#12 INNOVATION Insider : Is the promise of CDBCs towards a more distributed & egalitarian financial system ? A view from China

In this special edition, I want to highlight the expertise of the ADN China Chapter around payment ecosystem in China, through their own market analysis but also through interviews with Tian Luan, Director at Innoway and Gavin WANG, head of China cash management. Let's find out more about what's going on there!

Emerging trend of CBDCs (Central Bank Digital Currency)

The digitization of world has pushed digital payments and settlements to a whole new level, booming through fast and game-changing innovations. However, most of these innovations are still based on conventional clearing and settlement banking infrastructure, efficiency, instantaneity and universality may be challenged.

Inspired by the blockchain and distributed ledger technology (DLT), several government bodies emerged to study, pilot, and deploy their digitalized fiat currencies. No matter based on what technology, the digital fiat currencies, or Central Bank Digital Currencies (CBDCs), are attracting increasing attention globally.  The Chinese CBDC, namely DC/EP(1) scheme or e-CNY, has emerged in utilization in 2019 and marked several milestones ever since.

Below is an overlook of China digital payment ecosystem and potential future impact of newly released DC/EP.

Views on Digital Payment from expert of top TMT companies in China

About WeChat Payment

As a top TMT company in China, Tencent officially launched its WeChat payment business in 2013. In the past eight years, it has promoted WeChat Payment to almost all possible payment scenarios, including shopping, catering, and utilities, covering more than 30 industries and 2 million stores, and perfectly integrated into WeChat ecosystem of tools and services.

On-going transformation of China payment ecosystem

It is likely that third-party payment will be even more active in the future and more scenarios will appear for our users.

New technologies - such as facial recognition - will emerge to help payments. Obviously facial-recognition payments, while being convenient for end-users, will also foster new applications in payment scenarios in the coming years.

There are also additional underlying technologies that can improve payment efficiency, such as the integration of payment and blockchain. Though value-added for front-end individuals should be relatively subtle in the short term, if we multiply the efficiency increase by our huge traffic base, this impact should  be very large for our technology company.

Mobile or digital payment is supported by a variety of technologies, including computing resources, 5G infrastructure, algorithm support, and data storage, all of which consume large scale technical resources. We have observed that some large Multi-national Companies are considering migrating their data center to the Asia-Pacific region. Such moves should have huge impact on payment efficiency and its energy consumption.

China DC/EP and WeChat Payment

China’s Central bank digital currency or DC/EP on one side and WeChat Payment and Alipay on the other side should mutually benefit from each other ecosystems. WeChat and Alipay have already built mature payment ecosystems, and DC/EP would only need to connect to these ecosystems to be utilized in multiple business scenarios. 

To some extent, WeChat Payment has an ecosystem concept that there should be a wholistic system of third-party service providers around payments to realize its large-scale utilization. Thanks to the 2 digital payment giants in China, DC/EP only needs to be fed into the WeChat or Alipay ecosystem as an upstream or source, while WeChat or Alipay serve as a third-party tool to foster its impacts. As DC/EP is the source of digital currency, with more of the currency plug into ecosystems already established by the two giants, the ecosystem of digital payments in China market will be even more active.  

Interview on DC/EP to Tian Luan, Director at Innoway, China’s top Innovation Incubator by Freda wang

1. Innoway has a similar positioning for innovative entrepreneurs in China as Station F in France. Could you please introduce what kind of organization Innoway is? What differentiates Innoway from other innovation hubs in the world?

Established in 2014 with over 50,000 square meters, Innoway's was initially focusing on mass entrepreneurship, supporting start-ups to make entrepreneurial attempts with incubation and acceleration services.  Nowadays Innoway is more focusing on targeted innovation, investing dedicated resources on core technology companies, and providing specific services to these companies.

Station F is similar in set-up and size with Innoway. Indeed, Innoway is closely cooperating with Station F, as we have an office within Station F in Paris and we originally planned to build a large-scale Entrepreneurial Center in Station F (but the plan was put on hold due to the Covid epidemic).

2. In your view, what is the inner motivation for the development of the digital payment industry in China?

From my perspective, China's payment system jumped directly from cash payment era to mobile payment era very abruptly. There was of course credit card payment era, but it did not last long. The fact is: even until now China has not developed the culture and habit of credit card payments, and thus there are no Chinese credit card giants formulated such as Master and Visa. This, to some extent, helps to promote the development of digital payment in mobile side, as there are no credit card giants to occupy the potential market share and thus reducing the obstacles to the development of mobile payments. In addition, in the initial development stage of the personal mobile payment in China around 10 years ago, there was no such law like GDPR with specific regulations on data. Therefore, there was a relatively large room for data usage in the initial trial stage of personal mobile payment development in China market, and the government was also very supportive to the start-ups at that time. Till now, the Chinese government has established a series of data security laws and regulations, which have relatively more restrictions on the companies in this area.

3. Alipay and Tencent Payment are currently the two dominant digital payment service providers in China, and the central bank has gradually rolled out DC/EP testing to various scenarios in recent years. What’s your view of DC/EP in China and its meaning to the economic market?

Per my understanding, the implementation of DC/EP can help the government better monitor whether there are illegal money laundering activities. It can also be connected with the tax system to monitor invoice taxation and related economic crimes. Meanwhile, I think DC/EP can support supervision and strengthen regulation on financial market through technology, covering the dimensions of both digital currency and digital transactions. With the mass applications of DC/EP in China’s society, the source of funds can be traced to confirm the origin and destination of economic transactions. In addition, international business interoperability can be realized more conveniently through the implementations of DC/EP cross the border.

Overview of the Digital Currency / Electronic Payments by Gavin WANG, head of China cash management

Where Does China Stand on its CBDC?

