Episode 78 of Tech Buzz China features our co-host Rui Ma in conversation with Yán Xiāo 肖妍 on the timely topic of China’s proposed national digital currency. Yan is a San Francisco–based project lead at the World Economic Forum with substantial experience in fintech, having worked as senior legal counsel at Ant Group. She is also a lawyer by training and holds both American and Chinese legal licenses. Her current work focuses on digital payments and cross-border payments. Yan’s opinions on this episode are her own thoughts, and do not reflect those of the Forum in any way.
Rui was an early observer of the cryptocurrency space, and has witnessed the rise of bitcoin and other technologies unfold concurrently in the U.S. and China. Listen to their conversation to find out: What does Yan think about the prospects for China’s proposed digital currency, which is typically called digital yuan or digital RMB? How are these prospects affected by the existing payments and digital landscape in China? What are the key features of digital RMB? What technologies form its backbone? What are other countries doing, and what is the global landscape for this type of national initiative?
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Hey everyone! Today’s episode will be an interview format, as we talk to our friend Yan Xiao 肖妍 on a topic that we’d been meaning to cover for a while, but just never got around to until now. And that is, China’s proposed national digital currency! Well, I guess it’s technically called the DC-slash-EP initiative, which stands for digital currency, electronic payment, or DCEP. Now as some of you know, I’d personally been early in the Bitcoin / cryptocurrency space, which I always refer to as one of the first technologies I saw rise concurrently, at almost exactly the same time, in both the US and China. And this is very much not that, as we’ll make clear. But there are some overlaps, and now there are real pilot programs on the ground, we are getting a better although still very blurry idea of what China’s DCEP could accomplish. The government is also racing, by the way, to launch DCEP before Facebook’s Libra project, you know, that big permissioned blockchain-based payment system that was formally announced in June 2019. In China, big banks and fintech companies have signed on as partners, and a greater rollout seems imminent. I’m not sure how I feel about its prospects, frankly, but I’d be curious what you think. So don’t forget to reach out after the episode, and let us know what you think. And if you’re watching us from YouTube, definitely hit the subscribe button below!
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So first of all, let’s state up front that these are all Yan’s personal opinions and do not represent those of her employer, past or present, or future! Yan’s actually worked at a few pretty interesting places though that are super relevant to this topic, which is why we have her on the show. So here we go, please introduce yourself to our audience, Yan.
Hi everyone, I’m Yan Xiao, and I am currently a Project Lead focused on Digital Trade and Digital Payments here at the World Economic Forum. I am based in San Francisco. Specifically, I focus on Cross Border Payment, so China’s DCEP is of very high interest to me, and thanks for having me on the show to talk about it. I’m here to offer my personal understanding and opinions and these don’t represent those of the Forum. And I hope you find them useful.
Yan’s fintech experience actually goes far beyond the WEF though, because before WEF, she was senior legal counsel at Ant Group, you know, the company that owns Alipay, the billion-user digital payments app, and whose IPO was just halted, but will probably still end up going public sometime in the near future. My guess anyway. But really relevant experience. And before that, she was a securities lawyer in China, and she is one of the very few people I know with both American and Chinese legal licenses! That’s pretty hard to do. But it comes in handy when we’re looking at this stuff, because after all, there is a huge regulatory and legal aspect to the topic at hand. So let’s get started. First question to you, Yan. How did all this come about？
Thank you Rui for the additional information on my background. Well, as you mentioned, China got started on this digital currency plan back in 2014 or so. And in 2016, during an interview with Caixin, Zhou Xiaochuan, the then-governor of the People’s Bank of China AKA the PBOC, formally announced more details on a plan to issue digital RMB. At that time, Zhou Xiaochuan suggested that there was no clear time line and for a big country like China it could take as long as 10 year’s time. And that same year, the PBoC formed a digital currency research center.
OK, I mean, is the plan to replace the cash circulation entirely, but like why? Doesn’t cash already have very low usage in China already? We’ve talked many times on the show about the power of Alipay and WeChat Pay, for example.
