Recently, China’s central bank — People’s Bank of China (PBOC) — surprised the business and crypto world with its plan to launch a central bank-backed digital currency (CBDC). The news came after the announcement of Facebook’s Libra, creating a perception that China is playing catch-up. But China has put more than five years into researching the idea, and the product, DC/EP (Digital Currency Electronic Payment), was reported even back in 2018.
As expected, most responses to the idea so far have focused on how DC/EP could become the biggest competitor to well-known stablecoins such as DAI and Tether, as well as to Facebook’s not-yet-launched Libra. But the most significant impact China’s DC/EP could have involves another sector: payments.
I believe China is creating a new public infrastructure for payments that is completely open — like cash payment. And this new open payment infrastructure will cultivate many further innovations. An open payment infrastructure is a public service, and the US Federal Reserve, as the US central bank, shouldn’t just watch to see how the Chinese central bank’s big experiment goes. It should be leading similar efforts in the US.
An M0 substitute? Really?
According to the public news (in Chinese), China has positioned its DC/EP product as a substitute for M0, which is basically the amount of physical money in the economy at a given time. China argues that on the one hand, M1 and M2 (which include the less liquid forms of money supply) have already been digitized and there is no efficiency gain to introducing a new digital currency, and on the other hand, M0 has many problems such as counterfeit money and money laundering but has the advantages of anonymity, a feature that consumers like compared to other electronic payment tools.
You might think: That intuitively makes sense since China is less developed and hence more people rely on cash for payment than in other economies like the U.S. Surprisingly, the data says the contrary!
Let’s assume that the ratio of M0/M2 (in case M0 is not available, use ratio of M1/M3) provides a rough idea of the usage of cash in an economy. As shown in the figure above, China’s M0/M2 ratio is only 3.79%. Of all major economies, only the ratios of the United Kingdom and Hong Kong are smaller, and the ratio of South Korea is very close. The United States’s M0/M2 ratio is 21.92%, 5.8x times China’s.
Adoption of new technologies is never immediate or complete. Just like physical newspapers have not been completely replaced by digital newspapers, physical cash cannot be completely substituted by digital cash in the near future. Given the population segments and technology adoption in China, it would be really hard to imagine the ratio of physical cash over total money supply (M0/M2) could go down any further. This creates a big question: what are the real goals of China’s DC/EP product?
醉翁之意不在酒 (The ulterior motive)
I believe China’s DC/EP product is designed to replace the mobile payment systems in China. China’s mobile payment market is enormous, and its volume reached 277 trillion RMB in 2018. That’s about 38 times greater than China’s M0! This might also explain why China’s M0/M2 ratio is so low, as the velocity of money through mobile payments is super fast and thus less cash is needed to support the economy.
Alipay and WeChat Pay are the dominant mobile payment juggernauts in China and have a combined 90%+ market share. However, Alipay and WeChat Pay are digital wallets and their parent companies are not banks. To use the services, consumers first need to deposit money into these digital wallets. However, consumers are charged a withdrawal fee and hence are disincentivized to move money from these digital wallets back to their banks. The result is that these digital wallets store enormous cash reserves that they use to generate significant revenue through investing, lending, and other wealth management products.
Since Alipay and WeChat Pay are not regulated as banks, it creates huge financial risk for consumers. It is no surprise that China has taken actions to protect this money, which reached 1.24 trillion RMB (about 17% of China’s M0) by November 2018.
Another major risk is that Alipay and WeChat Pay are closed mobile payment systems. Payment is a critical component for commerce, and these dominant but closed payment systems absolutely represent a long-term threat to the growth of commerce, especially Commerce 3.0. Closed systems discourage innovations, and monopoly positions will eventually dictate terms for the commerce ecosystem. China’s DC/EP product will disrupt these closed systems by creating a new payment infrastructure that is completely open like physical cash, enabling true peer-to-peer mobile/digital payment. I believe this open infrastructure will stimulate a new wave of innovations in payment, finance, and commerce sectors.
What could go wrong?
