How China’s Cryptocurrency Could Reverse the Dollar

Nearly 900 years ago, the Chinese government of the Song Dynasty, then the most advanced civilization in the world, issued the world’s first centralized paper money. When Marco Polo encountered money made from “tree bark” circulating universally in the Mongol Empire during the Yuan Dynasty, a hundred years later, he witnessed a financial system with efficient transactions long-distance and a central banking authority with full confidence. Population. Today, the world is on the cusp of another technological revolution in the way humans trade. Once again, China is at the forefront, paving the way from cash to cryptocurrency with a new central bank digital currency (CBDC), e-CNY, commonly referred to as the digital yuan. Although the US dollar remains the dominant fiat currency in the world, an analysis of the geopolitics surrounding the battle for monetary hegemony reveals that China’s digital yuan will pose a serious challenge to the status quo of the dollar in the 21st century.

The digital yuan

China’s 13th Five-Year Plan, covering the period from 2016 to 2020, aimed to “promote the RMB [Chinese currency] internationalization and seeing RMB capital go global. China’s motivations for internationalizing the RMB include evading US monetary policy, protecting against dollar shortages, and lowering borrowing costs. From 2009 to 2019, 20 trillion yuan was traded across borders. However, the RMB represents only 2% of global foreign exchange reserves, compared to 60% for the dollar. The basic prerequisite for any reserve currency is the support of a large economy, high trade volume and net creditor status (meaning that a country’s international investments are greater than the external debt it he must). China is second only to the United States in terms of GDP and trade volume and is a 15% net creditor compared to the 80% net debtor position of the United States. Beyond pure economic calculation, however, monetary hegemony rests on a balance of factors that always remain clearly in favor of the dollar. Basically, China’s rule of law, reliability and tightly controlled economy make investors reluctant to rely on Chinese currency. So what is China’s path to a terrific RMB internationally?

The answer may lie in the Chinese digital yuan. The cryptocurrency has been in development for more than eight years, ever since the People’s Bank of China (PBoC) began investigating a government-run bitcoin in 2014. In the early 2010s, Chinese crypto miners were responsible of approximately 95% of all newly minted bitcoins. . The Chinese government discovered this mining activity in 2012 after investigating suspicious power consumption, as bitcoin mining is extremely energy-intensive. A decentralized and anonymous currency posed a major threat to China’s tight social and financial controls. When authorities started banning and regulating cryptocurrency, they also saw its potential. By 2021, all private cryptocurrency activity was banned, and the Chinese economy had also largely moved away from the paper yuan. Last year, 80% of Chinese adults made digital payments. Testing for the digital yuan began in 2020, but early adoption numbers were less encouraging than Chinese officials might have hoped. As of October 2021, there were a total of 123 million individual wallets, although the average sum in each was only 47 cents (three RMB), implying that many consumers were not actively using the new currency. . The number of adoptions then doubled in January 2022 ahead of the Beijing Winter Olympics. China planned to use the Olympics to introduce the world to the digital yuan, similar to the country’s extravagant displays in 2008 that propelled a modern China onto the world stage. Due to China’s strict covid policies, few foreign visitors were actually present. Still, the PBoC reported around $300,000 (RMB 2 million) in daily digital yuan transactions throughout the games. Although overshadowed domestically by major Chinese digital payment companies AliPay and TenPay, China’s ambitions for the digital yuan are undoubtedly international.

The geopolitics of monetary hegemony

The battle for monetary hegemony is better characterized as an insurgency than a cold war, and China may be willing to employ geopolitical tactics to outsmart the current hegemony. China can leverage its geopolitical influence in three main ways to achieve RMB internationalization through the digital yuan.

The first and most powerful lever available to China is the Belt and Road Initiative (BRI). Announced in 2013 as Xi Jinping’s flagship foreign policy project, the BRI envisions lifetime spending of more than $1 trillion. The initiative consists of both a terrestrial economic belt and a maritime silk road and encompasses around 60 countries that represent two-thirds of the world’s population. The national objectives of the BRI are mainly economic. China has overcapacity in raw materials such as steel and coal, and producers are desperate for new export markets. The BRI also aims to economically develop impoverished regions in western China as part of planned trade routes through Central Asia. However, the economic objectives alone do not justify the price of the initiative, and the foreign policy ambitions inherent in the BRI are vast.

