Central bank digital currencies are on the rise. A report published by the IMF in June 2020 lists dozens of white papers and various studies on the subject. Recently, two countries have passed the concept stage: the Bahamas have deployed their “Sand Dollar” currency nationally while China has conducted a large-scale test of its central bank digital currency “DCEP” in the summer of 2020. Commentators on China’s progress in this area argue that the currency will allow daily payments to be made quickly, easily and at a lower cost, and contribute to the internationalization of the renminbi in the world. The reality is much more nuanced.
Digital currency is not a novelty. In the USA for instance, physical money accounts for less than ~11% of the monetary aggregate (~$2.0T out of ~$18.6T), while the rest comes in digital form. In addition, financial institutions can already deposit reserves (~$2.7T) electronically at the Federal Reserve. What excites the imagination of the world of finance is the introduction of a new form of digital currency combining three main characteristics of existing currencies: direct liability of a central bank, digital like bank deposits, and universal like physical money.
A central bank digital currency (“CBDC”) would represent a positive development in terms of performance and user experience in countries where the electronic payment infrastructure is not well developed. In China, on the other hand, the DCEP will not add much value compared to the already popular Alipay and Wechat Pay electronic wallets. The first tests confirm this: “there is not much difference compared to WeChat Pay and Alipay” and “I’m not planning on using it again” are among the first pieces of feedback reported by Reuters and SCMP. The adoption by the Chinese population will therefore depend on the incentives, financial and otherwise, to use the new state-sponsored electronic payment method.
Central bank digital currency is expected to facilitate the settlement and delivery of electronic transactions, a process that can now take up to several days in countries where instant payments are not implemented. This will not be due to the technology, but rather due to the fact that the currency will be legal tender: the accounting entries in the electronic ledger will no longer reflect IOUs that have to be settled but a legal reality.
In theory the price paid by users to use such an infrastructure should be lower than the price charged by existing payment networks (from 1.5% to 2.5% for Visa and Mastercard, ~0.6% for Wechat Pay and Alipay). Any potential gain would have little to do with technology but would be due to the business model of a public infrastructure versus that of a private infrastructure. In practice, “someone” will have to fund the maintenance of the system. It will either be taxpayers or the users of the payment system if the Government decides to levy a tax on each transaction. Furthermore, there is no guarantee that a system operated by a public administration will be more efficient than a private solution. Experience often proves the contrary.
The technology for transferring electronic money is trivial and its cost is insignificant in itself: it consists of writing 0s and 1s to computer hard drives through an Internet connection. It is the controls around monetary transactions that are complex and thus expensive, including anti money laundering and terrorism financing controls, fraud prevention, cybersecurity protection and data reconciliation controls between various systems. Because regulation, fraud, hackers, and technological silos will not magically disappear with the introduction of a central bank digital currency, similar complex sets of controls will still be needed.
Electronic payments, whether domestic or cross-border, are not so much a technological problem but rather a problem of governance, standards, and regulation. When Chinese tourists pay a US merchant with Wechat Pay today, a minimum of four intermediaries are necessary: Tencent the developer of Wechat, a provider of USD payment services accepted by the merchant and several banks that do the renminbi / dollar conversion and ensure the settlement between the actors. Introducing the DCEP will not change this situation, everything else being equal. If the merchant used the same electronic wallet as his Chinese customer, had an account with the PBOC and agreed to be paid in DCEP, then the process would be much easier … But it would be similarly easy if the merchant had a Wechat wallet, an account with any Chinese commercial bank and agreed to be paid in renminbi! This is the same reason why people in different countries can trade bitcoins in a relatively simple way: they use the same closed loop system with its own rules. As soon as external constraints such as legal compliance or conversion into local currency are imposed, intermediaries (exchanges), controls (customer identification) and additional costs are re-introduced. The same principles apply for the usage of the renminbi in international trade. Public or private foreign actors could very well decide to use the DCEP in a closed loop fashion to transact with Chinese actors. Just like Iranian, Russian and Chinese actors could use the SEPAM, CIPS or SPFS payment networks, that are independent of the SWIFT network, to transact together today if they so wished. In practice, they barely use those systems. The internationalization of the renminbi is not a technological problem, but rather a question of standards, and economic and political incentives. Before any other consideration, the strict control of capital movements by China remains one of the major obstacles on the road to the renminbi and DCEP success abroad.