What is it and how does it work?

GUANGZHOU, China – China is arguably the world leader in the development of a national digital currency, a project it has been working on since 2014.

The People’s Bank of China (PBOC) has spearheaded work on the digital yuan, a so-called central bank digital currency (CBDC) that aims to replace some of the cash in circulation.

Real-world trials are already underway in the world’s second largest economy. Here’s what we know so far about the digital yuan or its official name – electronic payment in digital currency (DCEP).

It is actually a way for the central bank to digitize banknotes and coins in circulation. The Chinese market is already very advanced in cashless payments. The digital yuan would be a way to speed up this process.

It will be legal tender in China and no interest will be paid on it.

“The use of cash is decreasing. Eventually, cash will be replaced by something in digital format. This is one of the big drivers behind this,” Yan Xiao, project manager for digital trade at the World Economic Forum.

Fan Yifei, vice-governor of the PBOC, said last year that there is a “pressing need to digitize cash and coins” because their production and storage is currently expensive. In an article by state publication Yicai Global, Fan said that cash and coins are not easy to use, are easy to counterfeit, and because of their anonymity, they could be used to illicit purposes.

The PBOC sees a number of other advantages for the digital yuan.

In a separate article, Fan explained how a CBDC could make payments more efficient and improve the transmission of monetary policy. Fan also argues that a digital yuan could contribute to financial stability through a system of “controllable anonymity”. This is where payments would be anonymous to some extent, but data analysis tools could help the central bank detect illegal activity.

Another reason behind the PBOC’s efforts could be to increase competition in the payments space and reduce systemic risk. The digital payments arena in China is dominated by Alipay, which is run by the Alibaba Ant Group subsidiary, as well as WeChat Pay, run by internet giant Tencent.

“The existing system is owned by private companies. If Alipay or WeChat Pay goes bankrupt, which is extremely unlikely, it creates systematic risk,” Linghao Bao, analyst at Trivium China, told CNBC. “The main reason for them (the PBOC) to do this is to level the playing field. Perhaps another reason is to create a new platform payment system that will increase efficiency.

There are two sides to the question: distribution and ultimately how it will be spent.

The distribution will be done via a so-called two-tier system. This means that the PBOC will distribute the digital yuan to commercial banks. Commercial banks will be responsible for putting money into the hands of consumers. This could include services allowing consumers to exchange their coins and cash for digital yuan.

China has already donated millions of dollars in digital currency in real-world trials in a number of cities, including Shenzhen, Chengdu and Suzhou. These involve the local government distributing a certain amount of yuan through a lottery. Users typically need to download a separate app to receive the currency. JD.com, one of the largest e-commerce players in China, participated in the trial and allowed customers to purchase items with the digital yuan.

At this point, it’s unclear how users might actually hold and spend the digital yuan when it rolls out nationwide. The most popular form of mobile payment in China is based on so-called Quick Response (QR) codes. Users can display this barcode in their Alipay or WeChat app in a store and the merchant will scan it.

Xiao from WEF says it’s likely that commercial banks could build similar functionality into their apps. And that Alipay and WeChat Pay could have a section of their applications dedicated to the digital yuan. Meanwhile, smartphone makers could also create digital yuan wallets for their devices.

“It will be interesting to see how the telephone companies seize the opportunity to become a player in the payments market,” said Xiao.

The PBOC fan also said that commercial banks already have the infrastructure to distribute the digital yuan and it is better for them to do so rather than the central bank.

“Building a separate system would be a huge waste of these existing resources,” he said.

In some ways, it is designed to increase competition with Alipay and WeChat Pay but not to replace them entirely.

“The way I see it is that the digital yuan is not a direct competitor to Alipay or WeChat Pay, but a new platform that allows other players to come in and compete. with WeChat and Alipay, ”Bao from Trivium China said. “They could be commercial banks or other payment companies.”

The Fan of the PBOC also said that the proposed two-tier model can help “avoid disintermediation in the financial sector” because the central bank will not be in competition with commercial banks.

No. Bitcoin is a so-called decentralized cryptocurrency. This means that it is not controlled by any central authority like a central bank, unlike the digital yuan which will be issued by the PBOC.

Bitcoin is also built on a technology known as blockchain. It is not known at this point what sort of technical composition of the digital yuan would have.

Bitcoin supporters also tout the anonymity of digital currency.

The PBOC fan said the digital yuan would have “controllable anonymity.” This would imply that the operators of the yuan digital wallets disclose the transactions to the PBOC as “only third party”. Users are said to have a “loose linkage of accounts” meaning that their current bank account is not necessarily tightly linked to their digital yuan account.

It could be based on a phone number, according to WEF’s Xiao.

The PBOC claims that agencies operating digital yuan services should “submit transaction data to the central bank via asynchronous transmission in a timely manner.” This would allow the PBOC to “keep track of necessary data” in order to combat money laundering and criminal offenses.

Some commentators, however, have expressed concerns that the digital yuan could be used to increase surveillance of citizens.

China has pushed the internationalization of the yuan, and some commentators have seen the digital yuan as a means to do so.

But currently, digital currency has a national vocation and international use is “not the immediate priority,” according to Bao of Trivium China.

But the PBOC has started to lay the groundwork for the use of digital currency in cross-border transactions. Last month, the BPC joined central banks in Thailand, the United Arab Emirates and Hong Kong to jointly explore a cross-border digital currency payment project.