Inside China’s drive for digital currency dominance12 min read
In the 13th century, Kublai Khan, the Mongolian emperor who founded China’s Yuan Dynasty, upended monetary convention with a magisterial edict: Accept my money, or die.
The threat of execution was not so novel back then, of course. The Khan’s true innovation lay in his refashioning of money itself. The grandson of fearsome Genghis realized he could finance his realm untethered to finite supplies of precious metals. No longer would his geopolitical reach depend on backbreakingly mined and smelted ores hauled along the Silk Road. Instead, he could tap a boundless, lightweight resource—and make money grow on trees.
Mulberry trees, to be exact. In a contemporary account, Marco Polo, the wandering merchant of Venice, marveled at “how the great Khan causeth the bark of trees, made into something like paper, to pass for money overall his country.” The banknotes were issued, he wrote, “with as much solemnity and authority as if they were of pure gold or silver.”
Medieval Europeans were dumbfounded by Polo’s report. But the emperor was ahead of his time. Fiat currencies—descendants of Kublai Khan’s chao, backed by government edict rather than hard assets—are standard everywhere today.
Fast-forward to this century, and China once again is remaking money. Except this time, it is paper currency that’s getting tossed; China is going digital. And while things didn’t end well for the Mongols—they printed themselves into hyperinflation, and lost the throne—China’s current leaders have something far more stable and enduring in mind.
China is further along than any other large country in its development of a national digital currency—in this case, a purely electronic yuan based on technology inspired by blockchains, the record-keeping databases that underlie cryptocurrencies like Bitcoin. President Xi Jinping issued a ringing endorsement of blockchains in an October speech, making him the first major world leader to get behind the technology. Xi vowed to “seize the opportunity” that would let China “take the leading position” in the field.
The futuristic money, clunkily dubbed the “digital currency/electronic payment,” or DC/EP, is a dramatic step in that direction. The government aims for the currency, now in a pilot phase, to be ready for broader rollout by the time Beijing hosts the Winter Olympics in February 2022—allowing China to demonstrate its fintech prowess on a global stage.
Chinese officials publicly tout the currency’s many benefits: lower operational and transaction costs; greater financial inclusion; and, for the state, enhanced crime-fighting capabilities and expanded influence abroad. The innovation is set to strengthen the Communist Party’s control of China’s monetary system, while restoring the government’s power over China’s tech giants, especially Tencent’s WeChat and Alipay, run by Alibaba’s IPO-bound Ant Group division.
Some observers even believe the e-yuan could spell the beginning of the end for the U.S. dollar as the de facto conduit of international commerce. For Westerners who think China’s digital mulberry tree will bear fruit, that’s a startling possibility—one that would diminish America’s ability to defend its economic and political interests. “Letting China win this race to be at the center of payments for the next century is a far greater threat to our national security than the perceived threats” that Westerners attribute to digital currencies, says Kathryn Haun, a partner at venture capital firm Andreessen Horowitz who sits on the board of the Libra Association, a blockchain consortium assembled by Facebook.
For now, however, the perceived threats Haun alludes to—notably, balancing privacy, law enforcement, and economic stability—have hindered digital-currency development outside China. Out of 66 central banks surveyed in a recent study by the Bank for International Settlements, 80% reported having begun investigating the feasibility of a digital currency. But only 10% were anywhere close to minting one; the Federal Reserve is not among them. (For more, see the sidebar.)
The upshot: China is sprinting ahead in a race that few others realize they’re running.
A casual observer visiting a railway station in Suzhou, a canal-sluiced city northwest of Shanghai, might notice nothing out of the ordinary. Train cars are thronged with masked passengers. At entryways, commuters queue up and show guards their green-colored smartphone codes, indicating bills of good health for COVID-19.
But some passengers have another feature on their phones: an officially approved digital currency. China began testing an e-yuan in the real world in May, as municipal workers in Suzhou started receiving half their monthly transit subsidy in the form of DC/EP. Similar trials, some involving local merchants, are taking place in Shenzhen, Chengdu, and Xiong’an, near Beijing.
The transactions are small, but they send a big message: While most countries were distracted by a pandemic, China staged a technological coup. Matthew Graham, CEO of investment firm Sino Global Capital, conveyed the significance after posting leaked images of “beta” DC/EP wallets on Twitter. “Americans [are] still trying to figure out if they should put on a face mask while China pushes out a revolutionary technology,” he commented.
Beijing has said little about the pilot program since announcing it. Big companies operating in China have been reluctant to talk about DC/EP—not unusual in a country where businesses are loath to get out ahead of the government. But they’re watching the situation with interest, and homegrown stars such as ride-hailing service Didi Chuxing and food deliverer Meituan-Dianping, along with foreigners McDonald’s and Subway, have been reported to be preparing for the trials. (Didi confirmed its participation; Meituan declined to comment; McDonald’s and Subway did not reply to requests for comment.)
