Academy Industry Analysis Article

China’s Pan-Asian Digital Currency Plan and the Push to Break Down USD Dominance

2020.06.26 OKEx
Pan-Asian digital currency image

During a recent meeting of Chinese legislators, one group proposed the creation of a local, regional digital currency. Referred to in the proposal as a “stable digital currency” — and in the media as the “East Asia” or “pan-Asian” digital currency — the proposed currency is aimed at facilitating cross-border transactions in the region.

According to the proposal, it would be backed by a basket of four local fiat currencies: the Chinese yuan, the Hong Kong dollar, the Japanese yen and the South Korean won. The proposal, however, did not explicitly refer to blockchain as the underlying technology for the system. 

The context for the emergence of such a regional digital currency has two main aspects: the global move to digital and the current economic situation spurred on by the COVID-19 pandemic, as well as the dominance of the United States dollar in global trade. The proposal for a pan-Asian digital currency — one that expressly excludes the U.S. and USD — warrants a closer examination of its design and potential impact. 

Why propose a pan-Asian digital currency?

The concept of a stablecoin for the East Asia region was proposed at a session of the Chinese People’s Political Consultative Conference last month, part of the larger annual “Two Sessions” meeting on China’s national policy. According to Neil Shen, managing partner of Sequoia Capital China, who presented the project at the meeting, the pan-Asian digital currency will serve three objectives: 

  1. Lower exchange rate risk in cross-border transactions (facilitating trade in the region)
  2. Improve settlement efficiency
  3. Provide a testing environment for China’s Digital Currency Electronic Payment, or DCEP

The proposal suggested that the development of such a regional digital currency would be supervised by the PBoC, China’s central bank. However, it would be designed and developed by private sector firms.

In terms of problems that the currency’s creators are looking to solve, the focus of the proposal was on trade and cross-border settlement efficiency. The proposal highlighted the need for economic recovery in Asia following the effects of COVID-19.

The proposed currency was not presented as a replacement of the four fiat currencies that would back it as an official regional currency (like the euro in the Eurozone). Rather, it was proposed as a tool for making transactions between those four currencies and countries cheaper and more efficient, with the notion that this would help stimulate trade between them.

Looking at exchange rate risk, as mentioned above, one of the fiat currencies backing the proposed coin is the Hong Kong dollar, whose value is pegged to the U.S. dollar under the linked exchange rate system. Since Hong Kong is the main global offshore business hub for the Chinese yuan, accounting for 70% of total offshore RMB payments conducted vis-à-vis mainland China and within the global offshore market, HKD’s inclusion can help stabilize the proposed currency and encourage enterprise adoption. 

According to Shen, further value stabilization can be achieved by referencing the weight of fiat currencies from the special drawing right of the International Monetary Fund.

Settlement efficiency is the second objective of the proposed pan-Asian digital currency. Data from the World Bank indicates that the cost of sending money to China is 9.04%, which is much higher than the global average of 6.84%. The proposed digital currency is described as allowing enterprises to use dedicated digital wallets to conduct peer-to-peer cross-border payments. 

Finally, the pan-Asian digital currency also provides a testing environment for China’s DCEP, the country’s digital yuan system currently in development. Shen’s proposal indicates that the pan-Asian digital currency would facilitate seamless integration with the DCEP, serving as the first platform for its adoption. The proposal also suggests research collaboration between the PBoC and the Hong Kong Monetary Authority in areas such as cross-border fund transfer, transaction record-keeping and anti-money laundering policy.

A new Libra competitor

The emergence of a pan-Asian digital currency would — and indeed already has — inevitably draw comparisons with Facebook’s Libra, especially when it comes to cross-border payments. The very design proposed for the pan-Asian currency — a stablecoin backed by a basket of fiat currencies — closely resembles the most recent proposed design for Libra coin. 

Given Facebook’s massive user base, Libra coin has the potential to reach billions of people if it was launched and integrated with Facebook’s products. To be exact, Facebook currently has 2.3 billion monthly active users, with 1.1 billion of these users in the Asia Pacific region and 200 million WhatsApp users in India alone.

On the other hand, the proposed pan-Asian digital currency could potentially match these figures, if not exceed them, if it were to go mainstream just in China — pushed along by local regulators. 

In fact, in terms of adoption, one distinct advantage held by the proposed pan-Asian digital currency over Libra coin is regulatory support. While Libra has yet to receive a green light from U.S. regulators and is very much led by the private sector, the proposed pan-Asian currency is expected to comply with the Chinese regulatory authorities by design and integrate with the DCEP.

In comments to OKEx Insights, Dr. Alicia Garcia-Herrero, chief economist for Asia-Pacific at investment bank Natixis, noted that this regulatory support significantly increases the pan-Asian currency’s chances of success:

“Compared to Libra, which is a private currency, the Pan-Asia digital currency is driven by central banks and thus it’s much more likely to succeed. The question is whether it may challenge the USD.”

Challenging the market dominance of USD

Given the current dynamics of the global economy, it can be argued that this pan-Asian digital currency could be a tool for China to counteract the economic dominance of the dollar and the United States. 

