Explained: China’s Digital Currency & How It’s Expected to Work

China is ahead of the global curve to becoming a cashless economy. But how does the new digital yuan work?

Here’s everything you need to know about China’s new digital currency. 

(Photo Courtesy: Erum Gour/The Quint)

China is ahead of the global curve towards becoming a cashless economy.

In a first, efforts are underway in China to roll out its digital currency, eCNY through trials. As part of its third trial. China’s capital city Beijing handed out $ 1.5 million to its citizens, after doling out similar amounts in the earlier trials in May 2020 in Shenzhen, Suzhou, Xiongan and Chengdu.

The government is yet to announce the official launch date of its digital Yuan programme, for which it has been working since 2014. This move comes amidst concerns raised by Central Banks like People’s Bank of China (PBOC) over cryptocurrencies like Bitcoin and Facebook’s private project, Libra, reported CNBC.

Its digital payment systems are advanced, with four out of five financial transactions made through mobile using applications like Tencent’s WeChat Pay or Alibaba’s Alipay, accounting for 347 trillion yuan, reported South China Morning Post (SCMP).

China is ahead of others in the race to launch digital currency, and may lead the way for other G20 countries like Norway, Sweden and Switzerland who are exploring digital currencies as well.

What is China’s Digital Currency? How Was it Developed?

China has created its new Central Bank Digital Currency, (CBDC ) known as e-CNY, or digital CNY by using its new payment system, Digital Currency Electronic Payment (DCEP), a project underway for the last seven years to create a centralised digital Chinese currency. It would be used for everyday financial transactions using a digital wallet.

As popularity of Bitcoin and cryptocurrency grew in China, its central bank, PBOC began developing the digital currency in 2014 after setting up an internal group. In 2017, PBOC inaugurated the Digital Currency Research Institute to help design the currency.

The DCRI division was in charge of development and testing of the digital currency, and invited major banks like The Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China, and the Agricultural Bank of China as well as foreign corporations to design the DCEP system, reported SCMP.

How Does It Work?

Similar to digital payment platforms like We Chat Pay and Alipay, a user can download digital wallet application from PBOC where they can keep their money, linked to a bank account.

The money can be converted to digital cash on a one-to-one basis. To spend the money, A QR code is generated which can be scanned by shop owners. It will be a centralised payment system.

The DCEP system allows for “touch and touch” system, where two users can touch their mobiles together to make a transfer, leaving no record with a third party. It also does not require an internet connection, added the SCMP report.

The design borrows minor technical elements from Bitcoin, but does not use blockchain technology, reported Reuters.

The digital currency is meant to replace cash in circulation, and not for long term deposits in banks. Commercial banks will eventually play a role in distributing digital currency, and have to deposit the same amount of reserves to PBOC as they dole out. Both Commercial and Central Banks have to maintain detailed records tracking flow of digital currency, added the report.

China’s digital Yuan is expected to be very stable, unlike cryptocurrency which is known for its high price volatility. The eCNY is expected to not have price fluctuations and is expected to be safe and carefully regulated by the Chinese authorities, reported CNBC.

Trial By Lottery

Under the trial, PCOB distributed “red envelopes” - China’s traditional method of gifting cash - as online wallets worth 200 digital Yuan to 50,000 random pool of applicants, with a Chinese ID number, or hold residence permits from Hong Kong, Macao or Taiwan, reported Reuters.

Trials first began in May 2020 in four cities – Shenzhen, Suzhou, Chengdu and the Xiongan zone near Beijing, and later, pilot programmes are being developed at the venues for the 2022 Winter Olympics in Beijing and Hebei’s Zhangjiakou, reported SCMP. These trials are conducted in “closed environments” to not affect any commercial operations.

Some of the retailers participating in the trial include Starbucks, McDonald’s, Subway, Ant Financial, Tencent and 19 shops, added the report.

Benefits of Digital Currency For China

China’s move towards digital currencies will allow authorities to have an iron grip on its finances, with visibility on how money flows in the Chinese economy, and enough data to scrutinise its financial system.

The digital money will be distributed directly into the wallets of state-owned bank users, thereby circumventing the popular digital payments apps in the country, namely Alipay and WeChat Pay, reported Financial Times.

Digital currency is completely traceable. It will allow for the government to track financial transactions, enabling weeding out tax evasion, money laundering and other financial illegal activity as well as for doling handouts to beneficiaries.

This move will also create a database for cash flow information and credit data to study the credit structure of China’s economy, reported SCMP. This digital data record can be checked against citizens in real time.

The coronavirus pandemic has been a catalyst for increased work towards cashless payments over concerns of contact by banknotes spreading the virus and related hygiene and cost issues of paper cash, added the report.

Concerns Around The Digital Currency

Since the eCNY will be a centralised system, there are major concerns that the government may use it to crack down on dissidents.

The government will have greater control over financial transactions to observe how money is spent in real time since digital currency can be traced and recorded accurately, giving rise to privacy concerns.

(With inputs from The New York Times, South China Morning Post, CNBC and Reuters)