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Why the Digital Yuan Scares the US

tl;dr Summary: Recent activity around the blockchain, the war in Ukraine, and the eCNY has sparked interesting questions about the global financial system and the United State’s future influence over it. A bill proposed by the US Senate to ban eCNY has started a conversation around how the US plans to deal with future financial systems.

At the end of May, US Lawmakers introduced a bill called “Defending Americans from Authoritarian Digital Currencies Act.” This act proposes the prohibition of China’s digital currency payment system eCNY, the official digital payment system of the People’s Republic of China. The eCNY or Digital Yuan represents one of many Central Bank Digital Currencies that are being piloted around the world and is an attempt by governments to leverage blockchain technology for their own purposes.

While the proposed ban may seem insignificant the bill comes at an interesting time in the world when financial systems are weaponized during times of war. 

If you feel lost reading these first two paragraphs then don’t worry cause you are not alone. Financial Systems, SWIFT, CHIPS, blockchain, sanctions, eCNY… and then layer all this with political posturing and jargon and you get a confusing mess. These systems are complex and the dynamics that govern them are even more so.

In this article, we will break down key pillars of the global financial system, how they have been weaponized in the recent Ukraine war, and why the proposed Senate bill that bans eCNY might not be just about defending Americans against “authoritarian” digital currencies, as the title suggests.

How Does a Digital Transaction Work?

To understand why the Digital Yuan ban matters we first have to talk about the current global financial system, how it works, and America’s role in the system.

If you think about any digital transaction, the systems that enable such transactions aren’t limited to just you and the person you are paying. There are a number of intermediaries that are vital for such transactions to be facilitated. The parties involved in a digital transaction are as follows:

  1. The Originator: person/business that starts the transaction
  2. The Beneficiary: person/business to receive the funds
  3. Originator’s Financial Institution: financial institution or bank that receives the instruction from the originator and begins the messaging and release of funds
  4. Beneficiary’s Financial Institution: financial institution or bank of the beneficiary that receives the message and funds from the originator
  5. Additional Financial Institutions: intermediaries that are needed to facilitate or pass along the message or funds to another institution.

CHIPS, SWIFT, and the Global Financial System

In domestic transactions, the exchange of digital funds can be fairly simple. For instance, the originator and beneficiary might use the same financial institution, or financial institutions involved might have close relationships. 

When you think more broadly about international transfers, things get more complex. If an originator or beneficiary uses a bank that doesn’t operate everywhere, then financial institutions will need to play a game of telephone to find a network of trusted banks they can relay messages and funds to.

This is where CHIPS and SWIFT come in.

Clearing House Interbank Payments System (CHIPS) is the organization in the United States that processes international transfers of USD between international banks. They handle both the message transmission and the settlement of funds between institutions. So if you want to transfer USD between a bank in New York and a different bank in say Spain, then CHIPS would help facilitate this transfer.

Society for Worldwide Interbank Financial Telecommunication (SWIFT) is the global cooperative society of banks that manage message transmission so that associated banks can then carry out the request transaction. Unlike CHIPS, SWIFT does not settle transactions but they are responsible for passing along messages between institutions so that the transaction can be completed.

These two system’s importance can not be understated. For the US, CHIPS claims to handle more than 90% of all U.S. dollar-based funds transfers moving between countries around the world. For SWIFT, it claims to process over 2 billion messages per year.

Central Bank Digital Currency (CBDC)

So if you have read this far, hopefully you have an understanding of how messy and complex our global financial system is. And more importantly, with the US being the global reserve currency since 1944, the US’ leverage when influencing these systems cannot be understated. 

For some countries, this overly complex system isn’t preferential for them. This is where the idea of blockchain technology that eliminates the need for these middlemen financial institutions becomes attractive. If a government is able to successfully launch and manage a CBDC then transacting and managing a financial system becomes highly efficient. Benefits that can come from a CBDC blockchain system include:

  1. Improved cross-border payments 
  2. A strengthened currency
  3. Increased financial inclusion
  4. Increased innovation

The Digital Yuan

These benefits are at the heart of many CBDC ambitions including the eCNY system built by the People’s Republic of China. Having researched and tested the eCNY system as early as 2020, the government has long sought the benefits of a digitized monetary system.

While blockchain technology was developed with the intention of being decentralized and without the manipulation of a single power, CBDC system’s inherently centralized structure gives governments unprecedented control and creativity. The ability to track financial transactions, monitor for tax evasion, and crack down on financial crime are just a few types of controls that can be applied. But at the same time, creative benefits like time sensitive direct handouts to wallets also become possible.

The Bill and What it Does

So if there is clear justification for the People’s Republic of China building a CBDC, then why is the US making such a fuss about it?

Well, based on the title of the bill, it would suggest that the US is trying to protect the American people from what they claim to be an authoritarian digital currency. It reads as if the US is scared of the potential controls and monitoring the Chinese government can place on individuals that choose to transact with the currency. As a response, the US’s proposed bill forces application stores like Apple’s App Store and Android’s Google Play to prohibit any applications that support payments in eCNY within the United States. 

So if China has been working on this since 2020, why is the US now just responding to China’s eCNY system?

What Does It Mean

Well, there are two ways to read this bill. On one hand, you can take it at face value. The US is just protecting its citizens from being spied on and the US Senate is taking extreme measures to prohibit this possibility. The response just happens to come now because the eCNY and the overall adoption of digital currency has become very real and the US must now respond to this potential outcome.

On the other hand, you can read the bill as a continued effort by the US to maintain power over global financial systems. The popularity of decentralized blockchain technology and CBDCs threaten a traditional financial system that favors the US. As a result, the possibility of losing their leverage over the system poses a very real and scary possibility.

What’s Next

Regardless of how you read the Senate’s proposed ban on the Digital Yuan, it is hard to deny the importance blockchain technology will play moving into the future. With SWIFT already looking for ways to integrate with CBDCs and countries like Russia, India, and China rushing to launch their own digital currency systems, it is likely only a matter of time before these technologies become ubiquitous.

Author

  • Willy is Venture Capitalist focused on emerging technology. When he isn't reading up on cool companies you can find him learning to pole dance.

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