Central banks across Asia-Pacific are in the process of building the world’s first central bank digital currencies (CBDC) and – with China at the helm of this monetary revolution – the future of money may soon become re-defined. This article will analyse the fast paced CBDC developments in the most dynamic region on earth.
A Comment by Thaddeus Jahn and Peter Müller
China’s official currency RMB goes digital
There is no such thing as a free lunch? Think again! In China, the central bank – the People’s Bank of China (PBoC) – has given away 200 digital Yuan (about €25) each to 50,000 consumers in Shenzhen’s Luohu district. Setting up this major pilot scheme, the government was able to demonstrate the technical viability of a central bank digital currency. In basic terms, a CBDC is a digital form of a country’s fiat currency. This means that the currency is not materially backed by a resource, such as gold. Rather, it depends on the trust that individuals have in the creditworthiness of the central bank itself. The government – rather than banks – must maintain reserves and deposits to back it up.
Certainly, “for [a] digital yuan to be popularly accepted, banks and other institutions need to invest heavily in applications, marketing and education”, but the dizzying speed at which China has moved forward over the past years leaves little doubt that they are set to succeed. After all, according to China Finance, a magazine run by the PBoC, failure is not an option since the rights to issue and control a digital currency will become a ‘new battlefield’ of competition between sovereign countries across the globe.
It was three years ago that the People’s Bank of China had opened the ‘Digital Currency Institute’, a research lab tasked with development of a prototype for a blockchain-based digital currency. Fast forward to November 2020: The emergence of the Digital Currency Electronic Payments (DCEP) system has given China a clear lead in developing a sovereign digital currency. This ‘digital RMB’ will solely be issued by the PBoC, is backed 1:1 with fiat Chinese renminbi and will be distributed through selected banks and non-financial players (e.g. Alibaba, Tencent, Union Pay) who already operate widely-used mobile payment networks.
Whilst the European Central Bank (ECB) and the American Federal Reserve are still at a relatively early stage discussing how such a digital currency system could work, China has filed 130 patent applications ranging from issuance, circulation to application, installing a complete supply chain to launch the digital currency. First pilot programmes have been conducted since mid-2020 in the cities of Shenzhen, Chengdu, Suzhou and Xiong’an. There, the PBoC has opened over a hundred thousand consumer digital wallets and thousands of corporate digital wallets, processing RMB 2 billion (€254.8 million) across 4 million digital Yuan transactions between April and October. Integrating state-of-the-art technologies such as barcode scanning, tap-and-go payments and facial recognition, these transactions covered over 12.000 different use cases from retail to transportation and government services.
It has become more than clear that the Chinese government is willing to go to extraordinary lengths operationalising this new form of currency. But why is this the case? In an article from 2017, Jahn (one of the authors of this piece) and Heuermann already suggested that “from a governmental perspective, a digital currency provides unprecedented capabilities to control and monitor financial transactions.” Not only can authorities gain full control over financial flows, but a digital RMB also enables the PBoC to trace transactions and collect complete and authentic data in real-time to compile indicators of monetary policy.
By continuously replacing fiat cash with a system of traceable digital currency, a strong data feedback system is created powering decision-making in the immediate post-pandemic era and beyond. The fact that a digital RMB should also provide enhanced capabilities to crack down on money laundering and other forms of financial crime and better restrict capital outflows is an attractive added benefit.
In addition, “a digital version of the RMB lets China interoperate between different currency contexts where the US Dollar (USD) may start to fade.” Currently about three fifths of the world’s known central bank foreign exchange reserves are in US Dollar, thus effectively making the Dollar the global currency. By establishing a digital RMB as a viable, safe and convenient alternative, countries may consider a widespread uptake of DCEP reserves. This would give the PBoC greater influence over global financial markets, a vision that corresponds closely with other recent attempts to augment the Chinese currency’s role including the creation of the Asian Infrastructure Investment Bank (AIIB) and the addition of the RMB to the IMF’s special drawing rights currency basket.
An East Asian digital common currency?
