How China’s digital currency push can boost fintech and the yuan’s global presence

The digital yuan offers stability and convenience that most popular cryptocurrencies do not
It will allow for better regulation of fintech, improve risk management for businesses, simplify cross-border transactions and promote overseas circulation of the renminbi

David Chao

Published: 4:00pm, 7 Apr 2021

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Bitcoin recently shot past a market capitalisation of US$1.1 trillion, reigniting discussion about the future of digital currencies and stores of wealth. I should first say that I do not classify most forms of popular cryptocurrencies as a traditional currency.

There are three main reasons for this. They are way too volatile to be considered a standard of value, they cannot be easily bought or sold, and they cannot be easily used to pay for everyday goods and services.

There is, however, a digital currency that meets these requirements that is starting to gain traction – the digital yuan.

One of the earliest forms of paper currency can be traced back to 11th century China, when the promissory note otherwise known as jiaozi was used for trade in goods until hyperinflation caused its demise decades later. Today, China is the leader again among major economies in its push for a digitised currency.

The People’s Bank of China (PBOC) became the first major central bank in the world to launch its own digital currency in 2020, with trials ranging from payment of public employee wages to electronic cash payments at food and retail outlets. Unlike existing third-party payment functions provided by WeChat and Alipay, which process claims on a bank account much like a debit or credit card, it is the digital form of China’s fiat money and is designed to eventually replace paper money.

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PBOC governor Yi Gang said the plan was not to create a new currency, such as bitcoin or Facebook’s Libra project, but to partially digitise China’s existing monetary base, or cash in circulation. Yi has said the new digital currency will not replace other parts of the money supply, such as deposits held in bank accounts or balances held by payment apps such as WeChat and Alipay.

Retail banks and fintech companies will continue to manage customer deposits in the same way, but the new digital currency could provide a neater way for banks to settle payments with each other, rather than through the existing clearing system.

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China has a huge advantage over other countries with its coming roll-out of the digital yuan – its large captive market. During the past two decades, China has moved from cash to cashless with breathtaking speed. China’s ratio of M0, or measure of cash, to M2, or measure of broad money – a metric used to gauge the usage of cash in the economy – is among the lowest in the world, declining from more than 10 per cent to around 4 per cent in the past two decades. In contrast, the United States’ M0/M2 ratio is around five times that of China’s.

This decline in the use of cash reflects the increasing popularity of digital payment systems in China. An estimated 81.1 per cent of smartphone users accessed payment apps in 2019, while total mobile payments transaction volumes reached more than 347 trillion renminbi (US$53 trillion) in 2019. As a result, these digital wallets store an enormous amount of cash reserves and a significant percentage of China’s M0 money supply.

As China has one of the highest “fintech credit” per capita rates in the world, another potential reason for the government’s push towards the digitisation of the yuan is the increasing need for enhanced regulation of fintech companies, particularly those with robust mobile payment systems.

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Since providers of these closed mobile payments systems are not regulated as banks, this creates certain regulatory risks. As payment systems are a critical component of e-commerce, China’s digital yuan could serve as a long-term solution for policymakers to tackle monopoly risks in the sector’s ecosystem by introducing a new payment infrastructure that is completely transparent, enabling peer-to-peer transactions like cash.

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Compared to traditional banknotes, the most significant advantages of the digital yuan are its traceability, anti-falsification and directional circulation. These advantages make it uniquely suited for fiscal policy implementation, financial and tax regulation and cross-border trade. For example, when the government provides subsidies with a digitised currency, it can easily monitor the actual flow of the subsidies to ensure accurate delivery and supervision.

From a corporate perspective, the introduction of the digital yuan suggests stricter supervision, but it can also bring convenience for businesses and improve internal risk management. For example, discrepancies between cash flow and accounting records can be easily detected, making it easier to manage transparent financial statements.

Digitisation of the yuan will also help simplify cross-border transactions and perhaps enhance the overseas circulation of the currency, especially Belt and Road Initiative-related trade and financing settlements. Beijing policymakers have been pushing the internationalisation of the renminbi for the past few years.

As US-China relations have frayed, the need to reduce China’s reliance on the US dollar has become more urgent. In the long run, a digital yuan platform will aid in establishing the renminbi as the region’s predominant trade and reserve currency.

David Chao is Invesco’s global market strategist for Asia-Pacific