Understanding China's Digital Yuan

Among the world's biggest economies, China has become the frontrunner in developing a Central Bank Digital Currency (CBDC). The Asian giant completed a trial of the DC/EP, as its digital currency is known, in September and is currently rolling it out on major e-commerce platforms within the country. Here is a brief primer on the digital currency.

What Is DC/EP?

The Digital Currency Electronic Payment (DC/EP) is a digital version of the yuan – China's national currency. The DC/EP is backed by yuan deposits held by China's central bank and has been under development for slightly more than five years. Under the current arrangement, banks are required to convert a part of their yuan holdings into digital form and distribute them to businesses and citizens via mobile technology.

How Is DC/EP Different From Existing Cryptocurrencies?

The biggest difference between DC/EP and existing cryptocurrencies is their legal status. The DC/EP can be used as a payment mechanism and is acceptable as legal tender, but the legality of using cryptocurrencies to pay for goods and services in China is still unclear.

Besides this, there are two other main points of difference between DC/EP and cryptocurrencies available in the market. The first one relates to decentralization. Cryptocurrencies are decentralized, meaning their economics and supply are not controlled by a single entity. In contrast, the levers for the digital yuan will be firmly controlled by China's government.

The second difference between a standard cryptocurrency and the digital yuan is anonymity. The former is anonymous, in varying degrees depending on the coin, while the latter is not. As mentioned earlier, the Chinese government will be able to track the currency moving through its economy and monitor its usage.

What Are the Benefits of the Digital Yuan for the Chinese Government?

First, the digital currency will enable the Chinese government to better track the flow of money through its economy and make better planning decisions. Cash remains the dominant mode of transaction for payments in China, but new forms of payment that leapfrog card system have become extremely popular in recent times. These new payment methods rely on digital transfers of money using an assortment of technology intermediaries including mobile devices, QR codes, and token systems.

Payment firms like Alibaba Group Holding Limited's (BABA) AliPay and Tencent Holdings Limited's (TCEHY) WeChat are at the forefront of this change. A digital yuan fits in nicely with this transformation. It also serves the government's needs because digital tokens are easier to track than cash.

Second, a digital yuan will enable China to bring its unbanked population into the mainstream economy. China has the largest figure for people without access to a bank, and a digital currency will enable more of them to participate in the mainstream economy without expensive banking products and infrastructure.

A third benefit of the digital yuan is that it might help propel the renminbi to international reserve status. After the financial crisis more than a decade ago, international bankers and economists have increasingly discussed the possibility of a replacement to the U.S. dollar for international trade.

As the main mode of transaction in the world's second biggest economy, China's currency should be a natural contender for the spot. However, the U.S. dollar still accounts for 88.3% of all international settlement transactions while the renminbi has only 4%. Digitization of the currency will help fast-track international settlements using the currency and help make it more popular among international traders.