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Will China’s digital yuan pose a threat to the country’s fintech giants?

Alipay and WeChat Pay have almost turned China into a cashless society. The digital yuan might carry it even further.

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The People’s Bank of China (PBoC) has been quietly working on its sovereign digital yuan, officially known as China’s Digital Currency Electronic Payment (DCEP), since 2014. Recently, it launched a trial version in four cities—Shenzhen, Suzhou, Chengdu, and the Xiongan zone near Beijing—with plans to expand the pilot program to some venues of the 2022 Winter Olympics in Beijing and Hebei’s Zhangjiakou.

Although officials have yet to announce an official timetable for the digital currency’s official launch, it might become available to the public before the end of the year. The DCEP is expected to be the first digital currency operated by a major economy’s central bank, as the digital yuan will be issued and backed by China’s government while stored in a digital wallet app instead of a bank account.

At first glance, DCEP appears to be a type of blockchain currency; however, it is fundamentally different. “It is not a cryptocurrency, because it is designed by a very centralized idea of leveraging blockchain as the mechanism to format the country’s currency. But this doesn’t mean that the digital yuan is a centralized cryptocurrency,” said Wayne Shiong, partner of China Growth Capital and a veteran VC expert.

“China wants to use this form of currency because it will be well documented and transparent, which makes the financial system more controllable, safer, and manageable,” Shiong explained to KrASIA.

During the trial period, commercial banks, which are currently cooperating with PBoC, will convert some of their central bank deposits into digital currency. Commercial banks will also choose sectors of the economy with large volumes of daily payments that will start using digital yuan, including transportation, education, and retail.

Read this: Didi partners with China’s central bank on digital currency research and development

To use the digital currency, citizens will need to download an electronic wallet application authorized by the PBOC and link it to their bank accounts. By using their digital wallet, users will be able to execute daily transactions such as payments for commodities, sending and receiving money from others, and making transfers via ATMs. This means that the digital yuan will be a part of the most liquid form of money supply, known as M0, replacing some portion of coins and notes in circulation in the economy.

However, people in China are no stranger to cashless transactions for everyday purposes, due to the popularity of digital payment platforms like Alipay and WeChat Pay.

Established in 2004, Alipay was first created as the payment department of Taobao, the “business to consumer” platform of Alibaba Group (NYSE: BABA). Later, the platform expanded its services to allow users to send and receive money, as well as make transactions at ATMs and with merchants.

About ten years after Alipay’s launch, Tencent’s super app WeChat also launched its own payment service, WeChat Pay. As both platforms became extremely popular among Chinese people, these companies turned into fintech giants. Together, they account for more than 90% of China’s mobile payments. Mobile transactions in China, once a cash-dominated society, hit USD 49 trillion in 2019, accounting for four out of every five payments.

According to the 2019 financial report released by Alibaba Group, Alipay and its local e-wallet partners have over 600 million monthly active users (MAUs) and have gained a significant number of users in less developed cities in recent quarters. In the meantime, Tencent (HKG: 0700) announced last year that WeChat Pay exceeded 1 billion daily average transactions for commercial payments. The platform has been used by over 800 million MAUs, with over 50 million monthly active merchants, according to the firm.

Third-party payment platforms are very popular in China. Last year, four out of every five payments were made via these platforms. Photo courtesy of Alipay.

Moreover, third-party payment platforms are key elements of both Alibaba Group’s and Tencent’s lucrative businesses. It allows these companies’ platforms to attract active users through e-commerce, in-app purchases, and other services. Alibaba’s annual active consumer base on its Chinese retail marketplaces—Taobao and Tmall—increased by 102 million in 2019, reflecting successful user acquisition through the Alipay app, the company underlined in its annual report.

During the same period, Tencent’s revenues from fintech and business services increased by 39%, reaching USD 14 billion. The company attributed this increase to greater revenues from commercial payment due to an increased number of daily active consumers and transactions per user.

How does DCEP differ from Alipay and WeChat Pay?

Although DCEP shares many characteristics with third-party platforms, it diverges in two substantial ways. Whereas Alipay and WeChat Pay can only be used with an internet connection, DCEP can transfer cash even when offline. The function, called “touch and touch,” allows two users to touch their mobile devices together to make a transfer, via Near-field Communication (NFC), the same technology used by Apple, Samsung, and others to allow users to pay by waving their phones at a special terminal.

Another major difference is transaction fees. Alipay and WeChat Pay charge merchants and users a fee for external transactions outside of their platforms. WeChat Pay users incur a fee when users withdraw more than RMB 1000 (USD 153) from their WeChat wallet balance at a rate of 0.1%. Likewise, Alipay charges a transaction fee of 0.1%, once a user passes a threshold of withdrawing more than RMB 20,000 (USD 2,897). Merchants are also charged a fee of 0.55% on the flip side to every purchase.

DCEP, on the other hand, although not yet confirmed, is expected to not charge any commission fee, as mentioned by Peng Wensheng, chief economist at China Everbright Securities, during an interview with China Securities Journal.

With these functions, it’s possible that citizens and especially merchants will increasingly adopt the digital yuan, shaving away the popularity and business of third-party payment platforms.

China digest

Read this: What is China’s cryptocurrency-like sovereign digital currency and why is it not like bitcoin?

In addition, some industry observers have suggested that the Chinese government is launching the DCEP to wrest control from Alipay and WeChat Pay. They are basing this claim on possible failures in China’s third-party payment platforms. For instance, if a mobile payment systems fails, citizens might want to convert their money into cash, which might lead to a crash, as there is less paper money in circulation.

Also, governments around the world are not keen to cede control over payment systems to private monopolies or duopolies, which is also an incentive driving Sweden’s digital currency experiment.

However, other experts think that DCEP will not replace Alipay and WeChat Pay. “Although it is unclear yet if the PBOC will distribute DCEP through Alipay or WeChat Pay directly, both platforms will support a DCEP wallet,” wrote Zennon Kapron in an article published by Forbes.

Kapron added that China’s major e-payment platforms were probably already in cooperation with PBOC on digital currency research, and will likely be integrated with the DCEP. In this scenario, there will be a function on these platforms where users can switch to the digital yuan.

According to Shiong, Alipay and WeChat Pay are not competing against DCEP. These platforms’ values drive simply from their role as providers of cashless transactions. While Alipay and WeChat Pay are important for domestic market transactions, the digital yuan will be a game-changer in international trade, he told KrASIA.

“The RMB is very difficult to use in international trade. Currently, it is not an internationally exchangeable currency. But using a digital currency, which is 100% fluid, can make international transactions easier and safer, as the Chinese government backs it,” Shiong explained.

In short, Shiong predicts that DCEP will not affect third-party payment platforms, as it may even be included in these platforms. However, the digital yuan might become very popular in international settlements, and among big enterprises in the future.

He added that the DCEP might also become a reserve currency for small developing countries that do not have a stable currency system. Just like gold was once used as a reserve currency, those countries could use DCEP to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate.

In the long run, there is a chance that the digital yuan will take some market share away from established fintech giants. Yet, in the short run, DCEP may not threaten Alipay’s and WeChat Pay’s operations as the scale of dig­i­tal cur­rency is­suance will initially be lim­ited. Also, users will need to grad­u­ally bring their pay­ment habits in line with the dig­i­tal cur­rency ap­pli­ca­tion, which might take some time.