China Leads the Push for Central Bank Digital Currencies with e-CNY

While still in its infancy, China’s efforts to spread the use of its own digital currency will have an impact on both the domestic economy and China’s role in the international monetary system. 

This article is part of a series of articles authored by young, aspiring China scholars under the Future CHOICE initiative.

In response to the improvements in financial technology and the rise in the popularity of cryptocurrencies issued by private entities, the central banks of many countries have begun studying and pilot testing their own central bank digital currencies (CBDCs). 

China began exploring a potential digital currency of its own in 2014. In 2016, the People’s Bank of China (PBOC) announced that it had successfully designed a test prototype of the digital yuan, which was used in a pilot project first in the cities of Shenzhen, Suzhou, Chengdu and Xiong’an, and in early 2021 extended to other provinces. In September, the Central Bank of China said it was improving institutional arrangements for cross-border payments in the digital yuan. 

Central Bank Digital Currencies

Central bank digital currencies are legal means of payment issued by a central bank. The various definitions of the phenomenon are similar in that they characterize CBDCs as currencies that are quite similar to physical money in their functionality but are issued in digital form and represent an asset on the central bank’s balance sheet. All CBDCs rely heavily on the products of the outstanding progress in financial technology in their operation, but they differ according to the technological approaches they use. 

When considering this aspect of CBDCs, we can distinguish between account-based CBDCs, where the sender of funds checks the identity of the recipient before fund transfer, and token-based CBDCs, where the sender does not verify the authenticity of the recipient’s account, but the authenticity of the token for each transaction. The implementation of an account-based digital currency system can be quite challenging because it requires the existence of only one identifier for each user of this means of payment, as is the case with traditional bank accounts. 

Token-based digital currencies, which rely heavily on blockchain technology to operate, can be problematic from a cash flow control point of view, as they don’t allow law enforcement authorities to see transactions as they do with cash purchases, meaning that such digital currencies need several safeguards to function successfully and securely. 

CBDCs also differ in scope and accessibility – retail CBDC is available to the general public, while wholesale CBDC is only available to financial institutions. Retail digital currencies are intended for payment transactions between individuals and companies, while wholesale ones are used mainly for interbank payment transactions.

Digital Yuan Lottery

The Chinese government distributed 40 million digital yuan in June 2021 through a lottery in Beijing, in order to incentivize citizens to use the digital currency. Residents were able to sign up through two banking applications, thereby participating in a draw for one of the 200,000 ‘red envelopes’ containing 200 e-CNY (digital yuan, about €28), which they could then spend only at selected stores. This enabled China to test the digital currency on a larger sample of the population.

By June 2021, more than 20 million personal digital wallets and more than 3.5 million business wallets had been installed. The digital yuan had been used on more than 1.2 million occasions during this time, e.g. for paying for public transport, shopping, using government services, etc. The total volume of transactions during this time is estimated to be over 70 million e-CNY.

During the Winter Olympics in Beijing in 2022, the digital yuan was offered as a payment option for the first time to foreigners without a bank account in China. The digital yuan was used more times than Visa inside the Olympic bubble on the opening day of the Olympic Games. However, it should be emphasized that this did not internationalize China’s digital currency, as foreigners could not use their digital wallet and currency outside of the Olympic Games venues. In April 2022, China announced that digital wallets and digital yuan are now available for use in 23 cities across China, and will also be available at the upcoming Summer Universiade in Chengdu and the Asian Games in Hangzhou.

However, despite the successful pilots, there is still a lot of work to be done in terms of promoting the use of digital yuan. Some of the issues that the POBC will have to address are the use of digital currency by foreigners living in China, due to restrictions on opening a bank account in China, as well as concerns related to privacy and data protection.

Competition with China’s Tech Giants

It is still difficult to judge the actual impact of the digital yuan until the project is fully realized. For the digital yuan to succeed, it must be adopted by the majority of the Chinese population. As part of the pilot project, 261 million wallets were issued, but a closer inspection reveals that most of them are not in use or are practically empty, as the average balance in the wallets is 3 RMB, i.e. about €0.5. 

Digital payment platforms are already widespread in China, and private providers represent major competition to central bank digital wallets. The main providers are Alipay and WeChat Pay, which differ from digital wallets primarily in that they work via QR codes and not the NFC system. About 83 percent of transactions in China are made over mobile phones, and as many as 776 million users of digital payment platforms were registered in March 2020.

Currently, the digital yuan is only used through a digital wallet, which is not integrated into social networks like AliPay and WeChat Pay. The existing digital payment platforms in China are unified to the extent that through a single application (e.g. WeChat) an individual can make all purchases, order a taxi, make an appointment with a doctor, use it as a social network (like Facebook and Instagram), transfer money to friends, etc. 