More than 80% of Chinese people already use smartphone apps like Alipay and WeChat Pay to conduct payments. Cosmetically, DC/EP apps resemble those omnipresent e-wallets. Yet technologically, there’s a wide divide between the two types of digital money. The DC/EP, in one key innovation, will be usable everywhere, even among parties who are otherwise “offline.” But the biggest difference lies in who logs the debits and credits. Unlike its private-sector counterparts, the e-yuan is intrinsically linked to a centralized ledger maintained by the People’s Bank of China (PBOC), the nation’s central bank.
The ramifications are manifold. China’s gambit could help bring 225 million “unbanked” people into its economic fold; all they’ll need is a smartphone, not even a traditional bank account. E-yuan wallets could be used to distribute stimulus payments, subsidies, and tax refunds. But most fundamentally, the digital money will grant the government unparalleled oversight and fine-tuned control of China’s economy. As with the Khan’s ancient cash, the biggest benefits are likely to accrue to the state.
When Edith Yeung, a Chinese national and investor at VC firm Race Capital, caught a Chinese state television segment on blockchain technology a couple of years ago, something seemed off. “It tried to teach the masses in layman’s terms what blockchain was all about,” she recalls. But “the word ‘decentralization’ ”—the antiestablishment mantra of cryptocurrency boosters—“was not mentioned at all,” she says. That’s not really blockchain, Yeung remembers thinking.
The omission is in keeping with the Communist Party’s focus on centralized authority. When the PBOC first started considering a digital currency, in 2014, Bitcoin was just breaking into the mainstream consciousness. Libertarians loved how it permitted the creation and transfer of value, independent of government. But many banks and states saw in the blockchain’s distributed ledger technology something equally attractive: the potential to track financial activity with incredible precision.
China, ever wary of capital outflows that could weaken its currency, preemptively barred banks from handling cryptocurrencies starting in 2013. But the country’s leadership studied and cherry-picked aspects of blockchain technology for the DC/EP project—keeping its innate transparency, while scrapping its potential to sideline authorities.
Meanwhile, China’s fintech sector, lofted by a fast-rising middle class, was taking off. Transaction volume on mobile payment apps in China rose from a negligible amount in 2013 to as much as 350 trillion renminbi, or $50 trillion, in 2019. Today, Ant Group’s Alipay and Tencent’s WeChat Pay command 55% and 39%, respectively, of that market. Phones displaced physical cash; China’s ratio of cash use to household financial assets, an increasing share of which is held in fintech apps, is among the lowest in the world, at 4%. (In the U.S., it’s 24%.)
The PBOC viewed this flight of deposits from state-controlled banks into a rising, under-regulated duopoly as too much, too fast. “Those big tech companies bring to us a lot of challenges and financial risks,” Yi Gang, governor of the PBOC, explained at a conference last year. “In this game, winners take all.” So, in 2017, the government started requiring Alipay and WeChat to store customer funds in non-interest-bearing accounts at the central bank. The PBOC also set up a clearinghouse for online payments, a checkpoint allowing it to scrutinize the giants’ money flows.
With an e-currency, China will gain even greater visibility into, and command over, the money sloshing around the system. Digital transactions won’t have to be routed through a checkpoint; transparency will be inherent in the all-seeing, back-end ledger. That could also enable the country to keep closer tabs on investment risks, potentially helping avert the debt crises that periodically disrupt China’s economy, explains Nathan Chow, senior economist at DBS Holdings, a Singapore-based multinational bank. Say authorities deem a “ghost town” mega–housing project to be unsalvageable: The nation’s fiscal engineers could restrict—literally, by tweaking e-yuan code—investors from plowing more money into it. Rather than address problems after the fact, an e-yuan will let China “have everything under control in advance, preprogrammed,” says Chow.
But skeptics fear more insidious outcomes. Mu Changchun, head of the PBOC’s digital currency research institute, has promised the DC/EP will offer “controllable anonymity.” But many people consider the phrase to be an Orwellian oxymoron. More likely, the digital currency will grant the state financial omniscience. With an e-yuan, China will be able to monitor the transactions of suspected criminals and terrorists, loose labels that could be applied to dissidents and ethnic minorities. It doesn’t take a great stretch of the imagination to envision how the technology could be combined with China’s nascent “social credit” system, granting privileges to upstanding citizens and revoking financial access for anyone deemed disloyal.
Marta Belcher, a tech-focused attorney at law firm Ropes & Gray, notes how Hong Kong pro-democracy demonstrators often wait in long lines at subway stations to purchase tickets with cash, so authorities can’t place them at the scene of a protest. If an e-yuan displaced its hard-copy forebear, that world would dramatically shrink. “A cashless society is a surveillance society,” Belcher warns.
“This design will have difficulty gaining traction outside of China, given the weak privacy controls,” says Chad Cascarilla, CEO of Paxos, a U.S.-based cryptocurrency company. But privacy concerns may not stop DC/EP from attracting a global following.
After Facebook announced its plans for Libra in 2019, CEO Mark Zuckerberg warned Congress that the free world risked losing its edge to China. Libra has since scaled back its ambitions after early stumbles, while the PBOC has accelerated its timeline. And China stands to gain more than just a technological edge: The e-yuan represents its best chance yet to challenge the dollar as the global reserve currency, plastering the visage of Mao Zedong over the face of George Washington.
