What is the Digital Yuan? A Summary of China's New Digital Currency
China has made the global financial headlines during the past few months for its development of a digital currency - the digital yuan. In this article, we explain what the digital yuan is and what it is not (e.g. it is NOT a type of cryptocurrency!), in addition to discussing the advantages of having a digital currency, the challenges involved in implementing the digital yuan on a wide scale, and of course what the future might hold for China's new digital currency.
Common Misconceptions and Related Questions
Has the digital yuan completely replaced physical yuan?
No, the digital yuan is still in the pilot stage.
Is the digital yuan a form of cryptocurrency?
No, the digital yuan is not a form of cryptocurrency. The digital yuan is just a digital form of the yuan. It is issued by the People's Bank of China (i.e. the central bank) and each digital yuan issued will be backed by real yuan.
Is cryptocurrency banned in China?
Transactions using crytocurrency are banned in China and will continue to be banned as the digital yuan is tested and rolled out. The mining and ownership of cryptocurrency is permitted, but any buying or selling of cryptocurrency is not allowed. Moreover, cryptocurrency exchanges cannot operate in China.
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The People's Bank of China (PBOC) set up a digital currency research group in 2014 and began testing the use of the digital yuan internally in 2019.
The first external pilot test took place privately in Suzhou in April 2020, where a small group of government workers were given digital yuan as transportation subsidy.
The second external pilot test was public and took place in Shenzhen in October 2020, where interested Shenzhen residents could sign up for the chance to win RMB200 in digital yuan and spend this money in over 3,000 selected businesses that support the digital currency. Out of the 1.9 million residents who signed up, 50,000 residents were selected by lottery.
In November 2020, the PBOC announced the plan to launch another pilot program in Suzhou involving offline transactions (i.e. transactions where users are not connected to the internet), perhaps for the 12.12 sale event.
UPDATE 29/12/2020: on December 12th, 2020, the third pilot test was launched in Suzhou where 100,000 people chosen from a lottery were given RMB200 of digital yuan each.
Important milestones from this pilot scheme include:
First Time Testing Offline Transactions
Selected users with supported mobile devices were able to download a beta testing version of the digital RMB app that allows two offline (i.e. without an internet connection) users to transact using NFC technology. This is the first time offline digital yuan transactions have been tested.
First Time Testing Online Transactions via Websites
Whereas in previous pilot schemes users transacted directly with other users (i.e. phone-to-phone) or with physical point-of-sale (POS) machines using a QR code, in the latest test scheme users were able to make purchases on a website with JD.com as the participating partner website.
First Time Testing Sub-Wallet Functionality
In previous pilot schemes, users only had access to one digital wallet with the digital currency. In the latest scheme, the sub-wallet functionality was launched where six participating state-owned banks each offered a digital wallet on the digital RMB app. Users could select which wallet(s) they want to use to pay or receive money. The sub-wallet functionality was implemented with the goal of improving security (i.e. so not all of your money is in one single wallet) and privacy (i.e. so it is harder to track all of your spending information).
UPDATE 21/01/2021: during the few days around December 12th, 2020, a few Alipay partner merchants have been reported to receive Alipay signs with the digital yuan symbol on them. These merchants were reported to have received digital RMB transactions from a small number of Alipay employees, and the pilot scheme was not open to the public.
UPDATE 09/02/2021: during the week spanning February 10th to February 17th, 50,000 users in Beijing will each be given a digital red packet worth RMB200 in digital yuan. To qualify, users were required to register on the JD application and winners were selected randomly. In this pilot test, the digital yuan can be spent at certain physical stores in Beijing as well as on a number of applicable online campaigns via the JD platform.
How is the Digital Yuan Different From the Traditional (Physical Cash) Yuan?
Legally, there are no differences between the digital yuan and traditional cash yuan. Both are issued by the PBOC. Each digital yuan will have a digital token, similar to the serial number on physical money. Both digital yuan and physical cash yuan are classified as M0 in the money supply.
How is the Digital Yuan Different From Digital Payment Platforms?