As Zhou Xiaochuan pointed out during his interview in 2016, there’s just been such a drastic shift in consumer behavior that the PBOC felt it needed to provide a digital alternative to cash for transactions. But the plan is never to replace cash entirely. Cash is still important to people who have no access to smart phones or are not tech savvy. Also like you said, Alipay and WeChat Pay have pretty much dominated Chinese digital payments market. These two companies are huge! Close to 83% of non-cash transactions were made through mobile payments in 2018 and these players accounted for 94% of that. DC/EP provides a public alternative to these private payments channels. And given DC/EP’s legal status, merchants cannot reject acceptance. At present, some merchants may have exclusive agreements with one of third party payments players and hence can reject acceptance of e-wallet payments of their competitors. DC/EP has a status of a legal tender. Merchants cannot reject the acceptance of DC/EP.
Some of those things you mentioned, Yan, such as exclusivity when it comes to which third party payment provider to accept, is probably going away with the new draft antitrust regulations that were just announced, but it definitely has been a problem in the past. Super inconvenient to have to use one or the other. But hey, just replacing cash doesn’t seem that sexy. There has to be other benefits right?
There are several other motivations and objectives behind the PBoC’s plan. Obviously, going digital means that the government will have direct access and more visibility over transaction data. A lot of those data currently are owned by private payments companies. Data collection could enable PBOC to do more analyses through big data and make more accurate decisions over monetary policies and to more effectively combat financial crimes. Or so that’s the hope.
And then there’s increasing transaction efficiency. Having a digital RMB account allows the users to establish a direct relationship with PBOC without any intermediary. Theoretically, it means anyone who has a digital RMB account could complete a peer-to-peer transaction without involving any bank or third party payments for domestic and international transactions. Also, digital RMB is expected to significantly reduce costs to banks in managing cash. Just imagine all the human labor involved today to count coins and paper currency, to move money around and to safeguard them. It could be quite costly for banks.
Got it. I have read several news articles claim that the issuance of digital RMB could eventually break up this duopoly of Alipay and WeChat Pay, and it kind of makes sense. I really suggest our listeners listen to our episode on Ant where we talked about this a little bit. Transactional data is being used to power credit and lending, which is Ant’s largest business, and will probably power more and more stuff down the road. Here in the US, there is no equivalent to those private payments companies because we rely mostly on credit cards. So I get it, the government is like, the country is digitizing fast, and there’s so much information from this digitization that I want, in order to make policy and whatnot, thanks Alibaba and Tencent for doing that, but I need the best access, because I need to run this country and make decisions. But it’s not just the domestic companies right? There are also foreign companies that the government is concerned about?
Yeah, a big motivation behind DCEP is to respond to potential competition posed by Facebook’s Libra and other systemic stablecoins. Mr. Mu Changchuan, head of PBOC Digital Currency Research Center, pointed out, Libra has a potential addressable market of at least 2.7 billion users globally. With this size of users and Facebook’s global reach, the impact of Libra is very likely to go above sovereign. One objective of issuing digital RMB is to improve the efficiency of use of fiat so that it will not be replaced by systemic stablecoins like Libra.
Yup, the government has had a pretty clear stance on “no to crypto and stablecoins.” For cash though, the government isn’t completely trying to get rid of it right? Although I’m sure the usage will become even less, as anyone who has visited China recently will notice. Pretty much no one wants cash, they all want mobile payment.
It’s true. But cash is here to stay for sure. In that draft law we just talked about, one of the added clauses is that RMB includes both physical form and digital form. One of the best uses cases of cash, of course, is that it’s anonymous, and transactions are untraceable. In the pilot, an account is tied to a person’s phone number and authentication will be conducted through sending messages to the person’s phone. In China, one needs to provide identification to purchase a phone number. Some of the screen shots of the pilot show that merchant information won’t be visible from the user end. However, it is not clear how much data will be visible to PBOC or the banks that facilitate the transactions.
