Wiser! #14 (Premium): Central Bank Digital Currencies are coming. It's not a question of whether, but when. And China has stolen the march and is years ahead of the rest of the world.
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CBDCs: a vision of what's to come with CBDCs, Digital Payments, QR codes, frictionless payments
If you saw the subject heading of this article and thought “not interested, I’ll skip this”…THINK AGAIN!
This a story you need to know about.
It’s a story of how China turned the world’s largest populace into a nation without the need for cash. The old, the young, the poor and uneducated, from the beggars on the street to the largest businesses.
It is also a story about Central Bank Digital Currencies, aka CBDCs. A 4 letter acronym that you’ll be seeing a lot of as more governments begin the transition to Digital Currency.
Insight from an Expert
To help me explain this lesson in mass-scale cultural and technological transformation, I turned to an expert with first-hand experience of this fascinating story.
Richard Turrin is/was a banker, a business school professor in Shanghai, and an IBMer with a brief to "reimagine banking" in Singapore. He went freelance as an AI and innovation consultant, writing a highly acclaimed best-selling book called "Innovation Lab Excellence".
Richard has lived in China for the past 11 years and experienced firsthand China's rapid transformation into a cashless society.
There is nobody better qualified to tell the story of how China moved the entire population of the world's most populous nation over to cashless payments. A story that he has written for his second book, called "Cashless: China’s Digital Currency Revolution".
Much of the content for this article is taken from Cashless, although I only scratch the surface of the subject covered by the book.
To accompany this article, Richard and I recorded a zoom call recently.
What do we mean by Central Bank Digital Currency?
Simply, a CBDC is a digital version of real money. Just like a banknote or coin, it is a form of money that is issued and backed by a central bank in the same way as the cash you have in your physical wallet right now.
But don't confuse a CBDC with cryptocurrency, because they are not the same thing. They share some similar properties, such as they are both controlled using cryptography. And they are both digital assets that can be programmed to behave in certain ways.
But, where they differ is that a CDBC is a legal tender.
It is issued and centrally controlled by the government. These are not tradable assets in the same way as, say, Bitcoin or Ether.
By contrast, cryptos are created by entrepreneurs (and "hustlers", to quote Elon) to fund technical projects and startups. Cryptocurrencies are decentralised and transactions are confirmed through a process called consensus. This is the complete opposite of a centralised CBDC where the central bank’s systems confirm a transaction.
2010-2014 - Origins of China’s Cashless Society
Arguably, the inspiration for CBDCs is Bitcoin and the emergence of credible, alternative cryptocurrencies like Ether.
But for China, it was also the government's desire to lift its "unbanked" into the mainstream. Banks begrudgingly acknowledged that they needed a better way of reaching the rural poor, with services previously limited to the urban wealthy.
Add into the mix, the desire of the emerging tech giants, like Tencent and Alibaba, to find easier ways for people to buy things online…and you have the ingredients for technology innovation on a scale that is hard to match.
"These are the conditions that gave birth to China’s digital finance."
The defining moment occurred in 2014 when the Chinese government allowed Tencent's WeChat (think Facebook's WhatsApp) and Alibaba (think Amazon) to provide banking services.
By way of contrast, in 2019 Facebook announced it was planning to launch its own digital currency, originally called Libra, and now renamed to Diem. Shortly after the announcement, the Facebook-led consortium met with strong opposition from regulators around the world (outside of China).
Key partners, like Visa and Mastercard, backed out under the pressure. And Facebook was forced to water down their plans.
The reinvented Diem is now seeking a payment licence through Switzerland's financial regulators and plans to launch later this year as a stablecoin in the US.
The reason for highlighting the Facebook story is that it gives us an interesting compare and contrast between China and the USA.
Seven years ago China took a bold step by giving WeChat a banking licence. Meanwhile, its nearest equivalent in the West, WhatsApp, has so far been prevented from doing the same.
Richard explains it this way in the book:
"As we look at China’s advances, we have to ask why we don’t have them in our own countries? The United States, in particular, as a master of all things digital, is far behind China in the adoption of digital finance. Banks in the US still expect clients to wait three days for deposits to clear, as though we were still back in the days of paper checks. The reasons are difficult to untangle because they are rooted in resistance by incumbent banks to go digital, in combination with regulators that largely protect incumbents from the entry of digital competitors."
There’s a “so what?” about Diem that shouldn’t be missed.
Which is that the opportunity for Facebook is huge.
They have around 2.8bn monthly active users globally. For many, Facebook IS the Internet and their only connection to the online world through their smartphone. The potential of Diem to be a near-zero cost means for a third of the world's population to move money is game-changing!
Transition to a Cashless Society
With the ability to provide banking services now given to the two largest technology innovators - Tencent and Alibaba - the landscape changed. And quickly.
To understand the impact, it's important to understand the two apps that drove the change.
WeChat - the "Super-App"
WeChat is the dominant social platform in China.
There is almost nothing that you can’t do in the digital world on WeChat. It's the glue that holds everyday life together for almost the entire population. It is used for just about everything to do with an individual's personal life, their banking, their work.
WeChat is more like a separate version of the internet, with everything from messaging, gaming, banking, government services, healthcare, Zoom calls, and payment all in one.
Alipay is part of Alibaba, owned by Jack Ma's Ant Group.
Whilst WeChat handles the online world, Alipay deals with the physical world. To say Alibaba is like Amazon is almost right, but the range of life services is much more expansive with Alibaba.
Alibaba brands itself as a "life operating system", and it has earned the right to use such an ambitious title.
Imagine a company that combines eBay and Amazon, with payments like PayPal, and banking services like HSBC, and investment brokerage like JP Morgan, whilst also handling your refuse collection and home delivery for tonight’s takeaway.
