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e-CNY, China’s Central Bank Digital Currency, and Its Impacts on the Crypto Market

e-CNY, China’s Central Bank Digital Currency, and Its Impacts on the Crypto Market

Recognizing the potentials and efficiency of stablecoins and digital currencies, China has been proactively developing a digital form of its yuan for almost a decade. But it was only when it was announced that they would begin paying public servants in certain regions with the digital Chinese yuan, also known as e-CNY, starting from May 2023, that the world truly began to take notice.

This significant development comes at a time when the whole world is concerned over the weakening of the mighty USD, rising inflation rates, and looming specter of a global recession. Amidst these pressing economic issues taking the center stage, it is imperative to delve deeper and understand the implications of this Digital Yuan and its potential impacts on the crypto market.

A Brief Introduction of e-CNY

The People's Bank of China (PBC) has embarked on an ambitious endeavor to create the e-CNY, a central bank digital currency (CBDC) that aims to fundamentally change the way people transact by providing a digital form of cash. Other than having the same legal status, e-CNY holds an equivalent value to its paper counterpart, the Chinese Yuan (CNY), with a one-to-one exchange rate between the two forms. This means individuals will have the ability to exchange e-CNY for physical yuan and vice versa. Unlike other cryptocurrencies, e-CNY is designed as a legal tender, serving as an official medium of exchange, unit of account, and store of value backed by the government.

According to the e-CNY whitepaper, the operational model of e-CNY follows a centralized management approach with a two-tier system. The PBC holds the authority to issue e-CNY and manages its entire life cycle. Commercial banks serve as authorized operators, exchanging and circulating e-CNY to the public.

Unlike other stablecoins and cryptocurrencies, e-CNY is not built on a blockchain-based decentralized ledger and it primarily serves as a substitute for cash in circulation. Consequently, e-CNY operates under a centralized framework and is overseen by PBC. Its network follows the concept of "One Coin, Two Databases, Three Centers." The "One Coin" refers to e-CNY. The “Two Databases” refers to the two databases stored and maintained by the two tiers of the operational model mentioned above, which are PBC and commercial banks. Last but not least, the “Three Centers” refers to the authentication center, the registration center, and the big data analysis center. The first one manages identity information of e-CNY users; the second one keeps track of the digital yuan circulation; while the third one manages and mitigates risks within the entire system, overseeing tasks such as overseeing Know-Your-Customer (KYC), Anti-Money Laundering (AML), and other risk control measures.

Even though e-CNY is issued by the PBC, other digital payment methods such as Alipay and Wechat Pay have long dominated the space, making many locals question the need for a new form of digital payment. To drive widespread adoption, the government has implemented a range of strategies. These include incorporating digital yuan as a payment option at millions of merchants nationwide, facilitating wage payments for public servants in e-CNY, offering vouchers to incentivize usage, sending e-CNY to new user’s wallets, and integrating e-CNY into Alipay and WeChat, among other initiatives.

The implementation of these effective strategies has yielded significant results. By November 2021, 140 million individuals and 10 million corporates registered for digital yuan accounts. Furthermore, the total transaction values surpassed CNY 100 billion (approximately $13.9 billion) by 2022. While these figures may seem modest when compared to the vast user base and transaction volumes of WeChat Pay and Alipay, they underscore the growing popularity and widespread adoption of the digital yuan. It's important to note that in its first year of public use in 2020, e-CNY facilitated only CNY 2 billion (approximately $290 million).

Currently, the e-CNY network is relatively limited in scale and primarily caters to small day-to-day transactions. PBC is actively engaged in infrastructure development while collaborating with banks, merchants, companies, and even foreign governments to promote the widespread adoption of e-CNY, both domestically and internationally. This concerted effort aims to establish a robust ecosystem that supports the seamless usage of e-CNY and encourages its acceptance on a global scale.

