Everything you need to know about China's central bank digital currency

2020 will be remembered for the many tumultuous developments around the world – the coronavirus pandemic, the Russian-Saudi oil war, and the potential commencement of a global recession. But it may also be remembered as the year of central bank digital currency, or CBDC.

The People’s Bank of China (PBOC) confirmed last Monday that it has been internally testing its digital currency, known as Digital Currency/Electronic Payment (DC/EP),  in four cities. The central bank has also hinted that the system might see use during the 2022 Beijing Winter Olympics.

So here we are: after six years of behind-the-scenes digital currency research and development, and the second-largest economy in the world may soon become one of the first nations to digitize their national currency.

Although the central bank has confirmed little, Chinese media has painted the new currency's launch as imminent.

Last week one of the four testing cities, Xiong’an, hosted a DC/EP "pilot promotion meeting," during which 19 merchants including McDonald's and Subway were invited to discuss the new digital currency, according to a local media report. It has also been reported that the city of Suzhou will use the system to distribute transportation subsidies to local government employees in May.  

What exactly is DC/EP? How can it be used? What kind of impact will it have and how will it be integrated with China’s existing digital payments system?

The Block collected all publicly available information – from both official channels and trustworthy media sources – to create a comprehensive guide.

What we know about the DC/EP design 

The PBOC started researching DC/EP in 2014. But the project had largely remained under the radar until June last year, when Facebook unveiled its Libra stablecoin initiative. Although there have been no official documents on the new currency’s design, several high-level government officials began to publicly discuss DC/EP in the wake of the Libra announcement.

Statements from these government officials, including Changchun Mu, the head of the digital currency research institute at PBOC, and the central bank's vice president Yifei Fan, help sketch an outline of the DC/EP.

First and foremost, the new digital currency will be a cash replacement. It will be pegged to RMB and issued by the central bank. It will also be backed by the PBOC's reserves. Commercial banks can acquire DC/EP from the central bank and then distribute it to the public. 

The 65 patents the PBOC’s digital currency research institute filed between 2017 to 2019 reveal more details. While PBOC will apparently control the centralized database that tracks all DC/EP transactions, commercial banks will function as digital wallet providers and manage user communications with the central bank for transaction queries.

There is no uniform design for DC/EP-compatible digital wallets. Rather, banks may launch varying wallet services. Once it has been downloaded to a phone, the software will create a private and public key pair and send the public key to the bank’s wallet management system. The bank will then create a unique tag for the wallet and forward the public key along with the tag to the central bank.

As illustrated by the diagram below, users’ inquiries for transaction details will be authenticated by commercial banks first and then forwarded to the central bank. The central bank pulls data for users then sends the information back through the commercial banks.

According to the PBOC’s Mu, the bank has considered using blockchains as the infrastructure layer for the new digital currency, but decided to "maintain technological neutrality without presupposing a technical route."

(Sort of) like cash

PBOC officials have said on several occasions that DC/EP users will be able to maintain cash-like anonymity. Two patents filed by PBOC in 2017 on digital currency transactions also outlined the concept of “controlled anonymity” as the most important feature of the digital currency. 

But the use of the word "anonymity" can be confusing in this context.

As PBOC’s Fan explained in 2018, the idea of anonymity should be interpreted as one by which two counterparties can remain anonymous to each other during a transaction. At the same time, the central bank still has access to all transaction information for anti-money-laundering and anti-terrorism purposes. 

It is unclear whether commercial banks or other designated DC/EP distributors will have the same level of visibility into transaction data as the PBOC. That being said, these DC/EP distributors will function as intermediaries between users and the central bank, passing transaction information from one to the other.

The bottom line: the PBOC will have full access to transaction data generated by DC/EP circulation, giving the government far greater visibility into users' financial activity than cash.

Another feature that will make DC/EP similar to cash, according to the PBOC, is a feature that will allow offline transactions.  The central bank has not, however, made clear how that will work.

In comparison, existing digital payment systems such as Alipay and WeChat Pay only support one-side offline payment. This means that users do not need to have internet access when making a payment, but merchants must be online. The party with internet access is responsible for completing the transaction and uploading the information to the database.  

How DC/EP could work with existing payment apps

Speaking of Alipay and WeChat Pay, which are already ubiquitous in China, how is DC/EP different? Whereas services like Alipay still rely on the existing banking system to settle payments, the DC/EP will be completely independent of current banking rails.

The chart below breaks down the various differences between DC/EP, cash, digital payment services, Libra (as currently envisioned) and bitcoin:

Although no official announcement has been made, it is likely that Alibaba, Tencent, and other fintech companies will act as DC/EP distributors in a similar fashion to commercial banks.

According to patents filed by Alipay, fintech companies may apply to become DC/EP distributors, and could then provide DC/EP-based financial services to users. 

Currently, both Alipay and Tencent are working on DC/EP related projects, one person close to the two firms told The Block. Alipay set up a separate office for DC/EP, with such projects being pursued in secret, the person said.

The national patent office shows that Alipay has filed at least five patent applications related to DC/EP, but a spokesperson for Alipay spokesperson declined to comment on them.

Since DC/EP is still in its early testing phase, the majority of the testing is being run by state-owned banks, another person with knowledge of the process told The Block. 

A challenge to the US dollar? 

The PBOC has revealed very little about the end goal of DC/EP. Still, some have speculated that it is meant to be a vehicle for RMB globalization, and a challenge to the U.S. dollar's role as the world's reserve currency. 

Some experts believe that the digital currency system will provide the necessary conditions to expand the global influence of the RMB. China may give businesses in other countries incentives to exchange their local currencies for DC/EP to pay for goods and services from China, for instance. Such transactions would bypass the existing international wire system, SWIFT, for cross-border payments, which has been used by the U.S. government in its efforts to sanction other countries. 

The bottom line, however, is that it is still very early days for the DC/EP, and much remains uncertain. No one outside the Chinese government really knows how it intends to use the digital currency.