China’s central bank – the People’s Bank of China (PBOC) – has successfully completed a trial of a blockchain-based digital currency prototype system, taking it one step closer to becoming one of the first major central banks to issue its own digital currency. The PBOC also plans to officially launch a digital currency research institute. In light of these recent developments, this article explores the digitisation of China’s currency, the renminbi (RMB).

In recent years, RMB internationalisation has become a hot topic in finance circles and beyond. As China emerges to become a global leader in financial technology (fintech), the digitisation of the RMB could not only upgrade domestic and cross-border RMB payment systems, but also significantly accelerate internationalisation of the RMB.

China’s digital economy

China has over 730 million internet users, more than the U.S. and Europe combined. To put this in perspective, one in five internet users in the world is Chinese. And we expect to see further internet penetration in China. Right now, just over half of China’s population have internet access, compared to nearly 90% in the United States.

For those 730 million (and growing) Chinese internet users, online payments, e-commerce and digital financial transactions have become ubiquitous and modern China is fast becoming a cashless society. China’s online payments reached 11.8 trillion yuan in 2015, up 47% from the previous year. In 2016, Alibaba’s Singles Day shopping festival (which took place on 11 November) generated over US$17.8 billion of online sales in just 24 hours, with 82% of those sales completed on mobile devices.

On the policy front, China’s economic blueprint for the next five years – the 13th Five Year Plan – is littered with references to and action items centred around the digital economy, ranging from Internet Plus to big data, fintech, 5G technology and the internet of things. In October 2016, China’s Ministry of Industry and Information Technology published the country’s first official whitepaper on blockchain technology. The whitepaper identified finance (including digital currencies) as the first area of application for blockchain, but also explored the use of blockchain technology in the areas of manufacturing, communications, health, education, internet of things, social welfare, philanthropy as well as culture and entertainment. And in January 2017, the first China Fintech Innovation Conference was held in Beijing. The conference was attended by senior officials from the PBOC, China’s financial regulators and major Chinese financial institutions.

Against the backdrop of China’s vast and rapidly growing digital economy, it is not difficult to imagine the emergence of RMB as a major digital currency.

Steps taken by the PBOC

As early as 2014, the PBOC established a research team dedicated to exploring the issuance of digital currency and related technological, operational and legal issues, the impact of digital currencies on existing economic and financial systems, and the relationship between digital legal tender and privately-issued digital currencies.

In January 2016, the PBOC announced that it was exploring the prospect of issuing its own digital currency in the “near future”. The PBOC noted that a digital currency can reduce the high costs associated with issuing and circulating traditional paper currencies; improve the convenience and transparency of economic transactions; reduce the occurrence of money laundering, tax evasion and other unlawful acts; enhance the PBOC’s oversight of the money supply and currency circulation; and improve financial inclusiveness. According to the PBOC, the issuance and circulation of digital currencies would also help China build a whole new financial infrastructure, further improve China's payment systems and enhance the efficiency of payments and settlements.

In September 2016, various departments within the PBOC published a series of working papers on digital currency, which analysed and discussed topics such as developmental path, prototype conception, choice of underlying technology, impact on monetary policy and key legal issues. The working papers represent interim consensus among the relevant PBOC departments and help establish the theoretical basis for the future issuance of digital currency.

Significantly, in late 2016, it was reported that the PBOC successfully completed a trial of a blockchain-based trading platform for digital bank acceptance bills. The issuance and settlement of a digital currency issued by the PBOC were also tested on this platform. The PBOC’s digital legal tender prototype system – “Demo” – could also be launched as soon as this year.

Digital legal tender

PBOC Vice Governor Fan Yifei has drawn a distinction between digital legal tender issued by central banks, on the one hand, and privately-issued digital currencies on the other. He noted that the shortcomings of privately-issued digital currencies include volatility, limited creditworthiness and limited acceptance. Accordingly, he argues it is critical for central banks to issue digital legal tender because it would be backed by sovereign credit and can be used in both online and offline transactions with greater scope, convenience and security. The PBOC’s preference for central bank issued digital legal tender can be seen in Chinese regulators’ recent crackdown on the usage and exchange of Bitcoin, a privately-issued digital currency. 

