International Compatibility Key to Success of China’s Digital Yuan

International Compatibility Key to Success of China’s Digital Yuan

Published: September 4th, 2020

China’s push to create the digital yuan, its new sovereign digital currency, continues to gather steam. Live trials are expected to begin in Q4, but forex analysts say the new e-currency’s underlying tech platform has to be compatible with those used in other countries if it’s going to achieve Beijing’s ultimate objective: to create a viable alternative to the greenback in international transactions.

As the threat of new US sanctions speaks fears that Chinese financial institutions could be shut out of the US dollar payment system, there’s a new sense of urgency to promote the yuan worldwide.

In the near term, at least, Chinese monetary policymakers want to minimise any potential disruption to Chinese trade and investment. But once the US election concludes in November, they have their eye on a bigger prize, which is a bigger piece of the international settlements pie.

Officially, the People's Bank of China (PBOC) is managing expectations that the digital currency might be on track for a full rollout in 2020. The bank is responsible for the digital yuan programme and is playing its cards close to its chest on details. For now, it will only confirm that its testing programme is continuing.

Beijing creates a sovereign digital currency

China's state-run China Daily reported last week that the PBOC had extended its digital yuan pilot programme to focus on applications in the retail sector.

The story quoted the National Internet Finance Association of China’s head of blockchain, who added that the digital yuan has already undergone limited live testing. In the case of retail, the PBOC believes the technology is robust enough to rollout more widely across the country.

Additional trials of the could happen in Q4 2020 or early in Q1 2021. The timing for any potential nationwide rollout won’t be made clear until this next phase is successfully concluded.

The PBOC’s current trial schedule encompasses a rollout of the digital currency with programme implementations underway in Chengdu, Shenzhen, Xiong'an, and Suzhou. Some of the facilities earmarked for China's hosting of the 2022 Winter Olympics are also being included in the trial.

Though it’s not part of the official PBOC programme, China Construction Bank announced earlier this year that it had undertaken tests of the digital yuan on its mobile banking system. It’s also been reported in late August that any digital yuan test wallets opened during the testing phase will be shut down and deleted after the test phase is complete.

A handful of screenshots have made their way onto social media that purport to show a page on the China Construction Bank's mobile banking app that includes a new option to create a digital currency wallet.

The bank also appears to have added new options for payments that include transfers, scanning and receiving. Upon clicking through to the digital wallet page, the screenshots claim to show more deposit options, like transaction details, cash gifts, transferring out of the wallet, credit card payments, and instructions for cancelling and removing a wallet.

Setting the stage for mass adoption

To promote the new digital currency make it more palatable to a sceptical Chinese public, China currency experts believe the PBOC is looking to coordinate actions with popular electronic payment systems run by WeChat Pay and Alipay.

Wide adoption within the populous country will be a crucial first step towards the longer-term goal of decoupling the yuan from the US dollar. The stability of daily usage by Chinese consumers and businesses will set the stage for internationalising the yuan for wider use in international settlements.

Right now the greenback is the default currency for commodity pricing in major commodities like oil and gas, and is the go-to international reserve currency for the world’s central banks.

In order for China's digital currency to find a regular place in cross-border transactions, the PBOC will have to interoperable with the complex technological systems that connect the transaction systems or major western economies. Since different central banks have their own plans and objectives for sovereign digital currencies of their own, Beijing will need to coordinate its rollout activities internationally.

That makes the success of the digital yuan a matter of successful diplomacy as much as technical efficacy. The US, UK, and France all have plans for central bank digital currencies, and China’s sovereign e-currency will need to work on the same systems that underpin these potential competitors.

Given the number of trials taking place today in China, the ability to communicate bi-directionally and instantaneously with Beijing’s international partners, wholesalers, and domestic financial bodies will play a crucial role in deciding which projects move forward first and ultimately succeed.

Central bankers appear to have embraced the benefits of digital currencies, and the idea is gaining traction around the globe. Discussions between monetary policy experts and technology companies are already underway behind the scenes to agree the best way to ensure compatibility between different digital currencies and facilitate cross-border payments.

China's pilot programmes for international cooperation will likely begin in Hong Kong and Macau, with PBOC engineers coordinating with local financial bodies in China’s semi-independent territories to make the necessary institutional arrangements for testing.

Forex analysts have suggested that currency-swap arrangements might be needed in the early stages of digital currency adoption if cooperation across the international financial system is slow to emerge.

A white paper released by the Bank of England in June suggested that the creation of a swap line with the PBOC raised the likelihood of the digital yuan’s cross border acceptance by about 20 per cent in the short term.

Beijing is unlikely to have an easy ride when it tries to move its digital currency into international markets, but the pathway appears to exist.

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