China’s launch of a central bank digital currency (CBDC) has become a question of when and not if. The more important question for businesses is: how do I get ready for a digital RMB? After all, digitising the currency of the world’s most populous nation and second largest economy may well be one of the most important changes to the financial system since China invented paper money more than one thousand years ago.
In this article, we unpack the key aspects of China’s CBDC from an onshore and offshore perspective as it continues to unfold, and provide insight into the key issues to consider in engaging with this refreshed and reimagined currency infrastructure.
Background on digital RMB – what, why and when
What: For the better part of the past decade, China has been developing and testing its own CBDC known as DCEP (which stands for Digital Currency Electronic Payment) – although the terms DCEP, digital RMB, digital yuan and e-CNY are often used interchangeably.
China intends for DCEP to become legal tender in China. Legal tender status means DCEP can only be issued by China’s central bank, the People’s Bank of China (PBOC), which distinguishes DCEP from privately-issued virtual assets such as Bitcoin and Diem Coins (Libra). DCEP will enjoy the same legal status as physical RMB, which means (unlike the account balance in mobile payment service providers such as Alipay and Wechat Pay) no one can theoretically reject DCEP as payment for any public or private debt within China. These fundamental features of DCEP are reflected in recent draft revisions to the Law of the People’s Bank of China, which will provide the legal basis for the PBOC to issue DCEP.
Operationally, it is expected that DCEP will be issued by the PBOC to commercial banks and non-bank payment platforms and intermediaries, who will in turn make DCEP available to consumers and businesses. The PBOC has developed a digital RMB wallet app in which DCEP is stored. The app can be installed on smartphones to enable payments via QR codes, near-field communication (NFC) tapping and other methods.
Differentiated wallets based on verification level
To use the digital RMB wallet app, a user must register an account. There might be several types of wallet accounts depending on identity verification methods. By way of example:
· The most basic wallet account may be registered with an email address or a mobile phone number only.
· The most premium wallet account may be registered with a Chinese mobile phone number, Chinese identity card and Chinese bank card and the identity of the user might be required to be verified face-to-face.
Different types of wallet accounts are subject to different function restrictions and maximum payment sums. The most basic wallet account may be subject to the most stringent restrictions while the most premium wallet account may support more functions and larger payments.
We expect differentiation is also likely in relation to wallets that may be developed to cater for special purposes or for certain users – for example, expansion beyond Mainland China will require care.
To top up the digital RMB wallet, the user may use the balance in its existing bank accounts. The digital RMB wallet app will open several sub-wallets for the user, one for each bank and the top up amount will be stored in each sub-wallet.
It is worth noting that digital wallets are not the same as bank deposit accounts. The balance in a bank deposit account represents a liability of the bank, whereas a DCEP in a digital wallet (both the digital RMB wallet and the sub-wallet) represents a direct liability of the PBOC, and the digital wallet offered by the bank is just an interface to allow users to access their DCEP.
Significantly, DCEP will not be limited to online transactions and an internet connection will not always be required to pay using DCEP. A feature of DCEP known as ‘dual offline payments’ will allow payments to be made even when both the payor and the payee are offline.
In essence, DCEP will be a digital version of physical RMB and will be pegged to its physical counterpart on a one-to-one basis.
Why: From China’s perspective, DCEP can help achieve a number of outcomes, including:
- DCEP is intended to reduce transaction costs and times for domestic and international payments, and avoid the significant costs associated with printing, circulating and eventually replacing damaged physical money for a population of 1.4 billion, not to mention the hygiene benefits of not having to handle physical currency (which is highly relevant at present).
- DCEP can help enhance the PBOC’s control of money supply and currency circulation and will allow China to transmit monetary and fiscal policies more directly and efficiently (for example, by paying financial aid and subsidies directly to relevant individuals).
- DCEP’s eventual use for cross-border payments should support China’s efforts to have the RMB used more widely for pricing and settlement of trade transactions, the financing of projects around the region and, ideally, a reserve currency accepted by central banks.
- As a centralised (as opposed to decentralised) digital currency, DCEP will give the PBOC visibility into DCEP’s uses (subject to ‘conditional anonymity’ arrangements) and abuses (for example, money laundering, tax evasion, terrorist financing and other unlawful activities), and will allow China to use big data generated from DCEP transactions to better inform policy decisions.
- DCEP has the potential to enhance financial inclusion by bringing digital payments to populations in remote or rural regions that have more limited access to traditional bank accounts, subject to the limitations that may be imposed from a technical, policy or regulatory standpoint.
- DCEP is likely to become an important feature of China’s digital economy and financial system, and support further financial and technological innovation in China and beyond.