As Chinese fiscal policy seeks to internationalise the RMB, the CBDC’s internationalisation strategy must be considered in depth and a national currency might easily reach its limits. In May 2020 for instance, the Chinese political advisory body CPPCC proposed a public-private collaborated digital currency backed by a basket of the Chinese Yuan (CNY), Japanese Yen (JPY), Korean Won (KRW) and Hong Kong Dollar (HKD) as a cross-border payment network avoiding the US Dollar and consisting of digital wallets for businesses supporting a regional free trade agreement.
Inui, Takahashi and Ishida, three Japanese economists, echo a proposal for an Asian digital common currency with the purpose of escaping the dominance of the USD and aligning East Asia’s financial and economic integration. This idea may turn out to be especially appropriate considering that twelve of the region’s countries including China, Japan and South Korea have just signed the Regional Comprehensive Economic Partnership (RCEP), the biggest free trade agreement in the world.
The Japanese economists base their idea on the history of China’s medieval sea trading market power and point to the fact that the names of JPY, CNY, KRW, HKD and New Taiwan Dollar (NT$) contain the same character of Yuán (圓). As digital and mobile payment systems have advanced greatly, technical prerequisites for an Asian common currency are being met. Furthermore, the recent surge in usage of cryptocurrencies and the political problems surrounding the Euro reveal the potential for and advantages of having multiple coexisting currencies.
An international organisation such as the secretariat of the Chiang Mai initiative, could issue common currency bonds backed by central banks to issue the digital currency, while retail banks would distribute the currency as they already do with fiat currency. Aware of the potential economic and geopolitical disruption that the DCEP poses, many Asian-Pacific countries have responded by pursuing the issuance of a CBDC, albeit with differing levels of ambition and speed. Asia’s CBDC landscape therefore deserves a closer look.
Greater China and East Asia
China’s special administrative regions, Hong Kong and Macau, have long perceived themselves as gateways to China’s internationalisation. Hong Kong’s general priority regarding a CBDC are wholesale cross-border payments, which the financial hub’s regulator already tested in a joint initiative (“Project Lion Rock”) together with Thailand. Responding to China’s progress in the digital currency realm, the city’s regulator is simultaneously looking to use the cross-border transaction potential of China’s CBDC to become the global hub of DCEP. Similarly, Macau seeks to become the lynchpin of the DCEP for the ‘Lusophony’, the Portuguese-speaking world, and other digital currencies, thereby reducing reliance on its casino industry.
Macau is a popular destination for mainland Chinese wishing to gamble, seeing as gambling is not prohibited in Macau. Such gamblers may soon find themselves under heavier scrutiny as capital flows are monitored more precisely. In terms of China’s engagement, Taiwan too started evaluating a CBDC in 2018 focusing on utilising the blockchain to improve banking efficiency. While a timetable for a digital New Taiwan Dollar does not exist as of now, a special task force has been established.
In considering a “digital Yen”, Japan has so far identified a set of distinct challenges. Loss of electrical power and therefore access to digital payments are not unlikely given the frequent number of earthquakes. Its ageing society also poses important questions about general access to technology. Therefore, particular attention will be given to the topic of offline payments and potential fraud schemes. Digital currency experiments have not yet started in Japan, but are meant to include financial institutions and technology companies, both of which have already engaged in various studies on private digital currencies and payment systems.
In July 2020, Japan finally included a CBDC plan in its upcoming policy framework and began research into CBDCs. The “Project Stella”, a joint research project with the ECB, is exploring the blockchain’s potential to improve financial market infrastructures and maintain digital money for reserve and settlement balances at a central bank. Following this international engagement, critics urge Japan to develop a globally interoperable digital payment infrastructure, considering the global position the Yen should have in the coming decades.
Due to concerns about China’s DCEP, the other major player in the East Asian region – South Korea – launched a twenty-two month plan this year to create a regulatory framework for running its own CBDC and fiat currency system in parallel, with tests meant to begin in 2021. Its hostile neighbour North Korea meanwhile allows state-owned businesses to transact in cryptocurrencies, as a result of which the UN has accused North Korea of stealing from exchanges abroad. More likely however, the DPRK actually seeks to launch a blockchain based “WeChat”-like international payment, agreement and settlement system using Ethereum-style smart contracts to substitute the international payment standard SWIFT and Chinese intermediary, and to avoid sanctions.
