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Digital currency

5th May – China’s digital currency

China’s digital currency

The People’s Bank of China has just launched its new digital currency, the digital yuan or renminbi.

Details –

  • In the initial pilot phase, the currency with its specific app will be available for download and use in cities such as Shenzhen, Chengdu, Suzhou, and the Beijing “smart suburb” of Xiongan.
  • This is the first time a major central bank is launching a digital currency, and it could have far-reaching ramifications on international trade as well as China’s domestic economy.
  • Not much is known yet about the digital yuan but it is said to share some features with cryptocurrencies like bitcoin and ethereum.

How does it differ from cryptocurrencies?

  • One key difference is that it doesn’t use the blockchain to record and verify transactions, since the People’s Bank of China (PBOC) manages a centralised system.
  • The PBOC is disbursing the digital yuan to banks (just as it does with the conventional yuan) and the banks will pass it on to users. Money supply will depend on the PBOC, rather than on mathematical algorithms.

How does it work?

  • The digital currency uses the bitcoin concept of asymmetric cryptography for security. Every user has a public key, which is also their personal identifier.
  • Every user also has a private key to make secure transactions. This affords what is being described as “controlled anonymity”.
  • Counterparties in a transaction can be anonymous though the PBOC will know all users and be able to access their transaction records.
  • The new coin will also be geared for so-called “smart contracts”, where money is automatically transferred in accordance with agreed terms, once a given contract is fulfilled.
  • Leaked screenshots in state media suggest that the app includes functions such as QR code payments, remittances, receiving money, and person-to-person payments simply by touching handsets.

Acceptability –

  • At the domestic level, there will be easy acceptance by both retailers and consumers. A billion Chinese consumers use the Alipay and Wechat digital wallets, running well over a billion transactions per day. Unlike Alipay and Wechat Pay, the digital currency also works offline through peer-to-peer touch payments and it does not need to be linked to a debit or credit card. So, there could be a seamless domestic transition, assuming the technical backend is solid. 

Significance –

  • This digital yuan would reduce the high costs of paper cash issuance and handling, and reduce difficulties in tracking transactions, and it also raises the barrier for fraud.
  • It’s estimated the digital yuan could be used to gradually replace 30-50 per cent of domestic money supply. Arguably, using big data, the PBOC will also get a better handle on consumption patterns, which could aid in monetary policy.
  • China is said to have hastened the launch in order to easily and quickly provide subsidies and tax refunds to households hit by the pandemic.
  • Once the currency is available for cross-border transactions, it has the potential to gain significant market share in forex markets and international trade.

A boost to Yuan –

  • China is, by far, the world’s largest trader and exporter, yet less than 2 per cent of SWIFT transactions are denominated in renminbi.
  • Similarly, the yuan is only the fifth-most traded currency in terms of volume on forex exchanges.
  • Even the vast majority of One Belt, One Road (OBOR) deals — well over 80 per cent — are dollar-denominated.
  • The new digital currency could address that dichotomy because it would reduce cross-border transaction costs and compress time drastically for completing cross-border transactions. China also possesses the geopolitical leverage to persuade its OBOR partners, and major corporations with China exposures, to start switching denominations.

The future –

  • The differential between SWIFT fees and a direct transfer or cross-currency transfer through the PBOC could be in favour of the digital yuan.
  • All this will obviously depend on network effects and good secure technology. But it is an interesting initiative by the world’s second-largest economy and biggest exporter. It could inspire similar efforts from other central banks.

SourceBusiness Standard

QUESTION China has become the first country in the world to launch a digital currency through its central bank. Discuss the issue in detail and analyse how it could benefit China in the long run?

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