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China's Digital Currency (I): A Sailing Ship

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01/03/2022

China's Digital Currency (I): A Sailing Ship

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China's Digital Currency (I): A Sailing Ship

Author

Philippe Aguignier

Senior Fellow - Asia

China’s project to create a digital currency, known as e-CNY or Digital Currency Electronic Payment (DCEP), has come a long way, and is now probably only months away from a full-fledged country-wide launch. This would make China the first large economy equipped with a retail Central Bank Digital Currency (CBDC). How does the e-CNY function? What has the government done to pave the way for it? And what are the main reasons behind the push? This article, published in two parts and written by Associate Researcher in Institut Montaigne’s Asia Program Philippe Aguignier sheds light on the lesser-known story of China’s digital currency.

The People’s Bank of China (PBoC), China’s central bank, has hinted several times that such a launch could take place at the time of the 2022 Winter Olympics. It has nevertheless been careful not to formally commit itself to any timetable. With the circumstances around the Games having changed due to Covid-19 (no international visitors, and very few spectators), it decided to still showcase the new technology albeit in a limited way, and to give itself some more time for more testing and fine-tuning.

Tests and clarifications

It does not seem that the project is encountering major teething problems, at least on the technical front. Since last 2020, tests are taking place on an ever larger scale. The first tests involved free giveaways of digital money to selected citizens in a few pilot cities. For instance, Shenzhen issued 50,000 digital RMB red envelopes, a total of 10 million RMB, for a one week trial in October 2020. Then, a beta version of a digital yuan application was made available to a larger number of users under limited pilot schemes. In October, the PBoC claimed that 120 million people had made use of the application. In January 2022, the number of registered users had reached 240 million, having used the new currency for transactions adding up to almost 100 billion yuan. More recently, citizens in twelve major cities (including Shanghai, Beijing and Zhangjiakou, the city of the Olympic Games) have been granted the possibility to open and operate digital wallets, through a new e-CNY application made available for free download on Chinese application shops.

In July 2021, the PBoC published a very useful white paper summarising and confirming the objectives, principles, and general architecture of the future digital currency system. There was no major surprise in the white paper, and a lot of the new currency’s features were already known or had been accurately foreseen The white paper nevertheless had the merit of giving official confirmation to what were previously only "educated guesses", based on information leaked on a semi-official basis.

We now know for sure that the e-CNY will be pure fiat money: part of M0, backed by the PBoC, and with full legal tender status.

We now know for sure that the e-CNY will be pure fiat money: part of M0, backed by the PBoC, and with full legal tender status. It does not carry interest, and is available through a two-tier structure involving commercial banks and to a more limited extent (more on this below) existing electronic payment services providers. These last features confirm that it is of paramount importance for the PBoC not to jeopardize in any respect the stability of the banking system, which could happen if the e-CNY had features that would put it in competition with bank deposits.

In the PBoC’s own words, "it has been paying close attention to the implications of e-CNY for monetary system, monetary policy, financial markets, and financial stability, among others".

One topic on which the white paper and the PBoC have not thrown much light is the system’s technical features and the technology roadmap. We know from early on that it will not at all work like bitcoin, but will rely at least partially on technologies similar to the ones used in blockchains ("blockchain lite", so to speak): "The e-CNY system adopts a distributed and platform-based design, which enhances the reliance and expansibility of the system". A major uncertainty is how the new system will handle transactions taking place with at least one party being offline. Being able to handle this type of situation is essential to the success of a digital currency but presents specific challenges, which nobody can claim to have fully solved at this point in time. It is in this context quite understandable that the PBoC does not wish to communicate too widely on this topic, if, as it is widely thought, it is far ahead of other central banks. Interestingly, we know that the PBoC takes the question of the protection of its intellectual property very seriously, having filed more than 80 patents related to the CBDC project by January 2020.

How does it work in practice?

We also know now how digital payments will integrate the new digital currency in day-to-day life. In order to acquire or open a wallet, a user will have to go to one of currently eight banks (a list expected to be progressively expanded): the six largest commercial banks, and two "digital" banks, respectively part of the Alibaba and Tencent/Wechat ecosystems.

We also know now how digital payments will integrate the new digital currency in day-to-day life.

One can open as many wallets as one wishes, e-CNY can be transferred freely from one wallet to another, or between a wallet and a bank account and vice versa. Wallet users are able to enjoy services offered by third-party payment service providers, including of course Alipay and WeChat. However, Alipay and WeChat themselves cannot directly open e-CNY digital wallets, as only their affiliated banks can.

In the case of an online transaction initiated on an Alibaba platform, for instance, a wallet user can choose to pay through their standard Alipay account (as they do now in most cases), but they will also be able to do it through whatever e-CNY wallet they happen to own. In the case of a physical transaction at a store, store operators will display not only their Alipay or WeChat QR-codes at the payment point but also an e-CNY QR code, so that customers can choose whatever payment provider they wish.

An important feature is that there will be different types of wallets, depending on the type of Know-Your-Customer (KYC) process performed at the time of the opening of the wallet, and on the depth of personal information provided: the stricter the KYC (like in the case where it is done physically at a bank branch), the more features will be available, with higher daily usage limits. In the case of a simpler KYC (like when it is done online), it will still be possible to open a wallet, but with less features and lower usage limits. The simplest form of wallet will still require a user to provide a phone number, though, which in China is linked and traceable to an ID card number. This kind of multi-tiered system, linking the functionality of a bank account or a wallet to the degree of information provided by the user, is of course meant to limit risks such as money laundering. It is directly inspired from the work done by banks and regulators when trying to put in place a new frame for digital banks. At the same time, the "loosely coupled design (松散耦合)" of the e-CNY is also meant to expand access and ease privacy concerns, at least when it comes to low-limit wallets and small amount transactions. As of now, it seems that the simplest type of wallet available, with the lowest usage limits, requires a user to provide a mobile phone number, and not an ID card number.

Copyright: ANTHONY WALLACE / AFP

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