People Bank of China (PBoC) has decided to focus on retail CBDC. While not explicitly reporting why such decision, there are reasons to believe that a retail-focused digital currency will benefit more the country than a wholesale one, considering the complexity of different usage scenarios required by 1.4 billion citizens, their digital maturity and China’s ambition for RMB internationalization.

According to White Book on e-CNY issued by PBOC in July 2021, the pilot scheme recorded total settlement of 34.5 billion CNY within China, through 25 million wallets, and 71 million transactions. Even though the scale of the test seems to be comprehensive and result fruitful, PBOC indicated that they do not have a time schedule for official launch of the e-CNY.

One frequently asked question is - is DC/EP a project based on blockchain technology? Well, there is neither official statement nor formal technology roadmap available to answer this question, and blockchain is not mentioned in recent PBOC white paper on e-CNY progress. So, we might infer that blockchain technology could be an option in the long run, but not necessarily in the existing infrastructure today.

How might banks benefit from a new Chinese e-CNY?

•  Change of ecosystem, use case, and more...

Alipay/WeChat Payment - which represent together 93% of the mobile payment market share - will face certain challenges from e-CNY in the long-run. Both are likely to be involved as operators of e-CNY, connecting to the service network to transact e-CNY for their customers. Their business model should likely evolve to include more value-added services. They must innovate hard to keep entertaining their users, providing rich functions on top of payment/collection, and remain relevant to the end-users and merchants. They also face the risk of losing their duopoly, as users will be able to transfer account balance from Alipay to WeChat Pay or any other third-party payment service providers leveraging on e-CNY’s interoperability.

Such change brought by e-CNY might have less impact to banks than to those third-party payment service providers, because banks low market shares on retail payment services. However, bank accounts and e-CNY wallets will hold predominant domestic individual RMB balances in the future, taking shares from Alipay/WeChat Pay account balance.

• Digital Yuan (e-CNY) implication in cross-border payments

As discussed, PBOC as made a natural and pragmatic choice to focus on its home market in China for current e-CNY promotion. However, for a forward-looking approach, we shall look at the overseas strategy of e-CNY and how it copes with the RMB internationalization progress.

The very precondition is the possibility to issue e-CNY in offshore market, like what PBOC does in home market today. Clearing would likely continue to be handled by PBOC in China directly, while issuance could be done by overseas banks. An e-CNY payment initiated from a wallet Brazil could be instantly settled in an e-CNY wallet held by someone in Shanghai within seconds, based on the P2P transaction design revealed in PBOC’s white book.

As promising as it seems, such cross-border payments will also bring new concerns, like financial sovereignty issue, KYC issue, information security etc. Countries will not support its citizens to widely use currency of another country in their home market. The scenario described earlier involves mostly international e-commerce or individual payments, but much bigger volume happens between institutions for large settlements. Wholesale CBDC will find its advantages against retail CBDCs in the institutional use here and could evolve to be the mainstream in future cross-border payment infrastructure.

Maybe for such reason, the multi-CBDC Bridge project co-driven with PBOC, HKMA, Bank of Thailand and UAE Central Bank has started. The purpose of the project is to test a shared ledger support for multiple CBDCs through a corridor network. This model should provide compatibility to different CBDCs when it comes to international settlement. It should solve the cross-border financial sovereignty concerns and may generate settlement efficiency versus old correspondence banking model. This project could shape the future global CBDC governance, while providing China with first-hand experience to improve e-CNY’s internationalization component for investment, FX, sovereign reserve and more. However, to further promote RMB internationalization, China must work hard on other dependencies, such as capital accounts, open domestic financial market, legal framework, and regulatory governance.

Looking Ahead ... by Gavin WANG

One thing for certain is that e-CNY will continue to be one of the strategic financial system infrastructure topics in the long-term horizon in China and abroad. Among many reasons, we believe these can be on top of the long list:

• Based on its strong digitalization, China needs a robust currency in digital form for the future.
• The e-CNY will provide in-depth insight from cash circulation in the country to help fine-tuning their policies (better understanding of China credit structure, management of the money supply, cross-border transactions controls, …).
• Operation costs will be lower than cost of physical banknote, with features to better counter money laundry, terrorist financing and proliferation financing, etc.
• Based on collaborations with the CBDCs of other countries, opportunity to challenge SWIFT and the dollar monopolies, while helping a further internationalizing of the Yuan.

The official deployment in the China market seems to be promising and nearing soon. Conventional bank outlets should further reduce in number, replaced by more ATMs scattered across the country only processing e-service and e-CNY, and banknotes usages should continue to decrease.  More “automated” transactions should emerge, powered by smart contracts in e-CNY to complete payment without any human intervention. Travelers to China should be able to register e-CNY wallet with email and then get e-CNY through online service. And the list of changes shall go on.

Appendix

1. DC/EP stands for “Digital Currency / Electronic Payments”. e-CNY is a “sub-product” derived from the DC/EP scheme, although today it is still the only product visible to public.

2. Non-interest-bearing: e-CNY is a replacement of physical banknote, therefore it does not bear interest, nor does it fall into the category of “bank deposit” accounting wise.

3. Disconnection to bank accounts: e-CNY wallets are not necessarily bank-account based. Users can open stand-alone wallet without bank account.

4. Legal Indemnity by PBOC: e-CNY has same legal claim right to the physical banknote, obviously.

5. “Controllable” anonymity: e-CNY wallets have different classifications. Information is stored and managed by different parties along the flow, only PBOC has oversight of all information while other designated operators will have limited visibility. Users can open anonymous wallet under certain condition and amount threshold (although we assume PBOC shall still have ultimate oversight even wallet is opened anonymously).

6. Programmable smart contract: without compromising the core indemnity feature, e-CNY could be programmable into something “smarter”.