People in China are no strangers to digital payments—if anything, it’s easier to move around and shop in Shanghai or Beijing with an Alipay or WeChat Pay smartphone app than it is bearing a pocketbook filled with yuan notes. Now the Chinese government has begun a pilot program for an official digital version of its currency—with the likelihood of a bigger test at the Beijing Winter Olympics in 2022. Some observers think the virtual yuan could bolster the government’s power over the country’s financial system and one day maybe even shift the global balance of economic influence.
Most money that gets swapped around electronically is just credits and debits in accounts at different banks. China’s digital cash is designed to be an electronic version of a banknote, or a coin: it just lives in a digital wallet on a smartphone, rather than a physical wallet. Its value would be backed by the state. But virtual cash would be quicker and easier to use than the paper kind—and would also offer China’s authorities a degree of control never possible with physical money.
The program started small in April, with a limited rollout in the cities of Shenzhen, Suzhou, Chengdu, and Xiong’an—a new “smart” city in the making, southwest of Beijing, conceived by President Xi Jinping. Local media have reported that some of the money was distributed in the form of transport subsidies paid to individuals in Suzhou.
One thing authorities have to be careful about is that the digital currency doesn’t start crowding out other forms of money, such as bank deposits. Banks need those deposits to extend as credit to borrowers. The system would also potentially compete with two of China’s most successful tech giants, Alibaba Group Holding Ltd. and Tencent Holdings Ltd., which back Alipay and WeChat, respectively.
That might be part of the point. Payments for consumption using big tech companies’ mobile apps represent 16% of gross domestic product in China, compared with less than 1% in the U.S. and U.K. Policymakers have expressed some concern about too much of the country’s financial plumbing being in the hands of a few companies. “Those big tech companies bring to us a lot of challenges and financial risks,” People’s Bank of China Governor Yi Gang said during a conference last year. “You see: In this game, winners take all, so monopolies are a challenge.”
The rise of independent cryptocurrencies such as Bitcoin and Ether, meanwhile, have created the danger that a huge swath of economic activity will occur out of the view of policymakers. China, in recent years, has cracked down on the use of such coins but was quick to see some potential in the basic idea—as long as it had some control. China started studying issuance of its own digital unit as far back as 2014. “This has very strong political will behind it,” says Andrew Polk, co-founder and head of economic research at Trivium China, a Beijing-based consultant. “They see an opportunity of being a global leader here.”
While a digital currency is likely years away from a national rollout, China’s moves have triggered concern about a new threat to U.S. financial dominance. Aditi Kumar and Eric Rosenbach of the Harvard Kennedy School, writing in May for Foreign Affairs, argue that the digital version of the renminbi, as China’s currency is officially known, could eventually allow Iran and others to more easily evade U.S. sanctions or move money without it being spotted by the U.S. government. That’s because it might one day be possible to transfer the digital currency across borders without going through dollar-based international payments systems.
Not everyone is so worried. Former Treasury Secretary Henry Paulson has written, also for Foreign Affairs, that despite China’s plans, the threat to the dollar’s status as the world’s preferred currency is “not a serious concern.” Even if a digital yuan proves to be highly mobile around the world, the dollar is widely trusted, and oil and other key commodities are still priced in it.
When the new denomination is up and running, individuals will be able to exchange it using digital wallets. They won’t need to have bank accounts. That could make it accessible to the 225 million people in China who have no access to the banking system. In rural areas, electronic distribution and exchange of money could help bolster development and reduce fraud by making cash easier to track.
The PBOC, China’s central bank, would be able to see where the money goes. The PBOC has also indicated that it could put limits on the sizes of some transactions, or even require an appointment to make large ones. Some observers wonder whether payments could be linked to the emerging social-credit system, wherein citizens with exemplary behavior are “whitelisted” for privileges, while those with criminal and other infractions find themselves left out. “China’s goal is not to make payments more convenient but to replace cash, so it can keep closer tabs on people than it already does,” argues Aaron Brown, a crypto investor who writes for Bloomberg Opinion.
Even if digital currency takes off nationally, it’s still unclear whether it would be allowed move across borders. There could be great appeal for a secure international payment method with instantaneous transfers. Foreign-exchange transactions currently can take a business day or two to clear. A widespread digital yuan could also encourage countries and people overseas to get on board with China’s technology—and eventually, its currency. “It’s very possible that other countries adopt the China framework, and then a first-mover advantage turns into a strong network effect,” says Matthew Graham, chief executive officer of Sino Global Capital, a Beijing-based consultant on blockchain, the technology behind many cryptocurrencies. “This is the best-case scenario for China.”
At the same time, China will likely be wary of any circumvention of its capital controls, which aim to keep people from moving significant amounts of wealth out of the country. These controls were significantly tightened after a messy exchange-rate devaluation in 2015. Da Hongfei, founder of blockchain platform Neo, says the central bank could split part of the digital currency for use outside of China, much as it did with the offshore version of the yuan in currency trading.
Once a national rollout begins, things could move quickly. More than 80% of smartphone users in China regularly pay for transactions on their devices, the highest rate in the world, according to UBS Group AG. And Chinese consumers are eager adopters of appealing new financial tech. One money market fund offered via Alipay, Yu’E Bao, became so popular after its 2013 launch that it was at one point the world’s largest money fund. It drained so much, so quickly, from the country’s bank deposit system that in 2017 the central bank stepped in to restrict it. The test will be whether Chinese consumers trust the new cash technology—as well as the power behind it.