A wide range of commentators have expressed their own views on how DCEP will support Chinese policies and the impact this may have locally, regionally and globally.
However, we believe there is consensus that DCEP and other central bank digital currencies generally seek to incorporate substantially similar considerations, including:
When: While no official nation-wide launch date for DCEP has been announced, China has made considerable progress in steadily pilot testing DCEP in the real world. The pilot program has already expanded to major cities such as Shanghai (China’s financial centre) and Shenzhen (China’s tech hub), and is set to reach Beijing ahead of the 2022 Winter Olympic Games to be hosted there.
Internationally, China has been testing DCEP’s cross-border use in the Hong Kong Special Administrative Region and has been working with some central banks on international payments involving DCEP. The fact that the PBOC has set up a joint venture with global payments messaging network SWIFT is an indicator of China’s plans for DCEP’s international use.
In light of the paramount importance of financial and social stability, any roll-out of DCEP in China can be expected to be incremental, with physical RMB being gradually phased out after a long period of co-existence.
It’s worth noting, however, that an ‘incremental’ roll-out in the context of a USD 15 trillion (and growing) economy, the world’s largest trading nation and a population of 1.4 billion (with a bulging middle class dominated by digital natives) is still a game-changer which presents enormous opportunities for businesses.
Distinguishing features of the digital RMB
Besides being offered to retail and not being blockchain based, some of the most important distinguishing features of DCEP are conditional anonymity, support for offline-to-offline payments and support for smart contracts.
1. Conditional anonymity
DCEP has privacy considerations embedded “by design”. But as with almost every jurisdiction in the world, privacy does not equate to full anonymity and DCEP takes a structured approach to data access.
- Data provided by users is tiered – as noted above, low value payments can be made directly through a basic wallet account – that is, no identity card needs to be provided and no bank account needs to be linked thereto. If a larger payment needs to be made, the user may upgrade the wallet into a premium wallet by submitting their identity card and linking the wallet to a bank account.
- Data access is highly restricted. For example, in respect of a digital RMB wallet app where the user’s identity card information has been submitted and verified, the PBOC will know the identity of the user. However, a transaction made through that digital wallet will only contain the relevant wallet ID and neither the other transaction parties nor the sub-wallet account bank would know the user’s identity.
These conditional anonymity features help ensure the protection of personal information and prevents transaction service providers from accessing unnecessary personal information.
2. Support for dual offline payments
As noted above, the digital RMB wallet app allows dual offline payments, which means payments can be made from the payor to the payee while neither is connected to the internet.
As DCEP will enjoy the same legal status as physical RMB, it is important to ensure that payments can be made anytime, anywhere regardless of internet connection.
The technology behind the dual offline feature is significant, as critical to the success of any digital currency is avoiding the risk of “double spend”.
3. Support for smart contracts
The technology used for DCEP supports smart contracts. The precise coverage of smart contract functions are not clear at this stage, but a simple example might be the programmed provision of a governmental subsidy or allowance. The smart contract function could restrict the usage of the proceeds as well as the deadline for such usage.
How your business can get ready for a digital RMB
A business that operates in China or transacts with Chinese companies and individuals (as business partners, suppliers, customers, employees etc.) needs to start thinking about how to get ready for DCEP.
At the current stage of DCEP’s development, it is somewhat early to produce a comprehensive DCEP readiness checklist for businesses, but there are many thematic issues worth considering now. These issues include:
1. Systems and infrastructure considerations
Your business will need to have the systems and infrastructure in place to make and accept DCEP payments.
Within China: DCEP must be accepted as legal tender within China and over time, we expect most if not all businesses will need to operate within the new ecosystem surrounding DCEP.
On the surface, the emergence of DCEP may not change the day-to-day practices of Chinese consumers who already use their phones to make payments via popular mobile payment platforms such as Alipay and Wechat Pay. But behind the scenes, a whole new technological infrastructure and updates to the supporting regulatory framework will be developed to support the creation, circulation, payment and acceptance of DCEP, including new concepts such as digital wallets and dual offline payments.
Businesses will also need to consider how DCEP will interact with traditional bank accounts and existing mobile payment services. We expect physical cash will continue to have a diminishing role in major cities, although it will still play an important role in rural areas and less developed cities.
Outside China: The transactional convenience and policy importance of DCEP may see it being widely used by Chinese individuals and companies (including China’s growing middle-class and Fortune 500 companies) to make and accept international payments. Therefore, even if your business does not operate in China, there may still be benefits to considering how DCEP payments from Chinese consumers and businesses might work.
