The successful application of the Chinese model of digital currency would reduce the ability of the United States to impose sanctions and blockades.
Mangalore
In mid-May 2021, people across the globe witnessed a major downfall in the market for Bitcoin and other cryptocurrencies. This steep fall was seen as a reaction to the latest crackdown by China. This step by the People’s Bank of China (PBOC) has emphasised to orient its actions towards financial and investment stability. The move has come at a time when there is widespread economic instability due to the ongoing coronavirus pandemic across the world. All this in turn has resulted in the rise of geopolitical tensions and commodity prices. The recent measures came at a time when the market for various cryptocurrencies had been on a bullish run. For some time now, cryptocurrencies have shown a boundless growth, for example, the value of Bitcoin has seen a rise of over 300% in the past one year. Such growth trends indicate the formation of a bubble which could make the market for commodity increasingly volatile. The measures to tighten crypto activity by Chinese regulators has sparked a selloff spree of digital assets globally, which resulted in the price fall. However, this is not the first instance wherein China has tried to regulate its domestic cryptocurrency market. There has been a gradual evolution of China’s relationship with cryptocurrency for the past few years. China, which is the most populated country in the world, has also grown to become one of the most important hubs of cryptocurrency mining. Some estimates state that the Chinese in crypto mining account for two-thirds of global production. In spite of such a large market representation, the Chinese government is seen to be averse towards the rising popularity of these currencies. The various containment measures implemented by Chinese authorities, first in 2013, then in 2017 and now the recent one in 2021 are evidence of attempts to restrict the services of these assets by tightening regulations.
REGULATIONS AGAINST CRYPTOCURRENCIES IN CHINA
Before getting into the legal regulations, one must know that China does not recognize cryptocurrencies as a legal tender. Hence, it is neither accepted by the banking system nor any other transaction. The first regulations came way back in 2013 when the arena of digital currency was still at its early stages. According to the 2013 regulations, bitcoin was defined as a virtual commodity by the government. It had allowed individuals to participate in online trading of these commodity freely. However, within a year, several financial regulators including PBOC prohibited banks and other payments companies from providing any services related to these currencies. Again in September 2017, China came up with a ban on the Initial Coin Offerings (ICOs). The rules banned the trading platforms from converting legal tender into cryptocurrencies and vice versa. This induced several cryptocurrency trading platforms to either shut down or move offshore. By 2018, as per PBOC, 88 virtual currency trading platforms and 85 ICO platforms had already withdrawn from the market.
The recent ban reiterated the 2017 measures which had restricted banks and online payment firms from offering any crypto-related services. However, a new measure was the inclusion of institutions into the ambit of restrictive regulations. As per the new policy measures, the PBOC has guided the various institutions not to accept virtual currencies, or use them as a means of payment and settlement. Nor can institutions provide exchange services between cryptocurrencies and the yuan or foreign currencies. In addition to this, the institutions are further prohibited from providing trust or pledging services and issuing crypto-related financial products.
CHINA’S BLOCKCHAIN CONTROL STRATEGY
When one looks at various restrictive measures imposed by the Chinese authorities, at the outset it looks like China is wary of cryptocurrency. However, this is not true as China is seen to have embraced blockchain technology and actively work its way towards attaining global supremacy in the field of both blockchain technology and cryptocurrencies. China seems to be tolerant of these technologies as long as they can be controlled. This approach is in contestation with the original concept of blockchain, as it is conceived as a system that is rigid and resistant to any kind of government interference.
Domestically, China is building a blockchain technology which it can control. For this purpose, it utilises two prongs: a framework for building enterprise blockchain products known as Blockchain-Based Service Network (BSN) and a digital yuan, which is the digital currency of China’s Central Bank. The BSN was launched within one year after President Xi announced that blockchain technology would be made a national priority. It was backed by State Information Center, China Mobile, China UnionPay and Red Date Technology, which oversees the development and operation of the national network.
One of the main features of a blockchain technology is that it allows smart contracts. Due to this, there is always a chance of people posting content onto the network which may not go well with the interests of the Chinese government. In order to mitigate these situations, China has come with a blockchain system that can be controlled by the authorities through a process known as open permissioned service. The service here is a hybrid of several permissioned as well as permission less approaches which aim to control the entire activities that are carried out within the network. Yet another distinct feature of the service which is enabled for users inside China is that it cannot operate with a cryptocurrency, that is when a user is required to pay a transaction fee, one cannot make the payment using blockchain tokens but instead use fiat. This is done by linking the traditional payment system with public chain infrastructure. Therefore, in case if someone needs to pay for something, they are required to go to a specific portal and input their wallets. These wallets can be filled using only real money. Hence the entire system is still regulated and within the purview of the authorities. Further, BSN is built in such a way that it can stop any smart contract that are non-compliant to with Chinese law.
