Real-world tests of the digital yuan show how it could disrupt China’s mobile payment giants

During the past decade, digital payments platforms Alipay and WeChat Pay have emerged as the dominant form of mobile payments in China. They now account for more than 90% of the country’s mobile payments market.

But recent tests of China’s much-anticipated central bank digital currency (CBDC) suggest that the new system, called Digital Currency/Electronic Payment (DC/EP), may be poised to disrupt the business models of these commercial payment giants.

Testing, testing

The central bank for the world’s second-largest economy has so far conducted three city-wide tests of DC/EP, also called the digital yuan.

The first test happened in October in Shenzhen, followed by one Suzhou in December, and a third one back in Shenzhen in January. In total, the People’s Bank of China (PBOC) has given away 50 million digital yuan, worth nearly $8 million, to 250,000 local residents. Across these tests, more than 20,000 merchants have participated.

One feature that has remained consistent throughout the DC/EP trial period is that merchants who support central bank digital currency payments don’t have to pay any transaction fees. 

That's in line with a statement in November by Mu Changchun, head of the PBOC’s Digital Currency Research Institute. Mu said that the central bank and commercial banks won’t charge merchants or consumers any service fees for using or converting digital yuan.

According to various local news reports, that has indeed been the case during the trials. “Compared to other methods, there’s no transaction fee [for me] if I receive payments via digital yuan, which can lower down our operational expenses,” one shop owner told Securities Times. 

Alipay or WeChat Pay, on the other hand, generate a significant portion of their revenue by charging transaction fees.  

According to the October IPO prospectus of Alibaba’s Ant Group, which operates Alipay, the total payment volume for the 12 months ending June 30, 2020 reached $18.2 trillion. It made $5.38 billion, $6.77 billion, $7.8 billion and $4 billion in revenues from its “digital payment and merchant services” in 2017, 2018, 2019 and the first half of 2020, respectively.

 “We primarily generate digital payment services revenues by charging merchants transaction fees based on a percentage of volume,” Ant Group said in the filing.

Indeed, the category “digital payment and merchant services” accounted for over 50% of Ant Group’s revenue in 2017 and 2018. That  share has declined since 2019 because the firm has expanded into financial services like insurance, lending, and investments.

According to Alipay's service pages, it typically charges offline and online merchants between 0.6% to 1% of their transaction volume. Tencent’s WeChat Pay has a similar pricing structure. 

Further, if merchants or individuals want to withdraw funds from their Alipay or WeChat Pay wallet balances to their bank accounts, they must pay a 0.1% withdrawal fee.

Content vs. platform

All of this is consistent with a Financial Times report in August that quoted unnamed Chinese regulators and executives at Ant Group saying that PBOC officials had Alipay and WeChat Pay “firmly in their crosshairs.”

But perhaps it’s not quite so simple. Consider another point Mu made in November: DC/EP is not meant to compete against Alipay or WeChat Pay, he said, because they are not in the same dimension. Instead, Mu said, the CBDC will be like content that can be supported by many platforms, including AliPay or WeChat’s native mobile apps. 

Indeed, Alipay quietly conducted a three-day digital yuan test earlier this month in which eligible Ant Group employees in Shanghai could pay with DC/EP inside their Alipay apps at two bubble tea stores.

During the test, merchants had two options within Alipay: either receive payments via conventional ways, like bank saving transfers with a transaction fee, or via digital yuan without any cost.

Still, it remains to be seen how merchants will be able to incentivize customers to pay via CBDC in the long-term because DC/EP is not without disadvantages relative to the commercial apps. Alipay and WeChat Pay have amassed enormous network effects, which have set the stage for widespread adoption of additional financial services.

For instance, merchants using Alipay or WeChat can take advantage of the various financial products they offer on top of their mobile wallets, such as credit loans, currency and mutual funds with different levels of interest yields. 

The fact that the revenue ratio of Ant Group’s digital payment services is declining is a sign that China’s payment market is saturating. That also may help explain why the firm has expanded the scope of its financial services.

But the future of those business areas is uncertain, too. Ant Group’s increasingly popular credit lending and investment services have drawn intense scrutiny from Chinese regulators. 

In December, regulators halted the massive dual-listing IPO Ant Group had been planning. According to Bloomberg, following the IPO suspension, regulators told Ant Group to “rectify” the company’s lending, insurance and wealth management services and return to its payment roots.

Now, according to a draft rule proposed on January 20, the PBoC is seeking to enforce stronger antitrust laws on non-bank digital payment providers. The proposed rule would define “payment monopoly” for the first time. The draft also states that any non-bank payment provider possessing half of the online payment transactions — or two firms with a combined share of two-thirds of the market —may be subject to antitrust investigations. 

Such actions indicate that the Chinese government really does have Alipay and WeChat Pay in its crosshairs. 

Either way, it seems safe to say that DC/EP will disrupt China’s payments market. Yet we will probably have to wait until it’s finally released to the wider public before it becomes known exactly how it might threaten the two biggest commercial incumbents.