• Zainab Rehman

CMI Explains: A Digital Renminbi

China is on the move to become the world’s largest economy to experiment with a sovereign digital currency. As a part of the digital currency test, authorities in China handed out tens of millions of renminbi as new year packets. These packets can be downloaded on to a smartphone. They can be used to make purchases from designated e-commerce websites, in a way similar to transactions through existing payment systems used by WeChat Pay and Alipay. China plans to showcase its digital renminbi at the Winter Olympics in 2022.

The big and obvious question is about the motivation behind China’s digital currency ambitions. First, it appears that China aims to achieve its long-time goal with digital renminbi: freeing itself from having to conduct trade in US dollars. Also known as the ‘dollar trap’, the idea is that the US dollar has reigned supreme as the world’s dominant currency reserve for nearly a century. If digital renminbi is able to compete with dollar as a dominant currency in global trade, it will be enough to mark China’s hegemonic control over global transactions regime. Some have argued that developing nations, especially along the Belt Road project, will embrace the convenience of China’s digital payments systems. Such arguments ignore concerns about the cross-border surveillance function that a state-owned digital currency can facilitate. Second, a state-owned digital currency can act as a force against foreign currencies such as Facebook’s Diem from becoming a medium of exchange in China and globally. Diem, initially known as Libra pegged to a basket of currencies, has its value tied to the US Dollar. This ensures more trust in the currency in terms of its stability and regulation. If Diem is ahead in the race to be widely used in international trade and finance, it will threaten China’s ambitions for successfully rolling out its digital currency. Third, the digital renminbi allows for greater social control in China. The People’s Bank of China will issue and regulate the digital currency, retaining its status as a legal tender. This means that the central bank will be able to track all digital transactions in real time. The bank will also gather data on citizen’s economic activity based on tracked transactions. This will reinforce stronger domestic control with abated anonymity of users.

It is also important to understand how digital renminbi is different from cryptocurrencies. Cryptocurrencies are a digital asset designed to be used as a medium of exchange. All transactions using cryptocurrencies such as Bitcoin are verified and recorded by a decentralized system using cryptography. By contrast, the digital renminbi is issued by the state-owned bank. We know little about the supply side details of digital renminbi as opposed to capped supply of cryptocurrencies. However, it is evident that all transactions will be verified and recorded in the state-owned bank’s database.

Both digital currencies and cryptocurrencies are a recent phenomenon. Many global corporations, institutions and sovereign nations are still navigating their options as opposed to a handful experimenting with such currency alternatives. However, recent events imply a possibility for cryptocurrencies to dominate over state-owned digital currencies. For instance, Tesla announced that it had spent $1.5 billion from its cash reserves to buy bitcoin and would soon start accepting it as a payment alternative for electric vehicles. Mastercard announced that it would support some cryptocurrencies on its network. BNY Mellon said it would start holding and transferring cryptocurrencies for asset management clients. More recently, a cryptocurrency exchange known as Coinbase underwent a successful IPO to secure a market valuation of roughly $85bn. This means that despite volatility, the market sees cryptocurrencies as a potential alternative asset class for investment portfolios. If the trend continues, it will set the stage for other corporations to follow. This is because there is an element of freedom with cryptocurrencies. They are decentralized, secure and free from state control. This is why an ambition for digital renminbi to become a global medium of payment is still far from reality.

Will cryptocurrencies prevent China from pushing its digital renminbi towards global supremacy? The answer is no. China has held an ambition to advance renminbi globally for more than a decade. It may take several years for a digital renminbi to dominate global trade. One reason for this is the concern about its surveillance function. Such a concern may not present a domestic threat to China’s ambitions. This is because surveillance is omnipresent in China. But a global audience will remain skeptical about transactions that are monitored in real-time by the central bank. However, we cannot dismiss the possibility where cryptocurrencies such as bitcoin remain highly volatile. It could be that crypto optimism is a result of a speculative mania.

We should also not dismiss the possibility of rise of multiple sovereign digital payment systems. Third-party digital payment platforms such as Alipay and WeChat Pay enjoy strong market positions. This means there is a growing sense of trust in digital payments platforms. For governments, third-party platforms have already created a foundation upon which they can advance their payments systems. Such systems will enable the conduct and control of monetary policy in real-time. Central banks will be able to bypass intermediaries to issue loans or credit, making the process fast and efficient. Governments will also be able to track money supply, spending and inflationary pressures based on the data they gather in real-time. A sovereign digital currency will also counter the growing popularity of private digital currencies and the possibility of all payments being controlled by private sector banks.