Playing Catch-Up with China’s Fintech Strides

The evolution of financial technology will likely determine the future of money, not to mention the world balance of power. China’s work on digital currency is a pointer.


The People’s Republic of China (PRC) is implementing a long-range strategy to challenge U.S. dominance in international finance without directly trying to compete with the U.S. dollar in the short run. China is a few years into a pilot of its central bank digital currency (CBDC), a digital version of the Chinese yuan or renminbi. While still in its early stages, the pilot shows part of the PRC’s approach to global economic competition: to advance and gain influence in technologies that it deems will be strategically important in the future of global commerce. Financial technology (fintech) is one of those areas.

By prioritizing digital financial innovation, the PRC is not seeking to make the yuan immediately more attractive than the dollar. Rather, it is aiming to lead a global push for alternative payment rails running on new technology that would, over time, obviate the need to go through U.S. banks, or to at least reduce the need to go through financial infrastructure and institutions highly influenced by the United States.

The United States’ best response to this PRC strategy is a strong offense of digital finance innovation in its own right, because the future of money will likely depend on how fintech evolves.

Fintech and National Security

The United States has led the global financial system for more than 70 years. It maintains this position of primacy because of the strength of the U.S. dollar in international currency markets and the high relevance of U.S. banks in facilitating cross-border trade. The dollar is the leading global reserve currency. Any foreign bank that wants to operate broadly in the global financial community needs access to dollars and, thus, needs U.S. banking relationships. This gives the U.S. tremendous leverage in economic statecraft and gives U.S. financial coercion tools like sanctions their potency.

In 2016 I began looking closely at the national security implications of new technologies like cryptocurrencies and blockchain. My research inquiries first focused on non-state actors, like terrorist groups using Bitcoin and other digital tokens. But I soon found that U.S. adversary nations like Russia, Iran, Venezuela, and China were also exploring blockchain. In some cases, politicians in these states claimed openly that they wanted to use blockchain systems to evade U.S. sanctions.

Early attempts were not so fruitful, with Venezuela being a perfect example. In late 2018, the Nicolas Maduro regime created a simple cryptocurrency it called the “petro,” which it marketed as a way to conduct international trade outside the global banking system. But the launch of a crypto token did not change the fundamentals of Venezuela’s disastrous economy or offset its political corruption and instability. Nor did the regime build the necessary digital infrastructure to support its proposed alternative payment rails. There was no well-developed system for dispersing the token to citizens, nor were domestic businesses set up to accept it.

The U.S. quickly added the petro to its sanctions list, making the token an untouchable asset for anyone wanting to remain in good standing in the international banking system. Observing the failed petro project, I turned my attention to other nations, like China, that were going about things differently. In early 2021, I coauthored a report with my colleague Emily Jin at the Center for a New American Security unpacking China’s digital currency project. A second report, looking at the pilot’s progress, is forthcoming.

The PRC’s digital currency project is not motivated by immediate sanctions evasion, but by a longer-term vision for the future of money. Since 2014 the People’s Bank of China (PBOC)—the nation’s central bank—has been researching digital currency technology. By 2020 it had launched its first trials of the CBDC, called the electronic Chinese yuan (e-CNY). This digital fiat currency is also called the digital renminbi. In watching this project, I’ve become convinced that while the pilot is a tiny experiment relative to China’s overall economy and will not alter the renminbi’s international competitiveness (which is based on many other economic and political factors outside its technology stack), the U.S. needs to track its development closely. The geopolitical implications of the e-CNY are less about currency and more about what China is doing with data innovation.

The e-CNY Up Close: A Central Banker’s Dream

The electronic Chinese yuan is a payment instrument that is the digital version of China’s fiat currency, and it is created and managed by the People’s Bank. It is a retail central bank digital currency available for individuals and institutions to use and will coexist with physical renminbi. The e-CNY architecture is a two-tiered digital payment system. The PBOC is Tier 1 of the e-CNY system, and it issues digital renminbi to Chinese financial institutions that provide the currency directly to users through digital wallets. These institutions make up Tier 2 of the system. Typically, the way users acquire digital renminbi is by downloading the People’s Bank’s e-CNY app. Then, users must select one of the financial institution wallets within the app in order to begin transacting in the digital currency.