The U.S. has benefited enormously from the greenback’s status as the global reserve currency since World War II. Exporters sell to the U.S. more cheaply, and lenders ask for lower interest rates, because they get paid in a globally prized currency. The U.S. also faces less risk from fluctuating exchange rates and wields greater sway over lesser economies’ monetary policies.
All money systems are subject to network effects—gaining greater value as more people use them. Today, the renminbi makes up only 2% of global foreign-exchange reserves, while the U.S. dollar accounts for more than 60% (and the euro 20%). But if the DC/EP ever attains critical mass, it will likely be thanks to China’s “Belt and Road” global trade and infrastructure initiatives.
Every day that passes, it gets harder and harder for Western-backed projects to keep up.
Kathryn Haun, General Partner, Andreessen Horowitz
Belt and Road, the centerpiece of Xi Jinping’s foreign policy, is helping China cinch together a network of economically dependent client states from Southeast Asia to Egypt to Ecuador. If China can lure those countries into the e-yuan ecosystem, that could help the currency become a serious counterweight to the dollar. China has considerable leverage over these nations—many have borrowed heavily from Beijing. But China also has enticements to offer. Transaction fees can make cross-border trade and borrowing slow and costly in developing nations. Because digital currencies require fewer intermediaries, an e-yuan could “minimize transaction lag while lowering barriers to entry,” says Da Hongfei, CEO and cofounder of Neo, a Shanghai-based blockchain project.
The DC/EP could cause problems for the U.S. even without attaining global-reserve status. Thanks to the dollar’s dominance, the U.S. is a global financial gatekeeper: It can effectively decide who is approved for or blacklisted from using the SWIFT network, the international bank money-wiring system. That enables the U.S., for example, to “inflict very targeted sanctions on specific Russian oligarchs in response to bad behavior,” says Aditi Kumar, executive director of the Belfer Center for Science and International Affairs at Harvard Kennedy School.
A Chinese digital currency threatens that power. “One of the built-in functions for DC/EP is direct remittance, which would bypass SWIFT,” notes Jennifer Zhu Scott, founder of investment firm Radian Partners in Hong Kong. Wider adoption of DC/EP could reduce America’s ability to punish adversaries and criminals—and give anyone embroiled in a policy dispute with the U.S. an alternative place to do business.
Last December, Treasury Secretary Steven Mnuchin told Congress that he and Fed Chairman Jerome Powell considered digital currency a low-priority issue. “In the next five years, we see no need for the Fed to issue a digital currency,” Mnuchin said. The pandemic has revived interest on Capitol Hill—in part because Washington has struggled to issue stimulus benefits quickly through traditional channels—but progress remains slow.
The inertia may reflect a deep-seated disbelief that China can overtake America. Hank Paulson, former secretary of the Treasury and founder of a think tank focused on U.S.-China relations, regards DC/EP as “not a serious concern,” as he wrote in an op-ed for Foreign Affairs in May. Beijing’s approach to governance is too illiberal for its currency to win widespread adoption, Paulson argued.
But others believe the naysayers miss the bigger picture. “I think of it as analogous to the debate we’re having about 5G,” Kumar says. “The U.S. has had a tough time urging allies not to use the 5G tech Huawei is providing,” she says, referring to the controversial Chinese telecom giant. While the U.S. alleges that the company poses espionage risks, customers argue that they can’t pass up a chance to get high-quality tech at low cost. Haun, the Libra board member, laments: “Every day that passes, it gets harder and harder for Western-backed projects to keep up.”
China’s government, meanwhile, is seizing the chance to become an integral part of the world’s digital fabric for decades to come. Yifan He, CEO of Red Date Technology, a state-supported company that aims to offer blockchain-based cloud services, likens all this work to “building the next Internet.” The current Internet, of course, owes its existence to Pentagon-funded research. It’s a reminder that technologically ambitious governments can reshape economic history in profound ways. Just ask Kublai Khan.
From PayPal’s Venmo to M-Pesa in Africa, the private sector has dominated digital payments. Now central banks are exploring national digital currencies of their own, often with corporate partners—though none has progressed as far as China.
Sweden’s Riksbank, the world’s oldest central bank, has talked about launching a digital currency since 2016. It’s now working with consulting firm Accenture to develop the technology behind an e-krona that it plans to test next year.
In July, the Monetary Authority of Singapore said it “successfully” concluded a trial with JPMorgan Chase and state-backed giant Temasek that settled payments in different currencies on a blockchain-based network. The bank’s managing director has said he would welcome cooperation with China.
The Bahamas started its “project sand dollar” pilot in its Exuma district on Dec. 27, 2019. The trial attracted more than 1,000 testers in a month, and the nation plans to expand the program across all 700 of its islands before year’s end.
In 2018, Venezuela launched the petro, a cryptocurrency (allegedly backed by oil reserves) designed to help citizens cope with international sanctions and the dysfunctional nation’s hyperinflation. The petro has been a flop, and the U.S. is offering a $5 million bounty for information leading to the capture of the initiative’s leader, who has been indicted for drug trafficking and sanctions violations.
A version of this article appears in the August/September 2020 issue of Fortune with the headline “China’s drive for digital currency dominance.”
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