Finally, China’s northern neighbour Mongolia adopted a “digital currency regulation” in 2018, based on which Mongolia’s largest mobile telecom operator became the first licensed entity to issue its own digital currency titled “Candy”. Candy has evolved from an original customer bonus programme to a non-cash payment instrument equivalent to the Mongolian currency Tugrik, offering tremendous potential for efficiency in the world’s least densely inhabited country.
Nowhere has China’s DCEP been more critically perceived than in India, with whom geopolitical rivalries have flared up in recent times. Subsequent to the proposal by the National Institute for Smart Government (NISG) of a so-called “Central Bank Digital Rupee (CBDR)” to follow up the national digital identity project “Aadhaar”, India was engaged in researching a CBDC to bridge the gap between 582 million bank accounts and 1.21 billion mobile connections. A further rationale for the CBDR would be a potential monetisation of shared health, communication and financial data providing disposable income for all citizens.
Financial crime such as money laundering, fraud, counterfeiting of notes for drug smuggling, terrorism financing and tax evasion could also be prevented by on-chain analysis, securing real-time transaction monitoring and reporting. A careless implementation is nevertheless seen as risky (especially considering the recent Indian monetary policy) in that it may devalue the national currency, increase inflation, or hurt foreign exchange reserves held by the Reserve Bank.
In 2019, India’s rival Pakistan allowed non-bank entities to issue licensed e-money and subsequently hopes to issue a CBDC by 2025 in order to promote financial inclusion, efficiency and combat corruption with a complete deployment by 2030. Sri Lanka is trailing behind India and Pakistan and has just begun researching Blockchain technology with a shared KYC facility, which may enable digital and remote onboarding for customers and therefore increase financial inclusion. Nepal has thus far not worked on a CBDC, despite a local initiative arguing that CBDC could help with several issues the country faces including decreasing its high rate of unbanked citizens (50 percent versus nearly 100 percent mobile penetration), tackling financial crime and allowing for an improved inflow of saver remittances.
In terms of digital currencies, few regions are as dynamic as Southeast Asia. Here, many states are involved within inter- and intra-regional research projects focusing on cross-border transfers, while others focus on financial inclusion via national payment systems. Project Inthanon, for instance, saw Thailand and Hongkong completing a successful cross-border transfer prototype in January 2020. A prototype payment system for businesses launched in July 2020 and it is expected that the project will conclude soon.
The regulators in Singapore and Canada are engaged in a similar project that is aimed at clearing and settlement (Project “Ubin” or “Jasper”). In line with its multipolar and balanced foreign and economic policies, Singapore’s regulator has nonetheless engaged in meaningful exchange with China and even encouraged discussions about Facebook’s well-known development of the cryptocurrency “Libra”.
The Philippines’ central bank is studying the feasibility and policy implications of their own CBDC at a time when digital payments are on the rise due to the COVID-19 health crisis. Nonetheless, they have rejected the issuance of a “digital Peso” any time in the near future as further research is needed regarding capacity-building and network-creation with other central banks and financial institutions.
In January 2020, Cambodia was meant to launch “Bakong”, a blockchain-based payments app powered by a CBDC. “Bakong” is not yet operational, but it promises to make it easy for end-users to pay each other regardless of their respective bank accounts. Finally, despite a ban on cryptocurrencies as payment instruments, Indonesia’s Central Bank tested a “digital Rupiah” in 2018 with the stated goal of sharing data between its provincial banks, curb illicit activities and make the payment system more efficient.
Despite the fact that many Asian nations have proactively pursued CBDCs, Australia and New Zealand have so far neither found a strong case for introducing a digital Dollar, nor have they seen crucial benefits of having their current modern payment systems replicated by electronic currencies. As such, neither of them plan to launch their own CBDCs.
The small Pacific island nations on the other hand have approached CBDCs remarkably differently, as demonstrated by the so-called “Sovereign” (SOV) CBDC of the Marshall Islands. Developed in 2018, the SOV is seen as a crucial second legal tender for a country that since its independence in 1979 has recognised the USD and whose financial support agreement with the US will end in 2023. While half of the SOV tokens will be offered to foreign investors, the other half is envisaged to generate steady revenue to help the low-land islands tackle climate change.
The plan is to issue the SOV in several months time to improve financial inclusion for a population that has to a large extent been excluded from the international digital banking system. The SOV could furthermore serve to reduce the tremendous transaction costs which currently average 10 percent. The International Monetary Fund (IMF) nevertheless opposes the SOV, pointing out that the country’s last remaining US Dollar correspondent banking relationship would be at risk.
