What Will Be the Impact of China’s State-Sponsored Digital Currency?

Commentary by Robert Greene for the Carneige Endowment for International Peace

In April 2020, electronic Chinese yuan (e-CNY) pilot programs launched in four cities. The digital currency’s debut was the culmination of a six-year journey that began when China’s central bank, the People’s Bank of China (PBOC), announced its research into a “Digital Currency/Electronic Payment” system in 2014. Today, although many critical details of the payment system remain opaque or undecided, e-CNY pilots are rapidly accelerating in scope and size. In the coming years, the e-CNY will likely be deployed across China as part of Beijing’s focus on bolstering domestic financial security. The e-CNY could also be used to navigate international transactions around payment systems and networks that can be shut off to Chinese financial institutions serving U.S.-sanctioned entities.

The growth trajectory, financial stability implications, and geopolitical consequences of the e-CNY will depend on how the PBOC and other state organs resolve important structural details regarding its underlying network. One big question is whether Beijing will allow e-CNY transactions with U.S.-sanctioned entities such as affiliates of Iran’s Islamic Revolutionary Guard Corps. Central bankers should consider the trade-offs of state-sponsored digital currencies, and the U.S. national security community should watch the e-CNY’s rollout closely.


As one PBOC official recently explained, the e-CNY is legal tender, meaning no entity in China can refuse it. Like paper Chinese currency—another form of legal tender—its issuance is facilitated by the PBOC. One e-CNY is worth the same as one yuan in paper currency, and each will be exchangeable with the other. Users can hold e-CNY in a mobile phone “e-wallet” app, and the ability to purchase e-CNY is currently set to be possible through China’s six large state-owned banks and the bank affiliates of Tencent and Ant Group, which control China’s two dominant digital retail payment platforms. Other types of wallets—including hardware wallets, essentially reusable prepaid cards that can either be separate from or part of a hardware device such as a mobile phone—that are not linked to a particular bank, may offer more privacy, and hold small amounts of e-CNY are currently being piloted.

The e-CNY network has two tiers. One tier, the lower tier, is (for now) exclusively made up of a few commercial banks that can facilitate the exchange of e-CNY with cash or bank deposits. The other tier is the PBOC. It controls the supply of e-CNY and manages e-CNY payments between the lower-tier banks.

The entire e-CNY network is, according to the China Banking Association’s chief economist, built upon the concept of “one coin, two databases, three centers” (一币,两库,三中心). “One coin” refers to the e-CNY unit of currency, which researchers at one major state-controlled financial institution explain is essentially an “encrypted digital string representing a specific amount that is guaranteed and signed by the central bank for sale.” The “two databases” refer to (1) the central bank’s ledger that keeps track of all e-CNY outstanding and (2) all the e-CNY ledgers maintained by the network’s lower tier either locally or on the same cloud used by the central bank.

The e-CNY network’s “three centers” are all reportedly PBOC entities. Details on these are scarce. Reportedly, the first is the certification center, which will keep a database that maps real identities against all digital wallet users; the second is the registration center, which will track e-CNY ownership and transactions; and the third is the big data analysis center, which the central bank will use to monitor payment flows for financial risks and detect illegal behaviors. According to former PBOC governor Zhou Xiaochuan, institutions that issue e-CNY will also bear some responsibility for compliance with payment rules and regulations, such as those related to China’s capital controls (regulations on the transfer or use of yuan outside of China) and sanctions (rules that prohibit companies from doing business with or serving particular persons).


The e-CNY seems to be primarily designed for domestic (within China) “retail payments”—meaning relatively small day-to-day payments involving consumers, businesses, or public authorities, which can be made either online or in person. In the future, however, e-CNY could be used for cross-border transactions, according to Wang Xin, a senior central bank official. Most e-CNY pilots thus far, however, have only involved relatively small domestic lottery giveaways or trial salary payments in e-CNY. This means that cross-border e-CNY transactions are nearly nonexistent and domestic e-CNY transactions are barely a crumb of China’s payments pie. For example, in November 2020, the central bank reported just 4 million e-CNY transactions. By comparison, in 2018, TenPay and Alipay—China’s two payment giants—reportedly processed 1.2 billion transactions (including WeChat Pay transactions) and 500 million transactions on average per day, respectively.


