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16 Jul 2020

Econ Digest

How much do you know about the Digital Yuan?

       China's digital currency development scheme is often viewed as a tool that can be used by Chinese authorities to reduce the influence of the US dollar (USD), while the COVID-19 pandemic has turned contactless payment systems into a factor that is accelerating the adaption of related parties, promoting the adoption of digital currencies. This trend could help accelerate the development of the digital currency ecosystem and could soon replace the role of the traditional financial system. KResearch has gathered and summarized interesting facts about China's digital currency development scheme and other related issues as follows:


Q: How is the Digital Yuan (Digital Currency Electronic Payment or DCEP) different from the fiat Yuan?

A: There is no difference, as DCEP is a digital currency launched by the central bank (the People's Bank of China or PBOC), which means it is backed by currency reserves the same way the fiat Yuan is, and can be used as a medium of settlement in accordance with the laws of China. The PBOC has issued DCEP to replace the circulation of the Yuan used for domestic spending, meaning that the money supply in the China's economy has not changed by the issuance of DCEP. The major advantages of DCEP compared to the fiat Yuan is that DCEP's usage can be traced by the PBOC, which helps to reduce the risk of financial crime and tax evasion, and the features that can be connected with other financial services through automated systems help to increase efficiency and reduce transaction errors.


Q: What is the scope of DCEP usage?

A: Currently, China is starting the limited trial use of DCEP in 4 major cities, namely Suzhou, Shenzhen, Xiongan and Chengdu. Chinese authorities aim to push DCEP to be used nationwide by 2022, driven by contactless payment that is likely to gain popularity as a result of the COVID-19 outbreak, hoping for it to become a catalyst for Chinese operators to improve their infrastructure to support DCEP deployment and to increase convenience through a DCEP payments system that does not require internet connection.


Q: Is there any chance DCEP will be able to be used outside of China?

A: In the future, DCEP may be able to be used outside of China, depending on the policies of the PBOC and destination central banks, but the use is likely to be limited. It is being used informally in some countries, especially those with high dependence on China, in particular countries with low foreign exchange reserves and high reliance on China may allow the use of DCEP in conjunction with the use of local currencies. However, the use of DCEP abroad may not be popular, because many countries remain concerned about security issues and the impact on monetary policy from exposure to DCEP. In addition, issues like exchange restrictions, capital movement and liquidity management challenges will also affect the use of DCEP outside of China.     


Q: What are the implications of DCEP in terms of international relations?

A: The emergence of DCEP may be a signal by Chinese authorities in positioning China as one of the leaders in the digital economy through building a prototype for development of the digital currency ecosystem, and is also an attempt to gauge the reaction to Chinese influence in world  financial markets. In addition, the development of digital currency will be accompanied by digital payment systems, which could provide a back-up mechanism to support China's international settlement with trading partners with strong ties to China, in case international political risk factors worsen in the future.


Q: Is DCEP similar or differ from other central bank digital currencies (CBDC)?

A: DCEP is a central bank digital currency with the purpose of general domestic payments (Retail CBDC), while there is another form of CBDC issued by central banks for interbank payments (Wholesale CBDC). At present, many central banks are under trials for Wholesale CBDC (W-CBDC) projects, including Bank of Canada (Project Jesper), European Central Bank in collaboration with Bank of Japan (Project Stella), Hong Kong Monetary Authority (Project Lionrock), the Monetary Authority of Singapore (Project Ubin) and the Bank of Thailand (Project Inthanon), while China is also preparing a stablecoin project for international settlement.


Retail CBDCWholesale CBDC
-China (DCEP)-Canada (Project Jasper)
-Cambodia (Project Bakong)-EU and Japan (Project Stella)
-Sweden (e-krona)-Hong Kong (Project Lionrock)
 -Singapore (Project Ubin)
 -Thailand (Project Inthanon)


Q: How will the international payments system change under the advent of CBDC?

A: CBDC may bring significant changes to the international payments system, especially in terms of efficiency. A settlement that is effective immediately and a payment system that may be able to connect to various activities in the economy automatically could greatly reduce both cost and transaction errors, compared to the traditional payments system. In the future, such payments systems may gradually replace SWIFT and the agent banks system.


Q: Will the widespread use of CBDC affect the role of USD in international financial transactions?

A: The use of CBDC is unlikely to affect the role of USD in any way, but a highly efficient international payment system through CBDC and the ability to use a payment system that can be transacted 24 hours a day may reduce the needs for liquidity that rely on major international currencies such as USD. It is highly secure in managing the risk of repayment systems during the period of waiting for delivery, and thus can indirectly reduce the role of USD.


Q: How is Libra 2.0 similar and different from CBDC?

A: The Libra 2.0 project is a digital currency developed by the private sector with the aim of being an international digital currency. The similarities between the Libra project and CBDC could include the use of highly reliable underlying assets to reduce currency fluctuations; Libra is equal in value to the basket of support currencies. Alternatively, the main differences between the two can be summarized as follows: First, CBDC is backed by the law while Libra is not and is in the process of requesting permission to operate in several countries; Second, the issuance and control of the money supply created by Libra and managed by the private sector in the form of the Libra Association, using rule-based money supply management, makes it possible for such currency to experience fluctuations during unusual times, while CBDCs are issued by central banks and can be used by central banks together with other financial instruments during times of unusual money markets, thus causing less volatility.


            In summary, the emergence of the DCEP project should be a factor that sparks global central banks' awareness of the widespread development of digital currency programs, contributing to a massive upgrade of the global payment structure. China hopes that the widespread adoption of a digital money payments system will provide the country with a backup mechanism to support international settlement, in case international political risk factors worsen in the future. With the increased efficiency of the new payments system that shortens settlement times, the demand for USD as a medium of international settlement will decrease. However, the emergence of DCEP is unlikely to affect the influence of USD significantly.


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