China’s relationship with cryptocurrency is not a straightforward story and the latest twist in the tale is the confirmed development of DCEP. SolutionsHub CEO Lee Hills takes a deep dive into China’s attitude to blockchain tech and explores how, with a state-backed token, the People’s Bank of China will change the world forever

Cryptocurrencies are not a particularly natural fit for any sovereign state, especially one with such a high degree of control as with China. Indeed, a significant threat to China’s monetary policy is the power cryptocurrencies hold in avoiding foreign exchange rules.

China has a history of harmful policies towards cryptocurrencies, which came to the fore in 2013 when the People’s Bank of China (PBOC) issued a notice banning banks from transactions relating to Bitcoin[1].

Despite this, China was a hotbed for digital asset exchanges, with several of the world’s largest exchanges based in the country. However, in a steady and structured move to tackle crypto exchanges throughout 2017, the authorities first notified leading exchanges of their obligations towards managing risk and avoiding “irregular practices.” According to sources, they went as far as saying the exchanges could not mention depreciating renminbi, or measure its performance against cryptocurrencies.

During 2017 concerns grew over the initial coin offering (ICO) hype and large unregulated exchanges operating from within the country’s borders and what that meant for capital outflow concerning the country’s economy. This prompted formal investigations and a steady increase in associated regulation, which resulted in PBOC declaring ICOs illegal and ordering exchanges to close[2].

Many of those exchanges redomiciled to Seychelles or the now much-beleaguered Malta. However, reports from Sanyan Finance[3] suggest the Chinese authorities identified 39 exchanges still operating illegally as recently as November 2019.

Even with this backdrop, one notes China has not prohibited citizens from owning cryptocurrency. On October 24 2019, President Xi Jinping addressed the Communist Party of China Central Committee Political Bureau (CCCPB) on the development and trend of blockchain technology.

President Xi Jinping underlined the importance of blockchain technology, urging continued progress with the view to positioning China as a leader in defining international standards. [4]

It has been clear for some time China’s prohibition policies relate specifically to Bitcoin and cryptocurrencies generally, especially where they highlight negative aspects of the Chinese economy, performance of renminbi, or allow large-scale foreign transfers.

If you’re not first, you’re last

While the US is seemingly stuck in the process of defining tokens and unwinding ICOs it deems to have breached securities laws, China has been busy steadily introducing guidance and regulation, as well as supporting private, public sector partnerships.

The Deloitte’s 2018 Global Blockchain Survey concludes 49% of Chinese firms “deployed blockchain technology in production,” compared to just 14% in the U.S. However, 2019’s Survey suggests US respondents reporting a rise to 29%, while China’s dropping to only 16%.

One has to query such a drop against the expected US rise and question if perhaps Chinese respondents were somewhat ‘liberal with the truth’ in 2018, or maybe some of 2018’s pool is no longer in the country, such as the exchange businesses that now operate from foreign shores.

In any case, analysing the survey results, one notes a general upward trend in adoption, development, and positive attitudes towards blockchain technology, with 73% of Chinese respondents confirming blockchain technology as a ‘top-five strategic priority,’ compared to 56% in the US.

China also boasts various government-led initiatives, introduced with the cooperation and support of the private sector across China.

The race to define, develop, and own the technology is an interesting one, especially given the liberal origins of the technology. Still, China’s focus is unrelenting, and the China National Intellectual Property Administration (CNIPA) records over 10,000 blockchain-related patents have been filed, including 63 by PBOC. [5]

PBOC plans for DCEP

The clear focus on technology development leads nicely into the role PBOC plays as we move through 2020, and the critical reason China is likely to dominate the headlines this year. For some time, many reputable media outlets have informed China is working on its state-issued, and sovereign fiat-backed cryptocurrency. Then, at the China Finance 40 Forum, Executive Vice President of the China Center for International Economic Exchanges, Huang Qifan, confirmed PBOC was in its final preparation stages to launch its digital currency, DCEP[6] (Digital Currency Electronic Payment).

Although DCEP has been six years in the making, the confirmation was interestingly timed, with media coverage of US-headquartered Facebook developing Libra dominating the media. Perhaps one should give credence to the inference PBOC’s plans had been accelerated due to a threat of Libra?

It certainly makes sense that Libra would create serious concern and acceleration of plans. If Libra launched with access to Facebook’s userbase, it would be accessible by a quarter of the world’s population, making it a primary global currency and backed by various fiat currencies, with the majority likely in USD, a point focused on by PBOC’s research bureau director, Wang Xin:

“If [Libra] is widely used for payments, cross-border payments in particular, would it be able to function like money and accordingly have a large influence on monetary policy, financial stability and the international monetary system? “If the digital currency is closely associated with the US dollar, it could create a scenario under which sovereign currencies would coexist with US dollar-centric digital currencies. But there would be in essence one boss, that is the US dollar and the United States”

China’s approach, at least as presented, is much more cultured, with Wang Xin explaining:

“In order to ensure that this digital currency is not over-issued, the PBOC digital currency will remain the central bank’s debt, which is guaranteed by the People’s Bank of China’s credit guarantee. That is to say, while the commercial entity is reporting to the PBOC to issue digital currency technical reports, it must pay 100% of the reserve to the PBOC to ensure the stability of the commercial subject of the cryptocurrency in commercial circulation”

DCEP – a closer look

The initial thoughts were DCEP would be very similar to Libra, with each unit matched by fiat currency deposit (with PBOC). This is perhaps the purists’ form of a stablecoin; a digital currency issued by a central bank, backed 1:1 with a Yuan deposit. However, speaking at The China Finance Association Academic Annual Meeting and China Finance Forum Annual Meeting, Changchun Mu, Head of the PBOC’s research institute on digital currency said[7]:

“The [DCEP] currency is not used for speculation. The RMB is used to spend, not for speculation. It does not have the characteristics of Bitcoin speculation, nor does it require the currency basket assets to support the value of the currency like stable currency”

This statement deserves analysis, seemingly inferring DCEP will not be backed, at least wholly, by fiat currency, yet price stability is essential to ensure usability. So, how could PBOC ensure DCEP is usable?

