The first central bank-backed digital currency

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In the digital era, popular trends spread like wildfire and the blockchain-enabled digital currency mania appears to be reaching critical mass.

At some point in the near future, the People’s Republic of China (PBOC) will be launching a new “digital yuan”—basically an online version of its existing currency (i.e. the Chinese Yuan, Renminbi, or CNY).

Unlike a cryptocurrency such as Bitcoin, the digital yuan is backed by the central bank of China, and will therefore be categorized as the first-ever “central bank digital currency” (CBDC). The new digital yuan is already being tested by about 100,000 citizens in China, although no official timetable has been released on its forthcoming availability to the broader public.

Given the cutting-edge nature of this development, it’s difficult to project how exactly the digital yuan will impact life in China, much less the global economy.

But in terms of the former, digital payments have been commonplace in China for many years and are already mostly the norm.

For example, a reported 98 percent of urban Chinese consumers use a digital wallet daily. In practice, that means when most Chinese citizens go to the coffee shop, they use an app on their phone to pay their bill—typically with Tencent’s WeChat Pay or with Ant Group’s AliPay.

If one can believe it, even homeless people in China accept digital payments via those same platforms. And it’s not unusual for that to occur—digital payments are so entrenched that it’s a part of normal daily life.

Trading the Digital Yuan: The first central bank-backed digital currency

In that sense, a digital yuan won’t likely represent a seachange for the average consumer in China. The digital yuan should feel familiar to Chinese users of digital payments because it will also be available through a familiar-feeling mobile app (developed by the People’s Bank of China). Interestingly, transactions on the app can be conducted without connectivity to the internet.

One big change with the digital yuan, as compared to existing platforms, is that the Chinese government will be able to monitor all transactions executed using the eCNY. That reality will undoubtedly strengthen the government’s ability to track the movement of Chinese currency, and greatly assist in reducing nefarious, and undesired, transactions.

Certainly, there will be plenty of critics of such control—viewing it as a further infringement on the personal freedoms of Chinese citizens.

CROSS-BORDER TRADE AND FINANCE

But beyond those domestic implications, there are plenty of questions swirling around how the digital yuan will impact the existing cross-border system of international trade and finance.

One of the linchpins of the current global payments system is the Society for Worldwide Interbank Financial Telecommunications (SWIFT) network, which is a digital messaging system used by international commercial banks. SWIFT is co-operative domiciled in Belgium and controlled by its member banks. In 2018, about 11,000 member banks routed roughly 34 million daily transactions through the network.

The United States relies on the SWIFT network to monitor suspicious activity, as well as to deploy and enforce sanctions against countries, organizations and individuals. Importantly, the digital yuan ecosystem will be completely detached from the SWIFT network, meaning the currency’s impact on international payments could be significant, and difficult to forecast.

Will the digital yuan be accepted as a form of payment in rural America anytime soon? Certainly not. But what about an international airport, where travelers might prefer to purchase digital yuan instead of changing hard currency at a counter?

Another big concern is that countries/organizations/individuals sanctioned by the United States could theoretically use the digital yuan to circumvent restrictions and penalties. That would undoubtedly serve to weaken the influence of the United States, as well as its own currency—the U.S. dollar.

Currently, the greenback is used in roughly 88% of international foreign-exchange trades, as compared to about 4% for the Chinese yuan. But those figures could be poised to change, potentially dramatically.

CONSIDERABLE LEVERAGE

Because China is more of a global supplier than a global buyer, Chinese companies will likely still be forced to accept the currency of the importing country when executing international payments. But one could see how China might use its considerable leverage to try and coerce close allies, and regional neighbors, to use the digital yuan.

Currently, more than 60% of all global central-bank reserves are held in dollar-denominated assets. Another statistic that may be poised to take a hit.

However, one expert on international payments doesn’t necessarily think it will be easy for the yuan to displace the dollar—digital or otherwise. Eswar Prasad, a former head of the International Monetary Fund’s China division and current economics professor at Cornell University, said of the situation, “Most cross-border payments either for trade or finance are already digital, so it’s hard to imagine a digital yuan having a huge impact on international payments.”

He argued that a more important development was the introduction in 2015 of China’s Cross-Border Interbank Payment System, intended to directly compete with SWIFT. In combination with the digital yuan, that system could theoretically make it easier for countries sanctioned by the United States to circumvent those sanctions, and continue to interact with the global economy—albeit on a more limited basis.

Regardless, any reduction in the dollar’s status as the world’s preeminent reserve currency could also theoretically hurt its value. The British pound was once in the same position as the U.S. dollar is now, and suffered a decline in value when it was displaced by the greenback.

Trading the Digital Yuan: The first central bank-backed digital currency

Source: BusinessInsider.com

Considering all of the above, foreign currency traders—cryptocurrency or otherwise—may want to monitor ongoing developments related to the digital yuan very closely in the coming months.

Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to support@luckboxmagazine.com.

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