While politicians and central bankers in the U.S. and Europe wrangle over Facebook’s proposed Libra coin, one government is moving to seize the initiative: China.
The People’s Bank of China has been studying central bank digital currencies (CBDCs) for several years and probably has the greatest technical understanding of any public institution. Introduction of a digital yuan could come any day now.
There are a lot of unknowns and misconceptions about this, however. Here is the second set of three out of six myths about the digital yuan that tend to crop up in media, conferences, and cocktail conversation. See here for the first three.
A digital RMB would crush the payment rails of AliPay and WeChat.
The thinking here goes that by making cash digital, the PBoC would be reinstating the primacy of China’s commercial banks, or bringing the tech platforms to heel.
But these are different things. AliPay and WeChat Pay are examples of electronic money. They are in the same category as, say, Kenya’s M-Pesa. It is a means of payment wholly backstopped by a private company, limited to users and services on that company’s platform. A digital yuan is cash that is accepted anywhere the renminbi is legal tender.
If the PBoC wanted to use bank money to compete against e-money, it could, but the evidence so far suggests the opposite, particularly as the PBoC has said it will restrict a digital yuan to wholesale institutions, rather than let it run in the wild for all consumer payments.
The potential to compete against e-money is there. Uruguay’s experiment (see previous story) set its digital peso in direct competition with the likes of local WeChat users. But China’s approach has been convivial, with the government cooperating with its biggest tech players.
Notably, although use of cash by many Chinese people has declined, cash levels on balance sheets have not. Internet companies are basing their e-money on users’ bank account balances. So in the Chinese example, cash has already become a largely interbank concern – so digitizing it wouldn’t have a big impact on the relationship between cash and e-money.
What might change, however, is the way that e-money platforms compete, both which one another and with banks. One potential use of a central bank’s digital currency is to require compatibility among e-money players if they are to offer customers access to digital yuan. Right now, Alipay, WeChat etc are closed loops. If a digital yuan is restricted to interbank markets, this may not change, at least not for a while. It’s a bigger question mark if the government decided later it wanted consumers to pay with digital yuan.
A digital yuan restricted to wholesale (interbank) channels is no big deal to consumers or merchants.
So far it seems the biggest impacts of a digital currency are negligible because the PBoC has said it wants to keep its CBDC limited to the interbank market. So is this a giant yawn?
First of all, the wholesale market may be just a stepping stone. The PBoC hasn’t ruled out allowing (or encouraging) banks to disseminate digital currency to individuals.
How the central bank structures its digital cash is all-important. How much of the central bank’s liability can be lent out using digital currency? How much value in the form of digital currency is stored on the central bank’s balance sheet (i.e., reserved)? These things help determine the extent to which digital cash can be lent out, or if it is just used as a means of payment.
(Another question is whether the central bank issues these in the form of tokens valued at par, or if it creates a synthetic stablecoin to invest in a portfolio of cash-like instruments, a sort of proprietary/national Libra.)
Other technicalities that will impact use of a CBDC is whether it is just for interbank settlement, or if it is similar to cash (usable by anyone), or as a policy tool (to increase or decrease the money supply by making digital cash more or less appealing to hold), or as a deposit currency for accounts with the central bank.
Although the PBoC has indicated it will take the safest route and limit its digital yuan to interbank settlements, it hasn’t stated clearly how universal it wants its e-currency to be, or what goals it has in mind. Who will be allowed to access e-money in the interbank market: state-owned enterprises? Foreign bond fund managers? Domestic mutual-fund company portfolios?
CBDCs won’t matter to bitcoin or other private crypto projects.
Bitcoin enthusiasts might think a digital yuan that is limited to the wholesale market won’t impact public crypto-currencies. That is probably mistaken, although the impact will depend on how the central bank designs its system.
Even if the central bank’s goal is simply to do away with physical cash and encourage payments via e-currency, that is already a use case for bitcoin in many poorer countries. CBDCs are traceable, which might make bitcoin the preferred choice for users – but not necessarily for the payment rails they still need to connect to the traditional world.
The fact is that CBDCs are going to have a massive impact on private crypto. It could be positive, by legitimizing digital cash and making room for assets denominated in crypto tokens to flourish. It could help spur constructive regulation around the entire digital-asset environment.
But digital assets in what denomination? Because central banks, once they enter the digital-cash game, can also make life hard for private crypto. They could for example provide a yield on holding the government’s digital currency. They could encourage banks or companies to lend their digital currency. Or they could require banks, companies or private investors to place some of their digital assets on reserve with the central bank. Finally, the great mass adoption of crypto that many in the bitcoin space are working towards might be fully realized – when the coin in question is the government’s.
Of course, if states also choose to use digital currency to exert social controls over their citizens, and obliterate privacy, private currencies may become fashionable. But central banks have the option of wielding many carrots and sticks.
This whole crypto thing may have gotten started with Satoshi Nakamoto but it is going to be governments that determine how it ends. Expect CBDCs to evolve into competitive tools by governments to woo capital, punish capital, or channel capital.