I don’t know that so far the behavior of Chinese people, who have adopted mobile payments so quickly, show me that they’re concerned with privacy over convenience. I mean, I certainly don’t carry cash unless I absolutely need to when I’m in China, and haven’t for a very long time. I think the only cash I’ve seen recently is red packets I received when I got married, and that’s probably going away soon too. Speaking of red packets, that’s how they’re distributing it right now in these pilot programs, right?
Well the first few pilots that are reported by public media started around April 2020. They were actually for employees of the Suzhou government to receive part of their salaries and benefits in digital RMB. But in October 2020, PBOC launched its pilot testing in Luohu District of Shenzhen by issuing red packets to residents there through a lottery system. The total value of the red packets were 10 million RMB, equivalent to about US$1.5 million. Each red packet has a value of RMB200, which is about $30. One can choose to tie his/her existing bank accounts to the Digital RMB App and upload money into Digital RMB e-wallet from their bank accounts. Just as how one can tie their bank accounts to their Alipay/wechat pay accounts.
One important observation I want to make is that the ultimate product may be very different from the recent pilot. Based on many speeches given by PBOC, they do not intend to issue digital RMB directly to consumers. Digital RMB will be distributed through banks and then to the general public just like the distribution of cash today.
So right now, it’s basically just another app. And the pilot is expanding now to other parts of the country, there will be pilots in the big cities of Beijing, Shanghai, and Shenzhen and their surrounding areas. What’s the rollout plan?
The ultimate goal seems to be officially launching digital RMB (or to test digital RMB on a larger scale) and introducing cross-border settlements/payments during Winter Olympics in 2022. The next stage is to test the ability for foreigners to use digital RMB in China by using their foreign phone numbers and to test expanding the use of digital RMB beyond China for cross-border payments, both of which require coordination with central banks or payments supervisory authorities of foreign countries.
I really wonder how many foreigners, who are just visiting, cuz you’re saying it’s those who use foreign phone numbers, so people like me, will want to use the digital RMB, I mean, I am OK with using Chinese apps, but many others don’t seem to be.
Indeed, privacy is a big concern overall when it comes to any kind of digital currency issued by central banks. When it comes to foreign users, does the digital RMB wallet fall within the jurisdiction of privacy laws of other countries? If so, what is the plan for compliance? It is unclear at this stage.
While we are on the subject of foreigners using the digital RMB, a ton of people have said that digital RMB will enable the RMB overtake the USD as the world’s reserve currency. What do you think of that?
Whether or not RMB will take place of USD depends on several factors. currency is both an asset and a tool for transactions. . As Powell, the chair of the Fed, points out in his recent talk at the IMF annual meeting, the reason why people choose one currency over the other is not because of tech advancement. Rather it is because the economy and the political system behind the currency and a country’s monetary policy, which is complex and dynamic. rAnd it also depends on how liquid such currency is. China still has pretty strict foreign exchange control. At present, individuals are subject to $50,000 USD annual limit in terms of FX both inbound and outbound. For companies, in order to exchange RMB for foreign currencies, they need to provide a set of documentations to prove the transactions are not for investment purposes. As a tool for transactions, currency is a bit like a network. The more people use it, the higher value it has and the more people would want to continue to use it. At present, about 80% of international trade is settled in USD. Taking over the close-to-monopoly status of USD is not likely to be something that can be achieved in the short run through tech advancement alone.
Wel, it does seem like a real concern, but it does also seem like it’s pretty far off. I think that’s one thing to say that’s easy to get headlines and coverage though because it would be such a big deal if it happened. But like, so much needs to happen before that happens right？
Right. What will be digital RMB’s value abroad isn’t clear. Digital RMB will have the same value as onshore RMB, that’s because unlike cryptocurrency, it’s a legal tender. Its value is backed by sovereignty. As I’ve been saying, it is meant to be same as cash but in a digital format. At present, there is a value gap between onshore RMB and offshore RMB (also known as CNH). If PBoC expands the circulation of digital RMB abroad, what the valuation will be is unclear.
