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What China could gain from a digital yuan

Matthew De Silva
Chinese Renminbi notes

If recent reports are to be believed, China’s central bank is on the brink of launching a digital version of the yuan. According to a Forbes article late last month, the digital edition of the national currency could go live as soon as Nov. 11, coinciding with Singles’ Day, a popular Chinese shopping holiday.

Before we dive into the ramifications of a digital yuan controlled by the People’s Bank of China (PBOC), let’s take a moment to review a couple things:

  • “Digital currency” is a broad term, referring to anything from a US dollar on PayPal to a unit of bitcoin. It can even apply to gold pieces traded in a video game.
  • “Cryptocurrency” refers exclusively to digital units transacted on a blockchain network (e.g., bitcoin, ether). These units are not backed by any reserves and they’re not unilaterally controlled by any government or institution. Instead, they’re fabricated mediums, generated and traded on open-source networks. These networks are maintained by participants (“validators”) who contribute computing power to ensure their security. Although there are thousands of “cryptos,” only a handful meet the standards of distributed power and community governance set by bitcoin.

For myriad reasons, China’s digital yuan is probably not going to be a crypto-currency proper. That would be too darn complicated and confer little obvious benefit to potential users or the government, which wants to retain control over its economy. Rather the digital yuan will likely be designed in the image of WeChat Pay or Alipay, except with the PBOC at the controls.

Although China’s forthcoming central bank digital currency (CBDC) has widely been referred to as a “national cryptocurrency,” it’s quite unlikely to take that form. That’s because utilizing a public blockchain, as bitcoin does, would be prohibitive. It would hamper the currency network’s storage capacity and transaction processing speed—a digital yuan needs to support more than a billion people—and a blockchain foundation would even compromise basic financial security. Indeed, the radically open networks pioneered by blockchain-based cryptocurrencies have repeatedly been victimized by phishing attacks, thefts, and catastrophic hacks. (Even private blockchains remain unproven—at least, the benefits aren’t apparent as compared to those of conventional databases.)

As such, it seems more likely that any Chinese-sanctioned CBDC would make use of, well, existing systems. Regardless of the exact technical specifications, though, a digital yuan stewarded by the PBOC could provide the Chinese government with unfettered access to its people’s finances.

Vili Lehdonvirta, a senior research fellow at the University of Oxford’s Internet Institute, explained the potential implications of a Chinese CBDC to Quartz:

“A CBDC could have several advantages from a central bank’s perspective. One is winning back more direct control over money supply, to use as a monetary policy lever. In the fractional reserve banking system, banks make the money, and central banks control its supply only indirectly, through adjusting banks’ incentives. In a CBDC system, the central bank could bypass banks and influence consumers directly.”

Imagine this: In a negative interest rate environment, perhaps the Chinese government could incrementally reduce its population’s holdings to stimulate spending. Bold? Perhaps. Enticing? Certainly.

Lehdonvirta continued:

“Another advantage would be data, or to put it more bluntly, surveillance. If all citizens had accounts with the central bank, and used those accounts to pay for all kinds of purchases, then obviously the bank would have a lot of visibility into what goes on in the economy. This would be useful for economic research, but also for law enforcement. In a country where the rule of law is less than perfect, this comes with concerns.”

Yes, in theory, the Communist Party of China—acting through the central bank—could place restrictions on who is eligible for loans made by retail and merchant banks. Going further, it might even be able to shut off political dissidents’ bank accounts with a click. What China might gain in law enforcement capabilities and anti-money laundering controls could easily come at the expense of its population’s freedoms.

To be certain, to date, the PBOC’s statements have been fairly non-committal. Only in August did the PBOC say it would “expedite the research of China’s legal digital tender.” Take that as you will.

Ultimately, even though the PBOC has studied digital currencies for the past five years, actually launching one would be unparalleled, especially on a scale to suit the Chinese population. But if it does achieve this feat, the PBOC could shape the financial future at home and abroad.

When asked whether the PBOC should be worried about Libra (Facebook’s crypto initiative), Lehdonvirta seemed dismissive. “The information coming from Libra’s recent meeting with central banks makes it sounds like Libra is pretty half-baked compared to the digital payments infrastructure that’s already in use in China,” he wrote.

None of the seven institutions rumored to be working with the PBOC on the digital yuan’s launch have responded to requests for comment. They include the Industrial and Commercial Bank of China, Bank of China, Agricultural Bank of China, Alibaba, Tencent, Union Pay, and China Construction Bank.

REGULATORY WATCH

CFTC hires ex-Coinbase lawyer. The revolving door continues to spin between US regulatory agencies and crypto companies. The Commodity Futures Trading Commission, which oversees crypto-linked financial derivatives (i.e., bitcoin futures), appointed Dorothy DeWitt as director of the division of market oversight on Tuesday (Sept. 17). DeWitt spent the last year with Coinbase, serving as the crypto exchange’s vice president and general counsel for business lines and markets.

Coincidentally, J. Christopher Giancarlo, the CFTC’s ex-chairman (aka “Crypto Dad”) joined a blockchain outfit on Tuesday. The Chamber of Digital Commerce, a pro-crypto lobbyist group, announced Giancarlo as the newest member of its board of advisors.

BITS AND PIECES
  • Central banks should not issue digital currencies (Financial Times)
  • Hedera Hashgraph launched its mainnet beta this week, with 26 live decentralized applications. (Hedera Hashgraph)
  • The team behind Zcash discovered a recursive method to verify private transactions at scale. They call it “Halo.” (Electric Coin Company)
  • Libra’s reserves could threaten monetary sovereignty. (@Hasufl, independent crypto researcher)
  • A blockchain auditor found a vulnerability in Libra last week. (Open Zeppelin)
  • France shuns Facebook’s Libra. How was Libra stupid enough to end up here? (David Gerard, blockchain skeptic)
  • The Bank for International Settlements published a paper on “Embedded supervision: how to build regulation into blockchain finance.” (BIS)
  • Wells Fargo plans to test internal settlement using digital cash on a distributed ledger. (BusinessWire)

Please send news, tips, and revolving doors to privatekey@qz.com. Today’s Private Key was written by Matthew De Silva and edited by Steve Mollman. Good is the enemy of great.

 

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