Business Standard
The digital yuan can disrupt both
traditional banking and the post-Bretton Woods system of floating exchange
rates.
So is China readying its own Bitcoin? Banish
the thought. It’s far bigger than that. Yes, just like any other cryptocurrency—or
for that matter, cigarettes in prisoners-of-war camps—the upcoming
digital yuan will be “tokenized” money. But the similarity ends
there. The crypto yuan, which may be on offer as soon as 2020, will be fully
backed by the central bank of the world’s second-largest economy, drawing its
value from the Chinese state’s ability to impose taxes in perpetuity. Other
national authorities are bound to embrace this powerful idea.
Little is known about the digital yuan except
that it’s been in the works for five years and Beijing is nearly ready to roll.
The consensus is that the token will be a private blockchain, a peer-to-peer
network for sharing information and validating transactions, with the People’s
Bank of China in control of who gets to participate. To begin with, the
currency will be supplied via the banking system and replace some part of
physical cash. That won’t be hard, given the ubiquitous presence of Chinese QR
code-based digital wallets such as Alipay and WeChat Pay.
Chinese disruptor
It may start small, but the digital yuan can
disrupt both traditional banking and the post-Bretton Woods system of floating
exchange rates that the world has lived with since 1973. No wonder that for
China, “blockchain and the yuan digital currency are a national
strategic priority — almost at the level of the internet,” says Sanford C.
Bernstein & Co. fintech analyst Gautam Chhugani.
Ever since the advent of the 17th-century goldsmith-banker in London,
the most crucial thing in banking has been the ledger, a repository of
irrefutable records to establish trust in situations where it doesn’t exist.
When Peter in Vancouver agrees to send money to Paul in Singapore, they’re
forced to use a chain of interlinked intermediaries because there’s no ledger
in the world with both of them on it. Blockchain’s distributed ledgers make
trust irrelevant. Paul devises a secret code, and shares its encrypted version
with Peter, who uses it to create a digital contract to pay Paul. A cumbersome
and expensive network of correspondent banks becomes redundant, especially when
it comes to the $124 trillion businesses move across borders annually. Imagine
the productivity boost; picture the threat to lenders.
China isn’t the only one experimenting. Fast, cheap cross-border payment
settlement is one application of JP Morgan Chase & Co.’s Quorum, an
Ethereum-based platform on which the Monetary Authority of Singapore is running
Project Ubin, an exploration into central bank digital money. These are early
days, but if blockchain technology shows promise in handling a large
number of transactions simultaneously, then digital currencies could become
substitutes not just for physical cash but also for bank reserves.
That’s when the game changes. Reserves at a central bank are maintained
by deposit-taking lenders. A digital yuan—or Singapore dollar or Indian
rupee—could bypass this system and allow any holder of the currency to have a
deposit at the central bank, potentially making the state the monopoly supplier
of money to retail customers. As Agustin Carstens, the general manager at the
Bank for International Settlement, noted recently, “If the central bank becomes
everybody’s deposit-taker, it may find itself becoming everybody’s lender too.”
Time for digital currencies
But why would central banks want to demote their own banking systems?
One answer, looking at Europe and Japan, is that negative interest rates are
doing that anyway. Lenders are starved of profit because while the central bank
charges them for keeping money on deposit, they can’t as easily pass on those
negative interest rates to their own depositors. If the global economy gets
mired in long-term stagnation, official digital currencies will at least be an
efficient way of monetary easing without involving banks.
The other, more concrete, reason may be that technological progress is
making the status quo untenable. It’s no coincidence that China hastened its
national cryptocurrency after Facebook Inc. announced the Libra project, which
was touted as an alternative dollar. Perhaps that was fanciful, and the Libra
has hit a wall of regulatory concerns. But if they’re offered like Spotify gift
cards at the local 7-Eleven, there will be demand for tokens that are
acceptable across borders, stable in value against baskets of national
currencies, and can be used in global trade and investing. Someone in Silicon
Valley will eventually succeed, blowing away the fig leaf of monetary
sovereignty in emerging markets in the process.
The changes won’t end with banking and monetary arrangements. Token
transactions will be pseudonymous: If the central bank wants to see who’s spending
where, it can. Anonymity disappears when cash does. While that will make life
difficult for money launderers and terrorists, it could also become a tool to
punish political activism. Meanwhile, currency as a foreign policy weapon loses
some sting. Pariah states will covet a crypto they can access by circumventing
banks that are terrified of flouting Western sanctions. As Harvard University
economist Kenneth Rogoff notes, technology “is on the verge of disrupting
America’s ability to leverage faith in its currency to pursue its broader
national interests.”
A roller-coaster decade — not just for banking and money but also for
privacy and politics — may just be beginning.
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