Well, it’s always good to think about the future, so I’m glad we’re talking about it, but it does seem that there are probably more motivations domestically to do this and the international effects are secondary, at least for now, anyway. Tell us a bit more about how this impacts the domestic financial system, the traditional banks, not the internet fintech companies that we talked about earlier.
China already has a very efficient domestic settlement system. Having a digital RMB is not going to make a huge impact on the existing settlement system. However, it may provide an alternative to existing settlement rails in case of natural disaster or any other situation that affects the functioning of existing settlement rails. commercial banks may benefit quite a lot from DC/EP. It will reduce their costs of cash management over time and improve operational efficiency. Commercial banks have started to develop payments tools within their existing apps. Digital RMB can potentially help commercial banks gain market shares from third party payments companies in consumer payments. So instead of linking one’s bank account with Alipay or Wechat pay, one can spend digital RMB directly through their bank apps. If digital RMB does end of gaining a lot of tractions, it may put banks in equal footing with third party payments in terms of access to consumer transaction data. But obviously it depends on the ultimate design of digital RMB and how much details of data will be available to banks.
But at this point, it is hard to predict how popular digital RMB will be. Third party payments apps are super popular and efficient in China. Since the digital RMB is just like cash, it will not accrue interest rates so people may not have incentive to hold digital RMB in large amounts. It will be interesting to see what incentives will be out there to encourage people to use digital RMB.
Yeah, this is starting to sound less and less appealing to me, frankly. But hey, I understand that there is one, in my opinion, pretty edge case that the PBOC is also trying to solve with the digital RMB, that right now third party mobile payments haven’t solved or maybe don’t care about solving, and that is this thing about financial inclusion. It might be a little different from what you guys think it is, though, so Yan, please explain that part to our listeners and viewers.
One of the key features of digital RMB is dual offline (双离线), which allows transactions to take place between two phones that have no internet connection or cellular signals. So obviously this helps the very disadvantaged, remote areas with no or limited internet reception, and it could also help during major disasters when internet connection or cellular reception is affected. One of the value propositions of digital RMB is that it leverages near-field-communications or blue tooth to conduct transactions, which do not require the presence of the internet. However, I call this a “claimed benefit,” and the reason is because even if the transactions can take place at situations where internet access is not present, the settlement among banks has to take place at some point.
OK, so good to know the digital RMB will still work in a wildfire, but maybe not a total zombie apocalypse. What are some of the other things we should talk about? Like, we haven’t really talked about the technical aspects of the currency. What are some of the things that are notable, you think?
Well first, the digital RMB features a direct claim on the PBoC, but onboarding and real time payment services are designed to be operated by intermediaries, or so called authorised operators. So it’s not like there is some single government entity doing everything related to the currency. The authorised operators at present include the four major banks of China. While the pilot digital RMB e-wallet app is designed and owned by PBOC Digital Currency Research Institute, each commercial bank has also imbedded its own version of digital RMB e-wallet within their own apps. The central bank periodically receives and stores a copy of retail holdings and transactions.
So if I were to use crypto terms to describe this, the e-wallet apps process transactions, so they’re almost like independent exchanges, but then they all report back to this centralized ledger, of which the PBoC has the only copy.
Kind of, except we should emphasize that this is not all blockchain digital ledger technology or DLT. The backbone of the DC/EP’s infrastructure is a mixed system with conventional database and DLT instead of entirely basing on DLT. PBoC has emphasised that DLT is not yet sufficiently mature for such a large-scale application. To settle transactions, any system has to be able to accommodate 300,000 transactions per second (TPS) to accommodate the volume of large retail transactions in China. Wechat pay and Alipay can process way more TPS than what is required. On the front end, therefore, the PBoC does not require intermediaries to use any specific infrastructure or any specific technological path. Tech neutrality is something PBOC keeps on emphasizing as well.
I don’t want to get into the weeds here but I do think it’s important to understand the technical merits of the digital RMB and I know you’ve done a bunch of research on that. Tell us a bit more.
