e-CNY: Strategic Value and Implications

In Part I and II of our e-CNY series, we discussed the key players driving this digital currency’s development and the direction of its core technology, respectively. (The Interconnected research team compiled all of the People’s Bank of China’s Digital Currency Research Institute’s patent filings into a publicly viewable Google Sheet.)

In this Part III post, we will look at the e-CNY’s strategic value and implications, both domestically and internationally. (See Part IV on the e-CNY product experience, if you want to jump ahead.)

Domestic: Open Ecosystem, Closed Backend

Domestically, e-CNY is looking to become the common, infrastructure backend of China’s entire digital financial system. This movement comes at a time when China’s tech industry is moving from a “walled garden” landscape to an open ecosystem that will nonetheless be based on a closed, CeFi (centralized finance) project that is the e-CNY.

This landscape shift is quite monumental and worth underscoring.

From the outside, China often looks like a monolith. From the inside, it's anything but that, especially its technology sector. Until very recently, China’s tech giants have built their empires on a “walled garden” approach, intentionally not playing well with each other. As a user, you cannot post a link from an Alibaba-owned platform (e.g. Taobao, Ele.me) on the Tencent-owned WeChat. UnionPay, the state-owned interbank network and payment card service, does not work interoperably with AliPay or WeChat Pay. Relative newcomers like ByteDance must create their own “walled gardens” to succeed, knowing that their links and content would not be welcomed on other platforms.

The walls are coming down and the ecosystem is opening up -- and opening up rapidly. After a series of antitrust policy changes and fines (so far on Alibaba, Tencent, Didi, and Meituan), the Ministry of Industry and Information Technology (MIIT) directed all the tech giants in mid-September to open up to each other. In a matter of a few weeks, WeChat Pay started appearing on Alibaba-owned services, both WeChat and AliPay are playing nice with UnionPay, and you can now share Taobao (Alibaba-owned) or Douyin (ByteDance-owned) links in your WeChat messages.

These seemingly trivial-looking changes were unthinkable five years ago. More importantly, the ministry driving all these changes, the MIIT, also has a seat at the table in the development of the e-CNY, as we noted in Part I.

As these tech platforms open up, what will likely happen is all transactions will eventually be tracked, processed, and controlled using e-CNY. That won’t happen overnight, as the e-CNY is still a young, untested project with technology, product, and reputational challenges. But that is the long-term direction.

There’s an interesting dichotomy evolving here of an ever-opening ecosystem being built on a closed and centralized digital backend. An open ecosystem tends to be better for consumers, merchants, and new startups, while also making top-down government control easier to execute (no big tech becomes too big to control). That’s why we are witnessing a flurry of Chinese government tech policy changes in the last few months. But an ecosystem that is too open also produces more illicit activities, financial crimes, scams, and capital flight -- a problem that China has been uniquely concerned about for many years. UnionPay did a poor job of preventing capital flight; e-CNY seeks to close those enforcement loopholes.

The interoperability among Chinese tech giants is happening at an accelerated pace and will likely be completed next year before the 20th Communist Party Congress in October 2022. How quickly the e-CNY will mature as the common backend is harder to predict. There are two important milestones of adoption to watch:

• Singles Day: How much transaction volume the e-CNY will facilitate during this year’s Singles Day, China’s annual online shopping holiday, will be an important short-term metric to watch. JD.com has committed to accepting e-CNY payments, but other e-commerce platforms have not, as far as I know. This lack of adoption may be intentional, because e-CNY is too brittle to handle Singles Day peak traffic. This year’s launch on November 1 already crashed Taobao for 20 minutes, and Alibaba’s cloud infrastructure team is one of the best-trained teams in the industry to handle traffic surges. It’ll be a while before the e-CNY’s infrastructure team reaches that caliber.
• Lunar New Year: the next Lunar New Year is on February 1, 2022, when red packet exchange will be at its height. e-CNY-based digital red packets are already being piloted in major cities like Shanghai. How successfully the PBOC can use this uniquely-Chinese product launch playbook will be the next milestone in e-CNY’s domestic adoption journey. WeChat Pay pioneered this “red packet to payment gateway” playbook to perfection during the 2014 Lunar New Year; will e-CNY be able to replicate that success with PBOC’s backing?

