After more than six years of preparations, China’s central bank recently unveiled to the public its new digital currency, named “Digital Currency Electronic Payment” (DCEP) by former governor of the People’s Bank of China (PBOC) Zhou Xiaochuan.
The pilot cities for DCEP include Shenzhen, Suzhou, Xiong’an and Chengdu, and people with an account in major banks such as the Agricultural Bank of China (ABC). Account holders can open a digital DCEP wallet on their ABC app, top up its balance and use it to pay for service provided by local businesses including Starbucks, McDonalds and participating grocery stores and restaurants. China’s digital currency pilot program also includes the 2022 Winter Olympic Games in Beijing, which implies that it will take well more than a year before the PBOC fully launches the digital currency.
What is DCEP, and what is it not?
First, and perhaps most importantly, DCEP is designed to function as “cash,” or just as the base money supply, M0 — at least for now. The digital currency is issued by PBOC and works exactly like cash or reserve in monetary economics; it is not “credit” itself.
Households or firms may hold DCEP in special digital wallets or in some commercial bank accounts, but not at the central bank. Commercial banks place 100% of reserves in the central bank against DCEP (hence, no extra credit is generated). This particular “two-layer system” design prevents the economy from cutting out the commercial banks as middlemen. Chinese customers who are already familiar with digital payment systems should not perceive any difference between DCEP and their usual Alipay or Tenpay.
The bottom line: Beijing wants minimal economic disruption in the world’s inaugural central bank digital currency (CBDC) experiment.
Second, although the DCEP is built with blockchain and cryptography, which presumably ensure superb security, it is run on a centralized database and hence lacks all the excitement regarding “decentralization” brought on by bitcoin and other cryptocurrencies. Privacy issues aside, centralization is not necessarily a bad thing — efficiency at the cost of crash risk.
More importantly, despite being simple conceptually from the perspective of economics or business, the digital RMB and its implementation are quite challenging technologically. For instance, based on Bluetooth technology, China’s DCEP supports “double offline transactions,” which allows individuals to transfer their digital currency without internet or mobile networks — literally just like cash. DCEP touts innovations like these as its edge against its biggest competitors like Alipay and Tenpay.
See related article: As China’s DCEP approaches launch, Facebook’s Libra pivots
Hence, the DCEP project may shape payment and settlement systems in the decades to follow, setting the stage for building the next generation of financial infrastructure in China. Interestingly enough, the DCEP itself does not need bank accounts — though many companies, including Shenzhen Fintech Co Ltd., a subsidy fully owned by the PBOC, have applied for patents on how to integrate the digital RMB into the existing banking structure in a seamless way. Unlike Covid-19 bailout payments clogged in the outdated financial systems of Western countries, the Chinese government would be able to quickly transfer financial subsidies to the right organizations and individuals during the next pandemic (if there is another one in the future).
From an economist’s perspective, the government should provide a smooth, real-time and secure payment system — one of the most important public goods needed in any modern market-based economy. It is also quite conceivable that, once the upgraded financial infrastructure is running, China would like to export its digital currency to its allies, especially those in the One Belt One Road initiative. DCEP could be thought of as one of Beijing’s relentless efforts to internationalize RMB, as China has long been frustrated by the U.S.-dominated global financial systems like Fedwire, CHIPS and SWIFT.
This leads to my fifth point. Just like many mainstream economists, including me, policymakers in China are fascinated by “blockchain technologies” but do not like “cryptocurrencies” per se. This is because cryptocurrencies that are native to various blockchains are mostly copycats of each other and highly speculative. From a social value perspective, cryptocurrencies are invented for peer-to-peer payment, not for storage of wealth. But the current banking system — including central banks, commercial banks and fintech companies — in most of the major economies are doing a reasonable job in providing payment functionality for the society. In contrast, blockchain technology, as a part of China’s “new infrastructure” stimulus program launching soon in response to the Covid-19 pandemic, can support multi-party business activities and international collaborations, such as supply-chain finance and global trade, to buffer against distrust and rifts exacerbated by ideological differences.
From this perspective, Beijing would naturally ask the private sector to focus on blockchain itself and stop wasting time on cryptocurrencies. Instead, it is the PBOC that is developing DCEP — the only legal cryptocurrency that can be integrated into hundreds of blockchain projects. This highly ambitious vision that eventually will lead to device-to-device transactions will allow China to automate entire internet-of-things (IoT) ecosystems, bringing efficiency gains to supply chains and even smart cities.
Finally, DCEP should be viewed as a positive step for China, but not as an imminent threat to the dollar’s supremacy. Given the ambition to internationalize the RMB, the PBOC certainly felt pressure from Libra to expedite the launch of its own digital currency. But China’s digital currency is not a silver bullet. After all, RMB, not DCEP, bears the credit of the Chinese government and is subject to the usual exchange rate risk.
Yes, DCEP and its associated financial infrastructure — as technologies — facilitate the transaction/payment of RMB. But unless China fully liberalizes its capital account, it is far away from disrupting the U.S. dollar’s advantageous position, at least in the foreseeable future. Ultimately, the exorbitant privilege of USD is due to the strength of the U.S. economy, together with some “coordination/network” features — i.e., people want dollars because they know other people want them, ad infinitum. Although Covid-19’s current ravaging of the U.S. economy and its soaring budget deficit could hurt the fundamentals for U.S. dollars and hence the first “strength” factor, it is still quite far to break the second “coordination” factor to overturn the dominance of USD as a global safe asset in the near future.