Introduction of China’s Digital Currency
The invention of cryptocurrencies (Bitcoin, Ethereum, etc.) provided a verifiably secure financial alternative to traditional finance. Although it may seem that money is already completely virtual in some places, in fact, it is not. Financial technology (like Apple Pay in the US, and WeChat and Alipay in China) created this illusive perception by facilitating electronic transactions. Though these platforms are accelerating the rate at which consumers and investors feel comfortable using new financial technologies (fintech), they have the same limitations as traditional currency.
The Difference Between Crypto and Traditional Currency
Cryptocurrencies, like Bitcoin, are different from traditional currency in several critical ways. One main difference is that cryptocurrency is distributed and not controlled by a single entity, unlike traditional currency which is regulated by central banks. Cryptocurrency is also highly secure, durable, and programmable.
Several countries (Bank of England, Bank of Japan, European Central Bank, Swiss National Bank, etc.) have researched and piloted digital currencies to determine their feasibility according to the Bank for International Settlements (BIS). However, it is the People’s Bank of China that is taking the lead in pioneering its digital currency. China hopes to incorporate the inherent benefits of cryptocurrency into its own virtual currency system, the Digital Currency Electronic Payments (DCEP), while removing the aspects that threaten traditional finance, like the anonymity offered by a distributed system.
China’s Place in the Global Economy
China is experiencing economic growth that has garnered attention and praise from around the world, with many economists labeling it an ‘economic miracle’ according to the BBC. Since China opened up in 1978, GDP growth has averaged nearly 10% per year, lifting over 800 million people out of poverty and into the middle class (the World bank). China’s high growth was based on resource-intensive manufacturing, exports, and the advantage of low-wage labor. This economic growth brought the Chinese from a third world country to the second largest economy on earth. China is projected to become the largest economy in the world by 2028.
With this level of growth and economic activity, it’s imperative that the Chinese Communist Party (CCP) be able to manage and accurately analyze financial decisions throughout the country in a timely manner. The use of the DCEP will help the CCP accomplish these tasks. However, for any consumer to willingly adopt such a new technology, they will need to have already built familiarity and trust with fintech. Thankfully, the Chinese economy has led the world in the adoption of forward-looking financial technologies.
China’s Early Adoption of Fintech
Implementation of Alipay and WeChat pay, which is China’s major online payment platforms, have accelerated exponentially since their introduction into the Chinese market, with everyday citizens from teenagers to the elderly using these services on a daily basis.
Over the past decade, consumer spending in China has relied increasingly on fintech. According to the Global Fintech Adoption Index for 2019 from Ernst & Young, China leads the world with an adoption rate of 87%. Back in 2004 when Alipay was introduced, it would have been hard to speculate what its growth and impact would be. It would have been even harder to predict that it would overtake PayPal as the world’s largest mobile payment platform by 2013 (Business Insider). This massive success led rival Tencent to create its own mobile payment software, WeChat Pay. The competition between these two massive tech companies led to faster, cheaper services, and therefore greater adoption and use from consumers.
At the time these two payment processing apps were introduced, China was strategically positioned to take advantage of them. SME’s (small to medium enterprises) could not afford to purchase expensive POS machines for processing bank cards and were therefore more likely to only accept cash. Alipay and WeChat Pay provided a convenient solution. They offered clear advantages: they operated as P2P transactions, had either low or almost 0 commission, and could be easily incorporated by the most technologically challenged businesses.
The success and growth of fintech in China has created a knowledgeable consumer that trusts fintech. Although it may sound simple, it can be quite challenging to accomplish when starting with a culture that has little exposure to these types of technology. Now that these financial habits have seeped into the everyday culture of the Chinese people, the next logical step will be implementing the DCEP.
Benefits of Implementing the DCEP
The DCEP has potential to benefit the CCP and the global financial system in several ways. First, DCEP will enable the CCP to better track the flow of cash as it filters through the economy, allowing for greater collection of data. This data can provide strategic insights into economic bottlenecks restricting cash flow or other types of inefficiencies in the system.
Second, the DCEP will give the CCP the ability to bring segments of the population that don’t have access to banks. Twenty percent of Chinese citizens do not have access to a bank, making it the largest unbanked population on earth according to the World Bank. Digital currency will help provide financial services to these people because it does not rely on expensive banking products or have costly infrastructure.
Finally, if the DCEP proves to be successful, it might propel the RMB (renminbi) past the US dollar and into the top spot of international reserve currencies. The reliable nature of digital currency would allow for global investors to re-examine their reliance on other currencies for conducting international investment and increase their use of the RMB.
What are Cryptocurrencies and How is the DCEP Different?
Cryptocurrencies are digital currency that is secured using cryptography (a method for storing and transmitting data) and are usually based in decentralized networks using blockchain technology. Because of their secure design, cryptocurrencies allow two parties to easily transfer money without the need of a third party. This feature has a direct impact on how business can be conducted, since two parties can save both time and transaction costs by eliminating the need of third-party oversight.
It is this ability that brings both the advantage and disadvantage for China. On the one hand, removing the need of third-party oversight will allow the massive unbanked population to enter safely into the Chinese economy. On the other hand, money that is moved without this oversight allows illegal financial transactions to be conducted without risks, increasing the likelihood of financial crimes.
China will capitalize on the advantages of cryptocurrency while removing the negatives by using the DCEP. Because the DCEP is regulated by the government, it can be monitored for illegal activity while increasing accessibility of banking to those still without access to traditional banks.
How the DCEP May Disrupt International Trade
The DCEP has the potential to radically impact the way international business is done. Currently, the dominant system for international transactions is SWIFT (Society for Worldwide Interbank Financial Telecommunications). SWIFT is a digital messaging system, located in Belgium, that’s used by international commercial banks with approximately 11,000 member banks and 34 million daily transactions.
Countries like the United States use SWIFT to monitor suspicious activity from individuals as well as impose sanctions on countries and companies around the world. If China is able to successfully implement the DCEP into its economy, it could cumulate the disruptive power necessary to create an alternative to the current financial system. People may start using the DCEP at international airports instead of costly currency exchanges, and entities currently outside the financial system could have avenues to conduct trade in a new system that is secure and transparent.
The Chinese are currently implementing the DCEP as a way to take advantage of the inherent benefits that cryptocurrency offers, while removing the aspects detrimental to governance. After piloting the DCEP, the CCP is analyzing and preparing to launch it at a national scale. This technology has the ability to bring China’s unbanked population into the fold while also challenging the traditional financial system by functioning as a viable substitute. China is taking the necessary steps to lead the world in the use of cryptocurrency as a government regulated currency and positioning itself to reap the benefits.
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