Smart money

China's digital currency is not only aimed at playing a bigger role in the international monetary system, but also as means of safeguarding the country's financial security

In October 2020, the Bank for International Settlements, the Federal Reserve, the European Central Bank and other five central banks, released a report "Central Bank Digital Currencies: Foundational Principles and Core Features". The report aimed to provide reference for central banks to help them catch up with the private sector in the field of digital currencies. This marks that the digital currencies of central banks have officially entered the vision of international organizations and mainstream central banks.

E-CNY is a sovereign digital currency being floated by the People's Bank of China, the country's central bank. It mainly aims to replace M0－the cash in circulation, rather than replacing deposits in banks (M1 and M2). There won't be a large amount of deposits converting to e-CNY as holding e-CNY won't bear any interest. As authorized agencies, some commercial banks will develop their own digital currency wallets and participate in e-CNY operations. Individuals cannot bypass authorized agencies to directly exchange e-CNY at the central bank.

E-CNY's launch will have an impact on China's mobile payment market, but it's yet to be seen how much of a blow it will deal to the existing mobile payment service providers. Users are habituated to mobile payment services not only because of the payment function, but more importantly, because of the whole ecosystem centered on the means of payment.

Users utilize such ecosystems to arrange their daily life, from buying air tickets to booking hotels, and from paying electricity bills to hailing taxies. Although the central bank intends to encourage commercial banks to compete with the two mobile payment giants, in providing digital wallet services, it will be difficult for commercial banks to retain active users and become strong competitors unless they build a whole ecosystem that's appealing to users.

Even if e-CNY secures a landslide victory in the digital payment market, it does not mean Alipay and WeChat Pay will exit the market. What's more likely to happen is that e-CNY becomes a new addition to users' mobile wallets.

As a matter of fact, e-CNY is not a central bank digital currency in the real sense, since its main function is micro-payments in the retail sector rather than wholesale payments. Furthermore, since the renminbi has yet to realize full convertibility or become an international currency, the e-CNY can hardly compete in the global arena of central bank digital currencies.

Promoting the renminbi's internationalization and competing in the global arena of central bank digital currencies are targeted at playing a role in the international monetary system, and also serve as an important means of safeguarding the country's financial security. A major reason for some developing countries' international payment crises is a currency mismatch between their assets, which are denominated in their domestic currency, and their liabilities that are, mainly denominated in the US dollar. Once global confidence in a country's domestic currency is undermined, the currency will sharply depreciate, resulting in insolvency and a financial crisis. One of the major goals for the internationalization of the renminbi is to make both sides of the balance sheet (assets and liabilities) renminbi-denominated.

In a certain period to come, the digital currency issued by central banks will co-exist and compete with each other, but eventually, the international reserve currency will be one central bank digital currency or at most, a handful of central bank digital currencies.

The future international currency could be the digital dollar, the digital renminbi currency or other countries' digital currencies, or even a super-sovereign digital currency. The international reserve currencies are in nature currencies based on sovereign credit with similar functions whereas the basic feature of the digital technology is its long-tail effect. Therefore, the international currency competition will eventually settle on one central bank digital currency or a very few of central bank digital currencies. The premise of e-CNY participating in such competition is the improvement of its functions.

The author is director of the Institute of Digital Finance at Peking University.