China has a long-term plan for virtual assets that is surprisingly innovative and pioneering, given its acts of antagonism toward the cryptocurrency industry.

Since 2013, China has been introducing discouraging crypto development policies that eventually led to the nationwide extensive crypto ban in September 2021. The prohibition of cryptocurrency transactions and mining has incited crypto activists to complain about lost opportunities. Even the Chinese courts have at times dismissed cryptocurrencies by disowning their victims.1

If it had the desire to do so, China could have become a leading crypto mining hub, contributing more than 30% of the global hash rate (i.e. the total computational power dedicated to crypto mining) by the sheer force of its 1.4 billion population. By imposing a series of crypto-unfriendly rules, China’s global hash rate has dived to 0%. China seems to have dethroned itself and ceded its “trillion-dollar” crypto mining crown to competitors such as Kazakhstan and the United States.2 3

But the naysayers are speaking out reflexively and thoughtlessly. China is the first economic powerhouse to test e-CNY, a central bank digital currency (CBDC) with enormous potential.

Many countries have toyed with the idea of a CBDC, but few have the capacity or infrastructure to issue one or to undertake extensive pilot schemes. Once China launches e-CNY nationally, it could traverse this vast geographical and financial territory to reach the entire population.

If China’s e-CNY initiative is successfully implemented, it will be one of the world’s most advanced efforts to commercialise a CBDC through large-scale experiments and deployments.

China formed a task force to study CBDCs back in 2014. The People’s Bank of China (PBOC), China’s central bank, set up its Digital Currency Institute in 2016 to develop a CBDC prototype and the next year started collaborating with commercial banks with the State Council’s approval. Since then e-CNY pilots have sprung up in various cities; China debuted e-CNY to overseas athletes and visitors at the 2022 Beijing Winter Olympics.

When and if fully implemented, China’s e-CNY should be unstoppable. According to a July 2021 PBOC report, as of 30 June 2021, “e-CNY has been applied in over 1.32 million scenarios, covering utility payment, catering service, transportation, shopping, and government services. More than 20.87 million personal wallets and over 3.51 million corporate wallets have been opened, with transaction volume totalling 70.75 million and transaction value approximating RMB34.5 billion.”4

The International Monetary Fund (IMF) reported that “by October 2021, there were over 123 million e-CNY wallets registered with individuals and about 9.2 million wallets held by firms – a rapid increase from approximately 6 million active e-CNY wallets in April 2021. In a population of nearly one and a half billion, the share of e-CNY users is now approaching 10%.”5

By contrast, other major economies are nowhere near the epicentre of the CBDC landscape. U.S. President Joe Biden signed an Executive Order in March 2022 placing “the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC”. The Bank of Canada has not found a pressing case for a CBDC but says it will continue to develop its technical capacity to issue one in the event that Canada’s monetary sovereignty is impaired.6 7

e-CNY: A necessary redundancy to cash, mobile payments and bank deposits

China is no stranger to virtual payments. According to a 2019 PBOC survey, the value of transactions via mobile payment, by card and in cash accounted for 59%, 23% and 16%, respectively, of the total volume.8 Alipay and WeChat Pay have been the unshakable duopoly in China, dominating over 90% market share of the domestic digital payment in the private sector.9 In the domestic landscape, one cannot even shop without using one of these two payment methods, as China has become a truly cashless society.

What, then, is the point of launching e-CNY when it is foreseeable that e-CNY will have a hard time infiltrating and disintegrating the duopoly? The point is, e-CNY will be considered the same as “money”.

In short, e-CNY is a digital form of renminbi (RMB) issued by the PBOC and with all the basic functions of money–it is a unit of account, a medium of exchange and a store of value. It has the status of legal tender, which essentially means that e-CNY is the PBOC’s liability to the public and serves as a substitute for cash in circulation (M0). This legal tender is designed chiefly for domestic retail payments aided by a copious and fully developed e-commerce ecosystem. Now China is considering a major amendment to the People's Bank of China Law (draft) to confirm the dual forms of the Chinese currency.10

By introducing e-CNY, China wishes to promote financial inclusion and increase the resilience of payments. I shall examine each of these terms in turn.

Financial inclusion

China is an enormous country with a massive population, numerous ethnic groups, and significant regional disparities in growth. People's payment habits, ages, and security needs are bound to differ within such a social structure, which calls for diversified means of payment.

Despite China’s effort to promote digital payments and financial inclusion for two decades, around 10% of the Chinese population, especially those concentrated in rural areas, remain unbanked.11 As non-anonymous payment systems, traditional banking services sometimes demand forms of identification that might be expensive or hard to obtain.

