China is driving the digitization of its currency, which could change cross-border trade. Can the rest of the world afford not to follow?
“M.om, please I need one, ”said an angry Jeremy Crain to his suffering mother.
“You got a PlayStation last Christmas, we’re not going to get you an Xbox as a young man.”
“But you don’t understand, all the other kids have one and I can’t play Halo with them online if I don’t have it.”
“Then all you have to do is find another game to play with your friends, but we’re not getting you another console just so you can talk to your friends. You spend enough time doing these things as they are.”
When Jeremy stormed into another room he was furious about how unreasonable his mother was, how she didn’t understand, or what it was like to be a teenager using a PlayStation while everyone else was on Xbox.
But to the uninitiated, Jeremy’s complaints may sound false, or even unreasonable, because aren’t all game consoles roughly the same?
PlayStation gamers and Xbox gamers swam in their own tracks.
Deciding which console you wanted, whether an Xbox or a PlayStation, was often a function of the games you wanted to play rather than the performance of the equipment.
For a teenager, the cost of not having the right console can be a matter of social life or death, and potentially associated with exclusion from social outings, events, and conversation.
Imagine what exclusion should feel like for banks.
Are you one of us
Banking is a network and it depends on a complex web of relationships to ensure that money can get from a place like Caracas to a place like Cochin.
And exclusion from this network can be not only costly but also crippling.
International business is facilitated by a complex network of trade finance that includes bills of lading, letters of credit and a network of correspondent, intermediary and beneficiary banks, each taking their pound of meat from the transaction.
However, this could change with the advent of the central bank-issued digital currencies “CBDCs”.
While central banks from New Delhi to New York have all toyed with the idea of issuing their own CBDCs, a recent survey by the Bank for International Settlements found that up to 80% of all central banks were considering issuing their own CBDCs – only one major central bank has done this – the People’s Bank of China.
Inside the Great Wall of China, China introduced blockchain technology to develop new trade protocols and cross-border trade regulations that would support its digital yuan.
Many of the Chinese systems based on blockchain technology will reduce, and in some cases eliminate, the burden on world trade from the old trade finance system, which is still heavily reliant on paper.
Central to Beijing’s pursuit of such blockchain-based trading systems is that China’s CBDC, the digital yuan, will be the elixir of life flowing through the system.
While the digital yuan is currently limited to domestic use in China, it is only a matter of time before it is used for cross-border trading.
What size rail is important
But just as a traveler to China is rash without WeChat Pay (the ubiquitous digital payment app that pays for everything from taxis to travel agents), so too can companies looking to do business with China find that their non-digital dollars do so will no longer be accepted day.
Or their versions of digital currencies must use the same protocols developed by Beijing.
Keep in mind that over 60% of the world’s railways use the 1435mm standard gauge, which is an incentive for the entire rail ecosystem to bypass this standard gauge.
If China uses a particular blockchain protocol or process to set the precedent for global cross-border transactions, then over time this may well become the standard measure – the digital yuan.
However, the immediate impact of the digital yuan is likely to be felt more by China’s closest neighbors than the US.
Currently, the volume of trade between the ten member states of ASEAN, a group of Southeast Asian states, is China’s second largest trading partner, ahead of the USA.
The digital yuan would instantly make itself felt in ASEAN as elsewhere as it is a replacement for the US dollar-denominated trading practices and processes that are the norm today.
A digital yuan would also reduce the time it takes to process trades, especially for more routine transactions that are regularly conducted between China and ASEAN.
According to some estimates, trade settlement with the digital yuan can be reduced from six weeks to several days using blockchain technology, and a digital yuan can reduce this to hours.
In business, time is money. Given the choice between using the dollar and waiting for the funds to arrive and using the digital yuan, they may opt for the latter to lessen the impact of trade processing on cash flow.
The key to the speed of digital yuan-based trade processing is the elimination of foreign currencies, especially when processing trade transactions as part of China’s massive Belt and Road initiative.
Build it and they will come
China’s Belt and Road Initiative is said to already be using the yuan as a settlement currency, but a digital version could help speed up the transaction speed and thus increase acceptance along the Belt and Road Initiative (“BRI”).
China’s ambitious BRI is a huge infrastructure and trade project and seeks to revive old trade routes via the so-called “world island” and to connect China with Europe and Africa via the massive unified continental land mass.
When the BRI is completed, it could serve as a physical rail for the digital yuan.
But not only BRI could use the digital yuan.
Since cross-border settlement of currencies in yuan is still based on the US-dominated SWIFT system that was armed during the Trump administration to carry out US foreign policy, the digital yuan, which bypasses the SWIFT system entirely, offers an independent alternative to counterparties that would otherwise be blocked by US foreign policy measures.
China’s digital yuan could dramatically increase its sphere of influence in its own backyard, and companies looking to trade with China would otherwise be left out if they didn’t adopt the digital yuan.
China’s pioneering advantage in CBDCs is still in its infancy, but it puts it in the driver’s seat when it comes to developing payment tracks that would support other countries’ CBDCs.
The network effect of an early start of the digital yuan would mean that the lines established by Beijing to facilitate cross-border transactions in digital currencies would become railroads that other countries could use to transact their digital currencies.
Beijing may set an alternative to the US-dominated dollar-based system, from which the lockout price could potentially be high.