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Can a global power just invent a new currency, make it digital and give it some favorable traits? Apparently, China can.

A recent article of the Wall Street Journal sparked my interest in the Digital Yuan, a new digital currency that has the potential to disrupt today’s global financial system.

The Digital Yuan’s Design and How it Works

Essentially, the Digital Yuan is a digital payment method like Bitcoin. However, unlike Bitcoin, it negates the anonymity aspect and gives full control to the Chinese central bank. According to Mr. Mu, a Chinese central banker, the Digital Yuan is designed to protect the Chinese currency sovereignty and legal currency status.

In a sense, the new currency shares of lot of traits that services like WeChat Pay already offers. Digital Yuan will be available on the owner’s mobile phone or physical card and spending the currency does not strictly require an internet connection. The user interface will depict a Mao Zedong silhouette as current paper money does.

All that isn’t just dreams and future goals. In recent months, China has tested the system and more than 100,000 people downloaded a corresponding app to use the currency. Apparently, Digital Yuan will circulate alongside paper currency and coins at first. Under oversight of the central bank, it is said to be distributed through China’s six biggest commercial banks which then pass on the currency to smaller banks and app providers like Alipay and WeChat.

Advantages and Drawbacks

One of the major advantages of Digital Yuan stems from its nature of transactions. It is designed to provide instantaneous currency transfers without the need for middlemen. By cutting out transaction service providers, the central bank gains increased control over the currency flows. Additionally, cutting out fees and transaction expenses might turn out to be Digital Yuan’s greatest marketing asset. Reportedly, 1.7B people globally have no access to a bank account. Oftentimes, those people cannot afford the expensive fees at marginal transfers, thus likely favoring the instant and more affordable digital version.

Video Source: CNBC

But what’s so problematic about the Digital Yuan? One important similarity of today’s currencies is that they are tethered to the global financial system which is in itself tethered to the U.S. Dollar (at least to a very large degree). 88% of international foreign-exchange trades are conducted using the Dollar and the U.S. government is the controlling institution with the ability to monitor transactions. Although the Digital Yuan is meant to work in the international financial system, it will function untethered to the Dollar. Thereby, the U.S. government will directly lose oversight over a portion of international transfers. Particularly, the U.S. government’s ability to impose sanctions on individuals and institutions is decreased.

While China’s efforts in digital currencies represent the most advanced progress on the scale of a global power, the U.S. central bankers have not ignored the technology. Fed’s Chairman Jerome Powell has referred to digital currencies as a “very high-priority project”. Kevin Warsh, a former Fed governor, paints a more specific picture. “If we wait 5 or 10 years, we may well end up with some very bad policy choices”, Warsh said.

European Perspective on Digital Currency

As a German citizen, I cannot disregard the European perspective on the topic. Hence, I am happy that there is at least a “Report on a digital euro” from October 2020 available on the website of the European Central Bank. Although it alludes to a vast range of advantages and even necessities, given the changing economic and financial environment, it also highlights infrastructure and legal challenges. I am looking forward to future, more concrete, steps in this direction.

Closing Remarks

Obviously, there are many more areas to discover about the topic. I am sure that the technology will become increasingly relevant. Therefore, I am curious what is yet to come.

As always, thank you very much for reading. Please feel free to leave feedback!