Geopolitical Global Reform and New Technology: China’s Dash for Digital Currency Domination

As the US accelerates its printing press, China is already testing the digital yuan. Given this new reality, it becomes clear that the finance world will never be the same. But why do we need digital money? How is it better than traditional fiat money? What are the pitfalls?

The coronavirus epidemic has accelerated cryptocurrency’s exit process from the marginal state, and has firmly pushed it front and center into many more people’s consciousness than ever before. Today, the global economy needs a payment instrument with which you can make payments quickly, inexpensively and without unnecessary intermediaries, such as Visa or Mastercard, and it needs such an instrument now more than ever before. China is already testing its “digital yuan,” with the USA\, Great Britain, France, South Korea and other countries working on similar steps, too. Already 20% of 66 central banks reported that they are likely to issue a CBDC within the next six years.

After the coronavirus epidemic, a trend of regionalisation will result in new models of trade, investment and finance that will diversify the currencies used in settlements away from the US dollar, Liu Xiaochun, deputy dean of the Shanghai New Finance Research Institute, said to the South China Morning Post. “Under RCEP, currency choices for regional settlement in trade, investment and financing will increase significantly for the yuan, yen, Singapore dollar and Hong Kong dollar,” Liu was quoted as saying in comments posted to the China Finance 40 Forum, a think tank comprising senior Chinese regulatory officials and financial experts.

“Chinese financial institutions must unite with other countries and regions to position themselves beforehand to adapt to the needs.”

“It’s hard to predict the timeline but the People’s Bank of China is under a lot of pressure to accelerate the development because they do not want to be in a world where Libra (Facebook’s digital currency) becomes the global currency, which they think is worse than the current global financial system controlled by the US,” says Linghao Bao, an analyst from Beijing-based Trivium speaking to BBC World News.

Observers say China wants to internationalise the yuan so that it can compete with the dollar.

“The Chinese government believes that if some other countries can also use the Chinese currency it can break the United States’ monetary sovereignty. The United States has built the current global financial system and the instruments,” says an anonymous Chinese cryptocurrency observer known as Bitfool.

With all of this action behind the scenes, it seems inevitable, in the coming years, that state digital currencies will become widely available to ordinary citizens. However, few people understand what this will change, so let’s explore how it will evolve in the not-too distant future.

——————————————————————

In my latest illustration, I reference video game King of Fighters (KOF) fight scene among two female combatants – one dressed in Caucasian military style – representing Facebook Diem; while the other wearing a traditional Asian ‘cheongsam’ dress, representing China’s Digital Yuan. In center, is the referee draped skin-hugging latex, with a Bitcoin belt across her waist.

——————————————————————

China’s proactive push for digital currency/electronic payment

The Central Bank of China is launching the testing of its digital DC/EP (digital currency/electronic payment) in the cities of Shenzhen, Suzhou, Chengdu and Xunan. Four state-owned banks will be involved in the issuing of this digital  asset: Agricultural Bank of China, Industrial and Commercial Bank of China, Bank of China and China Construction Bank.

The Chinese authorities have chosen the easiest way to integrate digital currency – implementation through the social and budgetary sphere. Already in May, officials working in Suzhou will receive half of the transport subsidies in DC/EP rather than in traditional renminbi. To do this, they must install a special application on their smartphones – an electronic wallet that can be linked to an existing bank account. This new digital currency can also be used for payments at McDonald’s, Starbucks, Subway and other popular chains. All this reminds us of how the Euro was introduced into circulation, which combined 18 European currencies. This, too, was not instantaneous and began in 1999 in a non-cash digital format.

The revolutionary nature of the state digital currency isn’t just that issuing digital money becomes cheaper since no special paper with watermarks and other security measures will be needed. The revolution is with Chinese authorities believing that “a sovereign digital currency” is an effective alternative to the U.S. dollar settlement system. It dulls the impact of any sanctions and mitigates the threat of a boycott both at the national level and at the level of private companies.