Importantly, Mu Changchun—director of the PBOC’s Digital Currency Research Institute, which has spearheaded the central bank’s digital currency research—recently explained that WeChat Pay and Alipay should be viewed separately from e-CNY. Tencent’s and Ant Group’s platforms allow for end users to make payments with existing forms of money: primarily personal deposit accounts at commercial banks, and also, indirectly, central bank reserves, which the PBOC requires be used to back all Alipay and WeChat Pay e-wallet balances.

Unlike these balances, however, the e-CNY is legal tender and is not linked to just one company’s platform, so it can be transferred across e-wallets maintained by various entities. And unlike consumer bank deposits, the e-CNY is not interest-bearing. This makes it a less desirable form of money in which to park savings, relative to government-insured, interest-bearing commercial bank deposits. In short, the e-CNY is designed to be a form of money used for payments, not to compete with bank deposits.


In the coming years, Beijing policymakers will likely pull levers to accelerate the use of e-CNY in China. Indeed, the Chinese Communist Party’s (CCP) fourteenth five-year plan calls for steadily increasing digital currency research and development, while the PBOC and numerous lower-level provincial and city governments are planning for broader e-CNY deployment.

A widespread domestic rollout of the e-CNY would align with Beijing’s push for “financial security” (金融安全). For China, this entails not just the detection and mitigation of financial risks but also the fusion of efforts by state security organs such as the Public Security Bureau with those of financial regulators. In 2019, General Secretary Xi Jinping endorsed enhancing financial security through “controlling people, watching money, tightening the system firewall” (管住人、看住钱、扎牢制度防火墙). Late 2020 research published by the PBOC links digital currency research with this objective. And although the ultimate surveillance capabilities of the e-CNY network have seemingly not yet been decided, as one expert recently observed, the e-CNY will inevitably result in “much greater surveillance of financial transactions than the current system.”

Indeed, central bank officials and the CCP’s Central Commission for Discipline Inspection and State Supervision Commission have noted that the e-CNY network’s structure will give the state greater ability to control and monitor financial flows. The e-CNY network could also allow Beijing to curb Ant Group’s and Tencent’s control of important payment rails (the digital infrastructure that moves money from one place to another); in the eyes of many Chinese policymakers, these companies have a track record of flouting government requests for financial data and ignoring regulations. Indeed, statements by Mu Changchun suggest that Beijing sees the e-CNY network as a “public option” payment rail. Its success could weaken dominant incumbent payment platforms, enabling policymakers to bring these platforms in closer alignment with Chinese financial regulators’ objectives, such as cracking down on unauthorized cross-border capital flows and bitcoin trading. Payments made via the e-CNY network would provide Chinese state and CCP authorities with troves of data that could be used to block and monitor transactions, which major tech conglomerates have historically resisted handing over.


Beijing has numerous policy tools to encourage more people to use e-CNY within China, even though early users of the e-CNY network are reportedly underwhelmed by the service and worried about privacy invasion. For starters, financial incentives may help overcome such doubts. Promotional discounts for e-CNY, such as those already taking place, could be rolled out on a large scale. The state-funded e-CNY network will also reportedly offer merchants lower fees relative to Alibaba’s and Tencent’s payment platforms. Moreover, official statements suggest the e-CNY network could incur years of losses in an effort to grow market share. Government and state-owned employees may also increasingly be paid in e-CNY. This has already been done in pilots, and Chen Weigang, a senior banking regulator, has endorsed the widespread use of e-CNY for payroll.

In recent months, the State Administration for Market Regulation (China’s antitrust regulator), the PBOC, and other government bodies have launched aggressive “anti-monopoly” and “platform economy” regulatory efforts that are also likely to accelerate e-CNY adoption. These initiatives aim to curb the power of leading privately owned Chinese conglomerates such as Alibaba, its affiliate Ant Group, and Tencent. Helping facilitate the rollout of the e-CNY is a way to stay in Beijing’s good graces, and, notably, Ant Group’s April 2021 rectification plan—which sets forth how it will remediate business practices identified by Chinese regulators as problematic—reportedly urges it to give consumers more choices in payment methods. Against this backdrop, Tencent’s and Ant Group’s bank affiliates recently were allowed to enable purchases of e-CNY. These conglomerates’ large market presence could dramatically accelerate e-CNY uptake. Conversely, many large Chinese tech companies partnering with state-owned banks in e-CNY pilots have a financial interest in facilitating consumer use of the e-CNY. This could cut into the lucrative consumer data Alibaba and Tencent can obtain through Alipay and WeChat Pay by reducing these payment platforms’ market share.