International: Global Inter-Bank Settlement Layer

Three days after Lunar New Year is when we will get to observe the first sign of e-CNY’s international ambition: the 2022 Winter Olympics taking place from February 4 - 20. This global event is a natural, if not "sneaky", vector for the e-CNY to internationalize the RMB and chip away at the US Dollar’s dominance.

e-CNY’s Winter Olympics rollout has been frequently, though superficially, reported. What’s missing in the narrative is which countries will most likely take China up on this offer and why. Given that most countries strong in winter sports are wealthy Western or East Asian nations, many of whom are skeptical of China’s intentions, e-CNY adoption from their athletes will be low.

However, countries with high crypto adoption rates are mostly emerging economies. According to the 2021 Geography of Cryptocurrency Report compiled by Chainalysis, among the top 10 countries in the crypto adoption index (see below), 8 are lower-middle-income countries or below. The US is #8 and China is #13. (Note: this report was compiled before China’s blanket prohibition on Bitcoin and other cryptocurrencies in September.)

Given that cryptocurrency traction tends to be deeper in poorer countries with weak, untrustworthy financial institutions, the athletes who would download the e-CNY wallet and take it back home would come from countries that won’t garner much attention at this, or any, Winter Olympics. In other words, it won’t be your high-flying Canadian hockey team, but your misfit Jamaican bobsled team.

It is important to not conflate e-CNY, a project that uses limited blockchain features, with cryptocurrency projects, like Bitcoin, Ethereum, and many (many) others, where the blockchain is at the core of their functionalities and value propositions. Based on the PBOC press conference on its e-CNY development progress held in July, the Digital Currency Research Institute is cherry-picking blockchain concepts like consensus mechanism, programmability, smart contract, and data separation (to reduce security risks).

Thus, a high crypto adoption rate does not guarantee acceptance of another country’s Central Bank Digital Currency (CBDC) like the e-CNY, but it does make the marketing conversation easier.

Regardless of how “blockchain” is the e-CNY, the PBOC is no doubt positioning the project as yet another attempt to “internationalize” China’s currency. This is a long-held ambition with many false starts, most recently in 2015 when the PBOC launched the Cross-Border Inter-Bank Payments System to mute response. Not so coincidentally, soon after that failed launch, the Digital Currency Research Institute was established.

Fully achieving this lofty goal will take more than one Olympics to build the global network effect and trust necessary. The Beijing Winter Olympics is just the end of the beginning of e-CNY’s own Long March beyond its border.

No Prior Art

The e-CNY’s strategic value and implications, both domestically and internationally, are ambitious and will take many years to realize. So far, the Chinese government has proven its ability to both plan and execute on a multi-decade time horizon. But this e-CNY project is materially different from China's past achievements -- there is no prior art from the West to illustrate what success looks like.

China’s economic growth from the last four decades was largely predicated on the assumption that there is always some valuable information to transfer or successful Western models to emulate. These often-forced transfers have come in the form of technology, intellectual property, managerial and operational best practices, and raw overseas talent.

This assumption falls apart when it comes to the e-CNY. The US is still figuring out what a stablecoin is and which government agency should regulate it. Countries with somewhat mature CBDC projects of their own, like Cambodia and the Bahamas, are hardly economic success stories worth modeling. The e-CNY is breaking new ground, and its success or failure rests on whether China can attract or develop creative, elite-level technical talent to build it.

In this regard, China has already shot itself in the foot by becoming a hostile environment for technical talent with its blanket crypto ban. Although you can argue that because there’s no prior art from the West, foreign talent is no longer worth attracting. But ask anyone who’s working in or investing in Silicon Valley right now, and 8 out of 10 people will tell you the brightest, most ambitious technical talents are working on (or trying to work on) crypto projects. None of them will want to build anything in China, while the e-CNY will have to rely on domestic talent to fill its org chart.

As we noted in Part I of this series, the crypto tech talent gap in China is huge and only being filled by opportunistic programs by second and third-tier universities. No offense to my friends in Sichuan, but a four-year blockchain bachelor’s degree from the Chengdu University of Information Technology is not going to cut it.

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