What is it and how does it work?

GUANGZHOU, China – China is undoubtedly 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 led work on the digital yuan, the so-called digital currency of the central bank (CBDC), which aims to replace some of the cash in circulation.

Real-world testing is already underway in the world’s second largest economy. Here is what we know so far about the digital yuan or its official name – Electronic Payment of Digital Currency (DCEP).

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

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

“The use of cash is declining. Eventually cash will be replaced by something in digital format. This is one of the main factors behind this,” Yan Xiao, head of the digital commerce project at the Economic Forum, told CNBC. World.

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

PBOC sees a number of other benefits for the digital yuan.

In a separate article, Fan highlighted how the CBDC could make payments more efficient and improve the transmission of monetary policy. Fan also claims that a digital yuan could help financial stability through a “controllable anonymity” system. Here the payments would be somewhat anonymous, but the data analysis tools could help the central bank to catch illegal activities.

Another reason behind the PBOC’s efforts could be to increase competition in the payment space and reduce systemic risk. China’s digital payment arena is dominated by Alipay, which is run by Alibaba-affiliated Ant Group, and Internet giant Tencent’s WeChat Pay.

“The existing system is owned by private companies. If Alipay or WeChat payment goes bankrupt, which is highly unlikely, it creates a systematic risk,” Linghao Bao, an analyst at Trivium China, told CNBC. “The biggest reason they (PBOCs) do this is to balance the conditions of competition. Another reason may be the creation of a new platform payment system that will increase efficiency.”

There are two aspects to the question: the distribution and then how it will be spent.

Distribution will be done through a so-called two-tier system. This means that PBOC will distribute the digital yuan to commercial banks. Commercial banks will be responsible for putting the currency in the hands of consumers. This could include services that allow consumers to exchange their currencies and cash with digital yuan.

China has already offered millions of dollars worth of digital currency in real-world tests in several cities, including Shenzhen, Chengdu and Suzhou. These involve the local government distributing a certain amount of yuan through the lottery. Usually, users need to download a separate application to receive the currency. JD.com, one of China’s largest e-commerce players, was involved in the process and allowed customers to buy digital yuan items.

At this time, it is not clear how users could actually own and spend digital yuan when launched nationwide. The most popular form of mobile payment in China is based on so-called fast response codes (QR). Users can display this barcode in the Alipay or WeChat app in a store, and the merchant will scan it.

Xiao of WEF says that commercial banks are likely to integrate similar functionalities into their applications. 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 phone companies take advantage of the opportunity to become a payments player in the market,” Xiao said.

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

“Building a separate system would be an extraordinary waste of such existing resources,” he said.

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

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

The PBOC fan also said that the proposed two-tier model can help “avoid disintermediation in the financial sector”, as the central bank will not compete with commercial banks.

Not. Bitcoin is the so-called decentralized cryptocurrency. This means that it is not controlled by any central authority, such as a central bank, unlike the digital yuan that will be issued by the PBOC.

Bitcoin is also built on a technology known as blockchain. It is unclear at this time what kind of technique would form the digital yuan.

Supporters of bitcoin also support the anonymity of the digital currency.

A PBOC fan said the digital yuan would have “controllable anonymity.” This would involve those operating digital yuan wallets to disclose transactions to the PBOC as the “only third party”. Users would have a “weak account coupling”, which means that their current bank account cannot necessarily be closely linked to their digital yuan account.

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

The PBOC states that agencies operating digital yuan services should “transmit transaction data to the central bank by timely asynchronous transmission.” This would allow the PBOC to “keep track of the data needed” to combat money laundering and crime.

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

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

But today, digital currency has an internal focus, and international use “is not an immediate priority,” according to Bao from Trivium China.

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