As PBOC Governor Yi Gang suggested in late 2020, for the e-CNY to mature, there must first be more complete legal frameworks and transparent regulatory requirements in place. In fact, if important structural uncertainties are not resolved, then a swift rollout of the e-CNY could actually harm Beijing’s domestic economic policy objectives.

One major area of uncertainty is the e-CNY’s balance sheet treatment. In 2019, Mu Changchun explained that the e-CNY would be a direct liability of the central bank to the public. This means that from the central bank’s perspective, the e-CNY would have the same balance sheet treatment as paper currency and, to the end user, would represent a direct claim on the central bank. Likewise, a late 2020 central bank report referred to the e-CNY as a retail central bank digital currency (CBDC), which by definition, means that it represents a direct central bank liability.

But in late 2020, and again in spring 2021, Zhou Xiaochuan noted that the e-CNY differs from a CBDC in that it will be a liability on the balance sheet of issuing institutions, not the central bank. These commercial bank liabilities would in turn be backed by central bank liabilities held as assets by the institutions that issue e-CNY (similar to the treatment of Hong Kong dollar banknotes on the balance sheet of an issuing commercial bank). For the e-CNY to become a widespread means of payment, the overall amount of e-CNY issued and available to end users will have to increase significantly. It is hard to imagine this happening without top-level clarity about the e-CNY’s accounting treatment.


Other uncertainty surrounds how nonbanks such as state-owned telecoms will be involved in the e-CNY network. While e-CNY hardware wallets will be offered by big tech companies, PBOC Deputy Governor Fan Yifei wrote in late 2020 that according to Chinese regulations, only commercial banks can facilitate the purchase of e-CNY. So it seems likely that commercial bank issuers of e-CNY will end up existing alongside—through a “2.5 tier” structurecustodians of e-CNY (entities that offer the ability to store e-CNY either through mobile apps or hardware wallets but which do not directly issue e-CNY). Accordingly, while Zhou Xiaochuan says state-owned telecoms will be part of the network’s lower tier, per Fan Yifei’s comments, these institutions may not actually directly offer the ability to exchange cash or bank deposits for e-CNY.

Nevertheless, the expansive presence of state-owned telecoms in rural regions could enable them to target the 20 percent of mainland China’s population that is reportedly unbanked for e-CNY sign up. Yet doing so would likely put the telecoms in competition with smaller rural financial institutions trying to serve these communities. In fact, according to one report, 20 percent of China’s population—and 40 percent of its rural population—primarily bank with one of thousands of rural financial institutions or city commercial banks that are currently not linked to the e-CNY network.

Perhaps two of the biggest questions are whether and how these thousands of institutions and other Chinese banks will be part of the e-CNY network’s lower tier. If policymakers do not enable the conversion of deposits at smaller banks into e-CNY but do take major steps to incentivize e-CNY use through promotions, partnerships with state-owned telecoms, and payroll, then the deposit base of already-struggling smaller lenders—which account for a disproportionate share of lending to private small and medium-sized companies—could be harmed as consumers seek to establish relationships with larger banks offering convertibility.

These trade-offs illustrate how various forms of the e-CNY network could result in different winners and losers, which in turn helps explain the mixed messages from policymakers in Beijing. Notably, some officials, including Chen Weigang, seem to hope that eventually all banked Chinese consumers will be able to easily convert e-CNY received for payroll into commercial bank deposits. In a signal that Beijing is perhaps headed in that general direction, the PBOC’s Digital Currency Research Institute announced in October 2020 that it is partnering with the Rural Credit Bank Capital Clearing Center to aggregate e-CNY services through a “single access point” for China’s thousands of rural financial institutions; the goal is to promote the e-CNY in rural areas, which account for 40 percent of China’s population. In September 2020, the City Bank Clearing Service, which serves over one hundred urban small and mid-sized banks, launched a similar initiative. Recent reports that two mid-sized commercial banks, Xi’an Bank and Hainan Bank, can offer the ability to purchase e-CNY through a partnership with a large state-owned bank illustrate how the PBOC could rely upon similar partnerships to enable consumers with accounts at China’s thousands of smaller banks to convert deposits into e-CNY.


