CBDC Unmasked: The “Whys” Behind China’s Central Bank Digital Currency

Updated: Jan 24

Why is China adding fuel to accelerate the development of its Central Bank Digital Currency? What are the motivations behind the CBDC?

An inside look into China’s CBDC

Since 2014, the People’s Bank of China has committed significant resources into researching the potential of launching a Central Bank Digital Currency (CBDC). Despite the enormous legal system and public policy framework challenges, after six years in May 2020, a pilot run of CBDC finally took place in the Greater Bay Area. Several large firms, such as Didi Chuxing and Meituan Dianping have established strategic partnerships with the Chinese government in order to roll out CBDC test runs on a larger scale.

Being one of the first movers, China has recognized the need for CBDC in a digitalizing economy, but what are the underlying forces that are pushing China to establish the CBDC? What are some of the possible motivations?

timeline of China’s CBDC (by Americana Chen)

Digital Payment Environment

Image source: Merchant SavvyChina

China is leading the transition into a tokenized, cashless economy. In 2019, the number of proximity payment users in China grew by 10% to reach 577.4 million, becoming the largest user base in the world, with popular Mobile payment service providers Alipay and WeChat sitting at the global top two with 1.3 billion active users combined. It is forecasted that in 2022, mobile payments will take up more than 40% of payment transactions, exceeding all other traditional payment methods in Asia Pacific. Meanwhile, in the US, a mature and convenient credit card payment system has slowed the adoption rate of digital wallets.

Image source: Merchant Savvy
“Looking at matters long-term, the promotion of CBDC could have a far-reaching impact on all of society. At the micro-level, the first is that we will gradually enter a cashless society” — Xu Yuan, senior researcher with Peking University’s Digital Finance Research Centre

Pressure from Libra

Under such an environment, it didn’t come as a surprise that the Chinese government decided to research this area earlier than other countries. However, research progress has been slow, and it wasn’t until Facebook confirmed the launch of its Cryptocurrency — Libra in 2019— that the Chinese government started to push and accelerate the development by rolling out multiple piloting trails of CBDC to try and bring this project to reality. China has rigid regulations on cryptocurrency exchanges. Initial coin offering was banned in China since 2017, but Libra is a different story. It is a “Stablecoin,” meaning that it is pegged to a basket of fiat currencies, and this means Libra will not be just another speculative cryptocurrency, but could potentially be widely adopted for consumer purchases. Its multiple currency baskets clearly sets its vision to become a global currency. This imposes a threat to China’s capital control policies, as there is a risk that capital outflow could become hard to control, and capital flight may occur as citizens convert their assets to Libra digital currency. To combat these concerns, the CBDC, which is only be pegged to RMB, will fall under capital control policies, reassuring the Chinese government with the power to watch over its capital outflows.

Image source: China Power

Internationalization of RMB

Furthermore, being the first country in the world to issue a central bank digital currency may help RMB with its current position in the global currency market. Due to capital control policies and the dominance of SWIFT and CHIPS, the role of RMB in the global currency market has always been an elephant in the room for Chinese monetary policy makers. In 2020, despite the fact that China contributed to 10% of global trades, the use of RMB for payment only takes 1.76%. Chinese central authorities have been ambitious about the internationalization of RMB since the late 2000s; however, progress has been slow. With SWIFT supplying its transaction data to the US and having 12/25 directors from the US and its allies, China found it extremely difficult to set up a level playing field for Chinese exporters and importers in such an environment. According to SWIFT, China is expected to take up 15% of global trade in 2023. This further urges China to accelerate the internationalization of RMB. This could reduce exchange rate risks for Chinese exporters and importers and ensure them with better certainty. Not only would it improve financial stability, but the reduction in payment transaction cost would also open up more trading opportunities and strengthen domestic producers’ relationships with trading partners. With such an objective, establishing a worldwide currency clearing network and international payment architecture centering around CBDC is essential for RMB to internationalize at a faster pace.

Boosting Financial Inclusion

Digitalization has proved its power to drive financial inclusion in China, and compared to other countries, China’s progress has been significantly more impressive. Between 2009 and 2016, the largest peer to peer lending platform- Lending Club— issued nearly 16 billion USD in loans, whereas in China, Alibaba’s Ant Finance Service has provided a total of over 600 billion RMB (approximately 100 billion USD) to the public. Over the past few years, the extension of Alibaba and WeChat pay to providing easy-to-access financial services was highly effective in terms of promoting financial inclusion. Nevertheless, these financial services are not backed by the Chinese government— there is a limit in the products they offer. Now with the CBDC, it has promised to help 225 million unbanked Chinese citizens gain direct access to financial services provided by the central bank without opening an account at an intermediary commercial bank. With just a few taps on your smartphone, secured, government backed financial services will be available to you. It also acts as a convenient way for the government to distribute social welfare, economic stimulus packages, tax refunds and other financial support to the public, and improve the access to government support by the population at the bottom of the spectrum.

image source: WeChat — 52CBDC

In terms of improving financial inclusion, its ability to aggregate individual’s payment transaction histories and cash flows supplies China’s social credit system with a large amount of data to Improve accuracy of credit ratings. The social credit system is “a unified record system for individuals, businesses and the government to be tracked and evaluated for trustworthiness.”. With such centralized cashflow records, the extent to which the system could accurately reflect an individual’s credit is greatly improved; thus, many lower-income citizens who have faced restricted borrowing conditions could be opened to more funding services.

Comparing to WeChat pay and Alipay

But what does this mean for the two most widely adopted mobile payment wallet providers Alipay and WeChat pay? And what are their differences? The most obvious difference is that the CBDC will be accepted as an official currency. This means it will be accepted for tax payments, which WeChat pay and Alipay are not eligible for. Furthermore, to promote its wide adoption, the Chinese government has laid out mandatory requirements stating that all merchants accepting any form of digital payment will have to accept the CBDC. In the published draft law, it also appears to prohibit any third-party that tries to issue other RMB pegged stablecoins that might ‘replace’ the CBDC. Another key feature that distinguishes its functioning mechanism from WeChat pay and Alipay is that it supports a “dual-offline” model. According to Xu Yuan — a senior researcher with Peking University’s Digital Finance Research Centre— while using Alipay and WeChat pay requires Internet connections during transactions, the CBDC allows for transactions to be completed using near-field communications function of smartphones without an internet connection.

Image source: Lau Ka-kuen, SCMP

From past reports and its functioning mechanisms , it seems like the Chinese government has been using the CBDC as a way to regain its real-time monitor and control of payment flows in the economy, as well as limiting the duopoly power from Wechat Pay and Alipay. However, officials have confirmed that these two payment providers will be involved in the piloting project of the CBDC. At the Second Bund Summit in Shanghai, Changchun indicated that the CBDC will be distributed to these digital wallets :

“They don’t belong to the same dimension. WeChat and Alipay are wallets, while the digital yuan is the money in the wallet.”

However, it is still in question when China will commence with further large-scale piloting of the CBDC and how long it would take to be widely adopted by the public. Although the PBoC has published a draft law earlier in October to build the fundamental regulatory frameworks and legitimacy for the CBDC, it is still unknown when the CBDC will open its gateway to public usage. Previous reports have made ambitious plans to officially start public, large-scale issuance of the CBDC before the Winter Olympics in Beijing in 2022, and currently, The Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China are collaborating with the central authorities to set up stages for further test runs in several major cities in China, including Suzhou, ShenZhen, Guangdong and Beijing. It seems like with the current pace of piloting, partnership establishment, and bank collaborations, meeting this schedule is a very achievable target.


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