Implications for the Crypto Market

In the rapidly evolving world of digital currencies, the rise of CBDCs presents both major opportunities and challenges for cryptocurrency advocates, especially when the CBDC is backed by one of the biggest economies of the world as in the case of e-CNY. While CBDCs like the e-CNY validate the concept of digital currencies and could potentially drive wider adoption of crypto, their centralized nature contradicts the decentralized ethos of cryptocurrencies such as Bitcoin.

In fact, one of the motivations behind the creation of the e-CNY is to replace stablecoins, as the PBC perceives them as a risk to the international monetary system, payment and clearing systems, monetary policies, and cross-border capital flow management. By introducing the e-CNY, China aims to address these perceived challenges and risks associated with stablecoins.

Furthermore, the e-CNY provides China with a means to further restrict the trading and using of crypto within its borders. China has a long history of imposing strict regulations on crypto, particularly Bitcoin. In 2021, the PBC issued an announcement instructing Chinese banks and payment institutions to halt a wide range of cryptocurrency services, including account opening, transactions, and settlements.

Moreover, the e-CNY is anticipated to lower transaction costs and promote financial inclusion by providing a digital currency that is accessible to individuals without access to traditional banking services. The ability to use the digital yuan without a bank account and store it on a mobile phone facilitates participation in the economy for those previously excluded from financial services. These goals align with the broader objectives of cryptocurrencies. Hence, the adoption of the e-CNY poses a challenge to the use and adoption of cryptocurrencies, as it fulfills some of the same purposes in a controlled manner.

Also, to expand the influence of the digital yuan beyond its borders, the PBC is developing cross-border payment capabilities for e-CNY. This move is expected to help internationalize the yuan, enhance the efficiency of China's cross-border settlements, and surpass existing financial systems, including SWIFT, the largest global financial messaging network at the moment. By leveraging the e-CNY's technological advantages, China aims to position itself as a global leader in digital currencies. Considering the push for e-CNY on a global scale, it appears that China is not only looking to tackle Bitcoin from a regulatory standpoint but also in a competition to establish the yuan as a potential contender for becoming the next global reserve currency, as the dominance of the USD weakens. Though Bitcoin is gaining popularity, it still faces many hurdles in its quest to challenge the USD, mainly due to people's conservative outlook on a new and unregulated form of currency.

Some may argue that the e-CNY could serve as an onramp for cryptocurrencies, as digitized money could easily flow between different wallets. This is similar to how fiat currencies enter the crypto market through the creation of stablecoins like USDT and USDC. However, the Chinese government's complete control over the e-CNY raises concerns. Once the government detects the use of e-CNY in crypto exchanges or in crypto trading, it can swiftly ban the involved wallets. Despite claims by the Chinese government regarding the anonymity of the e-CNY, encryption and decryption processes are closely monitored by the government as evidenced in the “Three Centers” model, rendering real anonymity nonexistent.

Given the fundamental opposition between crypto's ethos and the centralized e-CNY, it is reasonable to question whether China may intensify its crackdown on cryptocurrencies to promote its own digital currency. This potential scenario raises significant implications for the future of cryptocurrencies and the extent to which governments can exert control in the digital finance landscape. These implications are particularly relevant now that an increasing number of governments, including those of the US and the EU, express interest in developing their own CBDCs.

As CBDCs like China's e-CNY continue to emerge, their impact on the crypto landscape remains complex. While CBDCs validate the concept of digital currencies and can drive wider adoption, the centralized nature of these currencies challenges the decentralized ideals of cryptocurrencies which are initiated by Bitcoin. The clash between the e-CNY and cryptocurrencies like Bitcoin represents a larger battle between centralized and decentralized forms of currency. The outcome will not only shape the future of finance but also determine the degree of control governments can exert in an increasingly digital world.

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Disclaimer: The opinions expressed in this article are for informational purposes only. This article does not constitute an endorsement of any of the products and services discussed or investment, financial, or trading advice. Qualified professionals should be consulted prior to making financial decisions.