By: Claire Murphy

Editor | Social Economy

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Years after the burst of the Bitcoin Bubble, China is rolling out a new pilot project called “digital currency” or “electronic payment.” Announced in late April, this is essentially a government-backed mobile payment system designed to be the electronic version of a banknote or coin, without the flaws of existing cryptocurrencies. Currently, the U.S. dollar is the preferred currency for key commodities such as oil. However, if China’s currency works as promised, digital payments could enable the evasion of American sanctions, ultimately proving a threat to American dominance.

Sanctions are a stick-and-carrot approach to foreign policy

Currently, the United States has 7,967 sanctions imposed on foreign entities. While many have been imposed for humanitarian reasons, some are the result of promoting political agendas.

Such sanctions may be crippling, depending on a nation’s reliance on imports and exports, resulting in economic and political instability. In Venezuela, sanctions resulted in an economic downturn that strengthened Maduro’s extremist regime; sending Venezuela into a humanitarian crisis.

The introduction of an official Chinese e-currency may allow China and other nations to trade with sanctioned entities without raising any attention from the United States, thus proving a solution to countries isolated from the American trade network.

Digital payments may give China a boost

A digital wallet has gained traction under the recent events of the global pandemic, with consumers looking to avoid the use of cash. The Chinese are not new to the concept of digital payments, with mobile payment systems already representing 16% of purchases, compared to a measly 1 percent in the United States. A digital currency also eliminates the need for bank accounts, allowing the 225 million people without bank accounts in China access to essential services.

According to the World Bank, China has seen a year-over-year increase in economic growth of 10% annually, with over 850 million people lifted above the poverty line within the last 42 years. However, the COVID-19 pandemic has brought this growth to a sudden halt. The timing of China’s announcement of the digital payment comes at a time when China is looking to improve domestic demand for consumer goods.

There are requirements for building a network effect

Currencies such as Bitcoin gained in popularity in Venezuela after being seen as a way to evade American sanctions. As of June 1, 2020, The U.S. Treasury Department has at least 144 sanctions imposed on Venezuela. Although Bitcoin’s value has been historically volatile, it was viewed as being more stable than the Venezuelan Bolivar and was widely accepted as a replacement. In 2019 alone, the Bolivar lost 98.7% of its value relative to the American Dollar.  The government was concerned by the tax avoidance due to the widespread use of American Dollars and bitcoin, and ultimately chose to design their own cryptocurrency, called the Petro.

However, the government’s low credibility made it extremely difficult to establish The Petro as a replacement for Bitcoin and The American Dollar. To effectively secure the voluntary use of a currency, a government must put it into circulation as part of government spending and commit to accepting it, which Venezuela was unable to do successfully. This is because cryptocurrencies largely rely on network effects – where a greater number of users increases the value of the currency.

Introducing the first digital currency puts China at an advantage in developing the highly coveted network effect required for the success of a digital currency. The digital yuan will be hyper-centralized by the People’s Bank of China and as a result, is more likely to overcome the major hurdles that have prevented currencies such as the Petro from achieving scale. Wide acceptance, price stability and legitimacy in the eyes of governments and regulators will allow for easy adoption. This gives China the potential to achieve widespread use.

Is China’s Digital Currency a threat to the American Dollar?

Americans may have to rethink the use of sanctions as foreign policy. Currently, the American-run Society for Worldwide Interbank Financial Telecommunication (SWIFT) is used to facilitate messages between banks and serve as an intermediary for international payments. Approximately $5 trillion in payments pass through SWIFT daily, providing Americans with tremendous leverage over smaller nations in international trade. The number of American sanctions has increased threefold over the past ten years; however, introducing a digital currency may reduce SWIFT’s influence by circumventing American surveillance.

China is not the only country looking to evade SWIFT - Canada, Japan, Sweden, Switzerland, and the United Kingdom have begun exploring the plausibility of a digital currency between countries.

Not only does the overuse of American sanctions undermine their leadership position in the global economy, but they mitigate the effect of the sanctions themselves. It was inevitable the allies of sanctioned countries would find a way to circumnavigate SWIFT. China’s ability to provide an alternative payment method places them in an advantageous position within the global economy. Without intervention, the digital yuan may replace the U.S. dollar as the world reserve currency.

As blockchain technologies develop, digital payment methods will almost certainly play a larger role within our economy. Government-backed crypto-currencies provide a solution to the instability of Bitcoin and Venezuela’s Petro, suggesting that digital payments may become the new norm going forward. China’s increasing ability to degrade the efficacy of American sanctions means that international trade as we know it may very well change. Being years ahead of the U.S. means that China may win the race to develop a network effect, and ultimately, replace the U.S. dollar on the global stage.