Operational model

There are two alternative models for issuing digital legal tender. First, the central bank can directly supply digital legal tender to the public, and oversee all related issuance, circulation and maintenance services. Second, the central bank can issue digital legal tender to commercial banks, which would then provide deposit and withdrawal services to the public. The second approach is the model used for issuing and circulating paper legal tender.

Vice Governor Fan has stated that the PBOC is inclined towards the second model because using the existing model would make it easier for digital legal tender to gradually replace paper money. This approach would also encourage commercial banks to actively participate in the issuance and circulation of digital legal tender, which results in appropriate risk sharing, fosters innovation, and better serves the public and the real economy. Indeed, the PBOC’s recent trial of its digital currency on the digital bank acceptance bills platform involved major state-owned commercial banks as well as one of only a few privately-owned commercial banks in China.

Key issues

In their working papers, the PBOC departments argue that it is important to carefully consider the following key issues relating to the design and creation of digital legal tender in China:

Mandatory acceptance of legal tender: The Regulation on the Administration of RMB (“RMB Regulation”) currently provides that no entity or individual may reject the RMB as payment for any public or private debt within the People’s Republic of China. Digital lender tender issued by the PBOC is expected to enjoy the same legal status as physical RMB. But at the same time, digital legal tender is unique because its acceptance may require special electronic equipment and networks. This has given rise to some views that the mandatory acceptance provision in the RMB Regulation should be made conditional upon the recipient having objective capacity to accept digital legal tender. However, the PBOC working papers argue that the authority and legal stability of legal tender means its mandatory acceptance should not be subject to this type of general condition. Instead, the PBOC is now leading efforts to amend the RMB regulation to improve the inclusiveness of legal tender and to grant specific exemptions from the mandatory acceptance of digital legal tender in certain limited circumstances.

Online and offline usage: The issuance and circulation of digital legal tender should support both online and offline transactions. To implement this from an operational perspective, different standards, specifications and processes may need to be in place for online and offline use. Convenience and security: In order to improve efficiency and convenience, it may be necessary to distinguish between large-sum and small-sum transactions and impose different levels of safety and security related measures. Identity and anonymity: On the one hand, identity management can facilitate the general oversight of digital legal tender and the detection of money laundering, tax evasion and other unlawful acts. On the other hand, it may disincentivise use, especially for small-sum transactions. The PBOC is considering an approach based on voluntary disclosure of identity for front-end transactions and mandatory use of real identity for back-end management controlled by the central bank to ensure the traceability of digital legal tender.

The PBOC’s new digital currency research institute will further explore these and other operational, technological and legal issues associated with issuing digital legal tender.

Looking ahead

Issuing digital legal tender can be challenging for any economy, let alone one as large and populous as China’s. As the Chinese economy enters the “New Normal” of single digit GDP growth and a period of significant economic transition, maintaining financial, economic, social and political stability are paramount considerations.

Accordingly, Chinese regulators will likely take a very cautious and prudent approach in this area. They will make sure every perceivable risk is adequately addressed and all systems are appropriately tested before fully introducing digital legal tender in China. We can also expect to see a step-by-step implementation approach involving further tests and trials, pilot programs that expand in scope over time, and an extended transition period during which both digital and paper legal tender are in circulation.

Having said this, China’s ability to implement and advance extremely complex systems and solutions in a timely manner should not be underestimated and, as is the case with every other aspect of China’s digital economy, there are enormous commercial opportunities associated with the development, issuance and usage of digital legal tender in China.

Digital currencies also have a tendency to transcend national borders. A successful digital RMB can help promote the usage of China’s currency in cross-border trade, investment and finance. Eventually, we expect RMB digitalisation to be closely intertwined with RMB internationalisation and could easily be a significant catalyst for its acceleration.

In the meantime, we will continue to keep you updated on key developments in this area.

Andrew Fei