By: Arnold Gao, Senior Director Analyst at Gartner
The hype around China’s CBDC has existed for years and caused financial institutions around the globe to wonder whether this initiative may have potential business impacts that they cannot afford to ignore.
While the U.S. and Europe are still in the planning phase, China started the pilot of its digital fiat currency in four cities (Shenzhen, Suzhou, XiongAn and Chengdu) in 2019. In October 2020, six more cities were included. Domestic retail use cases have emerged where CBDC is used as an alternative payment method to the current mobile payment services.
China’s CBDC refers to the digital form of the country’s fiat currency. Unlike Bitcoin or any other cryptocurrencies, it is issued and backed by China’s central bank, the People’s Bank of China (PBoC). Like other fiat currencies, China’s digital RMB holds legal tender status and is mandated to be accepted to settle any monetary debt.
China’s CBDC aims to replace the paper cash supply, with manageable anonymity and encryption features. Similar to paper money, it follows a two-tier operating structure for issuance, circulation and redemptions (see Figure 1). 1 At the first tier, PBoC issues and redeems its digital RMB via commercial banks, and has recently included Alibaba’s online bank, MYBank, as one of the seven financial institutions for pilot testing. Tencent’s WeBank is also expected to become one of the pilot participants very soon.
At the second tier, the distribution and circulation of CBDC happens among financial institutions, individuals and businesses where the user needs to first withdraw digital RMB from a commercial bank into a digital wallet in order to proceed with transactions. The deposit process also occurs in a similar fashion as paper money, from the digital wallet to the commercial bank.
Digital RMB also offers a dual offline payment feature to ensure that transactions will still work between the payer and recipient that are temporarily without internet access. It can support payment needs in networkless environments, such as basements, mountainous areas, deserts or disaster scenes where the network required for online and mobile payment is interrupted. At the moment, the dual offline payment feature is supported by Near Field Communication (NFC) technology that requires the payment parties to have a hardware wallet with a built-in security chip.
Figure 1: Two-Tier Operating System of PBoC’s CBDC
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As the country’s digital fiat currency, digital RMB offers unique benefits and use cases that are not available to traditional paper cash and internet-dependent mobile payment.
Reducing Payment Frictions
Current retail payments in China rely heavily on two major mobile payment platforms, Alipay and WeChat Pay. Both have established their own exclusive ecosystems.
Digital RMB as legal tender means that it is required by law to be accepted as satisfactory payment for any monetary debt (such as payment for goods), and hence it has the privilege of removing the barriers between the existing mobile payment ecosystems. Customers can always choose digital RMB to settle transactions, regardless of via which platform or ecosystem they want to pay for products or services.
From a user experience perspective, the use of digital RMB is very similar to mobile payment when the internet is available. End users will not have a much different experience using digital RMB versus mobile payment services when their mobile devices have network signals (for example, in large cities). However, the dual offline payment feature empowers digital RMB to have wider coverage in use cases where the network infrastructure is insufficient or unavailable. For example, transactions on the subway, in the air, in a desert or even at a disaster scene can be completed by digital RMB, which supplements the current mobile payment system.
Improving Financial Inclusion
Financial inclusion is a key development strategy in China. The goal is to ensure availability and equality of opportunities to access a range of financial services, such as savings, credit, payment and risk management products, by individuals and enterprises, especially low-income individuals and micro and small enterprises (MSEs).
Digital RMB can play an important role in financial inclusion. For example, mobile payment is not available to everyone in remote areas, not because people don’t have smartphones or the internet, but because they are unbanked individuals without bank accounts. Traditional paper cash has been the only alternative but the operating costs associated with it are relatively high in the existing cash-based system. For example, at the end of 2020, there were approximately 220,000 bank branches and one million ATMs in China. Costs in connection with issuance, transportation, security and redemption of cash slowed down the pace of financial inclusion.
The emergence of digital RMB offers less expensive and faster infrastructure to support financial inclusion. Unlike mobile payment services provided by digital giants, digital RMB doesn’t need a bank account to operate once the money is in circulation. This will empower unbanked individuals to enjoy the convenience of digital payment, as well as further advance financial inclusion services (for example, small loans) that usually require bank accounts via conventional channels.
The benefit of using digital RMB for financial inclusion also applies to small merchants. Using mobile payment services provided by digital giants, MSEs need to bear the cost associated with transactions, such as installing point of sale (POS) as well as the withdrawal fee. Digital RMB as the public financial infrastructure doesn’t require merchants to pay for any facilitation cost for transactions, which reduces the burden for small businesses.
Achieving the Balance Between Anonymity, Security and Compliance
Every system is imperfect and has its weak points. The most widely used mobile payment platforms in China are bound to the bank account system, which means anonymity is not possible due to the know your customer (KYC) process required by banks. Also, mobile payment service providers gather all the transaction details from users, which can lead to breach and abuse of data (such as for commercial purposes) so security and privacy have always been concerns.
Paper cash, on the other hand, is the best way to ensure anonymity for payments. However, it is also the easiest way to engage in illicit activities. The risk of using paper cash for money laundering and other illegal and criminal activities is high and has become a compliance challenge in the monetary system.
As the upgraded version of the existing cash supply, digital RMB is, by design, loosely coupled with bank accounts in order to achieve a balance between anonymity, security and compliance (see Figure 2), with its traceable anonymity feature. It is designed to maintain anonymity for a small amount of transactions and only require authentications for large amount transactions, to meet the needs of anonymous payments, and increase opportunities to foster anti-money-laundering and monitor potential illicit usage. Unlike commercial organizations, the central bank does not profit from users’ personal information, so the risk of privacy leakage and data abuse is relatively lower.
Figure 2: Achieve a Balance Between Anonymity, Security and Compliance
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Improving Payment Experiences for Foreign Customers
Digital RMB can offer improved experiences for people who cannot access China’s mobile payment services. For example, tourists who are not able to use mobile payment in China (because they don’t usually have local bank accounts) can use digital RMB to enjoy the convenience of cashless payment.
Last but not least, unlike disruptive innovators (such as digital giants), PBoC’s role as a regulator requires it to be prudent and risk-averse, rather than innovative, to ensure the security and stability of the country’s finance system. Therefore, in a paradox, the innovative characteristics of digital RMB may add unexpected risks or extra complexities to the existing monetary system.
Also, enterprises may overestimate the impact of digital RMB. Some are seeing it as a challenger to current mobile payment services, others believe the technologies behind it may even accelerate the internationalization of RMB, but that is very unlikely. In fact, digital RMB is designed to serve as a supplement to domestic mobile payment systems by using digital technologies to improve efficiency and reduce costs, especially in the cash-based retail industry, which is only in a small part of China. Instead of challenging mobile payment services, PBoC is partnering with mobile payment service providers in China and leveraging their digital platforms and infrastructure to implement digital RMB. In terms of the internationalization of RMB, it depends more on the political and economic choices of the trading partners, as technology is the last-mile effort rather than a game changer.
As a result, enterprise architecture and technology innovation leaders in China should: firstly, obtain a clear understanding of China’s CBDC by knowing how it differs from cryptocurrencies and traditional paper cash. Secondly, work with business leaders to prepare for the official launch of digital RMB by understanding the potential use cases described in this research, and to assess the business impact to their industry and organization. Thirdly, avoid overestimation, as digital RMB is not a game changer for international trading, at least not for the near future. And lastly, avoid overreaction, as the business impact of digital RMB will be limited in the domestic market. They can monitor how the innovation evolves, but need not worry much until trade settlement shifts – if it does.