The e-CNY is a digital currency, but it is not a cryptocurrency. Its main operating system is not blockchain or distributed ledger technology. The People’s Bank is planning for permissioned, state-controlled distributed ledger technology elements to support the e-CNY operating ecosystem, such as where the central bank conducts large-scale settlement operations to reconcile transfers between financial institutions. But the day-to-day retail transactions at the Tier 2 level use a centralized ledger, with a single point of control. People’s Bank calls the e-CNY a hybrid system, borrowing from blockchain architecture in parts, but allowing for flexibility in design as the system evolves.

The electronic Chinese yuan will use “smart contracts” for programmable transactions, especially in wallet technology. Users can access various types of wallets in the e-CNY system; software wallets, hardware wallets (including wearables), and wallets associated with personal machines (like cars) and other devices. Users can also have sub-wallets for different types of payment categories. For example, they can create a sub-wallet specifically for electricity bills to make fiscal management easier for payers and payees.

The People’s Bank does not publish up-to-date statistics about the e-CNY pilots, but it reported that in late 2021, 123 million individuals had e-CNY wallets and there were 9.2 million corporate wallets. As of August 2022, e-CNY pilots in 15 provinces handled 360 million transactions totaling 100 billion yuan ($14 billion), involving roughly 6 million retail merchants. By December 2022, the pilots spanned 17 geographical areas including municipalities and provinces.

Architecturally, the e-CNY is groundbreaking because it is government-run infrastructure whose transaction data go straight to financial authorities. This is not how banking and fintech work generally. Today’s legacy payment systems are built on private financial institutions’ infrastructure. Governments, whether democratic or authoritarian, always have to acquire transaction data by going through those private firms. Until the exploration of central bank digital currencies, governments have never had the technical potential to capture all transaction data in real-time. A CBDC designed in such a way might be considered a central banker’s dream.

In China, private sector mobile apps like AliPay and WeChat Pay have dominated the payment landscape for more than a decade. In recent years the Chinese Communist Party (CCP) has been wresting control of data silos from the private sector, seeing data as a factor of production that the state must harness to advance a more digital economy. The People’s Bank calls the e-CNY a backup system for retail payments; but I believe it is more accurate to call it the government’s preferred default system, one that gives it direct insight into the activities of the domestic population. In its pilots, People’s Bank is seeding e-CNY payment capacity into everyday services like groceries, public transportation, utilities, and health care.

People’s Bank claims that e-CNY transactions are de-identified so that the central bank does not have direct access to the personal identification information attached to transactions unless there is a reason due to suspected criminal activity. But given the CCP’s power to deem activity criminal at will, this is a paper-thin assurance against government abuse. People’s Bank describes the privacy protection within the e-CNY system as “controllable anonymity.” Users can be anonymous to the government only as long as the state allows them to be. The e-CNY is a boon for CCP tracking and monitoring of residents, and its programmability will make it easier to cut off citizens’ access to basic services if they run afoul of the state. For example, it is theoretically possible to program wallets of certain users (by location, demographic, or some other designation) to block certain types of transactions.

China’s Digital Currency Activity and the U.S.

While the electronic yuan won’t displace the dollar, it certainly will give the PRC an easier tool for economic retaliation against U.S. firms doing business in China. As the pilot expands and U.S. firms in the country accept e-CNY payments (as many probably will do given the allure of the retail market), they will need to understand that the People’s Bank will be able to block their e-CNY wallets at the proverbial flip of a switch. Such retaliation is not theoretical. In 2021, the PRC pushed a successful campaign to remove Swedish apparel store H&M from major Chinese e-commerce sites and geolocation and ride-sharing services after the firm posted concerns about forced labor in the Xinjiang region on its company blog.

Also, U.S. firms using e-CNY will be providing data about their company spending and operational patterns directly to the PRC government. The PRC will likely analyze that data and use the insights gained to advance domestic competitors. The collection of more, finer-tuned data overall gives the government much more consumer information than other governments can glean from their own populations. If “data is a factor of production,” as the CCP has said in state planning documents, Chinese firms will benefit greatly from a wealth of digital inputs.

