China is making encouraging progress in testing its digital currency, the yuan. It announced the success in Suzhou City in eastern China where 181,000 people were given Y=55 in digital wallets and allowed to spend their money at participating shops in the Double Fifth shopping festival, which took place between May 1st and 5, 2021.
This was part of a larger test that the People’s Bank of China conducted on 500,000 Chinese consumers. It took place in 11 Chinese regions. A simple app can be downloaded to receive a wallet. They can use this app to make purchases at thousands of participating stores and receive discounts.
The digital yuan, a digital version of the Chinese currency, is stored on a blockchain. This is the secure online ledger technology that is used to create digital coins such as Bitcoin and Ethereum. Digital Yuan is, however, permissioned. The People’s Bank determines who can use it.
This round of testing is ten times larger than the autumn 2020 original round. China has been also testing the digital Yuan cross-border between Hong Kong, Shenzhen, and Shenzhen. It is currently developing a platform to make the currency international viable. This platform will include Thailand and the Bank of International Settlements.
Each step forward increases the chances of China becoming the first country to allow its currency to be fully distributed on a permissioned Blockchain. Although no date has been set, it seems likely that a nationwide rollout will be completed within 12 months. This is most likely to take place in stages.
However, central banks in western countries like the Federal Reserve, Bank of England, and, to a lesser degree, the European Central Bank, have been slowing down on digital currency. They are concerned about privacy, as all transactions will be publically visible on the blockchain.
However, a digital Yuan raises serious questions about global financial stability. How to respond is the question facing other major economies around the globe.
Digital Yuan Eliminates The Need To Use Banks
Already, the digital yuan has legal tender status. It is fundamentally different from payments made through platforms such as Alipay and WeChat (or even PayPal in the West) because it allows for payment. Although such services can settle transactions quickly for customers, they are not efficient and take lots of time to settle transactions. There are ledgers that record large amounts of transactions between buyers and sellers. Sometimes intermediary banks also manage these transactions and settle them hours or days later.
Digital yuan eliminates the need to use banks. There is no fee for service, unlike other payment options, and payments can be made in a matter of minutes.
The currency is also supported by a government, unlike other cryptocurrencies like Bitcoin. The issuance of digital Yuan is just like cash in circulation. This makes it as secure as possible. Because officials can see all transactions occurring at any time, it gives the government better control of the money supply.
Three Dangers Associated With The Use Of Digital Yuan
Many central banks are looking into digital currencies. South Korea and Japan are following the Chinese lead. The European Union signals that a digital currency could be possible in four to five years.
There are many dangers for the laggards. First, international payments. Currently, transactions between currencies use the US dollar to act as an intermediary via the SWIFT international bank protocol. This creates a large demand for the US currency, which has many benefits such as the ability to borrow less and allowing the United States government more affordable loans. China exported $134 billion worth of goods in 2019, according to estimates.
With digital yuan transactions, you don’t need SWIFT and the dollar. This has implications for international trade in dollars. China is the largest trade partner of 120 countries. Many question the use of dollars in international trade as it increases the risk of negative exchange rate movements and adds unnecessary financial risk. China claims it isn’t trying to replace the dollar by the digital yuan and that its goal is to let the market decide how international transactions are settled.
The second danger is that central banks may not be able to meet the demand for digital currency. In that scenario, market forces will intervene. In China, paper money was created during the Song Dynasty of the 11th century. It is quickly becoming obsolete. During the pandemic, contactless credit cards became commonplace. Digital money is even better because it’s cheaper to use.
Third, countries who fail to adopt digital currencies may find their central banks losing control of monetary policy to cryptocurrencies. This could be decentralized initiatives such as bitcoin or centralized ones such as Facebook’s upcoming Diem currency.
This means that if non-sovereign currencies are widely used for payment purposes, central banks will have a harder time managing their economies by changing interest rates and money supply. It is possible to ban cryptocurrency, but that would hinder progress and the benefits they offer.
The rise of tensions between China, the US, and Europe is causing the digital yuan to be created. This makes it very difficult to give the Chinese first-mover advantage in this new currency.
It is possible to bypass sanctions like those imposed recently on Chinese officials due to human rights concerns. It is possible that the currency could be sanctioned, raising many questions about its viability and potential consequences.
It is crucial that the US and UK test their digital currencies immediately, given how important this is. The future of payments is being revolutionized by blockchain, and it is too risky to ignore.