China’s approach with the DC/EP reflects an effort to create a cash-like payment infrastructure without going through a financial institution and, more importantly for many entities (instead of just Alipay or WeChat Pay), to conduct transactions.
But China’s DC/EP centralized design does grant powers to the Chinese government, and depending on technical details that are not available yet, those powers can be abused to censor transactions, track individuals and their spending habits, and favor government loyalists.
I sincerely hope that the software of China’s DC/EP will be open-sourced like Libra and that its implementation serves the interest of the people.
As Michael Casey, senior analyst of MIT’s Digital Currency Initiative, points out: “One problem is that CBDCs [central bank-backed digital currencies] will raise fears of state surveillance, especially from China, whose encroachment on civil freedoms has fueled wild protests in Hong Kong. Enterprises and people don’t want their own governments, much less foreign governments, monitoring their expenditures.”
The potential, and why the U.S. must take notice
Cash payment is a completely open system. Neither consumers nor merchants need to rely on any third party to finish a payment. Technology advancement in payments definitely brings benefits to consumers and merchants but also introduces many powerful third-party gatekeepers. Payment networks are subject to a network effect, with the winning systems become dominant gatekeepers.
Payment started to lose its complete openness with the introduction of credit, debit, and prepaid cards as a substitute for cash. The growth of credit cards generated an entire industry of payment processors, point of sale system vendors, and card-issuing banks, each of which are competing for market share and the benefits of the network effect. This battle for consumer wallets was frequently waged at the merchants’ doorstep, with credit card companies trying to lock out competitors and sign up merchants as quickly as possible. The result is that merchants everywhere accept Visa and Mastercard, which started as cooperatives owned by the financial institutions that issue their branded cards, while American Express and Discover have fewer merchants where their cards are accepted.
Mobile payment is an even more closed configuration of that payment system. In China, the winners are Alipay and WeChat Pay, and banks are totally excluded from these mobile payment systems. In the US, Apple Pay and Google Pay are the leading mobile payment systems even though they are not as popular as their Chinese counterparts. Nonetheless, the closed system is maintained — if you are an iPhone loyalist and the merchant only supports Google Pay, you are out of luck.
Cryptocurrency or digital currency, on the other hand, is a completely open payment system like cash. Merchants can create their own digital wallet and share the address for consumers to pay, quite similar to the QR code used in Alipay or WeChat Pay but without the lock-in. Consumers can use any method to send money to merchants. The primary challenge to adoption has been the volatility of cryptocurrency and the cost of getting merchants and consumers to adopt cryptocurrency as a medium of payment.
A government-backed stable digital currency like China’s DC/EP can overcome the stability and adoption challenges all cryptocurrencies face when it comes to being used for payment and could facilitate a new, completely open peer-to-peer payment system. Such an open payment system is a public infrastructure and the government should lead the initiative. The US Federal Reserve should learn from China’s PBOC.
For today’s staunchest Bitcoin supporters, the idea of a cryptocurrency being launched by a central government might seem like anathema. But the original Bitcoin white paper talked not about government but about financial institutions, saying: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
As payments move increasingly to these closed systems, we’re all the more at the mercy of private institutions controlling how we exert our buying power. And this is exactly why we need to move seriously toward making digital currency a public service.
Building such a public payment infrastructure in the US would not be as straightforward as it is in China, of course. It would require Congressional action, executed by a range of federal organizations, primarily the US Federal Reserve and the Treasury Department, and the Office of the CTO for technical implementation. Bringing groups together won’t be an easy process, but if the government does not take action, then we will see private companies like Facebook, JPMorgan, and countless others with private economic motivations step into that payment void to capture the huge amount of value created. In my opinion, that is really what Satoshi wanted to avoid.
[VentureBeat regularly publishes guest posts from experts who can provide unique and useful perspectives to our readers on news, trends, emerging technologies, and other areas of interest related to tech innovation.]
Henry He is a serial entrepreneur, token economics evangelist, and security and IP routing expert. He is the founder of SesameOpen, a protocol that uses smart token design to enable new token-backed business models.
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