The People’s Bank of China is testing a state-backed digital currency, despite a recent ban on cryptocurrencies and ICOs, according to a paper published in the Tsinghua Financial Review.

Yao Qian, the director of the Central Bank, believes that a central bank-issued digital currency benefits China.

The country is currently leading the national cryptocurrency movement and is moving slowly to ensure the proper and safe implementation of the digital currency. Other players, like Russia, are working quickly to enter the space as well.

Why a state-backed digital currency is suitable for China

Like any form of currency, a digital currency requires acceptance and trust from the public.

Chinese consumers show significant trust, and acceptance in the non-cash payments system as transactions through mobile applications occurring on a frequent basis. In 2016, for instance, China’s most popular mobile apps WeChat and AliPay amassed over $5.5 trillion in digital payments.

For the Chinese people, transitioning from a fiat currency to the use of fiat and virtual currencies should not require too much time and re-education.

The government is piloting the use of digital currencies in Beijing or Shanghai to test this concept. The results of these tests will determine whether China is ready for a centralized digital currency.

Benefits of a centralized digital currency

With a centralized digital currency, China can include non-urban communities in the modern day banking system.

Unlike setting up a bank account, a centralized digital currency uses a virtual wallet. These wallets are faster to set up and contains fewer restrictions than traditional bank accounts. Since one-third of the Chinese population does not have a bank account, moving these people into the centralized system would promote further growth and trade for the state.

In theory, a centralized digital currency should also reduce fraud and counterfeiting. The blockchain network’s transparency can trace the movement of money and aid in the detection and removal of corrupt institutions in China.

However, having a centralized digital currency goes against the original idea of the blockchain network. Digital currencies were developed to be decentralized. In a country where the government manages digital wallets and controls the blockchain, it could remove small instances of fraud but allow large-scale corruption to persist.

China also sees significant benefits of the blockchain to foster international trade without the intervention of the US dollar.

China’s partnership with Russia to create a blockchain based securities settlement may remove U.S’s political and economic hegemony. Russia and China will probably explore

smart contracts and multi-signature escrow accounts, so importers and exporters can undergo direct cross-currency swaps.

Risks to consider

Although digital currencies have significant benefits, China needs to explore pressing security and regulatory issues. A big problem with digital currencies are the online hackers. In July, hackers stole $32.6 million Ether. In 2011, they took $460 million from Mt Gox, the world’s then largest bitcoin exchange.

If hackers can steal decentralized digital currencies like Ether and bitcoin, they would have an even greater incentive to hack a centralized system. If a hacker had access to the central bank’s system, they would theoretically have access to every wallet in the system.

With China’s steady progress, it could become the first country to issue out its national digital currency.

China sees the blockchain as a technology that could revolutionize the financial sector. Despite the significant benefits, authorities need to remain vigilant on the potential risks of virtual currencies. A flaw in the technology could easily cause problems to the Chinese economy.

Image credit: Wikimedia Commons

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