China is winning the digital currency race. Can it unseat the dollar?

Since the pandemic hit last year, China has made headlines by charging ahead with its efforts to become the first major power to implement a sovereign digital currency.

The digital yuan, domestically branded as the Digital Currency/Electronic Payment (DCEP) project, is not only set to disrupt the country’s well-developed mobile payment industry and create new efficiencies in the Chinese economy, but could also challenge the supremacy of the US dollar.

With China’s meteoric rise on the global stage, Beijing long hoped its physical currency, the renminbi (yuan), would ride on the back of its economic success and force a shift away from the dollar-dominated financial system.

But that has not yet come to pass. No global consensus exists today for China in the same way that it did for the US, when the dollar was pegged as the world’s reserve currency at the Bretton Woods conference in 1944.

For geopolitical futurist Abishur Prakash, China is in a challenging yet opportunistic position. He believes that the prospect of the digital yuan allows China to come up with a creative way to internationalise their currency.

“It’s a very streamlined approach to take its currency to the world,” Prakash, an author and consultant with the Toronto-based Center for Innovating the Future, tells TRT World. “For people using Chinese services, it will be very easy for them to adopt digital yuan and start to split economies and societies along new lines.”

Eventually, he says the right to issue and control virtual currencies like the digital yuan will become a “new flashpoint” between governments, which have traditionally controlled the circulation of currencies, and tech companies who can choose to facilitate the adoption of digital currencies.

“There is going to be a real fight over who has the right to govern currencies and what currencies can be accepted. There will be all kinds of geopolitical concerns as to who is behind these digital currencies and where the data is going.”

For now, China’s ambitious DCEP is ahead of the curve – and Western policy makers are starting to take notice.

Steady rollout

Digital currencies are a form of money that is stored on an electronic database and otherwise exhibits all the properties of physical currency.

Unlike cryptocurrencies like Bitcoin, which operate under a decentralised system and are anonymous, central bank digital currencies (CBDC) like the digital yuan are firmly under the regulatory arm of the state.

CBDCs act as a digital form of a country’s fiat currency that is also a claim on the central bank. Instead of printing money, the central bank issues electronic coins backed by the credit of the government.

According to the Bank for International Settlements (BIS), 80 percent of central banks are now engaging in research, experimentation or development of CBDCs – few of which have progressed to the soft launch phase, including Sweden’s e-krona and the Bahamas’ sand dollar.

China’s central bank, the People’s Bank of China (PBOC), began developing a digital currency in 2014 – a project which later grew into the Digital Currency Research Institute. Facebook’s plans to launch its own cryptocurrency, the Libra, in 2020, motivated Beijing to speed up development of the digital yuan.

By April 2020, it had introduced the DCEP pilot programme in four Chinese cities. In July, China’s ride hailing giant Didi partnered with the PBOC to advance efforts to test the digital yuan on its transportation platform.

This year, trials have expanded to larger cities like Beijing and Shanghai. Last week, the southwestern city of Chengdu received a handout of $6 million digital yuan, making it the largest scale of the trial to date.

Although there is no official timeline for a launch, economic planners are reportedly aiming for nationwide implementation ahead of the 2022 Winter Olympics in Beijing.

The DCEP is expected to work similarly to payment systems like Alibaba’s Alipay and Tencent’s WeChat Pay, the two main apps that Chinese consumers make purchases on. The dominance of these apps stand in the way of the digital yuan’s mass adoption, which might explain the government’s recent moves to rein in the power of Chinese tech giants.

Unlike Alipay and WeChat Pay, digital yuan users will not require bank accounts. According to Mu Changchun, the PBOC official in charge of the DCEP’s development, digital wallets will allow touch payments where transactions can occur even without the internet.

Although the PBOC claims that parties to the transactions will be anonymous, in practice it seeks “controllable anonymity” by tracking citizens' purchases to ostensibly fight money laundering and terror financing.

Such invasive control, however, has many expressing concerns that it will only deepen China’s digital authoritarian footprint in creating the “world’s largest centralized repository of financial transactions data” and promoting “unprecedented opportunities for surveillance” on every citizen – and dissidents in particular. Since it can create and issue money digitally, Beijing will have the ability to seize citizens’ money with one push of a button.

Digital Belt and Road

The immediate challenge China faces is one of transition. The government has begun incentivising people to use the digital yuan for free, but that’s only the initial marketing phase. How will it transition society from being paid in cash to digital tokens?

At the moment, it has started with disbursing government employee salaries and utility bills in digital yuan. The challenge after locking-in a certain percentage of the domestic population is to ensure that the digital currency can work at the global level.

Prakash says there are many ways China is attempting to take digital yuan to the world.

One is using its startups like Didi, which is already in Latin America and has announced plans to enter the European market, where it could begin offering future rides in digital yuan.

One risk he foresees is that since digital currencies rely on grassroots adoption – a customer can have several currencies on their digital wallet – will the adoption of digital yuan start to affect the policies of nations?

“If I start using digital yuan at a grassroots level, will my government be comfortable with citizens using it? Or will they resort to banning it?”

Another tool China can use is trade. “It can start cutting future trade agreements with countries to purchase Chinese goods and services using digital yuan,” Prakash says.

Indeed, China’s Belt and Road initiative (BRI) is a ripe entry point for the digital yuan’s internationalisation. It could ask BRI participating countries to start accepting the digital yuan, make loan payments and pay to install infrastructures such as point-of-sale terminals and lower transaction fees.

And it has already begun to do that.

Last August, China waived transaction fees between the yuan and twelve currencies, including the Singaporean dollar, Korean won, Thai baht and Russian ruble. According to China’s State Administration of Foreign Exchange, the decision was taken to “actively cooperate with the national belt and road development strategy.”

In another signal of its commitment to internationalise the digital yuan, the PBOC announced on February 24 that it would be joining the Multiple Central Bank Digital Currency Bridge to study the feasibility of the use of digital currencies in cross-border transfers, international trade settlement and foreign exchange transactions.

Challenging dollar hegemony?

A cheaper and faster payment system, which could also avoid US sanctions, would be viewed as a challenge to the dollar’s dominance.

With over 90 percent of international transactions presently conducted in US dollars, Beijing hopes the digital yuan will allow it to bypass the all-mighty greenback.

That sentiment was echoed by Daryl Guppy in an op-ed for state-media outlet CGTN, highlighting that “a sovereign digital currency provides a functional alternative to the dollar settlement system and blunts the impact of any sanctions or threats of exclusion both at a country and company level.”

In their Foreign Affairs article last year, authors Aditi Kumar and Eric Rosenbach believe that once the digital yuan is successfully launched in China, Beijing can simply share this technology with the same motives. They highlight a hypothetical scenario whereby Iran builds a compatible digital currency system and trade between the two countries isn't trackable by the US anymore.

This could lead to other countries adopting the China framework, whereby a “first-mover advantage turns into a strong network effect,” argues Matthew Graham, CEO of Sino Global Capital.

In the end, the onus is on China to play catchup and leapfrog the dollar. But the US cannot be asleep at the wheel, Prakash warns, if the recent past is anything to go by.

“The US has been jolted by how fast Huawei built 5G around the world, how fast TikTok spread, and how big Chinese investments in US tech companies became,” he says.

“Eventually, the US will come out with a digital dollar. The question is whether China can truly take on it or not. The Dollar has reached a point where new services and products are being built around it, so will China be able to start converting parts of the world to a digital yuan ecosystem?”

“For now, the US is playing a watching game.”