Being excluded by the banking system means no access to basic financial services, which can contribute to generational poverty. For-profit private payment service providers may be reluctant to expand their businesses to less developed areas where profitability is limited.

Within this context, e-CNY can boost competition in the Chinese payments industry in two ways: directly by competing with existing payment methods, and indirectly by serving as a platform for private payment service providers. The latter would ensure that new businesses wishing to offer new payment services face low entry barriers.

So e-CNY would circumvent the human, physical and financial resources required to produce and distribute banknotes and coins. The non-profit nature of PBOC means it could provide more cost-effective digital payment options with the aim of ensuring the public’s access to cash and maintaining financial security, all while taking profitability out of the equation.

Resilience of payments

The ability to pay and transfer money is more paramount than one might realise. Countries with a heavily digitised payment industry such as China are concerned about disruptions to digital services and concentration issues. The mere thought that single points of failure might be capable of compromising the financial stability of a superpower is thought-provoking and alarming, to say the least.12

Offline capacity is why China will not give up on cash anytime soon, despite its dwindling use. The new e-CNY also aims to bridge the “digital divide” by introducing a dual online and offline payment feature. Examples are hardware-based e-CNY wallets embedded in mobile phones, as well as cards that can be used to make payments to other mobile phone wallets in close proximity without requiring Internet connectivity.13

To prevent any impact of unauthorised device tampering, which might result in duplicate spending and counterfeiting, each user can make only a certain number of offline payments before returning to the main online ledger. To further limit risks, offline e-CNY payments employ technologies such as digital signatures and encrypted storage.

The PBOC has also deliberately protected commercial bank deposits during the e-CNY pilots in various cities. To prevent bank runs and the weakening of commercial bank functions, e-CNY offers no interest while the banks maintain a positive interest rate; consequently, citizens will not rush to convert their bank deposits to e-CNY. This is because the Chinese economy is not ready to transition to e-CNY completely due to pending issues such as “cross-border payments, compliance with anti-money laundering and data protection laws, responsibility and accountability for provisioning CBDC account access, and a lack of widespread infrastructure and acceptance”.14

e-CNY and cryptocurrencies: A false dichotomy

Some commentators have suggested that a CBDC can be seen as a country’s answer to cryptocurrency. Which raises the question: In relation to cryptocurrencies, are CBDCs family members or aliens?

CBDCs, like cryptocurrencies, can be powered by blockchain or other distributed ledger technologies (DLTs). Indeed, during the e-CNY pilots, the PBOC evaluated DLTs and determined that their abilities to execute transactions and retain data did not match their needs, especially on days with extremely high transaction volumes. DLTs are employed in the e-CNY system to a limited extent. Still, intermediaries can use any technology, including DLT, to conduct their businesses in the e-CNY ecosystem.

The PBOC’s openness to diverse technologies is part of a "Long Term Evolution System" that uses "hybrid architecture" to enable new technologies to be incorporated into the e-CNY ecosystem despite the centralised ledger at its core.15

CBDCs are not cryptocurrencies, as they are centralised and backed by central banks. They are often regarded as a more secure and trustworthy alternative to cryptocurrencies. The reason why cryptocurrencies (and cash) are generally seen as perfect tools to facilitate illicit activities such as fraud, tax evasion, internet gambling, money laundering and terrorist financing lies in their anonymity.

The policy trade-off is that the greater the anonymity, the larger the risk of illicit use.16 Logically, therefore, depriving e-CNY of anonymity must be the way to fight crime. But is it?

It is easy to fall victim to the fallacy that things sharing similar features replace each other, while things with dissimilar features are mutually exclusive. As discussed above, although e-CNY is a substitute for cash in circulation and potentially bank deposits as well, the PBOC explicitly allows it to co-exist with them as a necessary “redundancy” to promote financial inclusion and enhance the resilience of payments. Despite their functional resemblances, they are not meant to replace each other at all.

Similarly, e-CNY need not be completely transparent to locate lawbreakers. Therefore, e-CNY suggests the idea of “managed anonymity”, that is, protecting users’ privacy to a certain extent while detecting illegal activities. By using tiered CBDC wallets. e-CNY adheres to the principle of “anonymity for small value and traceable for high value” and prioritises the protection of personal data and privacy while complying with anti-money laundering and counter financing of terrorism (AML/CFT) regulations.17 This further promotes the prevalence of e-CNY in underdeveloped regions where virtual identification can be difficult. Instead of a policy trade-off, the PBOC sees policy synergies among anonymity, financial inclusion and reduction of bank run risks.18

With e-CNY, no one would be able to directly see who is paying whom, or how much is being paid, except that the PBOC can in principle trace the entire money flow. For the basic-level wallet (with the lowest spending limit), e-CNY users would only need to register their phone numbers to sign up on the official app; whereas, with platforms like WeChat Pay and Alipay, both of which allow cashless transactions, users are required to provide real-name verification, even for low-value transactions.