As the already prevalent payment systems are also free to use, from the consumer’s point of view, the digital yuan wallet brings only one big advantage – the possibility of NFC transfers. The use of NFC enables offline payment and transfer between accounts using the phone, where one device acts as a card and the other as a receiver. The ability to access the payment function without internet connection is especially relevant in rural areas, where communication infrastructure is often poor.

As this is the only major user-side advantage of the digital yuan wallet, it does not yet represent serious competition to the existing digital payment platforms, at least from the view of the average user. Since Tencent and Alibaba already announced they will include e-CNY as a payment option on their platforms, it is likely that the digital wallet will be used only to top-up e-CNY balances on AliPay and WeChat Pay.

Trading Convenience for Anonymity

The immediate goal of implementing the digital yuan nationwide is to transform the current Chinese payment system by providing a digital payment method similar to cash: accessible to all, cheap, anonymous (to a certain extent) and one which would limit the power of private providers of digital payment platforms.

The loss of anonymity when making payments – both business and personal – is one of the biggest concerns in the implementation of the digital yuan with the goal of someday completely replacing physical currency. A digital currency system can be centralized to the extent that the central bank has insight into every transaction, and the data could be easily accessed by the Chinese government with the aim of prevention of the gray economy, money laundering, tax evasion, corruption and terrorist financing. This would particularly affect service professions, which in China are often part of the gray economy, such as cleaning services, babysitters or gardeners. With the complete absence of cash, providers of such services will perceive regular monthly transactions as potentially suspicious. 

However, the PBOC says the digital yuan system collects less transaction information than traditional electronic payments and does not share information with third parties or other government agencies unless required otherwise by law and regulation. There is also a connection between the anonymity requirements of digital wallets and account balance and transaction limits. When acquiring a digital wallet with a certain daily transaction limit and an account balance limit, the individual needs to indicate only their telephone number. However, upgrading to a higher balance and daily and individual transaction limits requires entering an ID number and bank details.

Alternative to SWIFT

One of the goals of the transition to the digital yuan is to create a currency with which China can compete with foreign digital currencies and potentially internationalize the RMB. To achieve this goal, the digital yuan must be attractive enough. China has therefore enabled cheaper and easier international payments in international ports, thus bringing the digital currency closer especially to markets hindered by expensive access to global payments based on dollars. 

China also aims to mitigate the effects of potential decoupling, should the US move to exclude China from the international monetary system. Systems such as SWIFT, which international transactions depend on, are either dollar-based or involve at least one US financial institution in the transfer process. After the invasion of Ukraine, for example, Russia was excluded from the SWIFT system, limiting its international transactions. 

The transition to digital currency is a form of ‘insurance’ against such sanctions, since SWIFT is not required for the cross-border transfer of digital yuan, insofar as other banks also have a developed system for accepting digital currency. The PBOC is already working on institutional arrangements for cross-border use of the yuan to increase its use internationally. 

In this way, China not only shields its own companies from sanctions but can also carry out transactions with countries and companies that are themselves sanctioned. Indeed, China’s central bank would have full control over the establishment and operation of a cross-border digital yuan trading system that could allow Chinese companies sanctioned by the US, as well as Chinese companies wishing to transact with US sanctioned entities at home and abroad, to continue with business as usual. Namely, Chinese companies would not have to rely on middlemen who need access to US dollars, including big banks. Importantly, this could also happen without a change in capital control policy, as the digital yuan would easily be used in place of other existing payment methods.

Furthermore, cross-border payments in digital yuan would protect Belt and Road Initiative (BRI) projects from sanctions, thus stabilizing and also strengthening China’s position in international trade. If China lowers the cost of switching to the digital yuan, countries will have no reason to continue transacting with it in dollars. The use of the digital yuan for cross-border transactions with China would also establish greater transparency and controllability of transactions, while again raising the issue of China’s control over them. Indeed, in this case, China would gain greater control over the funds used in the BRI.

For China to internationalize the digital yuan, two steps await: the final establishment of the digital yuan system and the encouragement of partner countries to switch to the digital currency. Both steps are already underway, but there is still quite some time before their final realization. The field of CBDC itself is still in its infancy, as most countries are still exploring the possibilities of establishing their own digital currencies. 

Nevertheless, due to the far-reaching consequences that the introduction of the digital yuan can have in China, it is important to monitor its further development and, as it progresses, to closely observe the consequences both inside the country and abroad. If the CBDC implementation project is successful on such a massive scale as China’s, this achievement can serve as a basis for the digital transformation of many other economies, including those in the EU.

A previous version of this article was originally published in Slovenian in the professional journal Management (volume 17) issued by the University of Primorska Press.