Global trade is dominated by the U.S. dollar, the euro, the Japanese yen, and the British pound. The Chinese yuan has a share of roughly 3%, despite China being the largest trading partner for most of the world. As the world's largest trading nation and the center of many of the world's essential supply chains, China is left mainly at the mercy of other nations' currencies to compete in and drive commerce.
Because of these factors, creating a platform that can be used by those who trade with the country makes sense. Such a platform could decrease risks within the trading relationship and lessen the impact others can have on the system, such as currency speculation or sanctions.
Since 2014 when a Central Bank Digital Currency (CBDC) concept was initiated, China has been thinking of a way to make trade faster, cheaper, and more efficient. From a central bank point of view, currency stability, low inflation, liquidity, and ease of use are all critical for an effective trading system.
China has been thinking about all the modern-day trade and currency difficulties and has created a systematic currency, the Digital Yuan, to address them.
Automatic currency conversion
Imagine you are a business in Malaysia selling machinery to China. Historically you would go to your bank, exchange ringgit for U.S. dollars, and send those dollars to a bank account in China. The Chinese business would then convert the dollars into yuan. This process is time-consuming, costly, inefficient, and involves several intermediaries to complete. It also depends on how much dollar the Malaysian Central Bank has ($107 billion plus in 2020).
With CBDCs on everyone's radar, central banks will devise arrangements and agreements about their use between countries. This isn't cryptocurrency that anyone can use once issued. Central banks will have to approve the use of CBDCs by one or both parties. If you wanted to use a CBDC, the process could be completed on your phone or computer, with immediate conversion and payment. So for those who say they don't want to "hold" yuan, they don't have to for more than the few minutes required to transact with China's CBDC. With CBDC, there is no longer the need to hold foreign currency in your account if you don't want to, and for many nations, this will remove the need to rely on the dollar as an intermediary currency.
Payment times, Transaction fees, and intermediaries are no longer needed
Most businesses decry the current processes involved in transferring money. It takes significant time, sometimes 2-5 days, if not longer, for a payment to be completed and to receive money. There is usually considerable documentation and processes needed to complete such payment, along with the risk of refusal or an interruption in the process that can affect its completion. There are also fees and multiple intermediaries, which can affect payment along the way. It is a constant frustration and struggle for most businesses.
With a CBDC, initiating a transfer to receive payment would be almost instantaneous. The days it takes to receive payment would be erased, thereby helping cash flows, revenues, and ultimately, peace of mind. Also gone would be what in the West is known as "the check is in the mail," or "it will be there on Monday," all of which affect business operations and transactions.
With current bank and financial transfers, the dreaded fees charged by intermediaries would be eliminated as a CBDC has at most a minimal fee structure. No longer will businesses be charged various fees for transfers or business transactions, such as Visa charges up to a 2.70% fee per transaction. Also gone would be the challenges of sending payment on, or around, the various holidays in Asia. A CBDC removes most of the issues in sending payments, whether fees, time, or inconvenience.
Streamlining of processes
China's CBDC could provide a platform to build a smart ecosystem serving businesses and countries involved in trade. Logistics, export and import, transparency, and various other areas a business needs to deal with will be streamlined by a CBDC platform.
Part of this streamlining is the settlement process, which currently involves different intermediaries in various countries and regulatory environments that are complex and costly. Take export and import of goods. With the Malaysia example above, using the same CBDC transfer method, a CBDC, because it is a smart, digital currency, can have additional features programmed into it such as documentation, weight, price of goods shipped, or the calculation of taxes. All of this is currently provided by exporters in reams of paperwork.
A CBDC can be designed to streamline and fast-track customs and improve logistics efficiencies for those who use it. Because it is digital, it can also be tracked, improving utilization and resolving challenges, all in real-time.
A challenge for some businesses is fraud, incomplete or fake paperwork, or sending money to the wrong account. The CBDC can identify and trace goods and payments in the system because that information is embedded and confirmed by various parties in the network in real-time. This capability will remove current challenges in the system and build trust in the transaction.
With the current need to use an intermediary to transfer money, there is little incentive for those entities to change a system they have profited from handsomely. Innovative forms of technology and fintech would be supercharged, creating new solutions and services for customers to take advantage of a near frictionless payment system.
By using the dollar for a transaction, a country, business, or individual is beholden to the dollar's value. As seen with the recent Russia and Iran situations, sanctions can destabilize an entire monetary system or country. This broad usage of sanctions and other measures against users of the dollar, who do not follow the whims and actions of the U.S., are ultimately driving people to use it less. China's CBDC will play a key role in reducing dollar dependence and give countries other options in trade currency.
Potential challenges
Some potential drawbacks of using a CBDC are that it is not as anonymous as cash, can be restricted to specific usage, and is usually focused on a particular region. "Cash is king" became a mantra of the financial world in the late 1980s. Few assets compare to cash in terms of anonymity and ease of use, and it is the most convenient asset to utilize. A CBDC can be designed for use in a specific transaction and not others, thereby limiting its utility.
Because central banks create CBDCs in a particular country, the currency can only be used in a domestic digital payment framework until agreements are made with other banks and entities for its use. This process will take years, and not everyone will become a part of it. Unlike cash, it will not be able to transcend borders without having those agreements in place.
Getting people to use a CBDC will be challenging even within the country it is issued. Many transactions are focused on day-to-day transactions and use, such as buying groceries or ordering delivery. Some businesses might use it, but what do they do with it? One question asked is can we pay vendors with it? The answers to these questions are unclear and need a resolution before the large-scale application and implementation of a CBDC is completed.
Cameron Johnson is adjunct faculty at New York University and partner at Tidalwave Solutions.
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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