Context: Recently, People’s Bank of China (PBoC), China’s central bank has initiated the Central Bank Digital Currency (CBDC). It is christened as Digital Currency Electronic Payment (DCEP) which is available via a mobile wallet app.
Key Points

• In December 2019, a pilot programme was launched in Beijing to intensively advance the trial work of fintech innovation regulation.
• This pilot has now been expanded to include several other cities.
• This expansion of the pilot marks the initiation of China’s central bank digital currency (CBDC).
• Christened Digital Currency Electronic Payment (DCEP), available via a mobile wallet app.
• It is pegged 1:1 with fiat currency, and designed to replace M0 which comprises currency issued by the PBoC less the amount held by banking institutions.
• This is the first such serious initiative in the whole world.

About DCEP

• DCEP is designed to function as “cash,” or just as the base money supply, M0 (M0 is currency in circulation).
• DCEP is built with blockchain and cryptography, which presumably ensure superb security, it is run on a centralized database.
• DCEP uses a DLT architecture (with central controls) which preserves the primacy of the monetary authority, unlike private cryptocurrencies such as Bitcoin that are truly decentralised.
• The plan is part of the response to President Xi Jinping’s push to “seize the opportunity” of blockchain technology.

The digital yuan is structured on a two-tier monetary system:

• A central bank-issued CBDC for commercial banks and
• A commercial bank-issued CBDC focused on the public.
• This is the first such serious initiative in the whole world.

Pilot Cities

• It includes Shenzhen, Suzhou, Xiong’an and Chengdu, and people with an account in major banks such as the Agricultural Bank of China (ABC).
• Account holders can open a digital DCEP wallet on their ABC app, top up its balance and use it to pay for service provided by local businesses including Starbucks, McDonald’s and participating grocery stores and restaurants.
• It will also involve transferring salaries to government workers in the form of the new Digital Currency.

Why China developed it?

• Chinese investors were always enamored of cryptocurrencies. Bitcoin became increasingly popular as an alternative asset class in China. China has emerged as the capital of the crypto ecosystem, accounting for nearly 90% of trading volumes and hosting two-thirds of bitcoin mining operations.
• The PBoC tried hard to curtail this exuberance but achieved limited success. This move to introduce the CBDC in China is a logical outcome of the efforts to curb and tackle its runaway cryptomarket practices. Or, the philosophy of the PBoC could simply have been, if you cannot beat them, join them.

Advantages

• Compared to physical money, DCEP has its distinctive pros.
• For the government, a digital yuan could eliminate money printing costs and high handling charges.
• It is a powerful antidote for tax evasion, money laundering and terror financing.
• It can materially boost tax revenues while also improving financial compliance and national security.
• As a tool of financial inclusion, particularly in emergencies, Direct Benefit Transfers can be instantly delivered by state authorities deep into rural areas, directly into the mobile wallets of citizens who need them.
• It will provide central banks an uncluttered view and powerful insights into purchasing patterns at the citizen scale.
• By digitizing coins and physical cash and incentivizing the use of the DCEP on mobile apps tied to the PBOC, it could give China greater leverage over interest rates to spur spending or to curb the outflow of cash from the country.
• For commercial banks, DCEP could facilitate more money transactions with lower costs, increase business innovation while minimizing the risks.
• For the public, DCEP could save them from indirect transaction fees for interbank transfers. Domestic and cross-border payments will also involve less friction.

Disadvantages

• This would give rise to a surveillance state and the concomitant erosion in citizen privacy and anonymity.
• CBDCs be used to spy on every movement of people’s money.
• Monetary authorities previously have objected to idea of cryptocurrencies

It is due to the following reasons:

• Wild fluctuations in the value of cryptocurrencies
• The implied challenge to the monopoly of central banks in issuing fiat currencies
• The looming possibility of software bugs
• The tainted shadow of the dark web

Signals from the move

• First, on the world economic stage, it may want DCEP to challenge the hegemony of the U.S. dollar as the default global reserve currency.
• Second, in its war with American BigTech, it may want to showcase DCEP as its weapon of choice to counter Facebook’s Libra, which is planning to offer a common cryptocurrency to 2 billion-plus FB users across the world.
• Third, and still in the realm of speculation, it may wish to use the DCEP to clip the wings of AliPay and WeChatPay, gigantic fintech duopolies that control 90% of China’s domestic digital payments, and whose ambitions may one day pose a threat to the aura and authority of the central bank.

Why central banks are sceptical of cryptocurrencies?
Historically, monetary authorities everywhere have been sceptical of cryptocurrencies.
The reasons for scepticism includes following problems-

1. Wild fluctuations in the value of cryptocurrencies.
2. The implied challenge to the monopoly of central banks in issuing fiat currencies.
3. The looming possibility of software bugs.
4. The tainted shadow of the dark web.

• But some central banks have been planning to issue fiat digital currency Authorities were far more intrigued by CBDCs.
• In fact, the Basel-based Bank for International Settlement (BIS) has been conducting surveys on this issue for some time.
• The recent survey of 2019 “Proceeding with Caution – a Survey on Central Bank Digital Currency” revealed that while in general, central banks have been proceeding cautiously towards introducing central banks digital currencies.
• Some have been planning to issue a fiat digital currency in the short to medium term.
• In particular, the survey revealed that nearly 25% of central banks have the required authority to issue a CBDC, while a third do not, and 40% remain unsure.

Road Ahead

• From gold to silver to paper to digital, the march of currencies goes on. China has rolled the dice on central bank digital currencies, challenging other nations to follow. Welcome to the future of money.