Yet allowing for the deposit base of small Chinese lenders to convert into e-CNY could create other potential issues. Given that many small depositories in China have very troubled balance sheets and, unlike large state-owned banks, are not perceived as too-big-to-fail, it is easy to see how e-CNY could dramatically speed up bank runs by enabling people to take out their money en masse, uninhibited by the frictions brought about by cash withdrawals. Surely, caps on the daily amount of a consumer’s bank account deposits that he or she can convert into e-CNY will mitigate this risk, but notably, Shenzhen’s e-CNY pilot reportedly features a relatively high 10,000 yuan (a little over $1,500) cap on such transfers—one-fifth of China’s average reported per capita deposit account balance in 2018. What is more, according to an FAQ published through one pilot, wallet users can store balances of 500,000 yuan (almost $80,000), meaning that absent other regulations, an e-CNY wallet in theory could have the capacity to absorb large amounts of money withdrawn from banks in times of panic. In other words, without relevant restrictions, e-CNY app users could swiftly withdraw large sums of deposits by converting those funds into e-CNY.

These potential issues could grow more complicated if the e-CNY not only eases the ability to transfer funds between bank accounts but also eases the process of commercial bank account opening. As Mu Changchun has noted, even relatively small e-CNY wallets will be linked with the user’s identity, and presumably such e-CNY wallets linked to real identities could ease the ability of consumers to open accounts at banks; indeed, a stated goal of the network is expanded financial inclusion. But if e-CNY wallet apps offer end users the ability to transfer deposits at both large state-owned banks and smaller rural and urban financial institutions into and out of e-CNY, then the e-CNY network could during periods of market calm result in sizable upticks in deposits at smaller banks (which may offer much higher deposit interest rates) at the expense of large state-owned banks. Conversely, as discussed above, deposits could flow swiftly away from small banks during times of volatility. In short, the deposit bases of China’s banks could become much less stable because customers would find it easier to move their money around between banks, an outcome arguably not in line with Beijing’s vision of financial security.


The potential international effects of the e-CNY are considerable. For starters, as the analysis above suggests, an e-CNY network hastily launched under political pressure could ultimately result in destabilizing effects on China’s banking system, which as the world’s largest, could in turn lead to spillover effects outside of China. China’s central bank is seemingly devoting considerable time and resources to prevent such an outcome. But regardless, there would need to be a lot of people using e-CNY for this to happen, which is not likely in the near term.

Likewise, the immediate impact of the e-CNY on the internationalization of the Chinese yuan will be minimal, given China’s robust capital controls, which are not likely to loosen significantly anytime soon. Although the e-CNY is poised to enable small cross-border recurring payments—retail e-CNY use in Hong Kong, which does not use the yuan, is already being tested—large numbers of sizable international commercial e-CNY transactions (for example, payments between a Chinese company and a Middle Eastern supplier for large oil shipments) that would more meaningfully impact capital accounts are inherently constrained by capital controls. Experts close to the People’s Bank of China and state-owned bank officials believe, however, that e-CNY will ultimately contribute to the yuan’s internationalization in the long term.

The most meaningful potential near-term international impact of the e-CNY is the possibility that the PBOC will allow China-based firms to use it in transactions with people, businesses, and entities subject to U.S. sanctions. The United States can use sanctions to advance national security objectives by preventing sanctioned parties from accessing services provided by firms that need access to U.S. dollars. Banks and other entities that facilitate transactions with sanctioned persons can be sanctioned, severely restricting the ability to participate in a global economy built upon U.S. dollar dominance. Indeed, research finds that half of global trade invoices and two-thirds of external emerging market debt are denominated in dollars.