As most pacific nations are similarly using physical USD for daily settlements without access to modern banking infrastructures, their authorities are now looking to CBDCs for sovereign, inclusive currencies. Blockchain Fintechs from East Asia, together with local enthusiasts, are therefore working on designing national currency systems for the 26 island countries of the region, including pilot programmes in Palau and Micronesia and the “K-PAP Project” of a digital asset bank and CBDC in Vanuatu.
(Digital) money changes everything
Already on the verge of becoming a cashless society, China has forged ahead in developing a central bank digital currency. The impressive progress puts China in a good position to issue the first CBDC worldwide and thereby define the future of money. Inevitably, this has brought other countries to the scene who have been forced to closely look into central bank issued digital money and carefully weigh their options.
A recent Bank of International Settlements survey of central banks has shown that in advanced economies with their higher technological and institutional capability and innovation, central banks are considering CBDCs to promote safety and robustness, domestic payments efficiency or financial stability. Moreover, CBDC cross-border transactions are an important potential use for both advanced economies with a focus on innovative solutions for wholesale settlements, and jurisdictions with lower access to transaction accounts with a focus on more robust and efficient remittances as a financial inclusion policy. Growing Asia-Pacific trade exemplified for instance by the new Regional Comprehensive Economic Partnership might soon be denominated in future regional or cross-border blockchain-based currencies. Perhaps the concept of an East Asian common digital currency might materialise.
As our analysis of the region’s numerous initiatives has shown, the attitude towards, motivations behind and the design and pace of CBDC developments vary significantly across Asia-Pacific. Still, when it comes to its digital currency plans, the region is ahead of most Western countries. Inter- and intra-regional projects have sought to increase financial integration and design financial markets in more efficient ways, a fact that explains the engagement with CBDCs of financial hubs such as Singapore and Hong Kong. The geopolitical imperative of reducing the global dominance of the US Dollar may not be ignored either. While China may be the obvious proponent of such a system-changing strategy, Pacific island nations are also interested in reducing their dependence on the Dollar. What is more, North Korea would like to circumvent the global payments system altogether.
Meanwhile, financial inclusion has provided a powerful motivation to pursue CBDCs in countries such as Nepal where large remittance flows make up a significant source of income for their people and in countries such as India, Indonesia and Mongolia which are either severely underbanked or geographically complex. The search for higher interoperability in Cambodia, stricter capital controls in China and a more effective fight against financial crime in India may make the development of a central bank digital currency all the more attractive. The most unusual motivations, however, are those of the Marshall Islands, where a CBDC may help generate revenue to be used in the fight against climate change, plus those of Japan, South Korea and Taiwan, where the fear of Chinese technological pace regarding a digital RMB has been reason enough to look into their own CBDC.
Although beyond the scope of this article, CBDCs certainly raise serious questions about data privacy, cybersecurity and state-led surveillance. After all, the availability of cash still constitutes institutionalised freedom from government control and personalised data collection. In the end, however, and that has been the focus of this analysis, there are numerous good reasons why a country might seek to introduce a central bank digital currency. Many leaders have already analysed the strategic potential, disruptive ramifications and concrete applications of this new form of money. Even so time is running out, first-mover advantages will be hard for others to overcome. When the first CBDCs go live within the next few years, the implications – good and bad – will be profound.
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Thaddeus is a government affairs specialist, working for a major bank’s representative office in Berlin. He graduated from the Double MSc Degree in International Affairs offered jointly by the London School of Economics and Political Science and Peking University, China. Thaddeus also holds a BSc Hons International Relations from the LSE. His interests include finance and the international political economy, EU policy-making, Chinese public and foreign policy, as well as German and global diplomatic history. He has been involved with Polis180’s Connecting Asia programme since its inception.
Peter is a financial crime analyst at a fintech company, and has previously worked for a major bank in Berlin. He studied Linguistics and Political Science in Germany and Taiwan and holds an MA Degree in Contemporary East Asia Studies. Interested in geopolitics, international finance and blockchain technology, he has been involved with Polis180 since July 2019 and with the Connecting Asia programme since its inception.