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In April 2020, China began testing the digital yuan, becoming one of the first governments to issue a Central Bank Digital Currency (CBDC). CBDCs like the digital yuan are government-issued, blockchain-based versions of a country’s national currency. Like most conventional cryptocurrencies, CBDCs would provide greater transparency into how people spend in the aggregate, as the currency’s blockchain would act as a permanent, immutable ledger of all transactions. China is rolling out the digital yuan through state-owned banks and digital payment apps like WeChat Pay and AliPay, which are much more widely used in China than their American or European counterparts. Digital yuan trials are ongoing, with many pointing to Beijing’s 2022 Winter Olympics as the government’s occasion to unveil its new CBDC to the world, as it plans to issue the digital yuan to visiting athletes. As of July 2021, trial users have created more than 20 million digital yuan wallets and executed over $5 billion worth of transactions with the new CBDC.
CBDCs have far-reaching implications for both domestic and foreign policy, especially when rolled out by an authoritarian regime that sees itself as a growing economic rival to the United States. We spoke to Dovey Wan, a founder of cryptocurrency investment firm Primitive Ventures and noted expert on the Asian cryptocurrency market, and asked her what she believes the CCP hopes to achieve with the digital yuan. She outlined two key goals.
The first is relatively benign: more granular control over the economy. Under the fractional reserve banking system all countries use today, central bankers can only interact with the economy indirectly, such as by changing interest rates. If the monetary supply existed entirely in CBDC form, with all transactions recorded on one central ledger, central bankers could exert more control over financial flows. “It would make monetary policy programmable,” says Wan. “For instance, if the government wanted to cool down the stock market, they could write a few lines of code and stop money from flowing into the stock market.” In addition, Wan pointed out that the digital yuan is meant to be easier for older citizens to use than the mobile payment apps that are so common now, and also cited the CBDC’s potential to make transactions cheaper for merchants by eliminating the need for third party transaction settlement.
However, it’s easy to see how a centralized, government-owned ledger of citizens’ transactions could become a tool for financial surveillance in the CCP’s hands. While Chinese citizens don’t have financial privacy under their current banking system, the digital yuan would give the government the ability to exclude individuals or businesses from the financial system for any infraction. While it’s unclear if or how much the CCP would elect to use this ability, the possibility of a “financial death sentence” would exist under the digital yuan system.
We also spoke with Yaya Fanusie, an Adjunct Senior Fellow at the Center for a New American Security (CNAS) who has studied the digital yuan and published a report on the project in January 2021. Fanusie largely agreed that the digital yuan could be a tool of authoritarianism, but put more emphasis on its role in the CCP’s broader desire to collect as much data as possible on citizens. “There’s never been a centralized database for a government to access records of all citizens’ transactions,” says Fanusie. “Yes, China can request that data from mobile payment apps, but that takes time, and sometimes they push back.”
He also outlined ways financial data generated by the digital yuan could be combined with other types of data that feed into China’s controversial social credit system. “The CCP recently released a notice that Mongolian families who didn’t send their children to state-mandated schools would be put on a blacklist. The digital yuan would allow the government to combine financial data with lists like that.” Fanusie mentioned that the CCP has already voiced its intention to use the digital yuan to monitor for corruption in the government. While that sounds like a reasonable goal, one can easily imagine how those financial surveillance capabilities could be turned on ordinary citizens.
Is the digital yuan a threat to the U.S. dollar?
Many have speculated that China intends to promote international usage of the digital yuan in order to reduce reliance on the U.S. dollar and the SWIFT transaction system. In fact, a video published by the state-owned China Global Television Network outlines what this might look like, promoting the digital yuan as a way to circumvent sanctions and decrease American influence over world trade.
We asked Yaya Fanusie if he sees the digital yuan as a threat to the U.S. dollar. He says that in the short term, this is unlikely, as he believes it will be some time before the CCP promotes usage of the digital yuan outside of China. But in the long term, he believes that the digital yuan, as well as future CBDCs rolled out by other countries, could hurt the dollar’s status in the world financial system. “I think they’ll try to make arrangements with other countries where they enable CBDC-to-CBDC exchange. Think of it as an atomic swap of CBDCs.” Under such an arrangement, somebody in China could send digital yuan to somebody in Malaysia, with a currency exchange automatically taking place in between such that the Malaysian user receives digital Malaysian ringgits without either party having to touch their non-native currency. These transactions wouldn’t rely on the SWIFT system. If they became the norm, there would be less need for people outside of the U.S. to hold U.S. dollars. “This isn’t a risk for 2022, but probably more for 2032 and beyond,” says Fanusie.
In the long term, Fanusie also sees the digital yuan as part of a larger war of data proficiency that the U.S. risks falling behind in. “So far, China has been more innovative than the U.S. with fintech. If that happens with blockchain technology too, the U.S. economy risks missing out on the next wave of data-driven innovation,” says Fanusie. It’s hard to imagine today what exactly those innovations will be, but they could be crucial given the massive amounts of data CBDCs would generate, and how governments could use that data to manage their economies more efficiently.
However, Fanusie doesn’t think U.S. policymakers should simply create their own CBDC in order to mitigate this risk. While a CBDC project shouldn’t be ruled out, Fanusie believes the U.S. needs to think beyond a digital dollar and promote more innovation in blockchain, fintech, and monetary policy across the board, as it’s done in the past. “Our federal reserve system is innovative. It’s not like other central banks, because the U.S. has a specific character and historical experience that led it to resist a centralized bank for over 100 years,” says Fanusie. In other words, he believes that innovation needs to unfold organically rather than be lifted from what other countries are doing. One way Fanusie suggests fostering that innovation is for the U.S. to partner with universities to create a sandbox for the development of blockchain projects. “That’s how the U.S. led the development of the internet. There was a directive for universities to create a computer networking system the military could use. That infrastructure was then leveraged for much broader civilian use and unlocked a revolution in business innovation.”
One thing is clear: China appears intent on developing a digital yuan for immediate domestic use, and possibly future international use. Improved monetary policy and financial surveillance of Chinese citizens appear to be the project’s short-term goals, but in the long term, the proliferation of the digital yuan alongside other CBDCs could compromise the U.S. dollar’s status as the world’s reserve currency. Any U.S. response to the project or launch of an analogous digital dollar should consider the question of financial data, and how it can be used to build a stronger economy and maintain the country’s position in economic competition, while still respecting citizens’ privacy.
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