The riots in Hong Kong and the economic battles between China and the United States are catching headlines around the globe, at the expense of an intriguing announcement posted this week: the approaching yuan-based digital currency. The unprecedented Chinese announcement may well have to do with the events at the heart of the news, and we will examine these issues later in the article, but let’s first discuss what it’s all about.

The digital coin that China has been developing over the past five years is referred to outside of China as CBDC – Central Bank Digital Currency. This is a natural development, given the digitization of every area of our lives, and is an institutional response to the challenging crypto world, which has also been investigated by several dozen other countries. The People’s Bank of China (PBOC) has chosen a mechanism whereby digital money will function similarly to cash. Accordingly, the distribution of this digital-yuan to the public will be executed through commercial institutions, and not directly by the central bank. It will not be a yield-bearing asset (positive or negative).

The common technical term for cash is M0, which differs from the total amount of money in circulation, including the credit allocated by commercial banks known as M2. Most of the research already conducted around CBDC concludes that focusing on the basic level of money (M0) is more effective and reduces exposure to monetary system risks. China has yet to reveal the currency’s mechanism. Bloomberg reported that the PBOC has registered 78 digital currency patents and 44 blockchain-related patents. According to these patents, consumers and businesses will need to download a mobile wallet and swap their yuan for the digital money, which they can then use to make and receive payments.

If it doesn’t look like crypto and doesn’t swim like crypto…

There are common aspects between CBDC and cryptocurrencies, and the terms are admittedly similar, but it must be made clear that these are completely different, and even fundamentally contradictory instruments.

For example, the currency that China is developing is a very different situation to paying wages using Bitcoin — a new policy that according to reports, New Zealand is considering starting next month. If New Zealand implements this policy, it will be dealing with a decentralized currency beyond its control, and will consequently face complicated challenges regarding the flow of capital in the country.

On the other hand, the digital-yuan is not decentralized at all. It is a totally centralized currency, just like any kind of fiat. Digital-yuan issuance conforms to the Chinese policy that officially prohibits the trading of cryptocurrencies. PBOC will be able to monitor all movement of the currency, primarily to avoid money laundering, but also for any other purpose that it may choose.

Furthermore, the fact that over the last decade, China has had an ongoing social ranking system in place, where the individual “social credit score” of each citizen is expected to determine their ability to take flights, buy train tickets or send their kids to a good school, combined with the total control of the capital flow through the CBDC, could furnish the government with unprecedented power.

This is completely opposed to the aspirations of many crypto users, who wish to maintain their privacy, as well as having immunity from government censorship. Even opposers of crypto are likely to express doubt. Will China or other countries eventually develop systems that balance centralization and decentralization? Only time will tell.

Why now?

The official announcement of the completion of digital-yuan was confined to the professional and technical spheres, but there is little doubt that political unrest is hovering in the background. First and foremost, the currency war between China and the United States derives from the bitter battles currently being waged by the two countries with increasing intensity. Only last week, Washington called China a “currency manipulator” for the first time in 25 years. The reason for the statement, which the Chinese perceived as particularly aggressive, was that last week, China let the yuan breach the key psychological rate of seven yuan to the dollar, for the first time since the global crisis of 2008.

This followed the US’s imposition of new tariffs on Chinese imports. The weakening yuan disturbs the administration of President Trump, as it gives an advantage to Chinese exports. As a result of the growing pressure, Trump has already put off some of the planned tariffs, delaying it till after the busy holiday shopping season at the end of the year, in another round of this long game of hit and run.

The weakening of the currency is a step that benefits Chinese exporters and hurts the Americans but could also lead to capital flight out of China and brings further disadvantages for the red empire: its consumers will have to pay more for imports; Forex debt will be more difficult to repay; and global commodities denominated in dollars, such as oil, will also become more expensive.

In such an unstable environment, ruling the technological front with regard to currencies serves the Chinese well. As with the innovation battles in the cellular world which led to the US boycott of Chinese corporate giant Huawei, pioneering in the monetary realm involves risks, yet could also secure China’s status as an economic power. Digitization of the yuan, with added value of portability and usability, will serve China’s initiatives to encourage its trade partners to use its currency instead of the dollar. It is also possible that the recent announcement of the Libra project by Facebook — which is officially blocked by the Great Firewall of China — boosted the Chinese into coming out with their own scoop.

What happens in other countries?

As mentioned earlier, CBDC has been tested by many countries, but has not yet passed the pilot phase (except in Venezuela, which is dealing with a range of far more urgent and troubling issues). The key parameters for CBDC are whether its holders work directly with the central bank or through financial intermediaries, as China is suggesting; and whether it works within a centralized or decentralized network — and as a result, the level of user anonymity.

It is notable that one of the significant characteristics of cash is that it is almost anonymous. A national digital currency could be more suitable for countries where cash use is diminishing — or there is an incentive to keep using bills and notes. In countries that are becoming cashless, the transition from mobile payments to fully digitized currency is natural and straightforward. China has become a cashless society in recent years and therefore it is a suitable arena for experimentation with CBDC. Many businesses have completely renounced the option of paying cash, and no longer accept credit cards. Even market stallholders or beggars are known to display a QR codes, in order to receive mobile payments through such popular apps as WeChat and Alipay.

The IMF (International Monetary Fund) recently published research about e-money, offering a wider definition than CBDC. The research estimated that the adoption of e-money could be extremely rapid, but that it could also raise significant risks, related to customer protection, the safety of the payment system, and financial stability.

The status of CBDC testing worldwide

Sweden, which has extremely low levels of cash use, has been considering issuing e-krona in recent years. An experiment is currently underway.

Singapore, Canada and Uruguay are considering launching CBDC, and have already implemented technological and practical tests.

The UK investigated the issue, but for now has decided not to promote it following concerns over the stability of the financial system. Similar decisions were made in Germany, Australia, Japan and South Korea.

Venezuela is the only country so far to issue digital currency backed by the government, which it did in response to US sanctions. According to official declarations, every coin is backed by a barrel of oil, but in the bankrupted country it is difficult to know what is really the case.

Marshall Islands promotes digital currency, which would likely also give it monetary sovereignty, rather than having the dollar as its official currency, however the IMF has recommended that the little country avoid this due to concerns over financial instability.

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