Regionally, China hopes to counter the US “pivot to Asia” that began under the Obama administration’s strengthening economic ties with neighboring countries and promoting new investment opportunities. Globally, China aims to fund infrastructure spending in developing countries, currying favor and potentially gaining political clout in recipient countries. This practice, sometimes referred to as “debt trap diplomacy”, has recently been criticized for contributing to Sri Lanka’s economic crisis.

China is also considering using the BRI to internationalize the RMB. Indeed, the majority of BRI project beneficiaries have shown interest in settling cross-border transactions in RMB. This is where the digital yuan comes in. According to researcher Mahima Duggal, the BRI is a “perfect mechanism to accelerate the international use of a digital yuan”. In many developing countries, the banking infrastructure is sorely lacking and transactions can take weeks. The digital yuan bypasses third-party banks or local institutions and virtually eliminates fees when executing transactions instantly. Stanley Chao, an Asia business expert, says many BRI countries would “jump at the thought” of adopting a digital yuan. Another facet of the BRI is the Digital Silk Road (DSR), which aims to export Chinese technology to BRI participants, including high-speed internet, artificial intelligence and mobile payment systems similar to the own Chinese AliPay. With Chinese technology comes Chinese control, as many technology companies in China are only nominally privately owned. With greater control of a country’s digital infrastructure and the widespread use of a digital yuan, Duggal writes that China could even “rewire financial networks” in countries heavily involved in the BRI.

China’s BRI is primarily a foreign policy outreach program aimed at developing new allies and gaining influence in emerging markets. But for such an ambitious project as monetary hegemony, China is also turning to old allies to help set up an international CBDC. A majority of member countries of the International Monetary Fund (IMF) are currently studying a CBDC or have already developed one. Many of these CBDCs are limited to home use, but China is one of the first countries to seriously evaluate cross-border transactions using a CBDC, a crucial first step towards global adoption. Their experimentation gave rise to the Multi-Bridge CBDC, or mCBDC, project, a collaboration between four financial jurisdictions – China, Hong Kong, Thailand and the United Arab Emirates – which aims to create an infrastructure to facilitate efficient and low-cost transfers. cost between CBDCs while respecting existing regulations. and privacy standards in each jurisdiction. The project identified 15 use cases for CBDC transfers between countries, including commercial payments, wealth management, bond issuance, commercial settlements and supply chain finance. Several of the financial institutions participating in the mCBDC, such as Goldman Sachs (US), HSBC (UK) and UBS (Switzerland), are based in Western economies. This potentially points to a broader scope of collaboration than just Chinese allies and regional banks.

Finally, international sanctions provide a unique opportunity for China to show the benefits of a currency outside of US control. When Russia invaded Ukraine, the United States retaliated by cutting Russia off from the Society for Worldwide Interbank Financial Telecommunications (SWIFT). SWIFT is responsible for almost all international cross-border transactions. As 95% of all dollar payments are settled in New York, SWIFT is controlled by the United States. The White House has sworn that without SWIFT, Russia would depend on “telephone or fax” to conduct international business. The digital yuan offers a potential solution. By bypassing SWIFT and executing a secure cross-border transfer using China’s CBDC, Russia could theoretically trade with anyone willing to breach US sanctions. Should China itself be the target of widespread sanctions, the digital yuan could be crucial for continued trade relations with close allies. China could also offer the digital yuan to any country seeking to disrupt US hegemony, such as its ally Iran. Increased support for the digital yuan increases its reach and recognition, which drives the internationalization of the RMB.

Play catch-up

Regardless of the current shortcomings of China’s CBDC experimentation, the United States may be too far behind to produce a viable competitor. After the digital yuan already made its international debut in March 2022, Biden issued an executive order to begin investigating a US CBDC. Although the US is a dominant player in the privately traded cryptocurrency market, it has not spent the past decade researching and seriously testing CBDCs like China has. There is some hope, as early versions of a US CBDC being developed in conjunction with MIT have proven to be more sophisticated than the digital yuan, being able to handle more than five times as many transactions per second. . However, this technology is still far from being traded across borders. For now, as the vice president of a Beijing-based cryptocurrency firm, Ian Wittkop, writes, CBDCs are “a field of one.” In our post-pandemic world, with trends such as e-commerce, social media and remote working, it is clear that the world is becoming increasingly digital. A financial system dominated by CBDCs and, by extension, China, could become an inevitable reality.

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