Alibaba and Alipay connect the physical world with digital, and delivers it it to the doorstep of 1.3bn people!
Part 1 - The jump to Digital Payments
There are 2 parts to this story of transition to a cashless society.
The mass adoption of Digital Payments comes first.
This is how the entire population of China moved, in just a handful of years, to using QR codes and mobile phone apps for all payments (and removing any need to carry cash or coins at any time).
It started with WeChat, which was the first company to combine a social network with a digital payment system (drawing the attention of Mark Zuckerberg and prompting the Libra, now Diem, digital currency initiative I mentioned earlier).
The reason digital payments took hold was that the conventional system of credit and debit cards cost money and had barriers to use. If you want to be paid using a credit card, you need a card reader and you have to pay for the privilege. That might be ok if you're Walmart or Tesco, but not if you're selling dumplings on the side of the street.
However, these new payment apps broke this model. They were able to act as self-contained intermediaries and take out these costs and remove the need for specialist equipement.
To illustrate, if you use Square or PayPal to receive a payment, they charge around 3%. (Ed Note: we use Stripe at Wiser! and they take 3% of everything you spend with us EMOJI).
However, China’s payment apps perform the same service for free or 0.1%.
The effect on the Chinese economy was dramatic!
In 2019, mobile payments transaction volume in China was a massive c$51.8 trillion, more than three times China’s GDP of $14.4 trillion. WeChat and Alipay control about 98% of the payment market.
The key stat is the 'multiple of GDP'. This shows how mobile payments are used not just to buy coffee, but for business-to-business transactions and for an incredible 83% of all payment transactions that flow within the economy.
Now compare this to the US, which has a GDP 3 times greater than China. In the same year, the purchase volume of Visa, Mastercard, American Express, and Discover was less than 13% of China's volume ( c$6.69 trillion).
According to data from the People's Bank of China, mobile payments increased thirty-six times from 2013 and more than doubled from 2016 when mobile payment was already well established.
Compare Apple Pay and Android Pay, the top two mobile payment methods used in the US, with WeChat and Alipay; the difference is simply astounding. In 2019 WeChat and Ali Pay serviced 2.3 billion customers while Apple and Google Pay just broke 540 million.
Part 2 - implementation of China's digital currency
Work on China’s CBDC began back in 2014 (CBDCs aren’t thrown together overnight like some cryptocurrencies).
Then, mid-last year, China launched the pilot of their CBDC, also known as “DC/EP” (which stands for digital currency/electronic payment).
Side Note: Chinese money comes by two names: the Yuan (CNY) and the people's renminbi (RMB). The distinction between the 2 names is subtle and for the purpose of the DC/EP, the digital currency is called the e-CNY or digital Yuan.
The important thing to know is that the e-CNY is a digital equivalent of the official currency in all ways. Including its value.
Most importantly, the new DC/EP maintains the People’s Bank of China’s centralized control over the currency, just as it did with paper money.
To minimise disruption to the existing banking system, China have adopted a two-tier system (unlike the single-tier architecture of The Sand Dollar in The Bahamas where the digital currency is issued directly from the central bank).
This means that commercial banks will continue to manage their network and relationships with end customers and receive e-CNY digital currency from the central bank. (Remember this the next time you see a headline the CBDCs signal the end of retail banking.)
One of the key features of China's CBDC which differentiates it from the traditional card payment system is that users can make limited digital payments whilst offline.
This is through a concept known as "loose-coupling", which is possible only through a process called tokenization. This is where the digital currency is stored in a cryptographic form on a mobile device and can be transferred to another device without the need to have a network connection.
It is this feature, above all others, that makes the DC/EP the viable alternative to hard cash.
Another key component of the CBDC is the "wallet". This is the user interface where digital currency is stored, expended, or received. The wallet is provided by the commercial banks and not by the central bank.
China has made a concerted effort to avoid disrupting the banking network. By allowing commercial banks to provide the wallet, it gives the banks an opportunity to develop one-to-one relationships with their customers based on value-added services.
It also means that the People’s Bank of China does not have to deal with managing 1.3billion relationships!
Already the DC/EP trial is being extended and tested across large parts of the economy. The government is issuing e-CNY for the population to use and to test the system, for example, lottery winnings are being paid as e-CNY.
Last month, Chinese eCommerce giant JD.com announced it was paying employees in e-CNY.
China is only the start...
These are early days for the e-CNY and there's a long way to go. But the potential is huge.
Imagine this. Programable money.
Take the Covid stimulus cheques issued to every American registered in the tax system. Today, the government has no idea what they're being spent on. With a CBDC, the digital cash could be programmed to be spendable only at food stores or for essential supplies.
But not on Robinhood or Fortnite.
Or Interest rates.
Imagine the central bank being able to change interest rates instantly across the network, immediately impacting all transactions.
Of course, there are also major risks that need to be considered, such as significant disruption to the economy from cyber attacks. You only have to look at how the DarkSide ransomware attack on the Colonial Pipeline last week disrupted an economy the size of the east coast of America.
This is why it is so important that the whole world watches closely what happens in China.
Because you can be certain, CBDCs are coming to a central bank near you!
If you liked this article and found it of value, you can buy me a coffee for a couple of €s and help keep the hamster wheel turning.
Bahamian Central Bank Launches ‘Sand Dollar’ Digital Currency – World First? Source: Finance Magnates
Facebook-backed Diem aims to launch digital currency pilot later this year. Source: CNBC
The digital currencies that matter. Source: The Economist
Explainer: Central bank digital currencies - Moving towards reality? Source: Reuters
Central Bank Digital Currencies (CBDC) Explained. Source: Binance
Digital Currencies and Stablecoins (White Paper). Source: Group30