Raj Gupta, Research Intern, ICS
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The Central Bank Digital Currency (CBDC) race has begun to pick up pace and almost all the countries are getting into it. Around 86% of the world’s central banks are actively researching the potential of CBDC, which makes it evident that countries all over the world view it as an important development in the monetary domain which they need to be up to speed with. As of now, the Bahamas is the first as well as the only country to have launched a CBDC for nationwide use. Whereas among the major economies, China is at the forefront. China’s CBDC journey started early in 2016 when the Digital Currency Research Institute, the first official institution in the world engaging in research and development of digital currency was established.Early identification of potential, active research of the prospects of CBDC as well as successive pilot trials in major cities brought China to the forefront.
The official name of China’s CBDC is Digital Currency Electronic payment (DCEP), which is commonly known as e-yuan or digital yuan. During the pilot trials, it has so far received a positive response from the public, mostly because of the red packets containing DCEP which was distributed to the public on a lottery basis. It helped create the much-needed hype among the masses and kickstart China’s mission-CBDC. Platforms such as JD.com, Meituan and Didi Chuxing were roped in to participate in such trials as well in order to test the integration of CBDC into different apps. Since its first pilot trial to the integration into apps, the journey has been gradual and smooth. With the amount of control that the Chinese government yields over its institutions, integrating DCEP won’t be a challenge domestically. Getting people to use it instead of their WeChat or Alipay wallets can be a challenge but incentives similar to the red packets at early stages can help build that user base. Recent clampdown on internet giants in China might also soften the resistance from Tencent and Alibaba and make space for the digital yuan.
China also has its eyes fixed on the Beijing Winter Olympics 2022 to showcase its first major use case on a large scale and this may also serve as a gateway to wider use of CBDC in the country. Although the PBOC officials claim that they are looking more into the domestic use of e-yuan, many initiatives reflect otherwise.
The first is the Multiple CBDC (m-CBDC) Bridge which the PBOC joined recently. It aims to develop a prototype for cross-border payments with the Central Bank of the United Arab Emirates, BIS Innovation Hub, the Hong Kong Monetary Authority, and the Bank of Thailand.The main objective is to study the feasibility of cross-border payments using CBDCs and distributed ledger technology. Being the first-of-its-kind initiative, this has huge potential to solve issues related to cross-border fund transfers. Given the scale and timing, the results of the Proof-of-concept work can perhaps contribute to setting international standards around CBDCs.
The second is, Finance Gateway Information Services Co, a joint venture established by China National Clearing Centre of the PBOC and the SWIFT, which aims to establish and operate local network of financial messaging services to process cross-border Yuan payments through China’s own settlement system. Both, m-CBDC bridge and Finance Gateway Information Services Co. aim to challenge and change the current USD-dominated payments system in the coming future.
There is no doubt that both these initiatives aim to provide solutions and develop the current cross border payment infrastructure but these will also make the currently followed arrangement of Society for Worldwide Interbank Financial Telecommunication (SWIFT) less relevant. Currently, international payments are facilitated by the SWIFT. The dominant role played by the USD in SWIFT’s payment system is arguably one of the major reasons for the USD’s status as a global reserve currency. China is aiming to change that by trying to build a parallel system. And when that parallel system gets up and running, internationalization of the RMB could get easier by incorporating DCEP into various forms of economic activity in which it participates through multilateral and bilateral arrangements.
There are many avenues through which China would want its CBDC to flow and gain a grip over cross-border payments. From providing financial aid to BRI countries to waiving off transaction fees on repayment of loans, there are a plethora of options China has because of its trade links that make it the largest trading nation in the world. China’s growing integration with the developing world can help China rally countries behind it to follow Chinese standards of CBDC.
DCEP’s success internationally can tend to affect the dominance enjoyed by USD in global payments. The brunt inflicted by U.S sanctions is largely because of the USD’s dominance in international payments architecture. Hence, a parallel network system based on m-CBDC holds the potential to soften that brunt of U.S sanction policies which have increasingly been used against Chinese entities and individuals. Even Hong Kong’s chief executive Carie Lam was left with a pile of cash because banks did not want to deposit her money and expose themselves to the risk of U.S sanctions. This is an example of how strong and effective the U.S sanctions are against companies and individuals. If China can circumvent the sanctions through its system, it is likely to reduce the U.S hard power and will allow China to act with much more flexibility without having to worry about the aftermath of U.S sanctions. It can have far-reaching effects on how China deals with the nations facing sanctions by the U.S.
But all of this won’t be easy for China to accomplish. Cross-border usage of DCEP will likely face headwinds because the U.S and its allies may see the increasing acceptability of China’s DCEP as against their interests. On June 5, a communique issued by the G7 iterated the benefits and potential of a CBDC and underlined its commitments towards transparency and rule of law. It further stated that the G7 will work together towards common principles and will publish conclusions later this year. This communique reflects that the U.S and its western allies have perhaps woken up to the potential threat of e-yuan and are now pooling efforts to study its implications and ensure appropriate frameworks are in place.
There are issues such as interoperability among CBDCs of different countries which can prove to impede the goal of easier cross-border transactions. Another major issue is the lack of digital infrastructure in other countries to transact in digital currencies even if interoperability is achieved. But the single biggest impediment could be the privacy issues related to the DCEP. DCEP follows what has been termed as ‘Controllable Anonymity’ which allows the People’s Bank of China (PBOC) to have complete oversight of the data collected from its CBDC. The idea of data collection by a foreign government won’t go down well with democratic nations that have strict privacy laws. Besides, it will likely lead to an increase in scepticism and reluctance in foreign entities. There are rapid developments taking place in the CBDC domain with different countries moving up the ladder. DCEP, clubbed with China’s trade links, growing influence and strategic long-term thinking has the potential to counter Dollar weaponization but that will be a very long and difficult road ahead. China is hoping that someday e-yuan can play a key role in supplanting the U.S Dollar. But for that, there must be a system in place that can be used to gradually increase the tempo when needed. With the consistent pace at which China is developing and testing its CBDC, that system will likely be in place in the near future.