Could the Digital Yuan Unseat the Dollar?

The Harvard International Review has a fascinating piece on how China is, as it does in almost every endeavor, playing the long game on cryptocurrency. While we’ve expressed our doubts about central bank digital currencies (CBDCs) versus properly decentralized cryptocurrency many times, CBDCs as a tool in in the context of geopolitics between nation states is a different animal. HIR asks if China’s digital currency could unseat the dollar, and it looks like the answer is yes.

Nearly 900 years ago, China’s Song dynasty government, at the time the most advanced civilization in the world, issued the world’s first centralized paper currency. When Marco Polo encountered money made from the “bark of trees” circulating universally within the Mongol empire during the Yuan Dynasty, one hundred years later, he witnessed a financial system with efficient, long distance transactions, and a central banking authority with the complete trust of the population. Today, the world is on the cusp of another technological revolution in how humans conduct commerce. Again, China is at the fore, leading the way from cash to cryptocurrency with a new central bank digital currency (CBDC), the e-CNY, commonly known as the digital yuan. Although the US dollar remains the world’s dominant fiat currency, an analysis of the geopolitics surrounding the battle for currency hegemony reveals that China’s digital yuan will pose a serious challenge to the dollar status quo as the 21st century unfolds.

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China’s 13th Five Year Plan, covering 2016 through 2020, aimed to “promote RMB [Chinese currency] internationalization and see RMB capital go global.” China’s motivations for RMB internationalization include escaping US monetary policy, shoring up against dollar shortages, and gaining lower borrowing costs. From 2009 to 2019, 20 trillion yuan were exchanged across borders. Still, the RMB makes up a mere two percent of global foreign reserves compared to the dollar’s sixty percent. The basic prerequisite for any reserve currency is the backing of a large economy, a high trade volume, and a net creditor status (meaning a country’s international investments are larger than the foreign debt they owe). China lags just behind the United States in GDP and trade volume and is a fifteen percent net creditor compared to the United States’ eighty percent net debtor position. Beyond pure economic calculus, however, currency hegemony relies on a balance of factors that still remain squarely in favor of the dollar. Crucially, China’s rule of law, trustworthiness, and tightly controlled economy make investors skittish of relying on Chinese currency. What, then, is China’s path to an internationally formidable RMB?

The answer may lie in China’s digital yuan. The cryptocurrency has been in development for over eight years, since the People’s Bank of China (PBoC) began investigating a government-run bitcoin in 2014. In the early 2010s, Chinese crypto miners were responsible for an estimated 95 percent of all newly minted bitcoin. The Chinese government discovered this mining activity in 2012 after investigating suspicious power usage, as bitcoin mining is extremely energy intensive. A decentralized, anonymous currency posed a major threat to China’s strict social and financial controls. As officials started banning and regulating cryptocurrency, they also saw its potential. By 2021, all private cryptocurrency activity was banned and the Chinese economy had also largely transitioned away from paper yuan. Last year, 80 percent of Chinese adults made digital payments. Testing for the digital yuan began in 2020, but the early adoption numbers were less encouraging than Chinese officials may have hoped for. By October 2021, there were a total of 123 million individual wallets, although the average sum in each was just 47 cents (three RMB) implying that many consumers weren’t actively using the new currency. Adoption numbers then doubled by January 2022 in the lead-up to the Winter Olympics hosted in Beijing. China planned to use the Olympics to introduce the world to the digital yuan, similar to the country’s extravagant displays in 2008 that thrust a modern China onto the global stage. Due to China’s stringent covid policies, few foreign visitors were actually in attendance. Still, the PBoC reported around $300,000 (2 million RMB) in daily transactions with the digital yuan throughout the games. Although dwarfed domestically by China’s primary digital payment companies, AliPay and TenPay, China’s ambitions for the digital yuan are undoubtedly international.