to develop new ways to settle trades, she says. For example, in April, Bangladesh used yuan to pay off a loan from Russian lenders, using an interbank payment system that China developed called the Cross-border Interbank Payment System, or CIPS. “It did that partly because a) its dollar reserves aren’t very high and b) it wants to actually transact with Russia,” says Kumar. Sanctioned Russian banks are blocked from using the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the platform that facilitates most wholesale cross-border transactions.

In Kumar’s view, however, mBridge is about more than currency: “The more important part there is about the technology that is getting internationalized and used by other countries because there’s a geopolitical motivation for them to do that.” She has hypothesized that what might emerge if China is successful is “a set of technical and regulatory standards built in the image of the e-CNY.” 

It’s likely no coincidence that the US Federal Reserve is now researching CBDC systems for large-value cross-border transactions too. Last November, the New York Fed released results from the first phase of what it calls Project Cedar: “a multiphase research effort to develop a technical framework for a theoretical wholesale central bank digital currency.” In May, it published results from Phase II, a collaboration with Singapore’s central bank. According to the New York Fed, the project demonstrated that distributed ledger technology could support “enhancements to multi-currency payments and settlements.”

It will be “a long, long time” before the e-CNY might become a geopolitical problem for the US, says Stanford’s Duffie, not only because the technology is complicated but also because the legal and governance issues for cross-border payments are so complex.

Chorzempa agrees that it would take a long time for the e-CNY to significantly disrupt the dollar’s power, if it ever happens. China is betting that many other countries will adopt “tokenized” central bank payment systems, he says, but it’s still not clear if the technology offers advantages over conventional payment systems. Nevertheless, he says, “I would not write it off.”

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