The Chinese yuan is also deemed to be of the most significant impact to bitcoin amid vulnerable global currency performance and volatile geopolitical sweepstakes. The Chinese currency, out of all the G10 currencies, has the strongest statistical correlation to BTC over the last 12 months, at around 84%. That means that as the RMB gets stronger against the dollar, so does Bitcoin, 84% of the time, says Vladimir Signorelli, head of Bretton Woods Research in Long Valley, New Jersey to Forbes.

“When Bitcoin rises, the RMB is rising right along with it,” he says, adding that the euro has a 74% to 75% correlation with Bitcoin. The Russian ruble has a 25% correlation.

In addition, national digital currencies can actually accelerate payments, increase transaction volumes and thereby increase the level of GDP, which have fallen sharply due to the coronavirus pandemic. That is one example that American economists argue about concerning any future digital dollar. However, the introduction of digital currencies will change the economy at all levels: from global to personal finance.

A holistic approach: Political, social and productivity benefits to digital currency

China is not alone. Deutsche Bank Research has tracked almost 20 digital currency projects led by central banks across all regions globally. Meanwhile, the private banking sector has also launched multiple initiatives, such as the R3 consortium, or in India, the Blockchain Infrastructure Company.

The aim for most of these initiatives is efficiency and effectiveness. Digital currencies could remove the cumbersome operational and security apparatus which surround conventional forms of money transmission. Reducing the ‘cost of friction’ can help financial inclusion of individuals, while also making global trade more efficient and less risky. Increasing transparency and traceability can protect against money laundering and other forms of financial crime.

For central banks, the most important benefit is the ability to improve regulatory compliance and the effectiveness of monetary policy. This is particularly important now. It’s difficult, if not impossible, to know if or when monetary policy is having the intended effect on the economy. If such stimuli were executed through a central bank digital currency, its flow through the economy could be monitored precisely, informing future monetary actions.

There are political and social benefits as well. As research by Deutsche Bank shows, first movers in this space could win long-term geopolitical advantage. The potential for China here is immense. If the e-RMB is adopted broadly as a system to streamline trade and reduce risk, China could become the world’s trade banker, as well as its factory. Yet the bigger goal for China is actually more local, and relates to financial inclusion. Digitising the RMB will grant access to financial services to hundreds of millions of citizens, including some of the most disadvantaged. This benefit is something that can be applied to any country across the world.

That said, significant technical and structural barriers must be overcome before any CBDC becomes reality. Described as a ‘tri-lemma’, the challenge is that the underlying blockchain architecture of many cryptocurrencies can be designed to be highly decentralized, secure or scalable – but not all three at the same time. Scalability and security are crucial to the effectiveness of any CBDC, but losing decentralization risks creating other bottlenecks and inefficiencies.

Envisioning how payments and transfers will become cheaper

Today, we see a huge difference in how well known certain payment instruments in different countries are. For example, Russians are making full use of contactless payments such as PayPass, Apple Pay, and others. Meanwhile, the Chinese have long been accustomed to paying by QR codes and are actively “paying by their faces – even in the subway. Then, we see Americans loving their Amazon Go stores, where they just pick up the goods they want and simply walk  out, secure in the knowledge their purchases have been tracked in store and the correct payment  will be debited from their credit card automatically. At the same time, residents of Germany, Italy, Spain, and Austria prefer cash, although they have no obstacles or restrictions on the use of other payment instruments, with various forms of contactless payments now available in most places around the world.

Digital currencies look like a logical continuation of this evolution, another tool that will simply be added to the list, but this is not entirely true. Unlike other payment instruments, cryptocurrency does not complement the existing financial infrastructure, but creates a new one – without intermediaries, and which is transparent and reliable.

When we pay for any product or service, an average of 1 to 5% of the money goes to payment systems as an acquiring commission. Cryptocurrencies – like QR codes – allow the buyer to pay the seller directly, which means eliminating the intermediary – like, Visa or MasterCard – and which will make goods and services cheaper. Already, there are marketplaces where users can directly pay with various cryptocurrencies.

Of course, payments using the state digital currency will not be free, but commissions will be significantly reduced. Their amount will be assigned by the issuer of a centralized digital currency, that is, by the state, and not by international corporations seeking to maximize profits at all costs.