Some people say that by feeding the CBDC wallet application enough personal information, the CBDC will inevitably become an optimal surveillance tool to implement national policy and influence individual behaviours. This is because the CBDC and its wallet application can be programmed to support or discourage certain transactions in certain areas within a certain period, which is something that banknotes and coins cannot achieve.19 Further, it is worth mentioning that all telephone numbers in China must be tied to an identification number, implying that even minimal transactions would eventually be traceable by government agencies, albeit with more difficulty.20

Still, many citizens may place more trust in government bodies than in private payment service providers. They tend to be more wary of the latter commercialising personal data for profits and other ulterior motives.

To infinity and beyond: The RMB international dream

Although e-CNY is primarily made for domestic retail payments, it never hurts to dream big. Starting from scratch, e-CNY is a payment option across 23 Chinese cities as of April 2022, and users can employ their existing Alipay or WeChat Pay portals as the interface or approach various domestic banks as authorised arbiters to manage their e-CNY.21 A potential arena to launch e-CNY is the Greater Bay Area, an important national economic development strategy for China that comprises two special administrative regions (Hong Kong and Macau) and nine municipalities in Guangdong Province.22

China is playing a long game – countries within the Belt and Road Initiative (BRI) are on the radar as well. The BRI encompasses various Chinese companies that operate across the Asian Pacific and the Middle East.

Also, bilateral trade between China and Africa has steadily increased in recent years. This is especially true in Africa’s information and communications technologies under the Digital Silk Road initiative, fuelled by the extension of concessional grants and loans to African governments, competitive price points, and comprehensive mobile broadband solutions for more than half the continent.

It is speculated that if China decides to enable the use of e-CNY in BRI regions, it will reduce the cost of conducting cross-border trade along the BRI, benefit China’s geopolitical position, and immunise her commerce by circumventing the U.S.-centric financial system, a move that other countries have also been desirous of making.23

The Digital Current Institute of the PBOC, the Bank of Thailand and the Central Bank of the United Arab Emirates have undertaken another unprecedented project called the Multiple Central Bank Digital Currency (m-CBDC) Bridge. The project explores the possibility of completing real-time international foreign exchange and transfer on a 24/7 basis.

The essence of the scheme is introducing a wholesale platform where banks, when making cross-border transactions, can hold and transact in any participating CBDCs. Then the foreign CBDC can be converted back to their own domestic CBDC. This may halve the operating costs and boost secured transactions with large capital flows resulting from trade in oil, gas, and other commodities between these countries.24

The PBOC specifies three principles applicable to e-CNY cross-border payments, namely no disruption, compliance and interoperability. No disruption refers to avoiding drawbacks such as massive currency substitution in all economies. Compliance means any CBDC cross-border payment system must observe all connected nations' rules and regulations, including capital flow control policies.

The flow of information between nations should be strengthened to aid authorities in combating crime. Instead of a single CBDC used for multilateral transactions, cross-borde payments should feature interoperability between domestic CBDCs or between domestic CBCDs and existing payment systems. Therefore, the PBOC favours a system in which local CBDCs are convertible with other currencies as payments across international borders.25

It is often said that the early bird gets the worm. Spearheading the CBDC movement by managing trade-offs, leveraging synergies and embracing technological neutrality, China may be on track to claim first-mover advantages and crown itself as the global CBDC thought leader.

The 2008 financial crisis, which represented a regulatory failure of the Western financial world order, has inspired China to undertake a series of measures to internationalise RMB. Thus it can endeavour to regain monetary sovereignty by reducing its dependency on the U.S. dollar and exploring financial systems that counter the U.S. dollar’s hegemony.

China’s Cross-Border Interbank Payment System (CIPS) has been eye-catching as a possible alternative to the U.S.-backed Society for Worldwide Interbank Financial Telecommunication (SWIFT). Conceptually, CIPS clears and settles RMB transactions, whereas SWIFT is a vast messaging network that enables banks to send and receive money transfer instructions but does not move funds itself – it merely facilitates the secured flow of financial information. Banks can therefore clear cross-border RMB transactions onshore directly through CIPS, rather than through clearing banks in offshore RMB trading centres.

With the widespread availability of e-CNY, it would be more convenient for countries to trade with China, while reducing the risk of fluctuation loss when dealing with a third country’s currency.26

In the torrent of a Covid-accelerated currency revolution, cryptocurrencies and CBDCs are just vessels and we are nothing but adaptable sailors navigating the open sea.