How Does China's Digital Yuan Work?

Apr 21, 2021

Starting from this year, Central Bank Digital Currencies (CBDCs) will mark an entirely new era for the blockchain industry. As governments and central banks come closer to finalizing their new ‘decentralized’ solutions, it is the perfect time to take a look at the biggest contender in the CBDC universe: China’s digital yuan. How does this digital currency work, and how will it affect the Chinese economy?

The People’s Bank of China (PBoC) has a first-mover advantage in the field of central bank digital currencies for a long time. The institution began researching the benefits of CBDCs back in 2014, at a time where no other bank had the ‘guts’ to do so. After only four years, the PBoC’s research team completed their efforts and proved that blockchain technology indeed has a place in the modern financial world.

Today, China is seconds away from launching its CBDC, which they have dubbed as the digital yuan. Last year’s coronavirus pandemic has undoubtedly slowed down the project’s progress, but reports indicate that progress continued despite financial and health-oriented obstacles.

Because of their serious involvement in the project, China will be the first nation to launch a CBDC. Knowing this, other countries are becoming increasingly nervous about the fact that the dragon in the east had won the blockchain race before it even started.  

How does China’s digital yuan work, when will it launch, and how can it change the global blockchain industry? Moreover, what kind of effect will the digital yuan have on cryptocurrency markets? Let’s take a deep dive and answer everything one question at a time.

China’s importance in crypto and blockchain

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Even without counting CBDCs, we can safely say that China is entrenched in the world of crypto as its prime leader. Chinese miners represent the largest group on the Bitcoin network, controlling a notable percentage of its mineable supply. On the front of software development, we also know that China is the biggest blockchain hub, competing directly with the U.S. private sector.

However, policies show that China favors blockchain technology far more than cryptocurrencies and their ability to provide financial freedom. The authoritarian nation performed a crackdown on ICOs in 2017, and in some cases, the government even pressured miners and local rich citizens who were hiding their wealth overseas with cryptocurrencies.

Such blatant favoritism confirms that China attempts to evade the double-edged sword of cryptocurrencies by focusing solely on the technology behind them while dismissing assets like Bitcoin and Ethereum. With a focus on permissioned networks and digital currencies that are controlled by banks (or in this case, by the state), China has successfully dodged all of the disadvantages that crypto-assets offer.

This information is vital to keep in mind because many investors speculate that CBDCs are great for crypto. The main argument is that they push the mainstream adoption of digital currencies, which should make people more open to crypto.

But what if CBDCs are designed to replace cryptocurrencies and completely supplant them in the domain of payments? Keep in mind that this is purely speculation and that we still have to see whether China and other countries are heading down this road or not.

When did China start researching its CBDC?

The People’s Bank of China quietly began working on the digital yuan project in 2014, named the Digital Currency Electronic Payment (DCEP) at the time. But despite their early start, China’s intention to spearhead blockchain innovation was unknown for many years.

In fact, the idea surfaced in the public domain in 2019 when PBoC’s representatives first started to talk about their project. Funnily enough, the digital yuan was brought up at a time of turmoil and anxiety in the west over Facebook’s announcement of the Libra cryptocurrency.

The central bank’s governor Yi Gang revealed that the CBDC is designed not as a new currency but as a digital version of China’s existing monetary system. He divulged that the digital yuan is merely a transaction-focused currency used for payments that will help boost China’s thriving digital economy.

Note: China has a booming ecommerce market that expanded massively over the past few years. During the 2020 pandemic, online purchases boomed once more, and Chinese consumers spent $20.8 trillion on retail ecommerce, resulting in an astronomic yearly growth rate of 16%. How much will the sector thrive once solutions like the digital yuan become incorporated into China’s mainstream economy?

Yi further shared that the digital yuan will help banks settle payments faster. However, the governor noted that regular processes like deposits will still take place with the standard yuan/renminbi currency.

In October 2019, President Xi Jinping cemented China’s intentions of adopting a blockchain way of life by announcing the national blockchain strategy. In an unprecedented speech about decentralized technology, given by no other world leader before, Xi laid out plans for spearheading blockchain adoption.

Given the trend in which the Chinese economy has shifted, it makes sense for eastern giant to implement blockchain technology into almost all facets of life. Conglomerates like Tencent and Alibaba have previously led the way in digitizing shopping and payments, mainly through the introduction of apps like Alipay and WeChat. Combined with the push for smart cities and IoT infrastructure, it almost seems as if the digital yuan is part of China’s long term plan towards a cashless and digital society.

What is the Digital Yuan? Is it similar to cryptocurrencies?

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Based on the previously referenced statements from Mr. Yi, we already know about the digital yuan’s purpose. But how does the CBDC work, and is it in any way similar to cryptocurrencies?

Even in 2019, it was evident that when state and bank officials use the term blockchain technology, they specifically refer to private blockchains. Also known as permissioned blockchains, these networks are closed and can only be accessed by those nodes which have the privilege to participate in the network.

However, this is nothing controversial or unconventional in the world of central bank digital currencies. CBDCs from other regions (EU, India, Russia, etc.) plan to utilize the same system as well. After all, no central bank wants to have critical financial information and transactions revealed publicly.

For its purposes, China has designed the Blockchain Service Network (BSN) as its national blockchain infrastructure. It is a permissioned network on which developers and companies can build decentralized applications and digital assets.  

On paper, 3rd-party applications and projects (that run on the domestic version of BSN) are decentralized. However, it is tough to discuss decentralization when the overall network on which these applications run are controlled by a centralized entity: the Chinese state. We can consider decentralization to be real on the international version of the BSN.