The powers that will shape digital currency

Digital currency is not only money in the usual sense, but also a technology that is ideal for providing the state with financial resources. To put it simply, the introduction of a state digital currency can increase and simplify tax collection up to 100%. In parallel, of course, the state will receive a large amount of data about its citizens and their finances, for which centralized crypto technologies are often scolded. However, the transparency that the blockchain provides also works in the opposite direction.

Cryptocurrency technologies allow you to control not only citizens, but also the state, allowing you to track where each budgeted ruble, dollar or yuan has been spent. For example, did all the allocated $16 billion really go to fight the coronavirus in China, or did part of it go astray, landing instead in completely different accounts? Using digital currency, targeted social assistance will also become truly targeted, and commercial banks and payment systems will not be able to receive their percentage from such payments.

Digital currencies offer even more opportunities if they are freely convertible. In this case, they can be used for global settlements and indeed weaken the dependence of national economies on the US dollar, which, apparently, is what the Chinese expect in the future.

What is the catch?

Despite all the advantages, states are ambivalent about the topic of digital currencies. This is especially so, if these currencies, at least theoretically, want  to become globally recognized and a new standard of their own. Think of how hard Mark Zuckerberg has tried to advance Facebook’s digital currency Libra, once supported by so many partners, but since abandoned by many, including Paypal, Mastercard, Visa, eBay and Stripe. Libra’s hope for survival now rests on the appointment of Stuart Levy, a former senior US Treasury official as Libra’s new CEO, but whether he will end up making a real difference is yet to be seen.

Global competition and the protection of private and national interests are still of high importance, so the issue of “authorship” of money and control over it is really very important. If a private company becomes the issuer of state digital currency, it may pursue its own commercial interests. There is also a risk that the company’s employees may create some kind of vulnerability, which, for example, will lead to data leakage in the future. And who knows what will happen if the company changes owners? A striking example is the scandal with Crypto AG, which has long been one of the leaders in the encryption market. As it turned out, in the middle of the 20th century, it was bought by American and German intelligence services, which allowed them to read secret correspondence between governments and intelligence agencies of other countries for decades. In the case of money, it would be like a nuclear explosion. That is why private  corporations cannot be trusted with state issued currencies.

For the state to be able to launch its own digital currency, the mere desire to maintain a monetary monopoly is not enough. Central banks should become technology companies. This is a serious challenge, and as such, states are in no hurry to launch digital currencies before they are convinced of the availability of everything necessary – from advanced technologies to a reliable team of professionals able to provide as secure and reliable an infrastructure as is possible, given the entire economy will be depending on it and given hackers will be trying to penetrate the system. However, given how actively different countries are now considering the possibility of following the example of China, dozens of national cryptocurrencies will become available in the very near future.

The race to digital currency looks like China’s to take

A China victory in the digital currency race would have multiple negative effects for the U.S.—and Western capitalism generally. If foreign businesses can bypass America’s gatekeeping banks, Washington will lose its unique power to impose sanctions on other countries. Also, if they no longer face exchange rate risks, foreign central banks won’t need to backstop their currencies with dollar reserves. The resultant drop in demand for U.S. government bonds would result in higher interest rates, not only for the federal government, but for business loans, mortgages, credit cards, and every other form of U.S. borrowing.

Former Commodity Futures Trading Commission chairman Christopher Giancarlo is among those calling for U.S. action. He says Washington can harness the Constitution’s Fourth Amendment privacy guarantees to competitively position a digital dollar as superior to a digital renminbi, since many fear the latter becoming an instrument of state surveillance.

But the strategy need not focus entirely on a digital dollar. To align itself with more privacy-friendly monetary innovations than China’s, Washington could, for example, incentivize research into zero-knowledge proof encryption. This technology could one day let regulators extract information about the overall buildup of risks in the financial system but severely limit their access to people’s private transaction data.

Cryptocurrency developer communities are at the forefront of such work. To encourage more of it, the U.S. could signal a more accommodative stance on securities and money transmission regulations for cryptocurrency startups and encourage banks to service an industry that has been unreasonably demonized.

America’s 20th-century hegemony stems from the soft-power appeal of its ideas. Now its civil liberty values could bolster the possibility of dominance in digital currencies—and promote America’s broader interest in freedom globally.