Amidst the heat of the coronavirus outbreak in April, China has announced the ambitious undertaking of a closed pilot scheme for a ground-breaking digital currency.
Initially launching in Shenzhen, Suzhou, Chengdu and Beijing satellite city, Xiong’an, China’s Digital Currency Electronic Payment (DCEP) initiative is poised to revolutionise the way governments think about digital currencies and shake global economies.
While the rapid rise of decentralised blockchain-based cryptocurrencies in 2017 was met with controversy and criticism by major financial institutions, the Chinese government has taken an alternative approach by launching its very own centralised digital currency.
Join us as we explore what DCEP means for China, the benefits of a centralised system over blockchain, as well as the privacy risks associated with a state-owned digital currency.
Despite whispers of state-owned digital currencies reaching board rooms across the world in recent years, the Chinese government has taken an active interest in digital currencies ever since the inception of Bitcoin in 2009.
In 2017, a branch of China’s central bank called the Digital Currency Research Institute invited state-owned commercial banks to help with the design of a custom-built digital currency that would establish China as a leading innovator in the digital finance space.
Is DCEP Cryptocurrency?
Crucially, DCEP is not a cryptocurrency in the traditional sense of the word. While the likes of Bitcoin and Ethereum use distributed ledger technology (DLT) to store and record digital coin ownership, the Chinese initiative uses a central state-owned database to control the issuance and exchange of funds.
The value of DCEP will be pegged 1:1 with the Yuan and issued to citizens through a selected network of commercial banks.
The People’s Bank of China has developed an authorised app that provides users with access to a digital wallet and a seamless alternative to physical cash.
Conforming to Traditional Monetary Theories
One of the main reasons why the rise of cryptocurrencies has been met with resistance by central banks is the fact that most digital assets don’t conform to our classical understanding of money.
Typically, we attach value to a currency based on one of two factors:
1- Its physical value in relation to precious metals (e.g. the weight of a gold coin)
2- The fact that it will be accepted by a government as a tax payment
Unfortunately, the deregulated nature of most cryptocurrencies means they don’t meet the above criteria. While individuals can attach value to crypto coins and trade them as an asset, the lack of state support can make these digital currencies extremely volatile and risky.
That said, China hopes a centralised alternative that is accepted for taxation purposes will help the Chinese people reap the benefits of a stable and regulated digital currency.
So, why is China so determined to get ahead of the game by creating the world’s first official digital currency? Let’s take a look at some of the key benefits of DCEP through the eyes of both the government and the Chinese people.
Enhanced Economic Monitoring & Monetary Sovereignty with DCEP in China
The most attractive benefit of a digital currency for the Chinese government is the ability to collect data about people’s spending habits with unprecedented precision.
Instead of relying on forecasts and estimates, the data collected by DCEP payments will provide China’s central bank with a treasure chest of information that can be used to monitor economic trends, predict consumer behaviours and resolve issues before they would normally reveal themselves.
Crucially, the ability to monitor the issuance of a state-owned digital currency will help China fight-off threats to monetary sovereignty posed by the likes of emerging cryptocurrencies like Facebook Libra and Metal. China believes distributing a centrally-controlled alternative to privately-owned cryptocurrencies will give them the control they need to maintain a strong and stable sovereign currency.
Overtaking the US Dollar as the World’s Reserve Currency
If China manages to successfully roll out DCEP across China, expand to the rest of Asia and even parts of Africa, the world’s second-largest economic power could take the top spot as the world’s reserve currency.
If more and more central banks occupy their foreign exchange reserves with Chinese Yuan over US Dollars, China will have the luxury of printing (or rather uploading) huge sums of money, without experiencing significant inflation to the Yuan.
Removal of Private Payment Infrastructures & Card Transaction Fees
While most digital banking solutions rely on a chain of third-party payment providers to deliver services to end-users, DCEP removes the need for intermediary bodies (e.g. WeChat Pay, Apple Pay, Google Pay, etc.) that tend to take a slice of the pie.
Additionally, the direct relationship between the People’s Bank of China and DCEP-issuing banks means there will be no need for costly card network payments through the likes of American Express or MasterCard.
Offline Functionality
Unlike most digital payment systems, DCEP can work without an internet connection to avoid sudden economic collapses in the event of a technical blackout and guarantee access to rural populations.
While the nuances of how DCEP will support offline transactions remain unclear, reports suggest they will use ‘double offline payment technology’ to address a technical conundrum that has puzzled digital payments providers for years.
Hygiene
One of the biggest drivers behind the release of the closed pilot scheme in April was the outbreak of COVID-19.
Physical cash was identified as one of the biggest risks for viral transmission — presenting a golden opportunity for China to reap the benefits of a contactless alternative to contaminated notes and coins.
While DCEP presents exciting benefits for the Chinese government and reduced transfer fees for consumers, calls for a centrally-governed digital currency has sparked concerns over data privacy.
The Former Bank of China President, Li Lihui, claims DCEP will offer some anonymity options, but there is little clarity over how consumers can control what information the government can collect.
With reports indicating restrictions on the frequency and value of the anonymous transaction, the Chinese government could have access to an enormous bank of personal finance information.
Is DCEP the Future of Finance?
China’s proactive stance on digital currency innovation is both inspiring and controversial.
The adoption of cutting-edge technologies to improve financial access and enhance economic monitoring presents exciting opportunities for China’s growth, while concerns over how state surveillance and sovereign control could inhibit personal freedoms spark a wider debate around the regulation of digital currencies.
Either way, the rise of DCEP is sure to shake the world of accounting and challenge firms across the world to adapt to a digital world. Here at INAA, we’re committed to staying up-to-date with the latest industry innovations and supporting our community of 140 members across 50 countries.
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