In a recent article in the Chinese press, a journalist argued there’s still a lot to be done before China’s digital yuan is ready for mass adoption once the pilot phase ends. While the central bank digital currency (CBDC) wallet is now available to all in China through WeChat Pay and in the Apple, Huawei, Xiaomi and other Android app stores, only people in certain pilot regions can sign up to use the wallet. Next month’s Beijing Olympics is one of the pilot locations.
Author Mu Chu argued that four sets of issues need resolving to see broad adoption of the digital currency. Two relate to addressing fraud and scams and resolving the legal position of the digital yuan, which have both been highlighted as tasks by the central bank’s Digital Currency Research Institute.
Additionally, Mu claimed that the central bank is currently responsible for supervision, AML, chargebacks, and dealing with fraud. He envisions the roles beyond supervision becoming more decentralized. While we’d agree, we expect that’s probably happening already through the state banks.
Incentives without merchant fees
A key issue is incentives, especially as the digital yuan carries no merchant fees. So the journalist’s question is how the intermediaries will be compensated in the absence of merchant fees. He suggested programmability might be the answer, although the business model is unclear.
Conventional payments involve a quartet of players: the card organization, card issuer, merchant’s acquiring bank and the merchant.
Mu highlighted the incentives needed for WeChat Pay’s massive ecosystem that includes 23,000 service providers, more than 1,800 bank and payment institution partners, and over a million ecosystem business partners.
We have a similar but slightly different perspective on the topic. Let’s explore the four players in a CBDC scenario.
Are merchants incentivized?
Starting with merchants, they have some motivation to adopt the CBDC as they save on fees if they accept the digital currency. But it’s not as big as you might expect because China’s merchant fees for AliPay and WeChat Pay are only 0.55%. Additionally, the digital yuan will be legal tender, so merchants won’t have a choice and have to accept the digital yuan.
In an open market, one could envision AliPay and WeChat Pay offering incentives to merchants to keep using conventional payments within their apps rather than use the CBDC. Remember, the digital yuan wallet is also built into their apps but uses a separate payment rail.
The digital yuan should mean less friction involved in moving money outside the AliPay and WeChat walled gardens. And theoretically, the digital yuan app leaks less data about retail payments by using retailer-specific sub-wallets to prevent user tracking across stores. With its close association to retail oriented Alibaba, Alipay might prefer more data to be available to retailers.
However, a key government motivation for the digital yuan domestically is precisely to offer an alternative to AliPay and WeChat Pay, to provide resiliency, interoperability with other payment apps and reduce their duopoly. And currently, both organizations or their parents are under government scrutiny for monopoly and other issues.
The evolution of intermediary roles with CBDC
Looking at the payments end, a key benefit of a digital currency should be a reduction in intermediaries. There’s no card company. That role is effectively fulfilled by the central bank offering the core payment rail. Hence payments should be cheaper.
Every digital yuan wallet is associated with a bank, and there are two types, consumer wallets and corporate wallets, which will often be merchants. These are similar roles to a card issuer for the consumer app and a merchant acquiring bank for a retailer’s wallet.
In terms of the service providers for incumbent wallet WeChat Pay, at least some of those partners will be paid to sign up and support merchants to use WeChat Pay. In contrast, for China’s CBDC, that role is performed by banks.
Hence, arguably almost all the intermediary roles are performed by banks. Only eight banks are authorized to directly integrate with the digital currency platform: the six major state-owned banks that act as gateways for the smaller regional banks, as well as WeBank and MyBank owned by Tencent (WeChat Pay) and Ant (Alipay), respectively.
Banks are the intermediaries
So the real question is, how should banks be incentivized to promote the digital yuan?
And will the 2.5 tier banks – who have to access the digital currency payment rail via the state-owned banks – have to pay for that service?
In terms of supporting merchant clients, banks don’t have a choice. Retailers need to have digital currency wallets to comply with the law. If their bank doesn’t provide one, they’d have to find a bank that does. Hence, a CBDC could see more business migrate towards the six big state-owned banks if smaller banks haven’t signed up.
Already we’ve seen big state banks such as ICBC add functionality to automatically sweep money from digital yuan wallets into bank accounts because the digital yuan doesn’t earn interest. Smaller banks will have to implement similar functionality.
A major question is how regional banks will be incentivized to promote CBDC use by consumers.
Consumers are the king makers
We believe consumer incentives are the crux of the matter. What’s in it for consumers? They’re quite happy using WeChat Pay and Alipay. Why would they switch?
They may primarily use the CBDC as a backstop, for example, when they want to move money between wallet providers. They may perceive that their transactions are more visible to the state using the digital yuan, although they may have equal visibility in reality.
One big advantage China has compared to other countries is the scale of state-owned institutions. These organizations are likely to be major drivers of adoption by paying salaries in digital yuan and incentivizing receiving payments in CBDC.
So even if the average Chinese consumer isn’t that keen on the CBDC, there’s a good chance they’ll use it for public services such as transport. So a significant level of adoption may be all but guaranteed.