Fintech on Friday: China’s digital currency challenge

In a fast-evolving global digital economy, central banks are scrambling for footholds to determine the future of currency markets, even as the value of unregulated cryptocurrencies slumps below $1tn during 2022.

Advocates of Central Bank Digital Currencies (CBDCs) believe they can deliver regulated stability and global liquidity by replacing M0 – the total amount of currency in public circulation plus central bank reserves – with the electronic equivalent of today’s paper money.

They claim CBDCs held in encrypted digital wallets are safer, unforgeable, and free to operate, delivering costless, instant money transfers, even across borders. Moreover, runs their pitch, CBDCs remove the need for today’s cumbersome messaging format systems, increasing transparency, fortifying data protection and protecting against money laundering.

At present, says the IMF, around 100 countries are “exploring CBDCs at one level or another”, with the US in research phase, Japan further along in its development and Nigeria boasting a fully functioning CBDC.

The e-CNY (sometimes called the e-RMB), framed by China as a sovereign digital currency, was initiated back in 2014, with the People’s Bank of China (PBOC) task force to research the technological and social infrastructure necessary for a successful CBDC.

Now, China has launched its e-CNY app, to function in conjunction with payment giants Alipay, founded by colourful businessman Jack Ma, and TenCent’s WeChat Pay, from the thriving tech hub of Shenzen. Between them, these two boast more than 2.2bn users worldwide.

As China watchers know, the relationship between the authorities and these big techs has not always been smooth, even though their democratisation of payments has transformed urban society. The e-CNY does not require users to have bank accounts for transactions of less than RMB10,000 ($1395), or internet connection for small-scale digital transfers, highlighting financial inclusion goals for China’s unbanked, numbering close to 300m.

Winter wonderland

The project has started large-scale piloting in 10, mainly urban, locations, after trialing during the 2022 Beijing Winter Olympics. The app has been downloaded 261m times, with cash incentives for early adopters. To date, Beijing’s government has paid out RMB40m in incentives through the e-CNY application. Businesses have joined consumers, with 8m merchants signed up by December 2021.

But despite heavy promotion, these digital initiatives have not proved as popular as planned, with the PBOC counting 142m total payments in October 2021, compared to Alipay’s 100m daily transactions. Research by the University of Illinois revealed individual e-CNY wallets typically contain RMB3, with corporate wallets containing RMB31. Total transaction values reported by the PBOC are RMB56bn, accounting for only 0.005% of M0.

Our research at the Fintech Research Center (FRC), covering age demographics from 22-50, with varying levels of income and education across 32 provinces (only 40% from urban areas), found 55% of respondents knew the e-CNY while 15% have adopted it.

Given limited time since roll-out, this level of exposure and adoption indicates education and incentive efforts have seen at least some success, though both are highest among educated, urban consumers.

House of cards

Of those familiar with e-CNY, most received relevant information through traditional news rather than social media, suggesting credibility of information sources is important. Interestingly, those earning lowest incomes are most optimistic about the future of e-CNY, highlighting its role in financial inclusion. Most respondents point to cost savings, such as zero processing fees for purchases and transfers, as key considerations.

Other key barriers include smartphone penetration and user know-how, highlighting the key role which stand-alone, user-friendly digital wallet ‘cards’ will play, once China has developed a smart card  – like a key card with a small numerical display – for e-CNY transactions.

Our conversations with vendors found 20% of businesses already accept e-CNY payments, with penetration highest in hospitality and online retail industries, outpacing ‘offline’ shopping outlets. The largest corporations lead the way, as companies with more than 100 employees demonstrate the most knowledge and highest adoption. Additionally, vendors take a consumer-centric approach, citing customer convenience above direct monetary incentives. While the hospitality and online retail spaces predict near-term penetration will be virtually ubiquitous, even average vendors expects take-up of 60-80% in the next three years.

China is by far the largest economy to roll-out a CBDC and has done so aggressively, but there are several lessons regarding the initiative’s partial success to date.

Beyond payments

While framed principally for payments, the e-CNY may also gain traction as an investment medium. As wealth managers and capital markets reel in the wake of steep losses for so-called ‘stablecoins’ luna and terra, digital currency markets need a truly stable store of value, backed by the same sovereign protections as ‘fiat currency,’ which e-CNY provides.

Furthermore, the programmability of digital currencies makes interest-bearing products a simple next step for CBDC development. Inflation-protected CBDC products, linked directly to macro-economic variables, may also surface. China has already experimented with use-specific CBDC – welfare-like payments to individuals purchasing daily necessities – allowing targeted subsidies. Investment products of this nature represent a new digital investment asset class with potentially zero-cost and instantaneous, 24/7 global liquidity.

Social sceptics

In order for such digital projects to flourish, high levels of consumer education are a prerequisite, helping boost financial inclusion through standalone smart cards, particularly in developing regions, where access to technology proves a barrier. Whereas these consumers are partly motivated by monetary incentives, the businesses they interact with are more concerned with improving customer experience.

But most important of all is the issue of trust. Traditional news media remain the prime source of information for most users, still sceptical about the credibility of social media. For these citizens, the notion of a CBDC as the overarching financial infrastructure remains premature. These initiatives have the power to flourish, but only alongside other digital payment systems.

As China’s turbulent history shows, a slower pace of definitive change can often reap higher rewards.

Dr. Charles Chang is professor of finance and director, and Nathan H. Chan is research assistant, of the Fintech Research Center at Fanhai International School of Finance, Fudan University