While the U.S. only accounts for 10% of global trade and 15% of global GDP, half of the global trade invoices and two-thirds of global securities issuance are settled in USD.

In the Asia-Pacific region, China may be seeking to counter this pattern with its “Belt and Road” initiative — the Chinese government’s global strategy to develop infrastructure for trade and commerce, introduced in 2013.

According to a Morgan Stanley report from March 2018, countries that are part of the initiative present China with a huge opportunity to extend its economic influence, as they “account for 30% of global nominal GDP, 40% of global GDP growth and 44% of the world’s population.”

One of the key investments in the Belt and Road initiative is the $68 billion China-Pakistan Economic Corridor, which is accompanied by various other projects (worth over $200 billion) connecting China to Pakistan’s Gwadar Port.

While these figures reflect China’s focus on the initiative, the Morgan Stanley report estimates that the country’s total investment in Belt and Road projects could reach $1.2-$1.3 trillion by 2027.

However, despite these efforts, the U.S. dollar remains dominant in financial markets, accounting for 61.63% of globally allocated foreign exchange reserves as of Q2 2019, followed by the euro and yen. As of Q2 2019, China only accounted for 1.97% of globally allocated forex reserves.

Currency composition of FX reserves as of 2019. Source: Reuters, Refinitiv Datastream

If adopted in the region as a settlement currency for trades and investments in the Belt and Road countries, the proposed pan-Asian digital currency could help boost the yuan’s share of allocated forex reserves.

Moreover, with the pan-Asian digital currency facilitating low-cost cross border transactions, it may appeal to countries in the African region, which have historically struggled with high payment costs

For cross-border transactions in Africa, local banks need to comply with excessive regulations and thus they charge higher remittance fees. However, with 39 African countries listed in China’s Belt and Road initiative, the pan-Asian digital currency may prove beneficial in terms of reduced payment costs and in turn extend the influence of RMB, challenging USD dominance in the region.

Growing remittance market demands digital solutions

The current digital remittance market in Asia in particular presents enormous potential for disruption due to the high costs involved. Digital remittances, referring to money transfers using digital networks and applications, are growing exponentially and are expected to reach $269.78 billion by 2026. 

Moreover, in the case of China, the urban upper middle class population is expected to quadruple between 2012 to 2022, leading to a sustained increase in cross-border remittance payments for education and personal costs.

The growing remittance market requires digital solutions, strengthening the case for a pan-Asian digital currency. However, according to Dr. Garcia-Herrero, the launch of such a solution may require it to be pegged to an anchor currency:

“The only way I can think of this (blockchain-based digital currency) being feasible in a reasonable period of time is to use an anchor currency, which will no doubt be the E-RMB and have other currencies (possibly digital but not sure if necessary immediately) peg to the anchor currency.  One can of course think of a band as was the case for the exchange rate mechanism before the euro was created.”

While there are regional incentives when it comes to payments using a pan-Asian digital currency, the demand for cost-effective payment solutions extends far beyond Asia and, again, is particularly evident in Africa. Statistics from the World Bank indicate that Sub-Saharan Africa had the highest global average remittance costs in Q1 2020 — at 9% — well above the sustainable development goal of 3%. 

An opportunity for China and Asia

In December 2019, the European Central Bank noted that if the private sector could not develop an efficient pan-European payment solution, it would consider creating a Central Bank Digital Currency. 

Given this changing landscape and the move towards digital currencies among central banks in general, the proposal for a pan-Asian digital currency appears timely and relevant.

The development of a regional digital currency could allow Asia, and particularly China, to compete with USD dominance in the coming wave of increasingly digitized economies.

Commenting on such a scenario, Aly Madhavji at Blockchain Founders Fund told OKEx Insights that USD dominance could get “etched away slowly” with the emergence of a digital yuan and a pan-Asian digital currency:

“The US Dollar hegemony could start to get etched away slowly. We have already seen a Yuan denominated oil contract which accounts for more than 14% of oil trade on major exchanges. The Digital Yuan, Libra, and  the pan-Asian digital currency initiatives can have a major impact on USD dominance if they continue to bypass regulatory hurdles and generate support from institutions and governments.”

Highlighting the significance of this development as a potential harbinger for digital economies in the region, Henri Arslanian, PwC global crypto leader and partner, told OKEx Insights:

“This announcement is another example of the leading role that Asia may be playing not only when it comes to the future of digital assets but also potentially the future of money.

Whilst there is a lot of attention on China with its DCEP, some of the other smaller countries across Asia, like South Korea, Thailand or Cambodia, are working on their own interesting CBDC initiatives as well. And now the news of a potential pan-Asia digital currency simply reinforces the importance of Asia in the global conversation on the topic.” 

In any case, as Dr. Garcia-Herrero pointed out, China stands to benefit from a regional digital currency led by its central bank: 

“This sounds very much like pushing the e-RMB as no currency can start from zero (not even the euro did). The model the PBoC has chosen, a central distributed ledger, can help them trace the flows and, thus, allow for control of capital will still try to push the international use of the RMB.”

However, the U.S. is unlikely to forfeit its market dominance without a fight, which makes the digital currency space all the more interesting to watch as central banks and private organizations participate in the race for global economic influence.

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