Jaehyuk Choi: When Bitcoin Meets Digital Renminbi (DCEP)
2021-06-15 15:06:00
phbs phbs phbs
Bitcoin had an amazing year in 2020 with its price quadrupling. The Bitcoin price is currently hovering around 45,000 US dollars at the time of writing this article. Bitcoin once crashed to 3,000 US dollars in 2018. What made this big turnaround possible? First, institutional investors started buying Bitcoins as an alternative investment. MassMutual, a major US insurer, invested in 100 million dollars worth of Bitcoins. Second, aggressive monetary easing from central banks across the world has provided ample liquidity. This also makes Bitcoin an effective hedge against inflation, replacing gold.

Investment firm VanEck recently filed another application to launch a Bitcoin exchange-traded fund (ETF) after several rejections from the US Securities and Exchange Commission (SEC). Academic research before Bitcoin’s recent rise [1, 2], including my recent paper, investigated the trading in unregulated crypto exchanges such as BitMEX. The research found that the price discovery and trading volume were dominant in the unregulated exchanges and thus argued that SEC should be careful in approving the Bitcoin ETF. However, the trading volume in regulated exchanges (e.g., Coinbase and CME) surged thanks to institutional investors, and the outlook for Bitcoin ETF seems brighter. If approved, the ETF will further accelerate the adoption of Bitcoin by broader investors.

Although not as exciting as the roller-coaster ride of Bitcoin, an interesting digital currency experiment has been undergone in October 2020 in Shenzhen, China, where my school, Peking University HSBC Business School, is located. It was the first use of the digital version of Renminbi (RMB) among the general public. Digital RMB, formally named Digital Currency/ Electronic Payment (DECP), is developed and distributed by the People’s Bank of China (PBOC) and is a part of legal currency backed by the Chinese government, whereas Bitcoin is operated on a peer-to-peer network without any central authority. Despite the stark difference, digital RMB and Bitcoin both use blockchain technology for recording the transactions. According to local media, the experiment in Shenzhen was successful. 200 digital RMB was given to each of 50,000 members of the public randomly selected through a lottery that was oversubscribed by 1.9 million people. The recipients spent 8.8 million RMB in one week, creating 62,000 transactions at 3,400 designated shops in the Luohu district. Although the user experience was similar to those of Alipay and WeChat Pay, a few differences were reported. For example, the holder could use digital RMB without an internet connection.

With the huge success of Alipay and WeChat Pay, China is already a world leader in digital payment infrastructure. Without these apps, daily life in China would not be so easy. Then, why is PBOC considering yet another digital currency? If a legal currency is circulated in digital format, the government can more easily control and monitor the money flow. To cope with an economic downturn, such as experienced recently, the government can effectively distribute subsidies to individuals and small businesses. It is also possible to lower the interest rate to negative, which is why many other central banks are also considering the digital version of legal currency, broadly termed as Central Bank Digital Currencies (CBDC). Furthermore, to the Chinese government, digital RMB has another merit of pushing forward the RMB internationalization.

The stories of the two digital currencies above seem quite isolated as they are at the two extremes. However, they may impact each other in the near future, creating `A tale of two coins.’ Below I consider some possible scenarios. First, will the success of digital RMB diminish the value of Bitcoin and eventually kill Bitcoin? Many argue that Bitcoin’s outrageous price volatility is a hurdle for its wide use in everyday life. To resolve this problem, several stablecoins have been created whose fiat value is maintained by various algorithms. Digital RMB is the pinnacle of stablecoin while keeping the benefits of cryptocurrencies. Digital RMB cannot be an inflation hedge as it is a fiat currency. However, the advanced blockchain functions in digital RMB may diminish the need for other cryptocurrencies with similar functions. Second, can digital RMB be used as a reserve currency in crypto exchanges outside of China?

Tether (USDT), a cryptocurrency whose value is fixed to the US dollar, is already widely used in major crypto exchanges thanks to its fast transfer speed. Although Tether’s total market capitalization is only a fraction of Bitcoin, the trading volume of USDT has already surpassed that of Bitcoin. This indicates that Tether, not the fiat US dollar, has become the reserve currency for buying and selling Bitcoin. If PBOC has the internationalization of RMB in mind, the scenario is not impossible. There are good reasons that crypto traders may prefer digital RMB over Tether. Digital RMB is backed by the Chinese government, while USDT is operated by a corporation. The US dollar versus RMB volatility is nothing compared with that of Bitcoin’s price. The competition between the US dollar and RMB for the reserve currency will likely happen in the crypto exchanges first.

Last, will Chinese regulators allow institutional investors to hold Bitcoin or Bitcoin-based ETF (if approved) in the future, even though Bitcoin trading is currently banned in China? As with their western counterparts, Chinese insurers and pension funds may see the need for holding Bitcoin
for diversification and inflation hedge. If Bitcoin holding is allowed, we may observe Chinese institutional investors one day buying Bitcoin with digital RMB.

[1] Alexander, C., Choi, J., Park, H., & Sohn, S. (2020). BitMEX Bitcoin
Derivatives: Price Discovery, Informational Efficiency and Hedging
Effectiveness. Journal of Futures Markets , 40(1), 23–43. https://doi.
[2] Alexander, C., & Heck, D. F. (2020). Price Discovery in Bitcoin: The
Impact of Unregulated Markets. Journal of Financial Stability , 100776.

ByJaehyuk Choi
Published in the PHBS Magazine