China's digital yuan is a transaction helper, not a Trojan horse
Alumni and External Relations Office 2021-05-08
Each passing week seems to bring more media discussion about the digital yuan, China's version of a central-bank issued digital currency, or CBDC.
And with good reason: Late last year, the Bank for International Settlements surveyed 60 member central banks, including all Group of 20 members, and then reported that "central banks collectively representing a fifth of the world's population are likely to issue a general purpose CBDC in the next three years." The digital yuan will almost surely be the first.
CBDCs are digital forms of fiat money, a term commonly used since the 1971 Nixon Shock, which killed the Bretton Woods system by ending the dollar's convertibility to gold.
Since then, virtually all currencies have derived their inherent value not from a commodity peg, but rather by being backed by fiat, the full faith and credit, of the sovereign national issuer, such as the Bank of Japan, the European Central Bank, the U.S. Federal Reserve and the People's Bank of China. In this regard, CBDCs and physical bills and coins are identical, as currency in circulation, which measures the medium-of-exchange function of money.
CBDCs are also therefore only similar to the various cryptocurrencies, such as the Facebook-backed ingenue Diem, nee Libra, or the acephalous mutations such as bitcoin, in that they are digital.
Bitcoin is backed by two things alone: first, the full faith and credit of some ephemeral dude supposedly named Nakamoto. Second, an irrationally exuberant estimation of blockchain's power to be more than just really cool ledger technology and actually be a true originator and guarantor of value.
ECB head Christine Lagarde and U.S. Treasury Secretary Janet Yellen have both recently asserted that cryptocurrencies' primary societal contributions are to ransom collectors and money launderers, while Warren Buffett states he would be pleased to buy put options on the entire crypto sector. The recent large swings in bitcoin and Doge prices are just the most recent demonstrations that the sector is a classic speculative bubble, without any underlying value.
A Goldman Sachs report from November 2020 titled "Reinventing the yuan for the digital age," leads with, "China is at the forefront of digital currency development and will likely be one of the first countries to issue a sovereign digital currency." The PBOC's Digital Currency Research Institute, established in 2016, and two related research institutes have applied for nearly 100 digital currency patents. Last April, the PBOC started closed-system internal digital yuan tests in several municipalities, with the six state-owned commercial banks, three telecom companies, JD.com, Alipay and Huawei mobile phones all supporting.
China has good reason, and a good foundation, to become the world's CBDC pioneer. All jurisdictions will benefit from the sheer operational efficiency that a CBDC will create -- say goodbye to mints and engraving bureaus, large physical vaults and high-security transportation of physical currencies. Eventually, all those guys riding around in armored vans and carrying 12-gauge pump shotguns will have to find other employment.
China is also the most environmentally prepared among the large economies to launch a plausible CBDC -- Chinese consumers and the banking sector are already leading the world in mobile e-commerce and payment, and in some aspects widening the gap.
Are CBDCs Trojan horses? Nefarious attempts to enhance state surveillance? The China-specific answer to the Trojan horse question is "not really," for two reasons. One is an Ockham's razor argument: the reduced operations cost and transaction friction are more than enough motivation for any sovereign issuer to pursue CBDC development, as the BIS survey, and many other reports, demonstrate.
The other reason recalls the expression "carrying coals to Newcastle." Total online and offline transactions via China's banking system amounted to 8,195 trillion yuan, about $1,260 trillion -- yes, trillion -- in 2020, most of which is through the large-scale payment system established a decade ago.
The PBOC has long had the ability to see through these transactions, a figure that is about 25 times that of the total transactions made through Alipay, Tenpay and the other third-party payment providers. Moreover, from July 2018, all the online transactions of third-party payment providers must be cleared through China's NetsUnion Clearing Corporation (NUCC) platform, which is under the oversight of the PBOC.
The notion that the PBOC needs to make the effort to transit to the digital yuan, just to gain a bit of scrutiny over those third-party transactions, which represent less than 3% of total transactions, and are already visible to the PBOC, is, well, entertaining, but at the expense of those who entertain such a notion.
Furthermore, the establishment of the NUCC, and the implementation of a 100% reserve requirement for the transaction funds held by third-party payment providers, has provided a regulatory safeguard against liquidity risk due to illegal investment using these funds, or even money laundering.
The Chicken Little crowd, frightened of CBDCs and enamored of crypto, will do well to come back into the sunshine. CBDCs are an intuitive, rational evolution of the information age, while those crypto potatoes that speculators are eagerly passing around, each speculator hoping not to be the last recipient, are already hot and will become much more so. Asbestos gloves are advised.
(Li Nan is Associate Professor at the Antai College of Economics & Management at Shanghai Jiao Tong University. John D. Van Fleet supports industry relations for Antai College.)