Digital yuan: what is it and how does it work?

China’s answer to the cryptocurrency challenge, the e-CNY central bank digital currency, is set for rapid take-off on its expected launch in 2022. Deutsche Bank’s research team examines the digital currency in detail and provides answers to common questions about e-CNY.

What is e-CNY?

The e-CNY, or digital yuan, is a centralized, cash-like digital currency that is expected to be primarily used for retail payments in China. The People’s Bank of China (PBOC), the central bank, and e-CNY operating institutions have conducted large scale e-CNY pilot programs in multiple cities over the past few months.

Why did the PBOC introduce e-CNY?

According to Deutsche Bank research, the PBOC’s introduction of the e-CNY serves two different but related goals. The first, longer-term goal, is to create a digital currency that can compete with other digital currencies such as bitcoins, stablecoins, and other central banks digital currencies (CBDC), while ensuring that the renminbi continues to be the dominant currency in China. The second, more immediate goal is to reshape China’s current payment system by providing a cash-like digital payment method: accessible to all, low cost, anonymous (to a certain extent), and which facilitates competition among payment service providers.

How does the e-CNY work?

The e-CNY is fully backed by the PBOC and put into operation by payment service providers. It allows greater anonymity and includes better personal information protection, yet still keeps sufficient records for tracing illegal activities such as money laundering and tax evasion.

The PBOC chose to define e-CNY as cash in circulation, or as M0 in the language of central banks. Defining e-CNY as M0, rather than M1 or M2, has a number of implications:

  • Firstly, e-CNY will be a liability of the PBOC. In China’s monetary system, M0 implies direct liability from the PBOC, while M1 and M2 include certain liabilities from commercial banks. This definition means e-CNY will be completely risk free.
  • Secondly, the digital wallets that hold e-CNY will not be considered bank accounts. The PBOC’s pilot programs so far require only a mobile phone number to have a e-CNY wallet.
  • Thirdly, no interest can be paid on e-CNY. Interest can be paid on M1 or M2 (bank deposits), but not on M0 (cash). This is important because most digital currencies, including some CBDCs currently being considered, have not ruled out interest payments.
  • Lastly, only banks can convert e-CNY into bank deposits and vice versa.

An important consideration behind the e-CNY’s M0 definition is that it is likely to prevent disintermediation of banks. By defining e-CNY as M0 and banning interest payments, the PBOC likely envisages only a limited amount of e-CNY in circulation to replace cash, but not to replace bank deposits.

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