Banking & Finance

The future of money is now

Federal Reserve looks to play catch up with China’s digital currency


China's e-CNY has a head start on Fed's efforts in digital currencies

Almost 100 countries are evaluating central bank digital currencies (CBDCs), the IMF reported last month, with a pioneering group starting to roll them out.

But maybe it’s inevitable that reporting on these efforts is often shaped by the tensions of superpower rivalry – or more specifically whether the Chinese have a golden chance to grab the initiative back from the greenback by getting ahead in the digital race.

While the Federal Reserve is still asking for opinions on how best to proceed with a digital dollar, the People’s Bank of China is deep into preparations for a much fuller launch of the digital yuan, or e-CNY.

Fed officials have sounded divided on the need for a new currency and they canvassed for more views on the benefits and risks in a discussion paper in January. They seem likely to leave the decision to the US Congress and critics are unimpressed, saying that an American CBDC could be years away.

Contrast that with the situation in China, where testing of a digital currency began in 2014 before extending across a variety of trials in cities like Shenzhen, Chengdu and Suzhou. The programme has seen the e-CNY become the world’s most widely deployed currency of its type, with more than 261 million unique users and transactions totalling Rmb87.6 billion ($13.8 billion). It was introduced to international users for the first time at the Winter Olympics in Beijing last month (see WiC573), with payments of about Rmb2 million ($316,000) in the currency each day.

HSBC’s Global Research team have been tracking the preparations for the e-CNY for a while, including how it is likely to be issued by the central bank to a second layer of commercial banks, which will distribute it to the digital wallets of the general public.

Initially the e-CNY will mainly be used for domestic retail sales, HSBC’s analysts think, although the technology already exists to support cross-border transactions.

As Georges Elhedery, Co-CEO of global banking and markets at HSBC, pointed out further last month, digital currencies will be used primarily for payments, unlike cryptocurrencies, which are mostly held for investment purposes. Because cryptocurrencies can often swing wildly in price, it makes it harder to envisage their usage in everyday financial transactions, he explained in an opinion piece in the South China Morning Post.

CBDCs should be a lot more predictable, however. “Regulated and underwritten by their respective central banks, they are likely to be regarded as stable and trusted,” Elhedery adds. “One core principle is that they should be designed to do no harm to financial stability.”

Another major distinction is that cryptocurrencies circulate beyond the control of a central authority, with transactions that are recorded anonymously on blockchain.

That’s not something that is going to be allowed with the e-CNY, which will operate on the principle of ‘managed anonymity’ in which small transactions are waved through with minimal scrutiny but more stringent information is required for larger ones.

People’s Bank of China officials have argued that this principle will find a balance between reasonable privacy protections and the need to guard against criminal activity in areas such as money laundering and tax evasion.

What’s interesting is that the Federal Reserve is having a similar debate about privacy: it also says that a certain degree of transparency is necessary to deter criminal activity and that intermediaries will be given the task of verifying customer identities.

Indeed, what stands out in HSBC Global Research’s coverage of the plans for the two CBDCs is the common ground in the opportunities and challenges ahead. Yet the media commentary focuses more on the rivalry between the two superpowers in asking how a digital yuan could destroy the dollar’s dominance.

An argument could be made that setting the early standards in digital cash might give the Chinese new flexibility in the world’s financial markets, perhaps by making it easier to send money across borders without touching the US banking system.

But others have countered that talk of targeting the dollar is overplayed and that what the Chinese are really trying to do with the e-CNY is shift their domestic payments system away from platforms like Alipay and WeChat Pay and back towards the government and the banks. In this respect, Beijing’s battle is more with big tech than with Washington (see WiC502).

In the meantime other central banks will be hoping to learn from China’s trailblazing efforts, which have continued with the ‘m-CBDC Bridge’ project with regulators from Hong Kong, Thailand and the United Arab Emirates. Here the idea is to join up a group of digital currencies across interoperable platforms unburdened by legacy rules and technologies. This could promote the e-CNY as a settlement currency for more of China’s trade flows, although the yuan still has a huge distance to make up on the dollar as the world’s currency of choice. Payments with the yuan reached 3.2% of the global total in January, surpassing their previous highpoint in 2015. But the dollar was way out ahead with a 39.9% share.

Perhaps that’s why Fed chairman Jerome Powell has been arguing that it would be a mistake to rush headfirst into a digital dollar, telling reporters that it is “more important to do this right than to do it fast”.

He also sounds untroubled by fears that the dollar could lose ground to a newly energised yuan. “We’re the world’s reserve currency… because of our rule of law; our democratic institutions, which are the best in the world; our economy; our industrious people; all the things that make the United States the United States…” Powell insisted last year.

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