China’s Sovereign Digital Currency Experiment Seen as Response to Crypto

According to an article in the South China Morning Post Newsletter, China is experimenting with a sovereign digital currency – that is, currency that is used only electronically and is backed by the full faith and credit of the country. No need for bills and coins, all your financial transactions for which you previously used cash will be made through an app on your smartphone.

Now most retail transactions in China already are done electronically, using apps like Ant Group’s Alipay or Tencent’s WeChat Pay (Ant Group is an affliate of Alibaba, which owns the South China Morning Post).  But those are commercial services, charging merchants for their use, while the sovereign digital currency will be “issued” by the government, meaning it is “free” just like the paper bills with Mao Zedong’s face on them. Still, the digital currency is not meant to compete with the private payment services, the head of the programme said.

The Chinese government has high hopes for its digital currency, formally known as the Digital Currency Electronic Payments (DCEP), as a means of maintaining control over the domestic financial system and enhancing the international use of the national currency, the yuan.

In particular, Beijing hopes that the electronic yuan will help it ward off a financial war with the United States by substituting for the US dollar in international financial transactions, though significant progress on that front is likely to take years.

DCEP is also a reaction to cryptocurrencies like bitcoin that are owned by their users and have no connection to any government authorities, and to so-called stable coins, private digital currencies like Facebook’s Diem (formerly Libra) that are backed by an existing sovereign currency like the US dollar or euro.

When it was first announced in June 2019, Libra was seen as a threat to China’s financial sovereignty, prompting a new push for DCEP. China banned trading in cryptocurrencies a year earlier, even though other countries are embracing them. In October, China legalised the central bank’s digital currency and banned competitors.

While all major central banks in the world are toying with the idea of sovereign digital currencies, China is well ahead in the development of its version, having started in 2016.

It is now conducting a series of field tests of DCEP, shake down cruises to iron out the kinks. Major state-run Chinese banks and large US firms are joining the trials.

A major trial in Shenzhen was followed in December with another in Suzhou of twice the size, with trialists expressing satisfaction with its use. And, for the first time, consumers were able to use the digital currency in online shopping. While the trials are still in their early stages, transactions using DCEP have already reached $300 million.

Other major central banks are starting to take notice, with a group affiliated with the Bank for International Settlements – the international forum of central banks – calling for avoiding barriers to international transfers of digital money, though China did not participate in the group.

Chinese officials are trying to reassure that DCEP is not a threat to existing national currencies. Still, interest in the subject by other central banks has prompted calls for a faster roll-out of China’s version.

A major challenge for DCEP will be getting China’s rapidly growing elderly population to use it, given their general lack of sophistication with new technology.

A major advantage of the digital currency is that it will allow authorities to track financial transactions, potentially helping it to curb the 1 trillion yuan (US$153 billion) in gambling money that flows out of the country each year through cryptocurrencies.

There is as yet no timetable for the national roll-out of DCEP, though many expect it to come within the next two years. Then it will be time for Chinese citizens to update their smartphones so they can easily use the new DCEP app.