The digital yuan versus private cryptocurrencies - PwC China Compass

29 November, 2021

A commentary by Stephan Fölsing. China’s opening up began inside a sandbox in Guangdong Province, where Marxist-Leninist theory was relaxed to allow foreign capital to play more freely. The rest is, of course, economic history.  

Out of this sandbox arose a bourgeoise sandcastle of epic proportions, which pleased liberals and communists alike. Such is the power of judicial diversity. It worked in Guangdong Province, but also in the United States, Australia and Singapore. All these places started out as isolated experiments in governance.

The early internet was such a sandbox, not by decree, but because those in power largely ignored it. Almost by accident, a cultivated garden of free human expression sprang to life. Politicians now argue – not without popular support – that this garden has mushroomed into an uncultivated jungle, driven more by animal spirit than the administrative wisdom that enlightens our real world. Luckily, moralists and bureaucrats have caught up with this development, and now stand united in their desire to rein it in. Nowhere is this felt more keenly than in China. Its government has taken the initiative to remind those fortunate enough to have become rich that there is virtue in sharing – and those unlucky enough to have become powerful that there is nothing to share. 

There is one corner of the internet, however, that has proven resistant to the public gardeners’ pruning: private cryptocurrencies. Thanks to their powerful encryption – too powerful for governments to break – they exist in a sandbox of total judicial autonomy. This is what people mean by Web 3.0. Despite more stringent laws in the US and Europe, and an outright ban in China, the sector continues to thrive, almost undisturbed, as a hodgepodge of anarcho-capitalism. In Web 3.0 private cryptocurrencies like Bitcoin and Ethereum reign supreme. China, of course, doesn’t want this kind of internet money. It wants to offer a better alternative: the digital yuan. Can it? Well, it depends: 

Why go full-digital money?

Everything is getting a digital makeover, so why not money? Critics argue that traditional money is already mostly digital, and they are right. But the data infrastructure that traditional money runs on is outdated and heterogenous. This makes the exchange of information slow and expensive, especially across borders. The digital yuan can help to accelerate the modernization of payments through data-standardization, a key feature of private cryptocurrencies or blockchains in general. But this is also where the similarities between the digital yuan and private cryptocurrencies end. The digital yuan will not use any of the tools that make private cryptocurrencies so useful for Web 3.0. It won’t be immutable, like Bitcoin, or decentralized, like Ethereum. Instead, the digital yuan will be closer to traditional money and it will operate under the same central authority, aptly named the “Central Bank”.  Private cryptocurrencies need no such establishment. They tout the maxim “the best way to reform an institution is to close it”. 

Is China’s rejection of Bitcoin techno-pessimist?

China remains techno-optimist – only in a more centralist way. Hegel would approve.  Kudos for trying out a digital currency! Germany, by contrast, is techno-pessimist in an Amish way. We only adopt new technology when our village elders deem it safe (usually decades after its inception). Even then, we remain skeptical. Naturally, our central bank hasn’t even developed a prototype for internet money yet. 

Looking at other techno-pessimist societies can be informative though: The Taliban have adopted smartphones and armed drones to a point where they wonder how they ever lived without them.  Yet, they don’t feel the same about Bitcoin. All three technologies are roughly the same age, and you would think that Taliban-controlled Afghanistan presents an ideal use case for private cryptocurrencies: Much of the economy runs on physical dollars (which are becoming scarce) and contraband (which is hard to transact in dollars). But – lo and behold – instead of using Bitcoin, the Taliban are pleading for everyone’s dollar accounts to be unfrozen! This makes me techno-pessimist with regards to private cryptocurrencies. They haven’t fulfilled their promise of banking the unbanked. China’s rejection of Bitcoin, therefore, is no sign of techno-pessimism.

If you want to be the world leader in sovereign cryptocurrency, wouldn’t it be better to also have a private cryptocurrency sector? 

If your aim is to develop the world’s premium sovereign cryptocurrency – thus breaking the global monopoly of the dollar, there would presumably be some benefit in retaining the private cryptocurrency sector, just to see how things are going. The unregulated “everything goes” mentality of Web 3.0 provides for a steeper learning curve than the more guarded field of government research. But by outlawing private cryptocurrencies, China forfeited its leadership position in crypto-exchanges, crypto-hardware and even crypto-software development. Without private capital, the digital yuan will have to be dreamed up by loyal bureaucrats. Will the outcome be better? We will have to wait and see. China is big enough to brute force everything. Maybe even innovation. 

