China’s Central Bank Digital Currency Will Transform the International Monetary and Financial Systems

Most of us think money is created by our nation’s central bank. If asked, most English people would say the money they use is generated by the Bank of England. But this is not so. The Bank of England mints the currency English people use, and at times intervenes to influence its value. But most money in everyday usage in England represents promises by British commercial banks. In virtually all economies, central banks name the currency, shape its value, and issue the cash. But people are paid and make payments in digital commercial bank promises which function as money. This is normal. Furthermore, the usage of physical cash is in steep decline in most developed economies.

Our recent paper explores the current world-leading developments in China involving central bank digital currency (CBDC). In time, CBDCs will change the nature of money and effect a paradigm shift in the monetary, payments and financial architecture of our economies.

CBDC is a digital fiat currency issued by a central bank. It is existing currency delivered in an entirely new way, and one in which central banks are displaying extraordinary levels of interest. A recent Bank for International Settlements (BIS) survey suggests some 90% of central banks are actively engaged in researching or, in some cases, piloting a CBDC, although only Nigeria and the Bahamas have actually issued CBDCs. The EU and the US are both now engaged in intensive research into a CBDC.

China has been actively researching on a CBDC since 2014. Initially China’s CBDC was called Digital Currency/Electronic Payment (DC/EP), and is now known as the 'e-CNY' or 'digital yuan'. In 2021, the People’s Bank of China (PBOC) issued a white paper on the topic. China is exploring the CBDC design that ‘suits China’. Its motivations are many and include promoting safe, inclusive and adaptive retail payment infrastructures, the declining usage and costs associated with cash, cryptocurrencies (particularly stablecoins), other states’ CBDC explorations, enhanced efficiency of central bank payment systems, and maintaining monetary sovereignty.

Kristalina Georgieva, Managing Director of the International Monetary Fund, believes that ‘[t]he history of money is entering a new chapter’. CBDCs will create new ecosystems and require new infrastructure and technical standards. They will raise issues ranging from seigniorage to capital flight to loss of monetary sovereignty. They will bring many benefits such as efficiency gains, reduced costs and the opportunity to enhance financial inclusion, and many challenges especially around privacy and cyber-security.

China shares with other nations some of its reasons for issuing a CBDC, such as promoting financial inclusion and addressing the decline in the usage of cash. Yet China may also have other considerations such as strengthening the role of the state in the domestic payment market, gathering more information about money flows and the behaviour of consumers in China, and, in the longer term, promoting its currency as a global reserve currency and garnering some of the many economic benefits this brings.

As China’s reasons to introduce a CBDC exceed those of other nations, and it has a strong existing technological base in FinTech, it is not surprising China is far ahead of all other countries in developing and trialling a retail CBDC. China literally leads the world when it comes to CBDC development.

As we analyse in our paper, for so long as China’s developments remain in the context of a retail CBDC for domestic use they will not be globally transformative. This will change if and when China releases the e-CNY for offshore payments and settlements of international trade transactions, ie, in international wholesale transactions. Many obstacles remain in the way of the use of e-CNY in international trade, centred mostly on trust in China and its central bank. However, China also enjoys many powerful levers with which to promote the e-CNY. These range from making its use free and more convenient than other alternatives to mandating its use as the payment mechanism for Chinese exports or imports. In the fullness of time, China will likely release the e-CNY for offshore wholesale use not to make money, but to reorder the international financial system to its advantage. If merchants begin to trust and use the e-CNY in international trade, or simply use it because they have to do so, the e-CNY will provide a veritable river of valuable data to China about these transactions in real time. The need to have access to such data will be one of the major reasons other nations launch their own competing CBDCs.

Putting central bank money into the hands of citizens and businesses in digital form is a transformative change and not one any central bank will undertake lightly. Yet central banks around the world are now extensively involved in researching and developing CBDCs, because the nature of money and payments is about to change radically and they need to be ready. We all do.

Ross P Buckley is Scientia Professor and KPMG Law – King & Wood Mallesons Professor of Disruptive Innovation at UNSW Sydney.

Heng Wang is a Professor and Co-Director of The University of New South Wales’ (UNSW) Law & Justice’s Herbert Smith Freehills China International Business and Economic Law (CIBEL) Centre.