Another technical thing I didn’t talk about the digital RMB’s “Loosely coupled account” design: PBOC is using a value-based, semi-account-based and account-based hybrid payment instrument. What it means is basically something called tiered KYC. A user can open an account using his or her phone number without providing a real name. Such account will be subject to a transaction limit. If a user wants to have a higher limit, such user would need to provide full identification similar as what it is required to open a bank account. This would ensure that users remain anonymous to each other, but allow the central bank to keep track of necessary data to implement prudent regulation and crack down on money laundering and other criminal offences.
What about smart contracts? Digital currencies can enable that, obviously, so is that part of the plan?
People have been talking about programmable payments enabled by smart contracts, which allows distribution of social benefits and collection of tax payments once certain conditions are triggered. Interestingly, based on Fan Yifei, deputy governor of PBOC has said, PBOC seems to believe that the design of the functions of digital RMB should be as close as to cash itself and using smart contract to direct the distribution of digital RMB may infringe individual privacy and affect circulation of digital RMB.
So maybe no smart contracts, although that seems like it defeats the purpose a bit of releasing a digital currency. But I’m not a regulator so maybe I just haven’t thought it through. Anyway I read that there were other countries trying to do this as well, could you give us some idea of what everyone else is doing and thinking with regards to digital currencies like this, backed by sovereignty?
Both the Bahamas and Cambodia have beat China in terms of launching CBDC formally to the general public. But most other countries are at a research stage. Very few are conducting or have completed pilots. European Central Bank has recently announced a Digital Euro project. They are working on the concept, starting practical experimentation on possible designs, and discussing with stakeholders and international partners. Towards the middle of 2021 ECB will decide whether to launch a digital euro project. This will be followed by an investigation phase on user requirements and service providers.
The Bank of Canada has announced that it does not currently see a case for a retail CBDC, but that it is conducting work on retail CBDC as a contingency plan in case cash use suddenly declines or a private digital currency is widely adopted. As for the US, Powell has mentioned that the US is conducting a “hypothetical” CBDC experiment but does not plan to launch one anytime soon.
For anyone who is interested in learning more about stages of development of CBDC in different countries, Bank for International Settlements has published a report called “Rise of the CBDCs: drivers, approaches and technologies”. You can also follow a nice map created by Atlantic Council and Harvard.
Wow, I don’t think I realized that so many countries were doing this, although I did know that China was one of the farthest ahead. I’m in the US, should I be worried that we aren’t doing more here to push for a digital dollar?
I want to echo Powell’s talk at IMF annual meeting. It is not a race to be the first. Countries need to take a more cautious approach when rolling out CBDC. It is more important to be right than to be the first.
Finally, if you want to learn more about CBDC, I suggest you follow Ashley Lanquist, my colleague from the blockchain team at the World Economic Forum. She has put together a very comprehensive CBDC toolkit to help central banks make decisions on how to design CBDC. The paper itself is a product through consultation with several central banks. At present, the World Economic Forum is working with a community of over 80 organizations to produce a series of papers on digital currency.
I guess the digital currency experiment is already under way! Even if there are a lot of things that still need to be worked out. Like I know earlier before we started recording, you had mentioned that there isn’t a great answer to cybersecurity, and the protocols around that when it comes to the digital RMB, like who is responsible for what precisely. And you also mentioned a risk in the stability of the financial market: in the case of financial crises or major bank default, people may choose to convert all deposits into digital RMB to avoid loss of deposit due to commercial bank bankruptcies. And that may impact the stability of the financial system. But those are sort of edge cases right now, let’s hope, since the currency is still in such an early pilot phase. That could go pretty fast too, though. In China, I know that the internet companies such as Didi, JD and Meituan all said they’re going to participate in the testing of the digital RMB. The scale of these companies basically means that at least distribution will be no problem. By the way, if you are a listener or viewer who are part of the pilot, I really want to know what you think! Thanks so much Yan, for all the detail and context. You should be sure to follow her on LinkedIn just search for Yan Xiao, for more thoughts on digital payments and cross border trade.
Thanks Rui for having me. Digital currency is an exciting space and so much is happening. We are publishing our concept notes on digital currency in January. So please stay tuned.
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