Possibly as a result of extensive research, or perhaps by merely adopting what may be seen as a good idea, PBOC could take the same approach proposed for Libra and peg the value to a market-value basket of fiat bank deposits and short-term government securities (“the Basket”).

Somewhat simplified, but the Libra model denotes the Libra Association would be responsible for monitoring and maintaining the Basket, then making adjustments to the Basket to ensure stability as Libra is bought and sold.

The value of the Basket’s assets fluctuates (where value is stored outside U.S. dollars). Of course, a massive issue with the Libra model is the Libra Association member composition is mostly that of non-financial institutions and no Central Bank, so trusting monetary policy to such parties is considered dangerous.

Whereas, PBOC controlling the Basket would be an extension of natural activity by an experienced, trusted party with appropriate expertise and international grounding. In short, it would be hard to argue they have the right to oversee the management.

With the details still vague, one may conclude this is by design, or perhaps the DCEP launch is being rushed. Nevertheless, regardless of the reason for the lack of transparency, Changchun Mu is quoted as stating PBOC will be gradually issuing DCEP to citizens through commercial partners, including Tencent and Ant Financial soon.

One of the conclusions I do believe we can reach is “Digital Currency Electronic Payment” doesn’t sound like a token or a cryptocurrency.

It sounds like a description of the mechanism, and there is the curiosity; Chinese authorities do not think small. China takes slow incremental steps towards a much broader, long-term strategy. Therefore, I propose the introduction of a Central Bank issued cryptocurrency is only a part of an even bigger puzzle, and the shroud that surrounds DCEP is by design.

In essence, while the outside world is looking intensely at DCEP, they miss the wider revolutionary adoption of blockchain technology benefits within China’s government and financial services sector.

Global initiatives

From a global perspective, Central Bank issued cryptocurrencies are generally referred to as “Central Bank Digital Currencies” (CBDC), with most governments and many Central Banks researching CBDC’s for some time. Libra may have pushed China to accelerate its initiatives, and reports suggest Japan has tentatively entered the race to create a policy around a CBDC and issuance thereof, as a result of China’s progress. Hence, one has to question how long it will be before the global population is served by CBDC’s.

The Bank for International Settlements (“BIS”) published its second survey on central bank digital currency this month. Of those requested, 66 Central Banks responded, with an upward trend of Central Banks engaged in CBDC work. In 2018, 70% confirmed they were involved in CBDC work. In 2019 this rose to 80%.

The results show double the percentage of Central Banks surveyed confirm they are likely to issue a “general purpose” (public rather than interbank settlements) CBDC in the next three years (5% 2018 up to 10% 2019).

In a more proactive move, on the 21st of January 2020, BIS announced the creation of a working group to assess potential cases for CBDCs.[8]

The group includes the Central banks of Canada, England, Japan, Sweden, Switzerland, as well as the European Central Bank and BIS.

The group will include representatives of the group’s institutions and co-chaired by Benoît Cœuré, Head of the BIS Innovation Hub and Jon Cunliffe, Deputy Governor of the Bank of England and Chair of the Committee on Payments and Market Infrastructures (CPMI).

The press release states that the group’s creation was to “assess CBDC use cases; economic, functional, and technical design choices, including cross-border interoperability; and the sharing of knowledge on emerging technologies. It will closely coordinate with the relevant institutions and forums – in particular, the Financial Stability Board and the Committee on Payments and Market Infrastructures (CPMI).”

Some members of the working group have previously collaborated on the topic individually, and other collaborative initiatives have been announced, such as the World Economic Forum’s announcement of the 24th of January 2020, noting the creating of the Global Consortium for Digital Currency Governance. [9]

The news release states the formation of the Consortium is to “bring together leading companies, financial institutions, government representatives, technical experts, academics, international organisations, NGOs and members of the Forum’s communities on a global level”.

This follows the Central Banks in the Age of Blockchain initiative, which includes 45 Central Banks and designed to create a “community for central banks to share experiences, ideas and best practices related to DLT and digital currencies.” It includes a Policy Maker Toolkit[10] and other base resources to support enhanced development of international best practices with CBDCs.

Dominance vs dollars

Most Central Banks have some foothold in the development of CBDCs and policy. The Bank of Thailand published the results of its proof of concept for a wholesale (interbank) CBDC some time ago[11]. However, PCOB is exceptionally close, and the ramifications for the global economy could be dramatic, with the status of the US Dollar challenged as the global currency reserve.

China is lobbying the Association of Southeast Asian Nations and East Asian partners to add Yuan to the Chiang Mai Initiative, an initiative introduced to avoid a repeat of the 1997 Asian currency crisis. The initiative led to the creation of a pool of US dollars, which could be sold to slow a decline in the currency. However, this is just a focal point of China’s intention to displace the US Dollar dominance.

Approximately 50% of all international trade is conducted in US Dollars[12], many of China’s regional partners permit US Dollars to circulate alongside their own, and many peg their currency against the dollar. If this pre-eminence is challenged, the entire global financial system could reshape to Beijing’s will.

Sources and references