Is the digital yuan threatening global stability?

China is making promising progress in testing its digital yuan currency. The token announced the success of a pilot in Suzhou City (near Shanghai in eastern China) where 181,000 consumers were given 55 CNY (USD 8.5) free money in digital wallets to spend at participating retail outlets at the token. Double Fifth shopping festival between May 1 and May 5.

This was part of a larger test of the People’s Bank of China. This survey is targeting 500,000 consumers in 11 Chinese regions since April. For those who qualify, there is a simple app to download that gives them a wallet. With this they can make purchases in thousands of participating stores and receive a discount.

The digital yuan is a version of the normal Chinese currency that is deployed on a blockchain. The blockchain constitutes the tamper-resistant online ledger technology that supports digital coins such as the Bitcoin and Ethereum. However, this blockchain is allowed, which means that the People’s Bank decides who can use it.

The final test round is ten times the size of the original round that took place in the fall of 2020. China has also tested the cross-border digital yuan between Hong Kong and neighboring Shenzhen. They are developing a platform to make the currency internationally viable involving Thailand, the UAE and the Bank of International Settlements.

One step closer to the future

Each step forward increases the prospect of China becoming the first country to put its currency entirely on a licensed blockchain. No date has been announced, but a national rollout appears to be foreseen within the next 12 months. The rollout will most likely take place in staggered stages.

By contrast, Western central banks such as the Federal Reserve, Bank of England and to a lesser extent the European Central Bank are all slower to move on so-called Central Bank Digital Currencies (CBDCs). They are concerned about things like the right to privacy when all transactions will be publicly visible on the blockchain, and about the effect on retail banks.

Still, a digital yuan raises profound questions about global financial stability. The question for the other major economies in the world is how to respond.

Advantages of digital currencies

The digital yuan already has legal tender status. Payments using it are fundamentally different from those on payment platforms like Alipay or WeChat (or even PayPal in the west). Such services can settle transactions very quickly for customers, but behind the scenes ledgers of large numbers of transactions are between buyer’s banks, seller’s banks and often intermediary banks settling hours or even days later.

The digital yuan bypasses the need for these banks. There are no service charges unlike these payment alternatives. And in theory, the speed of payments could be even faster.

Unlike cryptocurrencies such as Bitcoin, the currency is also backed by a government. This means that the issue of digital yuan is the same as the issue of cash in circulation. This makes it just as safe. It gives the government better control over the money supply because (unlike cash) all transactions can take place at any time.

Will every country get a digital currency?

Many central banks have looked into the development of digital currencies. Some (such as Japan and South Korea) are not far behind the Chinese. The EU indicates that there could be a digital euro in four or five years.

There are various dangers for those who stay behind. The first is about international payments. Most cross-currency transactions currently use the US dollar as an intermediary, through the international SWIFT banking protocol. This represents a significant demand for the US dollar. This has advantages such as making it possible for the US government to borrow more cheaply.

Digital yuan transactions do not require SWIFT or the dollar, impacting dollar usage in international trade. As many as 120 countries have China as their largest trading partner. Many wonder if it is settled in dollars as it adds unnecessary financial risk from adverse exchange rate movements. China says it is not trying to replace the dollar with the digital yuan, and that its “goal is to let the market choose” “how to settle international transactions.

The digital yuan is happening amid heightened tensions between China and the US and Europe. This clearly makes it a worrying time to give the Chinese first-mover an advantage over this new type of currency.

Incidentally, sanctions such as those recently imposed on Chinese officials over human rights issues will be much easier to circumvent if and when the digital yuan is operational. Calls could well be made to sanction those who use the currency as a result, raising numerous questions about viability and consequences that are discussed on another occasion.

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