The Pros and Cons of China’s Digital Currency
In the last decade, the world witnessed a rapid transformation of money. It is now available in an electronic and even virtual form. From a physical form ranging from digital payments, mobile wallets, cryptocurrencies, and the latest on the list is 'digital currency.' 86% of the countries from the US to Japan are exploring this new-age form of currency. However, China is far ahead and is all set to launch its digital currency nationwide in 2022. The trials are already underway.
Nonetheless, the general population finds the term' digital currency' confusing, and many people interchange this term with cryptocurrency. However, it is different and has its own set of pros and cons. Let's begin.
What is digital currency?
Digital currency is a form of payment feasible only through electronic or digital means and is as old as the internet. However, acceptance and adoption were both problematic and took some time. As people become more comfortable with it, the reach has only widened. One of the trailblazers in this field was PayPal, who introduced the idea of digital transaction. And now new-age currencies are paving the way for digital money.
Also known as digital money, electronic currency, electronic money, or cybercash, one needs to be connected to the internet through an electronic device to store, manage, or exchange transactions in digital currency. Like its physical counterpart, it can be used to buy goods, pay bills, or any tangible services with a quick transaction. However, it should not be confused with virtual currency or cryptocurrency.
Understand it like this. When the central bank of a country issues it, we call it Central Bank Digital Currency (CBDC), and this form of money is regulated. When it exists in an unregulated form, we refer to it as virtual currency and is managed by the founding organization, currency developer, or an established network. Coupons or reward-linked monetary schemes and cryptocurrency are examples of virtual currency. The latter uses cryptography to confirm the transactions, manage and control creating new currency notes. Bitcoin and Ethereum are some popular examples.
The Digital Yuan
Interestingly, 500 years after inventing the paper currency, China is now spearheading its digital money, formally known as Digital Currency Electronic Payments (DCEP). China is the first nation to have a digital currency of its own, having had this plan in the pipeline since 2014. After years of research and planning, digital renminbi (RMB) testing and trials began in a few selected cities in 2020 and have now expanded to a few selected countries for cross-border trials. Note that twenty-three million digital yuan was distributed in lotteries last year for this purpose.
If everything goes well, digital money is expected to become the primary currency for making transactions. China plans to replace all cash with digital yuan and become a cashless society. It is already known for having an advanced payment system in place. When that happens, China would be the first economy to do so in the real world. This is also expected to help the economy recover post-COVID-19.
China is focusing on the use of DCEP as a means of settlement and payments in financial markets between institutions to make it transparent, efficient, and easier to regulate. The reason for the same is that cash payments run the huge Chinese economy. Breaking the cycle will help control illegal cash flow, corruption, and tax evasion.
At present, it is unclear what technologies are incorporated in developing China’s digital currency. Blockchain and near-field communication could be used to facilitate offline money transfer. Irrespective of technical prowess, it can transform the future of money transactions in the real world.
How does it work?
Like WeChat Pay and Alipay, people will not require a bank account with digital currency. This will promote financial inclusion by facilitating people with the power to pay online. The technology used will allow people to receive and even send money just by touching the phones even if they are not connected to the internet, making it better than Alipay and WeChat Pay.
When the app becomes available, users can download the digital yuan wallets and store their money in them. This would create a QR code that the vendors can use. The merchants can receive money by scanning the QR code on the users' phone or the users can scan the QR code of the shop and send them money. For this, the merchants will have to put up a signboard to convey that they accept the digital currency.
With China launching pilot projects across the country, many merchants have already signed up to accept a digital currency. Besides, the Central Bank is aspiring to make transactions possible even without a digital connection. So the businesses who fear transactions taking time can set their minds at ease.
The Yuan's Globalizing ambitions
For a long time, China has been making efforts for the internalization of its currency. In an article published in Qiushi, President Xi emphasized making yuan a world leader. The state leader said, "We should ... actively participate in formulating international rules on digital currency and digital tax to create new competitive advantages,".
The statement says a lot about the ambitions associated with the future of the digital yuan. And now, with trials running successfully, no one is even close to China. Experts see it as a big win and as a concrete step in making yuan a leading currency. Though it is maintained that the focus is on the domestic market and has nothing to do with the international market, PBOC (People's Bank of China) is working on cross-border transactions.
