A Bank of International Settlements survey of 63 central banks found that 70% are engaged in CBDC work. Some are simply researching its opportunities, while others have or will create a digital currency. According to an Atlantic Council Report Emerging markets are leading the charge, seeing it as a means to improve payments infrastructure and promote financial inclusion as they digitize their economies. The implications are clear: CBDCs will play a critical role in shaping the future of digital payments. (Atlantic Council Report).
The Digital Currency Electronic Payment (DC/EP), the CBDC project piloted by the People’s Bank of China is so far the most advanced projet of its kind in the world. The pilot testing of the DC/EP, also known as the digital yuan, is underway in four Chinese cities: Shenzen, Suzhou, Chengdu, Xiong’an and the 2022 Winter Olympics Area in Beijing. PBoC finally held trials in April. While trials were ongoing, the Agricultural Bank of China also launched an e-wallet to serve as storage for the digital yuan. In September, China Construction Bank (CCB), one of the country’s big-four state-owned commercial banks, opened up a wallet service to public users within its mobile app for testing the digital currency. Postal SAvings Bank and China Citic Bank joined the “Big Four” in deploying the DC/EP. Lately, the pilot program has been expanded to key economic regions in Beijing-Tianjin-Hebei, the Yangtze River Delta, and the Guangdong, Hong Kong, and Macau area.
The introduction of such an innovation in a country that has introduced paper money almost a thousand years before it was used in Europe, and which is the world’s most populous country and its second largest economy may have far reaching consequences.
Architecture of China’s digital yuan project
The CBDC pyramid
One way to look at CBDCs is through the “CBDC pyramid” exposed by Raphael Auer and Rainer Böhme in a working paper for the BIS published in March 2020. The pyramid maps consumers needs onto the associated design choices.
Based on this pyramid, Auer, Cornelli, Frost (2020) classify CBDC projects into four distinct architectures:
- Direct CBDC – A payment system operated by a Central Bank which offers retail services. A CBDC is a direct claim on the central bank, which maintains the ledger of all transactions and executes retail payments.
- Hybrid CBDC – Intermediaries handle retail payments, byt the CBDC is a direct claim on the central bank, which keeps a central ledger of all transactions and operates a backup technical infrastructure
- Intermediated CBDC– in which the central banks maintains only a wholesale ledger while private intermediaries execute payments and keep a ledger of retail transactions.
- Synthetic CBDC – a payment system operated by private intermediaries which need to fully back all liabilities to retail clients with claims on the central bank.
Whenever a DLT is used by a central bank it must be permissioned – ie. operators can decide who is admitted to the network and tie it to an identity scheme – unlike the permissionless DLT used for Bitcoin and other private cryptocurrencies which is based on anonymized digital tokens.
The PBC Deputy Governor Fan Yifey emphasised in an article published in 2018 that the role of the PBC would be to provide the core infrastructure, while intermediaries such as commercial banks, other payment service providers and telecoms would provide services to the public.
The Chinese central bank established a fintech laboratory in July 2019, taking its name from the central bank’s street address in the Chinese capital, Chengfang Financial Technology is armed with 2 billion yuan in capital for software development and research into data processing.
Regarding access, the PBC has decided to use a value-based hybrid payment scheme. Identity would be based on “loosely coupled account links”, such that users could use DC/EP anonymously with counterparts in daily transactions, but “operating agencies should submit transaction data to the central bank via asynchronous transmission on a timely basis” (Fan (2018)). This would ensure that users remain anonymous to each other, but allow the central bank “to keep track of necessary data to implement prudent regulation and crack down on money laundering and other criminal offences, as well as easing the workload for commercial banks” (Fan (2018)).
A tiered system of identification
To accommodate different levels of user anonymity and access, there would be several grades of digital wallets based on the strength of the KYC levels, with stronger KYC requirements associated with higher transaction limits. Limits would generally be linked to existing rules of use of banknotes and coins; details have, however, not yet been established.
The DC/EP would also be connected to existing retail and wholesale systems, including the RTGS system. This would enable the DC/EP to be used for renminbi- invoiced trade with foreign parties.
Direct wallet-to-wallet transactions
The digital currency would be stored in digital wallets held by users and transactions may take place, using a dedicated downloaded appn directly from wallet to wallet via the Internet or phone connections, or absent those connections, by putting two mobile phones close together—probably using near field communication protocols. (Cf. The Atlantic).
Impact of the digital yuan on China’s electronic payments market and Ant group / Tencent duopoly.
Amounting to a whopping 49 trillion yuan worth of electronic transactions (out of total 3.4 quadrillion of money transactions), China’s electronic payments market is massively dominated by Alibaba’s Alipay and Tencent Holdings’ WeChat Pay. The Duo (Alipay and WeChat Pay) have single-handedly transformed China into a nearly-cashless economy. In 2018, 83 percent of retail payments in China were made through mobile devices, while 17 percent were non-mobile, such as via cash and bank cards, according to estimates (cf. CGTN).
WeChat is regarded as China’s premier social media channel having more than1 billion users per month, many of whom make use of its financial and payment apps. Alipay is China’s biggest e-commerce platform, processing more than 120,000 transactions per second (TPS)—which is double the speed of Visa and MasterCard. Users fund and top up their digital wallets at these payment services with their bank balances or credit cards.
The digital yuan and the existing systems are not mutually exclusive. Most consumers are likely to continue using their Alipay or WeChat Pay platforms – or both systems, in many cases – for their multitude of applications and services that have evolved from simple payments to loans, asset management and money-market investments. However, being legal tender and fee-less, when the digital yuan would be widely adopted it could disintermediate the current payment platforms.
Impact of the Chinese CBDC on the global financial architecture and on alternative digital payments systems
The immediate effects of a Chinese CBDC on global payments will be minimal, but the long-term ramifications cannot be understated. The Chinese CBDC fits within a greater context of the country’s efforts to create an independent payments system based on its Cross-Border Inter-Bank Payments System (CIPS). CIPS provides clearing and settlement services for cross-border RMB transactions, and is expected to eventually feature an independent messaging system that does not utilize SWIFT.
Together, a Chinese CBDC, CIPS, and China’s robust digital payments ecosystem would result in a digital ecosystem that facilitates rapid and efficient payments across the country (Cf. Atlantic Council Report) When it will be fully operational, the Chinese system would allow for cross-border transactions between institutions and individuals without going through correspondent banks. While China may not seek to take on the responsibility of leading the global payments system, a CBDC is a critical piece for the country to solidify an independent economic ecosystem.
The adoption of the digital yuan internationally could also make Facebook’s proposed libra stablecoins unnecessary. Under Facebook’s updated White Paper, the libra will be based on the currencies of host countries of its users, not on a basket of currencies, thus becoming more stable and not competing against the legal tender. While it benefits from the large membership of Facebook, the libra will still need to be exchanged into and out of the Facebook universe when people want to transact on things or services that require a legal tender.