State-backed digital currencies — they may be here sooner than you think
- The Chinese administration has fast-tracked its scheme to launch a central bank-backed digital currency
- Getting a head start on rivals could bring long term benefits
- Reports suggest the rollout could be as soon as November, which puts it ahead of corporate rival Facebook/Libra and competing nation-states
Chinese authorities are scaling up efforts to launch their own digital currency as soon as they can. The People’s Bank of China (PBOC) has issued several reports through the summer, detailing an outline plan of what markets can expect. Less publicised is the nature of the operation, which has been tasked with getting to the market in time to take advantage of early adopter status.
If all goes to plan, the digital currency will close some domestic monetary loopholes — but more importantly, we might see what Circle CEO, Jeremy Allaire, calls the “‘internationalisation of the RMB”.Allaire said there would be immense political and economic benefits: “This becomes a mechanism by which RMB can be used in everyday transactions all around the world,” he noted. (Source: CNBC)
The technical framework
With there being uncertainty about quite how many digital currencies the global system can support, the efforts of the PBOC illustrate that this is a race.
A dedicated team from the PBOC’s Digital Currency Research Lab has been set up in a stand-alone location since early summer. Away from the central bank’s head office, a collection of blockchain architects and cryptography specialists are researching and developing the technical framework to support the Central Bank Digital Currency (CBDC). Operating in a closed-door environment, the team is concentrating fully on the task. State-owned newspaper China Daily reported on 4th September that closed-loop testing had begun.
The roll-out of the CBDC, from the lab to the real economy has been suggested by Forbes to possibly happen as early as November. Industry site Coindesk has even got hold of unconfirmed reports of the chosen location. It reports that the innovation hub of Shenzhen, the city that produces more than half of China’s international patent filings, might be the testing ground. In a report for Coindesk, Wolfie Zhao wrote:
“Local companies including Tencent and state-owned financial institutions are researching technical frameworks to support the development of the CBDC.” (Source: Coindesk)
Zhen also suggested:
“China’s big four state-owned commercial banks, as well as fintech giants Alibaba, Tencent, Union Pay, and an unnamed company, will be the first batch of organisations to receive the CBDC.” (Source: Coindesk)
To the winner the spoils
Official statements on the subject have seen the PBOC refer to the need to ‘protect’ its foreign exchange sovereignty. Whilst the exact meaning of that statement generates more questions than answers, analysts point out there are some clear benefits from setting up a CBDC, and setting it up early.
The PBOC has touched on the need to have greater monitoring of its M0 supply — the notes and coins circulating in their domestic economy. M0, like the purest form of cryptocurrencies of the world, allows for transactions where anonymity can be maintained. Beijing would like to take these transactions online where its version of crypto will have an audit trail, which will challenge the ability of the corrupt and the money launderers to go about their business.
Looking outwards, should the digital yuan be distributed globally, then China will become an increasingly powerful global force. It could feasibly be used for everyday transactions all around the world. The internationalisation of the yuan will allow it to be used wherever there is access to the internet. This bypasses western banking systems such as SWIFT.
The greatest reward would come about if the CBDC develops the yuan’s position as that of a global reserve currency. The US dollar remains the global reserve, but even eating into that position brings considerable benefits to the yuan. A reserve currency incurs reduced transaction costs, as both parties in a transaction hold the same currency. Importantly for China, it would reduce exchange rate risk, especially on commodities, which are often quoted and settled in reserve currency terms. Then there is the considerable benefit of lower borrowing costs caused by global individuals and organisations being willing to take and hold currency as insurance against the weakness of defaults in their own country’s currency.
Tempted by the benefits
The state-backed digital currency will have similar properties to those of Facebook’s Libra. Being asset-backed it will be a half-way house between fiat currency and ‘pure’ cryptocurrencies. Compared to these ‘pure’ cryptos, the CBDC will come with extra security and reduced price volatility, but it will not be anonymous.
There is still a place for currencies such as Bitcoin, but more direct rivals such as Libra should be concerned. Facebook’s Libra is the highest-profile attempt by a firm to introduce its own digital currency. Other firms considering the same move are, like Facebook, tempted by the benefits that come from being the retail world’s bank. On the other hand, the risk of losing that race may see them instead adopt a state-backed alternative. There would be less reward than winning the competition, but it would mitigate the risk of a close rival having the advantage of such a powerful position.
The elephant in the room is the USA and its current position as holder of the global reserve currency. Having been in the box-seat form more than a century, it can be assumed it would not want to relinquish that position. The process of giving up the benefits of being the reserve would be a particularly painful one. Imagine for starters the impact on USD values if every dollar, under every mattress in the world was suddenly sold to buy native currency.
As champion rather than challenger, the US has taken a different approach to the subject of cryptocurrencies. Whilst it benefits from being the default currency denomination for ‘stablecoins’ it has generally favoured constructing regulatory barriers to slow or stop the adoption of cryptos. Even the Facebook Libra venture has fallen foul of US authorities. Maxine Waters, chair of the house financial services committee has called for a check on Libra’s ‘unchecked expansion’ into people’s lives. She said:
“Regulators should see this as a wake-up call to get serious about the privacy and national security concerns, cybersecurity risks, and trading risks that are posed by cryptocurrencies.”
Source: The Block
Whilst it is still unclear how these changes will pan out, what is for certain is that the Chinese digital currency — the catalyst for the next stage of the process — is likely to be hitting the markets sooner than some had expected.