Many overseas projects have joined this unique iteration of China’s global blockchain-based infrastructure. In July 2020, BSN integrated the permissioned ledger framework Hyperledger Fabric. A month later, an entire group of public blockchain networks has joined BSN, including Nervos, NEO, Ethereum, Tezos, EOS, and IRISnet.

The latest projects which have joined the BSN are ShareRing, Solana, Algorand, Polkadot, and Oasis. Thirty more public blockchains are set to join China’s network this year.

Besides decentralization, one clear way in which the digital yuan is distinct in comparison to cryptocurrencies is anonymity. The BSN will have access to full financial knowledge regarding all transactions and individuals who use its services. Again, this feature is completely justified. It would be abnormal for any bank to work with anonymous clients.

When will the digital yuan launch?

A blog post published by the BSN in January revealed that the digital yuan would launch in the second half of 2021.

An excerpt from the announcement reads:

“This digital payment network will completely change the current payment and circulation method, enabling a standardized digital currency transfer method and payment procedure for any information system. Beta version of this convenient and cost-friendly global payment solution will be launched in the second half of 2021.”

As we can see, Chinese citizens will only gain access to a beta version of the digital yuan, which will most likely be used for testing and development purposes. The currency’s full launch is specified in another section of the post, which states:

“BSN plans to build a digital currency payment network in five years based on the CBDCs of various countries and stablecoins, working with several international banks and technology companies.”

The blog post most likely implies that the digital yuan could potentially launch at any moment during this five-year period, given that statements from other officials have indicated a far earlier launch date. Whatever the case may be, it is clear that China will be the first country to issue a central bank digital currency.

How will the digital yuan benefit China?

While the digital yuan will clearly benefit Chinese citizens, it is obvious that the CBDC will prove itself to be far more advantageous to the government rather than the average user. The digital currency will help the administration better track transactions and plan the socialist-based economy.

Naturally, cash will remain the dominant payment method. However, it is worth noting that the digital yuan will have a heavy influence on digitalizing China’s economy and converting it into a cashless society. Here are a few instances of how both the state and its people can benefit from the digital yuan.

More efficient payment systems

As previously mentioned, the digital yuan has the potential to become a core part of online systems and payment infrastructures developed by enterprises like Alibaba and Tencent. Both companies will most likely integrate the CBDC into their WeChat and Alipay smartphone applications.

Since these apps contribute to a large portion of China’s online transactions, replacing the ordinary yuan with a digital token will help the government track online payments.

Easier access to financial services

One more way in which the currency can help China is by assisting bankless individuals in gaining access to financial infrastructure. Data from the World Bank reveals that China has the highest percentage of bankless individuals, which is incredibly troublesome considering that we are talking about the world’s second-largest economy.

The aforementioned smartphone payment apps have already helped in this regard. With the arrival of China’s digital yuan, it will be even easier to assist the bankless in opening bank accounts (through digital wallets) and gaining access to mainstream financial services.

Improve Renminbi’s global position

Last but not least, we have the prospect of improving the status of the renminbi on the global stage. The U.S. dollar has long reigned as the main currency for settlement payments and monetary transfers. While 88.3% of all international transactions deal with the U.S. dollar, only 4% deal with the renminbi.

The pandemic had significantly weakened the dollar’s value in 2020. Moreover, countless money printing by the Federal Reserve might lead to monetary instability in the world’s largest economy. If the dollar somehow crashes and a financial crisis arises, other countries will have to find a different currency to trade with.

Would the renminbi be the top choice in that event? Probably not. But does the digital yuan improve China’s chances in that regard? Definitely.

Even if such speculative and radical situations do not occur in our lifetimes, we can still confidently assert that the future CBDC will breathe life into the renminbi and at least improve its position as a global reserve or settlement currency.

Can other countries compete with China?

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This is one tricky question. China undoubtedly outperforms every other country in the world through its sheer ability to jumpstart the digital yuan and have it be the world’s first CBDC in record time. Neither the European Union nor Russia, and not even the United States, will be able to launch their own digital currencies in the meantime.

The bigger question is, will the digital yuan impact and destabilize western economies through international adoption? It would make sense for China to compete with other countries in this manner, but such an event is improbable.

If the digital yuan can decrease the significance and utility of other digital or even fiat currencies, governments will most likely ban China’s CBDC or restrict its use. If European and American policymakers were so hostile against Facebook’s corporate stablecoin, we can safely say that the same would happen for the digital yuan as well.

One thing that is absolutely certain is that the digital yuan will reign supreme in China. In other countries? Not so much. Many jurisdictions currently develop new cryptocurrency regulations for 2021, and China’s future CBDC might be one major reason policymakers hurry to establish the legal status of digital assets.

Final Word

No country has the suitable environment and power to launch a central bank digital currency that is fully compatible with its native financial environment like China. Researched for four years (with development starting from 2018) China’s digital yuan gives the nation a first-mover advantage in the global blockchain race. Is there an economy capable of catching up, or has the race been finished before it even started?

Despite offering plenty of benefits to the average citizen, it is clear that the digital yuan is made by the state for the state. A permissioned and scalable network named the Blockchain Service Network (BSN) will completely eliminate the need for any other cryptocurrency, especially when it comes to digital payments. Moreover, it brings all the benefits of a blockchain network while removing all the fancy freedom that decentralized ledgers usually give to an individual.

Although the PBoC’s CBDC surfaced two years ago, there is still much left to be uncovered about the currency’s features and design. For now, we only know about the project’s timeline, main use case, potential partners, and some broad features.

Given how large digital China’s economy is and how many retail users interact with ecommerce and digital payments, we can safely conclude that a CBDC will be a game-changer for the dragon in the east. However, China’s digital currency will most likely stay within the borders of China.

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