Bitcoin and Reserve Currencies Vol. IV: The Digital Yuan and the Race to Central Bank Digital Currencies

The Chinese government already had one of the more unique currency frameworks with an onshore and offshore version of their currency - the Yuan. One reason for this unique setup is likely so that the government can exert extreme control over its citizens and their ability to move their money outside of China.

Source: Nasdaq.com

In 2018 Nasdaq wrote, “Greater volatility is more likely to be seen in the CNH than the CNY when they respond to the same event.”

In order to increase control further over its monetary sovereignty, the Chinese government has banned bitcoin and bitcoin mining, but the Communist Party seems to have been inspired by the cryptocurrency to implement a digital currency of their own. This is a significant development as the Communist party could attempt to roll out the Digital Yuan across its Silk Road footprint. The country is reportedly even utilizing the technology during the upcoming Winter Olympics by requiring visiting athletes to use the new digital currency while competing in China.

Such moves to implement a digital currency have likely pushed other nations to follow suit. Notably, the Federal Reserve’s Chairman Jerome Powell as late as 2019, had stated that it was not currently working to roll out this digital currency. However, their stance has since changed, as the Fed has reportedly accelerated its work towards implementing a digital dollar.

In the US, the Federal Reserve has planned a review of the potential benefits and risks of a CBDC, or central bank digital currency, according to a report from The Wall Street Journal. This so-called digital dollar would incorporate elements of decentralized cryptocurrencies, like bitcoin, but with a major difference: It's issued and regulated by the country's financial authority. And the US isn't alone. There are dozens of countries engaged in some stage of researching CBDCs, according to Kristalina Georgieva, managing director at the International Monetary Fund.

A CBDC is just the digital form of a country's official currency. As nothing more than a computer code, these currencies could be stored on central ledgers within a country's national bank or on a distributed ledger the way private cryptocurrencies like bitcoin are.

Sources:
September 2018, Nasdaq.com. “CNH vs CNY: Differences Between the Two Yuan”
April 2021, CNBC. “China may test its digital currency with foreign visitors at the 2022 Beijing Winter Olympics”
November 2021, WSJ. “Powell Says Fed Has No Plans to Create Digital Currency”
May 2021, Financial Times. “Powell advances Fed work on possible ‘Digital Dollar’”
November 2021, CNET. “Central bank digital currencies: Everything you need to know.”

Central Bank Digital Currencies or CBDCs seem inevitable at this point. In 2011, Marc Andreesen wrote in his opinion piece “Why Software Is Eating The World”, in the Wall Street Journal.

As governments get on board, sirens are wailing with the threats CBDCs potentially pose to privacy. Despite the various risks associated with digital currencies, however, there are plenty of benefits as well. Weighing the costs and benefits will be important for future government officials and voters and may vary based on region.

Millennials are the last generation to grow up without being completely immersed in digital technologies. Many innovations were introduced halfway through their adolescence. Despite the close age of Millennials with Generation Z, colloquially known as Zoomers, even these generations may view the government’s use of digital currencies differently.

The video below focuses on digital identity and wallets. These features are attached to the hip of digital currencies.

In the video, there are numerous stated advantages to digital wallets and identifiers. For starters, the video above makes it clear that identity services will be a standard facet of digital wallets that will make everything from healthcare to accessing government services, such as renewing a passport, more frictionless.

Another potential opportunity for currency with digital identifiers is built-in tracking and security mechanisms that would help protect users against fraudulent activity.

While Central Bank Digital Currencies may be designed to facilitate the privacy of identities from corporations, the concept would, more broadly, infringe on the privacy of citizens from governments.

As stated above, Chinese Authorities are already exploring a digital currency, in part to help facilitate their ability to increase transparency on private spending and transactions. This type of transparency would be considered a huge violation of privacy for some, and the United States would not be immune to the same privacy concerns if such technology was employed here.

For example, after the tragic events that occurred on September 11, 2001, the U.S Government wielded significant surveillance powers over citizens in an effort to bolster national security. Privacy for citizens, however, was weakened with the ACLU writing, “Over and above the invasion of privacy represented by any one specific program, a combination of new technologies, expanded government powers and expanded private-sector data collection efforts is creating a new ‘surveillance society’”. Not that this is the same type of situation as a potential threat to national security, but we can see potential for individual privacy rights being diminished when it comes to the surveillance of financial transactions in everyday life.

Sources:
October 2015, BBC. “China 'social credit': Beijing sets up huge system”
September 2015, Reuters. “NSA staff used spy tools on spouses, ex-lovers: watchdog” NSA staff used spy tools on spouses, ex-lovers: watchdog | Reuters
January 2022, ACLU. “Top Ten Abuses of Power Since 9/11 | American Civil Liberties Union (aclu.org)”
May 2018, Wall Street Journal. “The Unresolved IRS Scandal”

Some of the most valuable companies in the world are focused on processing payments and holding/protecting our money. Below is a quick description of the Federal Reserve’s FedNow Services that is currently in development:

“The FedNow Service is a new instant payment service that the Federal Reserve Banks are developing to enable financial institutions of every size, and in every community across the U.S., to provide safe and efficient instant payment services in real-time, around the clock, every day of the year. Through financial institutions participating in the FedNow Service, businesses and individuals will be able to send and receive instant payments conveniently, and recipients will have full access to funds immediately, giving them greater flexibility to manage their money and make time-sensitive payments. Consistent with the Federal Reserve’s historical role of providing payment services alongside private-sector providers, the FedNow Service will provide choice in the market for clearing and settling instant payments as well as promote resiliency through redundancy.”

Imagine you are at the butcher’s store in town. Instead of swiping your card and him losing 2% of his sales to pay the credit institutions backing the card, you just transferred him money directly using FedNow compliant wallets designed by your financial institution.

The implications of this are pretty significant, although not set in stone. While we should not expect payment companies like Visa and Mastercard to go down without a fight, we can still be cognizant of the progress the Federal Reserve is making to keep pace with the digital evolution of regulated currency and perhaps with China’s progress with their digital currency efforts.

Sources:
About the FedNowSM Service
March 2017, ProPublica. “Filing Taxes Could Be Free and Simple. But H&R Block and Intuit Are Still Lobbying Against It. — ProPublica”

In Vol I of our series on Bitcoin and Reserve Currencies we wrote, “While many people who get involved with Bitcoin think of it as an alternative investment or a speculative tool, Bitcoin enthusiasts assert that it is the finest money ever created. Some have gone as far as saying that the US dollar will be replaced by Bitcoin as the global reserve currency.”

In that piece, we discussed that its status as hard money would make it difficult to expand credit throughout an economy. This gives Bitcoin the potential to serve as a good store of value but would make it tough for the cryptocurrency to act as a reserve currency.

However, Bitcoin was still a trailblazer in terms of popularizing digital assets. So much so that it has forced global governments to begin experimenting with new types of monetary technology. This is no small feat.

China banned Bitcoin and Bitcoin mining from its national borders, but not before taking some inspiration from the digital currency.

And while Central Bank Digital Currencies are just as digital as cryptocurrencies, they are not cryptos by definition.

No matter what your opinion is of Central Bank Digital Currencies, they are in the works and they are set to impact the economy, even if we are not sure just yet of how large that impact will be.