Surprise, Surprise: China's crypto is ready to go

11 December, 2019

After months of on-again, off-again speculation, it appears as though the People's Bank of China (PBOC) is on the verge of doing what it said it was not going to do: launch a fully digital yuan by the end of the year. At the time of this writing, that gave them just three weeks to get it done. Granted, the launch will only be a test limited to a small number of cities.

China's decision to launch what they are calling a digital currency electronic payment (DCEP) platform probably will not have any significant global economic impact in the short term. It may not have any real impact in the long term. So what makes it significant? The fact that the PBOC beat Facebook to the punch. For the better part of the last six months, they have been working as hard as they can to get a digital currency to market in hopes of heading off Libra.

It is interesting to note that Chinese officials have not been forthright about their plans for the last year. One news report would say they were on their way to developing a digital currency while another would contain quotes from PBOC officials denying they were anywhere close to launching their coin. It appears those who were betting on the PBOC's success were right.

China's big four commercial banks

Coindesk reports that DCEP will be tested for real-world payments among China's big four banks: the Agricultural Bank of China, the Bank of China, China Construction Bank, and the Industrial and Commercial Bank of China. Three telecom companies will also participate in the test. They are China Mobile, China Telecom, and China Unicom.

The Chinese financial news outlet, Caijing, says that the test is not the first for DCEP source. Apparently, the PBOC tested it a few years back in a much more controlled environment. This test is different because real banks will be able to use DCEP for real-world transactions ranging from healthcare to transportation payments.

Coindesk says that each of the four participating banks will have the freedom to develop their own trial scenarios. In other words, they will decide how they issue DCEP, from whom they will accept it as payment, and so forth. It could be that the four banks limit transactions to business users only. If that were the case, average consumers would probably not see DCEP until well into 2020.

A Central Bank Digital Currency (CBDC)

Though the PBOC has not released any details about its technology, one thing we do know is that DCEP will be a central bank digital currency (CBDC). That means it will essentially be a digital form of fiat. It does not appear this time that DCEP will be separate from the yuan in either its value or utility.

This is an important distinction when you consider China's main goal of releasing a stablecoin before Facebook launches Libra. Chinese officials have long feared that a successful Libra would render the yuan less desirable - at least to some degree. Even a modest decline in consumer spending of yuan would have a significant impact on China's economy. As such, they could not afford to allow Facebook to get the upper hand.

By releasing DCEP now, they have the ability to introduce the digital currency idea to Chinese consumers and get them well entrenched with DCEP long before Libra ever launches. Their cause is helped by the fact that Libra actually making it to market is looking less likely every day.

In the meantime, DCEP will be controlled exclusively by China's central bank. Commercial and retail banks will eventually be dealing with it as frequently as they do fiat, but the People's Bank of China will still be the central authority in control. In light of that, DCEP will probably not be all that different from yuan in terms of its economic impact. So why launch it?

There are two primary reasons:

1. Being first

All indications suggest that it is only a matter of time before every country in the world replaces its minted coins and printed bills with digital equivalents. It is really just a matter of figuring out the technology and making it work on a global scale. Digital currencies will mean the end of printing and minting. It will mean the end of cash payments. Everything will be done digitally and online.

Moreover, there is something to be said about being first. Bitcoin is the world's most dominant cryptocurrency not because its technology is superior. It dominates because it was the first among thousands. By the time people began taking alt coins seriously, Bitcoin had already achieved an impressive market capitalization and value. They got such a strong head-start that others have not been able to catch up.

China wants to accomplish the same thing with DCEP. They want to be so far out in front that their digital currency ends up dominating. Indeed, PBOC officials have not been shy about their desire to see DCEP replace the U.S. dollar as the world reserve.

2. DCEP is portable

The other big thing about DCEP is the fact that it is portable. The only thing necessary to buy or sell in digital currency is an internet connection. You do not need banks with hordes of cash lying in a vault. Merchants do not have to keep cash on hand to make change. People do not have to worry about traveling with cash either. The end result is a financial system that really knows no borders.

So, what is portability? It is the ability to freely transfer between currencies so that you are not tied to any particular one. Portability is something that is lacking in the cryptocurrency universe right now. For example, there is no cross-chain portability between Bitcoin and Ethereum. If you want to convert some of your BTC to ETH, you have to sell BTC and buy ETH. You will incur transaction fees on both ends.

The fact that DCEP is portable suggests that the PBOC will allow for easy conversion between DCEP and traditional yuan. Consumers will be able to choose cash or digital as they see fit. Of course, this is speculation. The PBOC has neither confirmed nor denied this understanding of portability. If it is not portability between DCEP and fiat they are after, then they must be referring to cross chain portability between DCEP and other cryptos.

At any rate, the idea here is to make it easier for consumers to buy and sell without having to worry about cash. Caijing's report goes as far as to quote a central bank official who claims that the PBOC's eventual goal is to eliminate cash altogether. But doing so instantly would probably be a mistake. So for the time being, portability serves the purpose of easing consumers into the digital currency arena.

The value and utility

It should be easy enough to understand why the Chinese government wants a digital currency. What it all means to the Chinese consumer is not as clear. Two things that have to be considered are value and utility, as they really are the fundamental basis for monetary transactions.

In terms of value, DCEP will be tied to yuan at 1 to 1. After all, DCEP is simply a digital form of yuan for all intents and purposes. Issuance of the digital currency should therefore have a negligible impact on day-to-day economics in China. We would not expect any hyperinflation or deflation in the short term.

What will be interesting to note is how the yuan does against the U.S. dollar on Forex markets. Enough investors with enough confidence could mean more yuan contracts being purchased, thus pushing its value higher across the board. The opposite scenario is also true. Investors unsure of China's technology could lose confidence in the yuan and begin selling.

Utility seems a lot less risky. Because DCEP will be a drop-in replacement for yuan, it will also have built-in utility. Consumers will be able to use it just like they do bills and coins. Merchants will be able to accept it as legal tender - or at least the equivalent for all intents and purposes.

It is not beyond reasonable to consider DCEP nothing more than a payment system. As a one-to-one replacement of yuan, what it really does is integrate the existing digital payments system with a blockchain base. All the PBOC will have to do to completely eliminate cash is to mandate that all bills and coins be exchanged for DCEP and provide the necessary hardware for merchants to begin accepting DCEP payments.

In the race to be the first central bank to launch an official state cryptocurrency, China appears to be the winner. Their DCEP is set to begin testing in a handful of major cities by the end of 2019. How the test goes will largely determine whether DCEP becomes the currency of choice in China sometime in 2020.

Rest assured the rest of the world will be watching. If China succeeds, plenty of other countries will fast-track their programs while desperately trying not to fall too far behind. Failure in China would give those other countries more time to keep developing their projects.