Although the e-CNY is primarily for domestic retail use, the PRC is simultaneously developing a way to leverage it for cross-border trade. As a participant in the Bank for International Settlements’ mBridge initiative, in late 2022 the PBOC completed a series of transactions on a pilot blockchain platform that allows different countries to use CBDCs to conduct international trade. mBridge is a pilot sponsored by the Bank for International Settlements in collaboration with the People’s Bank of China and the central banks of Hong Kong, Thailand, and the United Arab Emirates. It uses a private, permissioned blockchain that only participating central banks can access and reflects a rising aspiration among central bankers around the world to develop more efficient cross-border payment systems.

The pilot only transmitted $22 million worth of value, but it is a proof-of-concept revealing the seeds of a new way for companies to finance large-scale international transactions without going through the U.S.-influenced correspondent banking system. This multilateral activity is in its infancy, but China’s progress with the e-CNY positions it to lead further experimentation and to shape the standards discussion around CBDCs that will occur in the coming years. If a system like mBridge expands and serves as a viable global payment rail outside U.S. influence, it would undermine U.S. sanctions power and fundamentally alter the world balance of power.

The U.S. is taking small, cautious steps on its own to explore the possibility of a U.S. CBDC and to innovate around payments. The U.S. Federal Reserve has made it clear that it has no current plan to launch a digital dollar, but is conducting research to help U.S. policymakers understand if it would even be in the interest of the U.S. to create one. The Boston Fed teamed up with the Massachusetts Institute of Technology on a research initiative called Project Hamilton looking at a theoretical design for a U.S. CBDC. Notably, their project envisioned a framework where users’ transaction details would not be archived by the system.

The New York Fed recently teamed up with several global commercial banks and a blockchain software firm to devise a proof-of-concept for banks to facilitate trade through digital versions of commercial bank assets on a distributed ledger platform. That proof-of-concept aims to use blockchain to “tokenize” assets without creating a formal CBDC. And the Fed has been planning for a few years to unveil an instant payment service called FedNow that will help U.S. financial institutions make faster payments to each other around the clock. It should be live in mid-2023.

These efforts notwithstanding, the U.S. is not very prominent in the global policy discussion around CBDCs, probably because it has less incentive to push for drastic shifts to the global payments order. China, on the other hand, with its wide range of data and experience from its e-CNY trials and multilateral collaboration, is becoming well positioned to influence other nations that are seeking domestic payment innovation and new cross-border transaction efficiencies.

What the U.S. Should Do

The U.S. needs to warn U.S. citizens and firms against the risks from using the e-CNY in China and also to message other nations about the geopolitical dangers of expanding PRC-influenced financial rails. But the most effective defense against the growth of CCP-influenced global financial infrastructure is a more concerted offense of digital finance innovation from the United States. The Fed’s current innovation projects are a drop in the bucket compared to the rising appetite for innovation by central banks and the high pace of international exploration.

My current personal view on this rapidly evolving, highly complex issue is that the U.S. does not need to create its own central bank digital currency. The risks and complications around privacy are a key factor, but another is that the private sector is much better suited than government bureaucracies for building and refining internet applications. (Imagine the threat to future innovation if an update to CBDC software ended up requiring an act of Congress.)

What the U.S. needs to do, however, is lead from the front—with a determined push into digital finance design and development. That means offering alternatives to the one-dimensional approach of building solely on government infrastructure. The U.S. should leverage its robust and creative private tech sector as it envisions the future of money. New global payment systems should be built, but they should grow on digital rails that are open and adaptable. Countries will continue to explore the benefits of digital assets and internet innovation. The United States needs to invest in research and development and international collaborations to construct a digital economy aligned with values of openness, privacy, and freedom.

Yaya J. Fanusie is a former CIA analyst. He is the director of policy for anti-money laundering and cyber risk at the Crypto Council for Innovation. He is also an adjunct senior fellow at the Center for a New American Security.


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