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China’s digital currency scare
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Mark Zuckerberg, in his October 23, 2019 testimony before the U.S. House of Representatives, positioned the Libra project as the answer to China's efforts to create its own digital currency and raised the alarm of a weakening American financial leadership. He also warned that foreign companies and countries that are launching their own digital currencies might adopt values contradictory to America's own and, therefore, may weaken the support of democracy and fundamental rights.
In an interview with Bloomberg David Marcus, Calibra CEO and Libra Association board member, expressed the same worries. He said that the U.S. risks “having a whole part of the world completely blocked from U.S. sanctions...and having a new digital reserve currency with no alternative." At his testimony before the U.S. Senate, he said: "If we fail to act, we could soon see a digital currency controlled by others whose values are dramatically different." He added that "Chinese progress could represent a real threat to U.S. influence."
Other voices have jumped on the alarmism bandwagon. "If Libra fails, China wins" declared RBC Capital Markets. Blockchain and crypto thought-leaders and influencers have also been pushing the US vs. China digital showdown.
The politicization of Libra's mission is quite remarkable. It may be well-timed given Washington's current partisan mood and aggressive trade posture, however, it's built on tenuous arguments.
China's digital currency is designed to tighten control over its own citizens, companies, and economy
The People’s Bank of China (PBOC) announced that it's developing and soon deploying a digital version of its currency, the yuan. This deployment is considered to be a first in the world. What China is about to launch is called a Central Bank Digital Currency (CBDC), and according to reports, centralization is the name of the game:
Two companies, Alipay and Tencent, control 94% of mobile payment transactions in China. China's central planners are not going to allow private companies to dominate the financial backbone of the country. The PBOC is working to regain its powers (Source). The digital yuan will deal a big blow to Chinese firms.
In digitizing the yuan, the PBOC aims to provide an alternative to unregulated cryptocurrencies such as bitcoin. In a country where the internet is heavily censored, cryptocurrency trading is prohibited, and with mass surveillance, this strategy makes perfect sense. China does not want to allow for any currency that's not under its watchful eyes.
By issuing a digital currency, Beijing aims to cut the costs of circulating paper money and boost policymakers’ control of the money supply (Source).
This excellent analysis by Coin Desk shows how China's digital currency will barely resemble bitcoin. The report highlights the central management of China's CBDC, a far cry from bitcoin's trustless peer-to-peer vision.
It will take much more than digitization to establish the yuan as a de facto global currency
The RBC Capital Market analysts wrote that "...China’s central bank digital currency may be strategically positioned to become the de facto global digital currency in emerging economies." The analysts based this conjecture on the widespread use of China's technology platforms around the world, i.e., WeChat and Alipay, which “represent the greatest opportunity to onboard consumers to digital wallets.”
Indeed, a large installed base of apps could easily and with near-zero cost distribute wallets to the masses. However, much more needs to be in place to achieve digital currency "supremacy." In the case of the digital yuan:
Wallet distribution is one side of the equation. On the other side is the cash-in/cash-out or "last mile" distribution. Users, say in Indonesia or Paraguay, must have an accessible way of converting their local currencies into the digital yuan and vice versa. In China, commercial banks will be responsible for distribution. Globally, to reach a critical mass, vast agent networks must be in place to provide reliable cash-in/cash-out services, ultimately at a cost to the end-user. This investment is enormous and prohibitive, especially when trying to reach the coveted 1.7B unbanked.
Today, the share of allocated global currency reserves held in yuan is a meager 1.97%, as opposed to the 61.63% held in U.S. Dollars. Central banks and investors have largely shunned the yuan because its price is manipulated, China's monetary policy is unpredictable, and its economy and financial system are not open (Source). Why would digitization of the currency change that?
As a store of value, I find it hard to believe that the masses would abandon the U.S. Dollar and gold for a digital yuan. I wrote about Venezuela, where bitcoin failed to act as a store of value for the masses. Compared to the U.S. Dollar, bitcoin in Venezuela is out of reach and lacks trust. Like bitcoin, the digital yuan will not be the chosen medium to store value.
But perhaps the digital yuan would dominate the cross-border remittance business? Without trust and accessibility, it can't. Users must not only trust that the Chinese economy will remain stable, but they would also have to contend with the specter of privacy infringements.
Central bankers will resist digital foreign currencies. In an article I wrote about Libra, I explained how regulators would regard the digital currency as economically weakening and an aggravator of money laundering and terrorism finance threats. Central banks will restrict or curtail the use of Libra and the digital yuan until their concerns vanish.
What about sanctions evasion? Would bad actors flock to the digital yuan? Probably not. China plans to tightly oversee its digital currency to the point that it can track the identities of its users and every transaction they make, a disincentive for bad actors. Of course, politics will play a role, but how is this any different than what could happen in today's fiat world?
Trust is the foundation of the Internet of Value
Comparing the Internet of Value to the Internet of Information led to the mental shortcut that cryptocurrencies, through network effects, would rapidly become the standard for money. Another fallacy is the assumption that there will be a winner take all scenario: just like in the case of Information where we have dominant internet giants, there must be dominant digital currencies as well. But in contrast with Information, Value is underpinned by trust. Value directly impacts people's livelihoods and wellbeing, Information does not. Trust is complicated and cannot be "dominated" by a few entities, at least not in the short term (this could be a good topic for a future article).
In today's world, institutions, like central banks, provide trust in money. If cryptocurrencies are to dominate the future, then smart contracts should underpin trust (programmable trust). Programmable trust is still evolving and has yet to prove itself.
China is developing the digital yuan on top of its existing trust infrastructure; the digital yuan is, therefore, not fundamentally different than its fiat version. And because of that, it will not reign supreme globally.
In the near future, there will be many digital currencies, and none will dominate
In another critique of Libra, I pointed out that there are many digital money initiatives (e-money) around the world. Most of these aren't built on distributed ledger technologies. These e-monies will probably evolve and plug into financial blockchain networks like Ripple, and perhaps themselves turn into CBDCs or crypto-like versions. Nations will be protective of their money supplies and oversight over their digital currencies. The U.S. Dollar will remain the world's preferred reserve currency, whether the Fed issues its own CBDC or not. Libra, if it successfully launches, will most likely be used as a conduit for cross-border transfers, but not for daily living expenses.