Challenges Facing China’s Digital Yuan

In the three years of the Chinese government experimenting with the digital Yuan, the country’s Central bank made significant progress in developing its central currency. The number of digital Yuan transactions has hit 84 billion since late 2019. Also, nearly 4.7 million entrepreneurs across China have come to accept the digital Yuan and are accepting its payments. However, the government of China has banned its citizens from trading or purchasing this virtual currency via Digital Yuan exchanges such as https://yuan-paygroup.com/ since 2017.  Individuals across China use digital Yuan for shopping, dining, personal finance, and business uses such as paying employees and taxes.

However, the People’s Bank of China still has a long way to go in its digital currency project. The use of the digital Yuan pilot programs is decreasing compared to the volume of commerce conducted using China’s two dominant payment systems, namely Ant Groups Alipay and Tencent’s WeChat Pay. Expanding the Peoples Bank of China pilot programs and application scenarios will create demand for software and hardware upgrades at financial institutions and opportunities for smart hardware consumption, therefore attracting more capital into the emerging sectors.

Moreover, the law will require the Central bank to establish and amend regulations. The current rules covering finance, taxation, accounting, and statistics based on a physical currency will no longer apply to the digital Yuan. The reason behind the creation of the pilot program is to build confidence in the digital Yuan’s reliability and ease of use. Additionally, any currency the government creates has three main functions: a store of value, a medium of exchange, or a unit of account. However, for currency consumers, the primary function of a currency is as a medium of exchange. Here are the key challenges facing the digital Yuan.

Subsidization Risk

China is creating momentum via several ways for a digital Yuan launch by cost absorption or subsidization, including zero fees transactions for entrepreneurs and the 10 million Yuan giveaway during the recent trials. The giveaway is likely to lure people, but 2 million individuals applied for the 50,000 red packets gifted in the Shenzhen trial, which can be costly.

On the other hand, some people objected to using the digital Yuan again unless there was additional red packets subsidization. Other than subsidies or direct financial costs risk, people are also worried about the impact of the digital Yuan on the broader payment market. The Chinese government backs the digital Yuan; hence people question how private payment platforms like WeChat Pay will respond to competitors. The big question has been whether these private payment platforms will evolve and survive against the state or whether accidental self-cannibalization will occur. Either way, this digital Yuan is facing the challenge of subsidization.

Competition from Cryptocurrencies

Major Cryptocurrencies such as Bitcoin have become more popular and have experienced huge market capitalization. However, trading this virtual asset between existing holders continues in a country that made up over 90% of global volumes before the ban.

Therefore, the digital Yuan, alongside other Central Bank Digital Currencies, could increasingly face competition from domestic payment infrastructure and the cryptocurrency ecosystem. Moreover, the People’s Bank of China has claimed that the digital Yuan will not rely on the distributed ledger technology from blockchains which could further turn away users attracted by the decentralization.

The Bottom Line

The digital Yuan faces numerous challenges. Among them is the issue of the Central bank and the shadow banking risk. If China implements the digital Yuan concept thoroughly before containing the shadow banking risk, there are higher chances of triggering potential liquidity risks.

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