China’s cryptocurrency power play

China is rolling out testing of digital currency in Beijing and the financial centres of Shanghai and Shenzhen. Trials of 'e-renminbi' (eCNY) position the People’s Bank of China (PBoC) as a global leader in moves towards implementing Central Bank Digital Currencies (CBDCs).

Most central banks have approached solutions based on blockchain with caution. After all, distributed ledger technology is essentially about decentralisation. Still, those at the top of the financial system need to get ahead of trends like the decline of cash payments, booming cryptocurrency trading and the craze for non-fungible tokens (NFTs) which are taking blockchain mainstream.

In the view of Vytautus Zabulis, chief executive of digital asset trading firm H-Finance: “With the pandemic, the move away from cash might force central banks to reconsider the possibilities that blockchain technology can offer if they want to have a stronger presence in the digital world of finance.”

Potential advantages include nearly eliminating the cost of clearing and settling securities, which blockchain software company Consensys estimates is $50bn a year in G7 countries. There is also an argument that financial crime might be inhibited, thanks to money on the blockchain and people’s balances being visible to authorities and the public.

But inclusion and transparency have a sinister aspect. Although there is no need to disclose publicly who owns accounts, the ease with which government bodies will be able to monitor activity raises questions about civil liberties.

Furthermore, combined with China’s lending to developing countries and the role its largest companies have in payment services, the integration of eCNY as a potential reserve currency has immense geopolitical significance.

e-renminbi, controlling finance and the digital Belt and Road

Chinese companies are world leaders in e-commerce, gaming, messaging apps and plugging payments solutions into their businesses. Yet, the Communist party is wary of ambitions in the private sector.

There is no greater illustration of this than the decision to halt Ant Group’s initial public offering (IPO) last autumn. The payment company, which was spun out of e-commerce group Alibaba (HKG:9988), was supposed to be floating in one of the biggest capital raises in history. But regulators slammed the brakes on the deal at the last minute.

Comments by Ant’s controlling shareholder Jack Ma, criticising China’s banking system, were widely blamed for the crackdown, which cited ‘financial stability’ concerns. Financial technology (fintech) platforms also present opportunities to decentralise finance and undermine the party’s control of the economy.

One of the ways the PBoC can keep companies like Ant Group and Alibaba on a leash in future is to embed the e-renminbi into the monetary system. It is arguably a perfect example of how the most central of authorities can use a distributed technology network to its advantage.

“You can say it [blockchain] is decentralised, but actually if you want to track everything you can do it easily,” says Zabulis, “they can see all the flow, all the wallets. It’s extremely powerful.”

China has long been concerned about regulating and limiting shadow banking activities. Blockchain ledgers are the perfect way to monitor loans. Before stricter oversight was introduced late in 2017, much shadow lending had been via banks’ off-balance sheet wealth management products, along with various trust products from non-bank institutions.

Fintech solutions open the possibility of greater levels of peer-to-peer financing and unsecured credit from companies, which gives context to the government's desire to rein in Ant Group.

China isn’t anti-capitalist, but its government has different expectations of big companies compared with those in the west. “What China doesn’t want”, says Gartner analyst Dale Kutnick, “is American-style laissez-faire, winner-takes-all capitalism.”

In practice this means big technology companies must help do the bidding of the Party, including when strategic foreign policy is concerned. Chinese technology firms are less objectionable emissaries than the government and their solutions are becoming embedded in the digital infrastructure of emerging economies.

It will not be a huge leap for payment solutions in technology such as messaging apps to support the roll out of eCNY as a reserve currency, which would give China ever more leverage in countries where Chinese tech is widespread. It is a digital and monetary manifestation of the controversial Belt and Road initiative (China’s policy of spreading its influence through ownership of foreign infrastructure and supply chains).

Global reserve status and ‘dollar imperialism’ has long been a lever of American power and defending the greenback’s status will be a priority that drives CBDC creation. There is also the need to have a foothold in the decentralised finance (DeFi) economy which looks set to explode.

Blockchain technologies will facilitate disintermediation of loans and liberalisation of capital but in a fully open and transparent way, a bit like shadow banking but without the shadow. No central bank can sit on the side lines and watch such a revolution.