China’s Digital Currency Could Help Counter Libra’s Effect in the Country

Data & Research / 15.03.2020

For around five years, the People’s Bank of China (PBoC) has been working on a digital coin. The central bank’s fiat reserve will back the Central Bank Digital Currency (CBDC), and its value pegged to the Yuan value. 

Although the government of China announced its plans to develop the digital yuan in 2014, Facebook’s announcement of the launch of Libra was the propelling factor. Now, the central bank says that the digital coin is near completion but hasn’t given any prospective launch date. 

PBoC has not yet released the coin’s white paper. As such, little is known of the currency. In this guide, we give all the details available on the digital yuan and some insight on how it will work. Keep reading to find out more. 

The Digital Yuan

In 2019, officials from PBoC confirmed that they were close to releasing the state-backed digital coin during the China Finance 40 Forum. This move would make China the first country in the world to issue a sovereign digital currency. 

During the event, Mu Changchun, PBoC’s Deputy Director in the Payment and settlement Department, gave a speech detailing the currency’s structure and design. 

The Chinese CBDC will not be a cryptocurrency. The original idea behind cryptos is that they are decentralized, with no central authority regulating them. The digital yuan, however, will be solely issued by the PBoC, which will also have complete control over the coin. 

The CBDC will operate on a two-tier system with two different layers. The first will represent the direct interaction between PBoC and commercial banks in the country, which will be issued the digital yuan to the commercial institutions only. 

The second layer represents the interactions between the financial institutions and the consumer. Commercial banks will be responsible for issuing the digital coin to individuals and businesses, who will then circulate the CBDC.

The current monetary system in the country is tow-tie. Therefore, by using a similar system for its digital currency, China will be able to replace paper money without interfering with the existing system. 

Why is the two-tier system necessary?

When deciding what operating system to use for the digital yuan, PBoC decided on the two-tier system for various reasons:

  • China is a vast country with a complicated economic system and a large population. Different regions in the country have different levels of development. A single-tier system would have the PBoC issuing the digital coin on its own, which would be a challenge given the various socio-economic differences among the Chinese.
  • The system helps to mitigate risks by distributing possible risks to various institutions. 
  • With a two-tier system, the country will be able to utilize its resources and talents fully, rather than having one institution take all the credit.
  • The system helps to avoid financial disintermediation, which would be the case in a single-tier order. 

The CBDC will feature high-value tech features as compared to Facebook’s Libra, according to Mu. He added that the coin would have the same functionalities as paper money, only in digital form. According to PBoC, Libra will impact the currencies and economies of various countries, hence the need to make the Chinese yuan stronger. 

Users of the digital yuan will be able to transfer funds without a bank account and an internet connection. With near field communication, users will be able to transfer funds by having two phones in contact, provided the user’s phone has a wallet.

Although the CBDC will be able to function with smart contracts, it will only do so with smart contracts that are a bit more complex beyond basic monetary features. The central bank argues that this will help avoid downgrading the digital coin to mere security, following addition to its value. Additionally, CBDC users will only receive interest if the currency is parked in a financial institution.  

Justification for the Adoption of CBDC

Specific questions arose following the announcement by the PBoC. For starters, cryptocurrencies are banned in China, so why would the government suddenly be interested in a digital coin?

PBoC confirmed that it set up a research group in 2014, which is about the time Bitcoin hit the four-digit mark. The lucrative Bitcoin prices likely encouraged PBoC to come up with its version of the same. 

Bitcoin, like all other cryptocurrencies, has no central authority regulating it. As such, the PBoC would have had no control over its effect on the Chinese economy and sovereignty at large. It is for this reason as well that the nation is very much against Libra, Facebook’s cryptocurrency. 

Besides the issues of sovereignty, most of the transactions in China are already electronic. So, why would the nation need a digital coin backed by the Central Bank?

  • The digital yuan will help facilitate easier cross-border transactions. With the CBDC, these transactions will be faster and cost less. Eventually, this could lead to the Renminbi achieving international presence. 
  • The introduction of the digital yuan will require commercial banks to develop an inter-ban ledger system to help keep track of the coin. This ledger system will help make clearing from these institutions more efficient. 
  • The digital yuan will also be an excellent option for retail payments. Given that most transactions in the country are already electronic, the CBDC will help address issues of portability and anonymity, which the yuan still struggles with. 
  • CBDC will help reduce operation costs that arise from issuing, operating, and maintaining paper currency and coins. 
  • The digital currency will help reduce money-laundering and other criminal activities facilitated by paper money.

Other Countries with State-Backed Digital Coins

The growing popularity of cryptocurrencies has raised governments’ eyebrows all over the world. Nations have different reactions to cryptocurrencies, with some adopting the new digital era and others banning the digital currencies altogether. 

Several countries already have national cryptocurrencies in circulation. Dubai launched its cryptocurrency, EmCash, in 2017, becoming the first country to launch a state-backed crypto. Venezuela followed suit in 2018 by launching its national cryptocurrency, Petro. Other countries that have national digital currencies include Estonia, Venezuela, Senegal, Tunisia, and Singapore.

Russia and Sweden have also shown interest in the digital coins and are working on their own. Russia plans to launch its coin cryptorubble, while Sweden’s e-Krona project is still in the works. 

Bottomline

With China and other major economies looking to introduce their digital coins to the world, we should expect some significant changes in the international monetary system. We can only wait and see what direction fiat currencies around the globe will take as cryptocurrencies gain increasing popularity. 

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Wayne is a Blockchain enthusiast and expert in crypto trading. Currently, he covers trendy issues on digital currencies.