In February 2021, PBOC joined hands with the central banks of Hong Kong, Thailand, and the UAE. This would authorize Yuan-denominated transactions to surpass the SWIFT system to perform international payments. Moreover, the Central Bank aims to release it during the Winter Olympics in February 2022 in Beijing. And with it, it seeks to challenge the dominance of the American currency as it can move quickly without any roadblocks.
Talking about the rest of the world, as many as 60 countries have started testing digital currencies, according to a Bank for International Settlements (BIS) report, with the US making a slow move with only basic research done so far. Since China is the first country to launch a digital currency, expect it to have an unprecedented advantage over the rest of the currencies.
Will it disrupt fiat currencies?
The Chinese communist government is often accused of manipulating the currency - The renminbi. This may hold some truth, putting clouds of doubt even on the digital currency. But as it can be e-transferred easily, controlling it is easier. This may help China to establish its monetary sovereignty.
As said earlier, with its digital currency, China is the world's first nation to have accomplished it ahead of the US and the UK. Many see it as a significant move now as it removes the possibility of the US imposing sanctions based on the SWIFT transfer system (controlled by them). Becoming a global currency may be difficult, but the launch will affect the international financial market.
The pros and cons of the Digital Yuan
Digital currency has numerous benefits, but at the same time, it poses certain risks. These would impact the use and misuse in the real world. Scroll through the various pros and cons of China's digital currency.
#1. Pros: Ease-of-use
If the experience of the early users is anything to go by, using e-CNY is easy, and one feels a close resemblance to the existing digital wallets, Alipay and WeChat Pay. The application is simple to use so that making a switch shouldn't be difficult for an ordinary user. When the currency goes nationwide, people should be able to adapt quickly.
#2. Pros: Zero transaction fees
Every time a user pays using a card or any other mode, the service provider charges a certain sum of money in place of the transaction. However, when making payments with e-CNY, there are no charges or transaction fees imposed.
#3. Pros: Financial Stability
Private credit supplied by the commercial banks increases the nominal interest rate. It decreases the bank's reserve deposit ratio, adversely affecting financial stability. But when these banks receive deposits in the CBDC account, a surplus amount implies no more reserve holdings. Thus, an increase in private credit supply lowers the nominal interest rate. And hence a more stable financial system. All in all, it offers controllable anonymity.
#4. Pros: Counter Criminal Activities
Extortionists and drug dealers are using Monero, Bitcoin, Litcoin, and Ethereum. Thus making it a preferred choice for tax evasion, Ponzi schemes, money laundering, and ransom for kidnapping. Fortunately, it is impossible with digital currency, extending assurance of combating money laundering, gambling, terrorism, and other criminal activities.
#5. Fast and Efficient
Since the transfer is through electronic means, expect it to end quickly than other payment methods. Besides, it is extremely efficient with no room for inaccuracies.
CBDC has its share of disadvantages as well. Check out the list below:
#1. Cons: Privacy
CBDC is 100% trackable by China's Central Bank. When one uses the digital currency, the Central Bank will know who is paying, how much they are spending, when they are paying, where they are paying, and then analyzing the payment patterns. The users may find it an intrusion into their financial management.
#2. Cons: Indirect but Forceful Imposition
It is well-known that Alipay and WeChat Pay hold data on transactions, and the government can access it. Since the Central Bank develops the digital yuan, there is no third party involved. There is a fear that the Chinese government could force Chinese companies to accept the digital currency. This, in turn, could cause the foreign companies to foreign counterparts to use only CBDC.
#3. Cons: Cannot Send Money to Friends
For a digital currency to gain acceptance, the users should be able to send money to whoever they want to. However, during the CBDC trial, many people felt that they could not send the Chinese digital currency to their friends and families. This realization felt like a handicap and a colossal disappointment.
#4. Cons: Foreign Government Doubts
Given the data collection fear, will the foreign governments allow their businesses and citizens to hold digital yuan and use it? That remains to be seen. It seems that the countries may not be ready to agree to transact in China's digital currency due to privacy issues.
Meanwhile, the digital yuan is in its pilot stage for domestic use. It is in a way ahead of the other world countries at the moment. Irrespective of the pros and cons, it is giving everyone a glimpse of the future ahead and will enjoy some first-mover advantages. Let’s wait for the Winter Olympics (the time of nationwide launch) and witness history in the making.