As one prominent voice in Beijing’s financial policymaking community recently noted, the United States currently has the power to dramatically restrict the ability of U.S.-sanctioned Chinese companies and persons to access financial services and to limit transactions with non-Chinese sanctioned persons—such as that occurring with Iran and Venezuela—by threatening Chinese banks that serve sanctioned persons or facilitate such transactions with sanctions that would shut off their access to U.S. dollars and payment infrastructure. The United States is for the most part not using this power against Chinese firms and entities. Yet when it does, the results are significant; the mere threat of such sanctions recently drove large Chinese banks in Hong Kong to avoid transactions with U.S-sanctioned Hong Kong officials.

Relatedly, Beijing is worried that international transactions denominated in yuan generally rely upon correspondent banking relationships and messaging through the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which Washington can insist comply with sanctions policy. In the eyes of many in Beijing, including one prominent economist, “the reliance of RMB cross-border infrastructure on SWIFT still has profound implications on China’s monetary sovereignty.” Xi Jinping’s call for China to actively participate in the setting of international digital currency standards indicates Beijing’s desire to replace financial messaging standards and payments systems with ones less susceptible to U.S. policy pressures.


The e-CNY network certainly fulfills this vision, as the PBOC will have near-complete control over its design and structure. The network’s use in large-value international transactions would hinder the United States’ ability to apply pressure on intermediaries to prevent such transactions between Chinese firms and entities in China, Iran, North Korea, and Russia subject to U.S. sanctions. In other words, the e-CNY could offer U.S.-sanctioned Chinese companies, as well as Chinese firms seeking to carry out transactions with U.S.-sanctioned entities at home and abroad, a way to do so without relying upon intermediaries that need access to U.S. dollars, including large banks. And importantly, this can happen without meaningful changes to capital controls policy; the e-CNY network would simply be used instead of other existing payment rails.

From a technical perspective, the e-CNY network is capable of facilitating international transactions aimed at skirting U.S. sanctions, particularly if the PBOC permits foreign entities to maintain sizable e-CNY balances. Yet allowing for e-CNY to be used to sidestep sanctions would be a deliberate policy choice, as the “three centers” structure of the e-CNY network and recent remarks by Mu Changchun suggest that the central bank would certainly know that sizable transactions with U.S.-sanctioned persons are taking place.

Beijing seems to have the political will to facilitate such sanctions avoidance. A few months ago, the Ministry of Commerce enacted a “blocking statute” that could ultimately force any business operating in China to not comply with U.S. sanctions if compliance harms Chinese consumers and businesses. More recently, the National People’s Congress Standing Committee passed a sanctions law that seemingly gives the Chinese government power to seize the assets of or prohibit the business activities of any company that, by complying with U.S. sanctions, harms Chinese persons. These noteworthy developments show that Beijing is willing to take dramatic actions to enable its businesses to transact with entities that the United States has sanctioned for national security and human rights reasons.


For the e-CNY to have a dramatic impact on China’s domestic financial system, China’s central bank will have to successfully navigate challenging structural trade-offs, particularly related to the design of the e-CNY network and any restrictions on converting bank deposits into e-CNY. The difficult trade-offs facing the central bank provide an important lesson for policymakers in other countries considering the costs and benefits of launching a state-sponsored digital currency. Doing so could create clear winners and losers, undermine financial privacy, and ultimately do more harm than good. Indeed, it is even possible that a botched rollout of the e-CNY could be detrimental to the health of China’s banking system, which as the world’s largest, should concern policymakers globally. Alternatively, the e-CNY could eventually help accelerate yuan internationalization if China’s capital controls are loosened.

From the U.S. perspective, the most important near-term consideration raised by the e-CNY is its capacity to enable transactions involving U.S.-sanctioned persons using payments rails controlled by the PBOC. Notably, China’s recent blocking statute and sanctions law signal Beijing’s willingness to use this technology to flout U.S. sanctions. Large transactions between companies based in China and entities sanctioned by the U.S. government for human rights abuses or national security reasons could take place soon without the need to change China’s capital controls. And it would be a deliberate policy choice by Beijing to let this happen. U.S. policymakers need to think through how best to prepare for and respond to such an outcome.

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