As a footnote: China still allows some form of private cryptocurrencies – for example, blockchains without tokens – meaning cryptocurrencies without the money function. This, however, removes the economic incentive that protects the legal autonomy of the blockchain. But it is only because of this property that private cryptocurrencies can teach us about markets, and its relationship with politics. Here is how they intersect: Whenever you have three people, and two decide to collude against the third, they can very much do as they please (a common problem in all forms of governance, from stock corporations to courts). This is a problem that private cryptocurrencies are increasingly good at solving. They do this by decentralizing decision-making and by taking, as much as possible, the money, or the contract, out of the reach of those who do politics. No political coalition – however powerful – can arbitrarily override community rules, or make changes to the contracts that community members have agreed on. The cryptocurrency software will stubbornly execute them – not because the political environment protects their faithful execution, but because a working political environment is not required (ironically, it requires money to maintain this independence). The business of private cryptocurrencies, therefore, is only business. If this sounds awful, compare it to a quote from an American president: “The business of America is business!” (OK, it still sounds awful.) 

Crypto philosophers, of which there are now many, do, however, act on higher motives. They champion a state where governance is free from politics (and the mysticism and dogma associated with it), where politics is replaced by reason. Incidentally, rational governance is fundamental to the doctrines of both liberalism and communism. At last, a win for all! 

If private cryptocurrencies are not good at payments, what are they actually good at?

What makes private cryptocurrencies interesting is that they allow all sorts of people – visionaries, geeks and armchair economists – to create their own economic sandboxes, at least within the confines of cyberspace. This doesn’t sound like much, but when you think about it, Marx was an armchair economist who never got to play with his ideas – he only wrote books. Like Marx, people who write cryptocode think the point is not to merely interpret the world as a sandbox, but to change it. For this, they already direct real communities and real funds – in fact billions of dollars – to whatever cause they seem worthwhile. They even dream of incorporating chartered cities in the real world – all with their own set of rules and governance. What will this look like? We will only find out if we build them! 

Is digital money conceptually better than traditional money?

The truth is, nobody knows what money will look like in the future. This is also the reason why Europe and the US have no roadmap for digital money yet. There are quite a few economists who argue that digital money is worse than traditional money, even conceptually. Some things to worry about include splitting a sovereign currency in two: If you have a digital yuan and a traditional yuan and then tell the market they are at parity, but the market says “I don’t believe you” and then finds a way to arbitrage it (as it always does), you may have to throw billions of “real money” at your “digital money” to prove your point. That can hurt. But having three sovereign currencies is also confusing. China already has two, the onshore and offshore yuan. Their prices can and do diverge. 

The bigger problem with the digital yuan, however, may lurk in credit. Commercial banks rely on cash deposits to make loans. If that money is parked in the digital yuan, commercial banks will make fewer loans. And if the digital yuan were used for credit (which is currently not envisioned), it would be safe to assume that the Central Bank would play a bigger role in loan creation. Thus, the digital yuan would amount to a transfer of power from commercial banks to bureaucrats (which to some extent is already happening in tech and real estate). 

Stephan Fölsing

Conclusion – modernity is not about new money, but new politics

The digital yuan will be a walled garden and there will be no community gardening, ever. Whatever grows in it will have been planted by incumbents. Whether Chinese consumers will devour such fruits depends on the attractiveness and power attached to them. But it is unlikely to appeal to the intellectual hipster crowd of Web 3.0. They will prefer the legal autonomy of Bitcoin and Ethereum. 

Judicial diversity is still very much underrated – even after the successes of Guangdong, the US and Singapore. What money can do, however, is overrated. Adam Tooze’s favorite Keynes quote is: “Anything we can actually do, we can afford.” Money should be a second thought. Governance is the more urgent problem. It affects us wholly and intimately. What makes governance with decentralized software interesting is that there is an impartial procedural correctness to it that is scarcely found in the real world.

To find out more on how the digital renminbi works and what China has done to develop it, see “Digitaler Renminbi – Transaktionen ohne Bargeld und eigenes Konto” by Sebastian Huth.

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