For banks, particularly those working within and outside China, there is a need to consider how to deliver ongoing support for RMB within this new framework. This includes adjusting traditional payment rails, considering how to divide tasks between onshore and offshore entities, carefully thinking through licensing and regulatory notification issues, and adapting corresponding AML/CFT controls, documentation and disclosure
Cross-border payments using DCEP can give rise to many systems, interoperability, data, legal and regulatory implications, especially if the recipient of DCEP is based in a jurisdiction that still uses physical currency, which is highly likely to be the case because China is on track to become the first major economy to roll out a CBDC at the retail level.
Legal and regulatory frameworks are also critical. Key implementation issues typically include:
Also, there are still multiple policy “unknowns” in relation to DCEP availability outside of Mainland China, including:
- Who can access a wallet outside of Mainland China?
- What verification information and documents will be required?
- Which institutions can offer a digital wallet, and how?
- Is any other nexus to Mainland China required (for example, being onshore or having an obligation onshore?)
- Will there be a “CNH” equivalent (that is, an offshore version of DCEP)?
The Beijing 2022 Winter Olympics are widely expected to be a litmus test of how those travelling into China or otherwise engaging with Chinese businesses – as well as their supporting banks and payment providers – might use DCEP, and whether broader cross-border use cases will emerge in the lead up to this event and beyond.
2. New cash management, payments and FX strategies and solutions
The efficiency and convenience of DCEP for domestic and, eventually, international payments means clearing and settlement delays could become a thing of the past. The near instantaneous nature of DCEP payments can have significant implications for your business’s RMB and multi-currency cash management, payments and foreign exchange strategies.
Over the medium to long term, DCEP has the potential to reduce your business’s RMB cash management, liquidity management and operational costs. Financial institutions that operate in this space will also need to think about what DCEP means for their cash management, payments and foreign exchange solutions and offerings.
3. Financial and technological innovation and integration
DCEP can present significant business opportunities for financial services and technology firms. As all financial products and services are ultimately linked to money, the emergence of digital money in the form of DCEP can – for retail and institutional clients alike – fundamentally change how financial services are delivered and the look and feel of financial products. For example, on the retail side, digital wallets will likely become the primary method for Chinese consumers to manage their personal finances and a new channel for delivering digital financial services.
On the institutional side, there’s significant room for innovation around the development of DCEP-denominated digital financial instruments, which can be traded on digital financial markets in China and beyond. As with DCEP itself, financial instruments denominated in DCEP may offer efficiencies in terms of clearing and settlement which are unmatched by traditional financial instruments. Financial institutions with a large international footprint will also have an important role to play in facilitating DCEP’s use in cross-border payments.
For tech and fintech companies, the new DCEP-centric ecosystem will also be ripe for innovation. DCEP will become the fuel on which China’s digital economy runs, and new technologies and applications will need to be developed to connect DCEP with artificial intelligence, internet of things, big data, 6G, blockchain, cloud computing and other pillars of China’s digital economy.
In addition to innovating new products and services, financial and technology firms will need to consider how to integrate their existing products and services (both front-end and back-end) into the new DCEP payment infrastructure and ecosystem.
4. Balancing various factors
A business may regard the features of DCEP (such as transactional convenience, efficiency, centralisation and visibility over use) as offering both opportunities and challenges; trade-offs and rewards.
Businesses that will be required to use DCEP (its acceptance will eventually become mandatory within China) as well as businesses that want to use DCEP (for example, to accept cross-border payments from Chinese consumers and companies) will need to consider the balances and counterbalances presented by DCEP, including legal, regulatory, compliance, data, privacy, security and other implications.
Businesses will not be alone in thinking about these complex issues. Central banks, regulators and governments around the world are also exploring issuing their own CBDC and are thinking about what the emergence of DCEP and other CBDCs means for existing international payments infrastructures, financial markets, transmission of monetary and fiscal policies, monetary sovereignty, global governance and the world economy.
When DCEP is officially launched in China, policymakers, central bankers and regulators in other jurisdictions may need to provide clarity and guidance regarding how and the extent to which DCEP payments can be made or accepted in their jurisdictions.
The path ahead – key steps for DCEP readiness
When paper currency first emerged in China more than one thousand years ago, it brought about lasting changes to the concept of money and human civilisation. At that time, China was the world’s largest economy. Fast forward to today, a new form of (digital) currency is about to emerge in China, and the IMF and others predict that China could once again become the world’s largest economy by as early as 2030.
These parallels are not only interesting from a historical perspective, they underscore the significant impact DCEP could have on China and the rest of the world. Use of DCEP in China and, in time, internationally, has real-world commercial implications that extend far beyond the technocratic spheres of clearing and settlement systems, monetary policy and computer science.
For any company that does or wants to do business in China or with Chinese individuals and companies, now is the time to start thinking about DCEP and its implications.
Some of the key strategically important questions for your business include the following: