Global FinTech Landscape
The creation of Bitcoin marked a critical phase in the digital revolution and the beginning of a new, disrupted financial world. The rapid growth of the digital sector has brought a plethora of cryptocurrencies. As of December 13th 2021, estimates point to a total of over 15,000 unique coins/ digital tokens with a shared value of more than USD2.2 trillion.
Embodying blockchain and advanced encryption, these cryptocurrencies promise decentralisation, independence, and anonymity. Amid government distrust, many view them as an alternative to fiat money. When speaking of a suitable substitute for the latter, we need to remember that the three means of money are:
the store of value
the unit of account
the medium of exchange
In comparison with fiat money, cryptocurrencies do not excel at these means.
Their price is a result of the complex level of competition within a production network, the rate of unit production and the mining algorithm’s difficulty. For the benefit of a larger audience, there won’t be an in-depth explanation of these factors in this report.
Nevertheless, it is important to note that all of them lead to acute price fluctuations and low trading efficiencies, thus rendering them an ill-suited currency for daily individual and corporate operations. Their store of value isn’t necessarily stable, and a good example of that is the most recent market dip in January of 2022. While they certainly have an active community as a medium of exchange, they are still not widely accepted by merchants and companies. As for being a unit of account, their price volatility makes accounting for items or services almost impossible.
Thus, while cryptocurrencies alone may not by definition fulfil the widely shared promise of independent finance, credit is due since they certainly pulled the trigger for economic and digital advancement. The need for implementing certain aspects of crypto in the financial world is growing, and Central Banks are starting to see the benefits of implementing them whilst still providing the store of value and social stability that crypto lacks. Central Bank Digital Currencies (CBDC) are the regulated market’s solution, and many countries are working on it already.
To put things in perspective, over 86% of all Central Banks are now researching CBDC. Seven of them (Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Federal Reserve, Sveriges Riksbank and Swiss National Bank), together with BIS, are actively exploring the process. Fourteen countries are in the pilot stage, and nine have already launched a CBDC. The financial world is getting up to speed, and we are moments away from everything changing globally.
“Central bank money has unique advantages – safety, finality, liquidity and integrity. As our economies go digital, they must continue to benefit from these advantages. Money is at the heart of the system, and it has to continue to be issued and controlled by trusted and accountable institutions which have public policy – not profit – objectives. Central bank money will have to evolve to be fit for the digital future.” - Speech by Benoît Head of the BIS Innovation Hub, at The Eurofi Financial Forum
China’s CBDC (DC/EP)
also known as Digital RMB, eRMB, digital Yuan, eYuan or e-CNY
FinTech Landscape in China
Growing technological advancement, coupled with a distinctive user segmentation in the financial landscape, prompts the need for a new payment network. Many factors build up to the financial revolution of China and lead to their Central Bank Digital Currency (CBDC) being launched ahead of others. Among all the names attributed to China’s CBDC, Digital Currency Electronic Payment (DC/EP) is the formal one.
Unlike Western countries, the adoption rate for the Chinese population is staggering when it comes to new technology. Mobile payment adoption is perhaps the most notable factor for fast-tracking China’s CBDC. The biggest payment apps in the country - Alibaba's Alipay and Tencent Holdings' WeChat Pay - have taken the lead in mobile banking with a user base of 872 million. This has been an immense boost for SMEs, as the apps are regularly used in B2B transactions. The mobile wallet payments in China in 2019 alone were roughly 1.5 times the amount that flowed through all credit cards globally.
It took only three years after the launch of WeChat to fully immerse more than half of the Chinese population. It is important to note that internet penetration in the country is 71.6%.4 Currently, WeChat and Alipay control approximately 93% of the mobile payment market in China. In 2019 mobile payment transactions’ volume was USD 51.8 trillion and accounted for 83% of all transactions - more than three times China’s GDP. In comparison, that of the US for the same year was only USD 98 billion.
The Covid-19 crisis has an immense impact, as people are shifting away from the big cities, and large remote areas need financial inclusion more than ever. Isolation and resource inequality have prompted the need for SMEs and individuals to access digital financial services from every point of the country.
In 2014, amid the rise of mobile banking, China set up the first official task force to research Digital Fiat Currency ahead of all competitors. Two years later, People’s Bank of China (PBoC) established its Digital Currency Institute, which develops the first-generation prototype. In 2017, they began working with commercial institutions to develop and test that currency. In 2019, the first large-scale pilot for China’s CBDC is launched. Today, the final stage of testing is being conducted in over 10 cities simultaneously.
Statistics show the DC/EP has been applied to over 3.5 million scenarios, such as paying for utilities, transportation fees, etc. In June 2021, the digital RMB became a payment method for subways and is already being implemented in a variety of other payments across sectors.
Мore than 140 million personal digital wallets have been created, and companies have opened an additional 10 million wallets as of Oct 22, 2021. Transactions made through these wallets come to more than 150 million, with the total transaction value approaching 87.5 billion yuan ($13.68 billion).
In 2021, China’s CBDC was released to a broader audience as part of the pilot phase via an app called “Digital Yuan” (数字元/数字人民币). The currency itself is provided by six state-owned commercial banks:
Bank of China (BoC)
Bank of Communications (BoCom)
Postal Savings Bank of China (PSBC)
As of Q1 2021, data by Finbold reports that 20% of the Chinese population is unbanked (225 million adults). The majority of that segment lives in rural areas and have an elementary school education or less.
The introduction of CBDC could bridge this socio-economic gap within the country, as no bank account is required for the creation of a digital yuan wallet.
Benefits will be especially notable within the merchant community, as there will be no registration fees, commission fees, or other charges. Users will not be charged for exchange and circulation services. This should significantly boost SME growth in all business sectors and dramatically increase the speed of economic development in more distant, rural areas. One of the most prominent benefits of DC/EP is growing the SME market, which makes up over 99% of all enterprises in China.
Architecture and Functionalities
“One coin, two repositories and three centres” is the definition given by Yao Qian, the former head of PBoC’s Digital Currency Research Institute, in 2018
One coin (一币, yī bì) refers to the digital currency - DC/EP.
Their CBDC is the equivalent of cash, or “M0” in financial terms. As such, it does not require network connectivity for transactions, and it retains the anonymity of cash. It does not pay interest and requires 100% reserving. Thus, banks cannot create additional RMB through interest, credit or lending. An important technical point is that the issuing banks will be guaranteeing the payments, i.e., the currency won’t only be issued by the central bank in strict terms. This is to ensure that the DC/EP won’t be replacing banks’ role within the ecosystem.
Two repositories (两库, liǎng kù) refers to the two-tier (indirect) architecture.
The central bank’s (PBoC) database will be transferring data to commercial bank databases, thus forming two levels of issuance, allowing for the current banking system to be kept intact. This model excludes private banking providers who will be transferring the DC/EP but not issuing it.
China’s DC/EP will be token-based and will not use blockchain for wholesale transactions from central banks to commercial ones. The retail part of the system will depend on each of the second-tier banks and might use blockchain or DLT technology for the distribution.
Following the interoperability approach, those banks are issuing DC/EP through an application (the Digital Yuan app), which connects to around 25 other services through “sub-wallets.”
Currently, there are six state-owned banks involved in the issuance. For a better user experience, the pilot app has one screen that lets the user swipe and transact between different bank accounts. There are also two private banks integrated with the DC/EP – Tencent’s WeBank and AliPay’s MyBank.
Digital wallets are an extension of the second (commercial bank) layer. From a technical perspective, the wallets hold the keys (one public and one private) that allow for the encryption and decryption of tokens (receiving and transferring).
The public key confirms that your private key has signed a token and allows for the encryption of an incoming token.
The private key allows for the decryption of an encrypted (received) token and permits the signing of a token that is then confirmed by the public key.
From a user perspective, wallets have different tiers depending on the transfer limits for DC/EP. They will vary depending on balance and transaction parameters. All limitations are intended as an initial regulation against bank runs.
Three centres (三中心, sān zhōngxīn) refer to Verification, Registration, and Big Data analysis centres. These are the three major central processing centres of PBoC.
The Verification centre is a centralised KYC platform responsible for authorising users. There will be three layers of identification. The first one is the central government that tracks people’s ID numbers (also those of corporate entities). The next KYC stop is the cell phone carrier, having in mind mobile devices that are linked to ID and facial ID scans. The last one is commercial banks’ KYC with the same IDs, phones and accounts. All three layers happen via the mobile app, online.
The Registration centre is where the tokens are created and where transactions are encrypted and decrypted. It is an authentication engine providing the computing power that allows payments to be verified. Through cryptographic calculations, transactions can be confirmed in parallel, resulting in higher payment processing speeds.
The Big Data Analysis Centre refers to the intelligence unit of the CBDC and predominantly analyses the registration centre data. This centre will be responsible for KYC, detecting fraud, money laundering (AML) and other financial crimes prevention. Potential uses of this data are limitless and could positively impact amendments on monetary policy, distributing loans to SMEs, or financial aid to certain areas as stimulus payments, to name a few.
Security & Privacy
The PBoC has highlighted the ability to track payments as a security feature without infringing on personal privacy. In addition, the sub-wallets will hide the user’s digital footprint from third-party online service providers and payment platforms, ensuring no transaction or piece of personal information gets passed on. In retail, the buyer can select whether they want to reveal personal information to the seller upon purchase. Commercial banks will see the vendor’s identity but not the details of the person initiating the purchase. They will additionally have visibility only on the last transaction of the token, not of those previously made with it.
Mentioned also as “loose-coupling”, this feature is quite unique for the DC/EP in comparison with other digital/cryptocurrencies. It is considered fundamental, as it makes the digital yuan the closest to paper money. Made possible through tokenisation, it permits users to make payments without any connection to a network. Because the token is stored in a cryptographic form on a mobile device, it can be transferred offline from one phone to another. This is known as the “tap and go” or “handshake” feature.
Unspent Transaction Output (UTXO)
There are two ways for currency to be stored and transferred - via accounts and in the form of tokens. The former operates with serial transaction processing, which means a multitude of transactions is processed serially – one after the completion of the other - something that generally slows down transaction speed. With tokens, payments can be processed simultaneously, with each transaction running independently. The unspent transaction output is the distribution of “change” left after a transaction. In the case of offline transacting, the payment is made instantly, and it is processed when the mobile device goes back online.
While cryptocurrencies have gained a lot of traction, and many hope they become a popular way of payment, their computational speed is rather slow. The rate of processing transactions depends on many factors and isn’t a constant. Nevertheless, the average speed for Bitcoin is 7 TPS (transactions per second) with a transaction time of 60 min. Ethereum is 15-45 TPS with 6 minute time. Diem (ex. Libra) goes up to 1,000 TPS. Moving to more widely adopted payment providers - PayPal has 40,000 TPS, VISA peaks at around 65,000 TPS.
The digital yuan has a minimum of 300,000 TPS. China operates at high speed and volume, and the new system should reflect this. An example of this is the 2019 Singles Day sale when Ant Group’s systems processed 544,000 TPS. The need for transaction speed is stated as the main reason why popular blockchain might not be suitable. In high volume scenarios, this could create a backlog of UTXO (Unspent Transaction Output) transactions.
The new digital currency has a built-in smart contract feature which, according to the PBoC, will facilitate business model innovation. The idea is to enable automatic payments upon predefined conditions and terms. This will facilitate trust between two parties in a business transaction and could greatly ease cross-border trading, given the lower transaction fees and instant payments.
Blockchain | DLT compatibility
Tech leaders and government officials have spoken publicly about the application of blockchain within the current infrastructure. Xi Jinping, General Secretary and President, himself shared an optimistic view and urged for the implementation of the technology.
Within DC/EP’s two-tiered architecture, commercial banks will have the opportunity to choose the technology with which to issue and distribute the currency, and it could be both a blockchain or DLT solution. So long as it complies with security requirements and delivers the transaction speed needed for China’s population.
In the country, blockchain initiatives have seen a rise. One of the biggest companies in that area is Blockchain Service Network (BSN) - a Chinese company creating a global network for hosting blockchain applications. The project has nodes in over 128 Chinese cities and 8 foreign nodes spanning six continents. The vision is to create a global network of over 200 nodes and make blockchain an infrastructure layer on top of the current Internet.
The Chinese government’s main intention is to meet the need for domestic retail payments and improve financial inclusion. Not far behind is the goal of internationalising the yuan, the start of which can be achieved through broad domestic use. The year of 2022 is a definitive testing ground with the crowds of tourists at the Beijing Winter Olympics.
Many patents related to DC/EP have already been filed, and they are shedding light on upcoming initiatives. Projects related to the use of BSN and DC/EP are exemplary milestones when put in perspective. The next step will be cross-border transfers within the BRI (Belt and Road Initiative), which covers 144 countries across all continents.
INDUSTRIA is a global technology consulting, development and ventures firm with extensive expertise in the field of enterprise blockchain, confidential computing, process automation and digital experience. Official and strategic partner of R3.
Moreover, INDUSTRIA pays attention to developing CBDC in all aspects and assisting different countries in their CBDC research and implementation.
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