The digital yuan is a digital form of the Chinese yuan (i.e. Renminbi) currency used in China. This is different from digital payment platforms such as WeChat Pay or AliPay, which are digital wallets and digital payment processors. Currently, WeChat Pay and AliPay wallets are backed by money that users transfer from their bank accounts to their WeChat Pay or AliPay account. In the future, WeChat Pay and AliPay will still be backed by money in users' bank accounts, although this money could be in the form of traditional (i.e. physical) yuan or digital yuan.
How is the Digital Yuan Different From Bitcoin?
The digital yuan is issued by the PBOC, as is the case with physical Chinese yuan. The central bank retains full control over the money supply and can increase or reduce the amount of digital yuan in circulation through the implementation of traditional monetary policy. In contrast, Bitcoin has a fixed supply determined by its protocol which central banks have no control over. Central banks cannot issue Bitcoin and cannot use traditional monetary policy to support the economy through the use of Bitcoin or any other cryptocurrency.
Furthermore, the digital yuan is centralized. The central bank is the authority providing transaction and authenticity support for the digital yuan. In contrast, Bitcoin is decentralized. Anybody can join the Bitcoin network and the party with the majority of the votes has control over the network.
What Are the Advantages of the Digital Yuan Over Traditional (Physical Cash) Yuan?
Given the implementation of supportive financial infrastructure, the digital yuan will be more convenient than traditional yuan. China is already a very cashless society as a large majority of the population have already adopted the use of digital wallets and digital payment platforms such as AliPay and WeChat Pay. Widespread use of the digital yuan could accelerate China's transition into a fully cashless society.
The use of a digital currency could also make it easier for the central bank to "print" new money since the PBOC would only need to release new digital yuan rather than actually printing real money.
Challenges to Implementing the Digital Yuan
There are several challenges to implementing the digital yuan on a wider scale, which we highlight below.
Facilitating Widespread Adoption
In order to facilitate widespread adoption and promote circulation of the digital yuan, a significant portion of the Chinese population and businesses will need to have the appropriate device or financial infrastructure to support the digital currency. This is anticipated to be one of the easier hurdles to overcome, since most buyers and merchants in China are already using digital payment applications. For example, Alipay had 711 million monthly active users as of June 2020 (refer here for further information on Alipay and Ant Group), whilst WeChat Pay had 600 million users in 2018 (no official information on the number of WeChat Pay users has been disclosed after that year).
Handling Offline Transactions
An important technological hurdle to implementing the digital yuan in a more full-fledged scale is the handling of offline transactions. For example, if two users transact offline, one user's device might perceive the transaction to be successful, whereas the other user's device might not. In order for the digital yuan to function effectively as a currency, it will be crucial for all participating devices that support the digital yuan to reflect accurate information in real time. Data accuracy, consistency and timeliness is also crucial to the success of monitoring efforts conducted by regulators and is key to the effective implementation of monetary policy by the central bank.
Managing Cyber Risks and Detecting Fraud
Naturally, there will be cyber risks involved in the implementation of a digital currency. These risks can take many different (and perhaps unanticipated) forms, which regulators will have to monitor and manage as effectively as possible on an ongoing basis in order to maintain financial stability in the long run. Cyber fraud is one of the more obvious risks, where it will be crucial for regulators to be able to detect fake versions of the digital currency generated by potential hackers.
What Does the Future Hold for the Digital Yuan?
The digital yuan is currently in the pilot stage, and we anticipate that in the future, even after the digital yuan becomes more widely adopted, the digital currency will most likely co-exist with the traditional physical cash rather than replacing the latter completely. Not everybody in China will have a device that can support the use of a digital currency, and not everybody would readily switch to using the digital yuan (e.g. the older generation might be more reluctant). It would also take an immense amount of time and capital to make sure that the necessary financial infrastructure is available nationwide.
As part of the continued effort to test and develop the digital yuan, the PBOC is researching ways to handle "lost and found" in case certain users lose their money (e.g. if somebody loses their phone), in addition to exploring potential regulatory requirements to prevent money laundering (e.g. requiring identification to conduct large transactions).
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