THE DIGITAL YUAN
The digital yuan is a Central Bank Digital Currency (CBDC), primarily being designed to replace cash, which is in circulation. This idea of digital currency will not use blockchain technology like other cryptocurrencies. The PBOC plans to use commercial banks in distributing the digital currency to users. The Chinese idea of digital currency holds the traditional role of banks intact, unlike cryptocurrencies. For example, Bitcoin uses a distributed ledger technology, due to which transactions can be validated without the need of banks. This is seen as a major difference between the Chinese use of digital currency. The push for widespread use of the digital yuan is seen as another method of control by the state, as it will provide greater visibility on money flow in China’s economy. The successful usage would also help in tracking illicit flow of funds, while providing an opportunity for experimenting with the monetary policy.
Hainan is a province in south China, which has been set up as a blockchain pilot zone. The tests were conducted from 12 to 25 April 2021, with the objective of fostering blockchain technology. The tests at Hainan are part of the second batch of cities to undergo the tests. The first batch included Shenzhen, Beijing, Suzhou, and Chengdu. This is a traditional way in which the Chinese government has been functioning, wherein it sets up cities or provinces as experimental zones. Since the development in the technology has been heavily backed by the state, especially through the active involvement of the state-owned enterprises, it is seen as a matter of prestige and the test is used as a cushion. If the blockchain technology turns out to be a revolution in a way intended by the state, it would be rolled out across the country and if the test turns out to be a failure, it will be shut down without affecting the country.
IMPLICATIONS FOR THE REST OF THE WORLD
China is seen as confidently moving towards taking a lead in blockchain technology, especially due to strong backing by President Xi Jinping. The road towards supremacy in the field has been easier because of two reasons—firstly, the absence of major competition from other countries or even regions; and secondly, the domestic push for developing the nascent technology. China, in its 14th five-year plan for 2021-2025 has referenced blockchain technology and digital currency. In the document a chapter called “Accelerating Digitalisation Development and Building a Digital China”, has spoken extensively on the government’s ambitions to strengthen these fields. This also the marks the debut of the term “blockchain technology” in a five-year plan. The plan further lays out the intention of China’s application of blockchain technology in an array of sectors ranging from fintech to supply-chain management and even governmental affairs. However, the idea is through furtherance of the digital yuan.
The successful application of the Chinese model of digital currency would reduce the ability of the US to impose sanctions and blockades. The US currently does this based on the Society for Worldwide Interbank Financial Telecommunication (SWIFT). It is controlled by the US, which also has the ability to obtain information regarding transactions being made using SWIFT. The move by Beijing is seen as a step to increase its monetary sovereignty. The wide scale usage of this technology would hinder the US and other western powers’ role in influencing international transactions, especially using the dollar. This will also provide an opportunity for Chinese entities to transact with companies and states sanctioned by the US.
The rapid digitalization of the Chinese currency along with other political and macroeconomic factors hold the ability to accelerate the decline of the US dollar’s dominance, both for international transactions as well as reserve currency. The steps adopted by China in bringing a digital currency technology through its Central Bank has grappled other central banks to come up with similar strategies. Such a currency which would be overseen by central banks of respective countries will eliminate the fundamental aspect of anonymity and the decentralised nature of blockchain-ledger cryptocurrencies. The possibility of exerting control in the approach followed by China has made several central banks across the globe to look into the prospects of such digital assets.
India too seems to be intrigued by the idea of CBDC. The Indian economy has been making significant strides in adopting financial technologies over the past decade. The increasing dominance of China should be considered as an alarm bell by India. The successful application of Chinese CBDC would enable it to strengthen its control on India’s neighbourhood. Hence, India should ensure it does not lack in terms of monetary leadership, by paving a path into the digital realm. In a conference held in July 2021, T. Rabi Sankar (Deputy Governor of RBI), indicated about the introduction of digital currency in a phased manner. This move, if operational, would help in India’s quest to become a global economic power.
In the international arena, China has grown to become the biggest nation that has come out with a comprehensive blockchain policy. Other than China, a few states and territories like Switzerland and Gibraltar have come up with policies that are intended to encourage setting up of blockchain firms. But there is no real competition to China from other states. Even a superpower like the United States is seen trailing behind China in the area of blockchain technology, where the push is seen only from individual firms and not the state. In fact, these firms are seen to face pressure from the regulators even before the initiation of their projects.