China is aiming to be the first country in the world to launch a digital currency, after five years of research by a team in its central bank.
The project is still shrouded in secrecy. There have been few details about what form a new sovereign digital currency might take, how it will affect banks and businesses and when it might be launched.
Confusion and speculation about the currency have grown since President Xi Jinping called for China to focus more on blockchain last month, and Facebook’s founder Mark Zuckerberg warned that Beijing’s digitisation efforts could leave American finance in the dust.
Here is what the People’s Bank of China is really up to.
What do we know?
Since 2014, China’s central bank has been working on a project called “DC/EP”: Digital Currency/Electronic Payments.
Yi Gang, the governor of the People’s Bank of China, said the plan was not to create a new currency, such as bitcoin or Facebook’s Libra project, but to partially digitise China’s existing monetary base, or cash in circulation.
Mr Yi has said the new digital currency will not replace other parts of the money supply — such as deposits held in bank accounts, and balances held by payment apps such as WeChat and Alipay.
Retail banks and fintech companies will continue to manage customer deposits in the same way, but the new digital currency could provide a neater way for banks to settle payments with each other, rather than through the existing clearing system.
The central bank added that there was no timetable for the launch, but China appears to be ahead of other countries undertaking similar research. “Most central banks are studying this, with Singapore, Canada and Switzerland having done advanced trials, but it’s likely that China will be the first to launch,” said Thomas Olsen, partner at Bain & Company in Singapore.
China is already well on the way to being a cashless society. Residents of its big cities often only carry their smartphones and pay for everything with apps such as Alipay or WeChat that are linked to their bank accounts.
Chinese users have got used to scanning QR codes to pay or to transfer money to each other, and are likely to be comfortable with using the same process to transfer digital money between digital wallets.
Is it a cryptocurrency and will it have a blockchain?
The People’s Bank has not determined what the technology behind its digital currency will be. But because of the president’s recent speech on the importance of blockchain, some have conflated the two.
The term “blockchain” itself has been highly contested, but in its original formulation it is a decentralised database stored across a network of computers, where all transactions are public and no single user has permission to alter other people’s accounts.
But the central bank would probably prefer to be in control of a database, so that only it can view all transactions and edit records. Some have called this a “private, permissioned” form of blockchain.
“Cryptocurrency” usually refers to digital currencies such as bitcoin that are implemented with blockchain technology, not controlled by a central entity. In that sense, the People’s Bank’s currency will probably not be a cryptocurrency either.
What happens to retail banks?
If people can hold their deposits of electronic cash directly at the central bank, they could cut out the middle men: the retail banks.
Former central bank governor Zhou Xiaochuan is well aware of the problems that could pose, saying: “Although in theory the central bank’s digital currency can also be used as a retail service, [we should be] very cautious, because of the major blow that could deal to the existing financial system.” In other words, Mr Zhou doesn’t want the central bank’s digital currency to become a threat to the retail banking system.
Instead, the head of digital currency research for the People’s Bank, Mu Changchun, has said the digital currency will be issued to existing financial institutions. That means the banks would then distribute it for use by customers, much as physical currency is issued now.
Why does the PBoC want a digital currency?
Under a digital payments system, it would be possible for the government to track cash transactions, which officials have said would help battle money laundering, illegal gambling and terrorist financing.
But beyond replacing cash, in the longer term the People’s Bank’s digital currency could also be used to improve the efficiency of transactions across the financial system.
If many countries adopt digital currencies, this could even reduce China’s exposure to US financial institutions, thus making the country less vulnerable to sanctions. “In the long term, central bank digital currencies could create a different settlement mechanism for cross-border transactions between countries, which could reduce dependency on US-dollar clearing,” added Bain & Company’s Mr Olsen.
Is there a privacy concern?
Critics have argued that replacing cash with a trackable digital currency poses a serious threat to privacy, because it will give the central bank — or the commercial banks issuing the digital currency — a view of everyone’s transactions.
According to a Reuters report, the People’s Bank’s Mr Mu has both promised to “give those people who demand it anonymity in their transactions”, yet “keep the balance” between privacy and clamping down on illicit transactions. But these two objectives are in tension — and the bank hasn’t explained how it will balance the two.
“I expect there’ll be resistance and some will keep using cash, because people in China still value the privacy of some transactions,” said Leo Weese, spokesperson for the Hong Kong Bitcoin Association.
What has this got to do with Facebook’s Libra?
Mr Zuckerberg recently warned the US Congress that if the company’s Libra project was blocked, it could lead to China overtaking the US in financial innovation and global influence. “China is moving quickly to launch a similar idea in the coming months,” he said.
But there are important differences between China’s DC/EP project and Facebook’s Libra. While Libra is likely to be backed by a basket of currencies, such as the dollar and euro, China’s digital currency will be purely renminbi-backed.
While Facebook’s explicit intention is that Libra will be used around the world, China’s digital currency will fall under the renminbi’s capital controls, which restrict how much can be taken out of the country.