Trans-Pacific View | Economy | East Asia

Blockchain in China: A Solution in Need of a Problem

Is China’s drive to master the blockchain a threat to American technology supremacy?

By Natalia Cote-Munoz and Sean Silbert for
Blockchain in China: A Solution in Need of a Problem
Credit: CC0 image via Pixabay

Last October, Chinese President Xi Jinping declared that China would “seize the opportunity” investing in blockchain, stressing that China should join the world in setting standards for this emerging technology.

Xi’s announcement will jump-start China’s formidable blockchain activity, where state support often translates to easy financing and subsidies. Since last March, searches for blockchain on Baidu, China’s top search engine, jumped by almost 1,400 percent and over 500 blockchain projects have been registered — as per Chinese regulations — with the government by a diverse range of actors, including some of the largest Chinese banks and tech companies as well as several government offices. Various sectors have begun adopting blockchain in force, using the technology to settling disputes in the courts, to drafting invoice standards, to tracking the shipment of luxury goods.

China seems to be set on blockchain’s potential, but this announcement is a shift from previously negative policies towards blockchain and cryptocurrencies. In 2017, China banned cryptocurrencies, their mining, and initial coin offerings, all efforts to tighten controls on risky investments. Cryptocurrencies had become increasingly popular in the country, and their price volatility and increasing amount of fraud were deemed a risk by the government. Following Xi’s announcement, previous articles calling blockchain a scam were censored and more than 85 Chinese companies with business related to blockchain saw their value jump by the stock exchange’s 10 percent daily limit. Universities rolled out courses in blockchain the very next day.

By investing in blockchain, China sees an opportunity to move into a high-potential technology as the United States backed away.

China’s most consequential goal in developing blockchain would be to help create a digital currency — not a new cryptocurrency like Bitcoin, but making already-existing monetary base digital. Blockchain can be the fundamental of a digital currency through tracking and recording transactions, creating a new unit controlled and distributed by the government. This could further enable China’s digital economy, where half of all digital transactions, totaling over $9 trillion last year.

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A state-backed digital currency would allow China to not only reap the benefits of digital transactions, but also potentially gain a glimpse at where money is being spent, and by whom, limiting money laundering and following a growing environment of surveillance. It will allow the government to retain control of the money supply, and serve as a barrier against international cryptocurrencies. Further, this would fit in neatly with China’s increasingly cashless society. In 2017, 82 percent of Chinese adults made digital payments.

China’s tight controls on its currency, combined with an open trade account, drive trade settlement. The argument goes like this: get other countries using the RMB digitally, and the demand for keeping RMB reserves will follow. By issuing a “digital yuan” cryptocurrency, China could facilitate a digital version of the yuan as a global alternative to the dollar, especially along belt and road nations seeking to modernize their financial sector. Further, it could help internationalize China’s e-payment systems, such as Alipay, which have not found success outside of the Middle Kingdom.  This would make China’s renminbi — not the U.S. dollar — the de facto currency of choice, cementing its influence abroad, and especially along Belt and Road Initiative countries.

It is an interesting coincidence that this speech came two days after Mark Zuckerberg took the podium at Capitol Hill to answer pointed questions about his cryptocurrency initiative, Libra. By that time, many of the partners of the original consortium had pulled out, and he had received strong criticism from both parties as well as the Federal Reserve Chairman Jerome Powell. Facebook’s CEO claims that if his creation doesn’t have the ability to achieve their goals of deploying at scale, China’s alternatives will take their place. This argument is simplistic. China’s digital currency ambitions have too many problems of their own to be globally competitive.

Facebook’s efforts may have inspired China, like many other central banks, to ramp up creation of their own digital currency. Having full control of their cryptocoin will allow them to achieve their stated goals of internationalizing their currency and preventing fraud at home, but previous efforts only worked in part. Further, it could possibly be easier to launder cryptocurrencies than cash. China’s currency — the “digital currency electronic payment,” or DCEP — may come into effect within the next year: a pilot program has been launched in Shenzhen, which could be expanded nationwide. There’s potential that this initiative will end up with a similar fate to China’s Cross-border Interbank Payment System (CIPS) in 2015, which is supposed to be an alternative to SWIFT, the Belgium-based system widely used for cross-border payments which primarily uses the dollar.

This alternative system has been expanding, but primarily in countries under U.S. sanctions, like Russia and Turkey, and a smattering of African countries receiving Chinese loans. It’s unlikely that a digital currency backed by the renminbi would be globally adopted in areas or industries without a heavy Chinese hand.

If China’s main goal in using the technology is to develop a digital currency, then blockchain might not be the best choice. The People’s Bank of China specifies that its digital currency must be able to handle 300,000 transactions per second to appease the Chinese market, but other cryptocurrency blockchains such as Ethereum can only handle 15 per second. China also only has a tenth of the United States’s total blockchain developers, and still has few formal ways of educating future blockchain engineers to meet its goals. Even in the West, blockchain engineers have been waning in popularity as the status of bitcoin has receded from front page news.

The full consequences of using a digital currency are not fully understood. The persistent risk and bad loans that trouble China’s financial sector is troubling enough to the government that Xi Jinping himself has declared it one of its top priorities, and taking resources away from retail banks by putting them into a government-backed digital currency might make things worse. Additionally, the renminbi still has a long way to go– less than 2 percent central bank’s assets and 1 percent of the international payments are made in the currency. This is something the PBOC is actively concerned about in its implementation strategy.

What’s more, China is centralizing a decentralized technology, requiring that all “nodes” using the blockchain register with the government and provide information on their users. This doesn’t achieve blockchain’s goals of privacy and transparency. On the contrary, it has implications for human rights as China tracks loyalty through financial transactions. Since data it is incredibly difficult be edited once added to the blockchain, it makes participating in party loyalty apps and purchasing of censorship-free materials more difficult to avoid as China moves towards a more cashless society.

It is true that China is aiming for technology supremacy, pumping billions into emerging industries from biotech to artificial intelligence. But as the West is weighing technological risks posed by China,  it should be looking for whether China can also keep its house in order. Investing huge sums into a new tool doesn’t make it effective. Unlike other technologies, such as robotics, quantum computing and 5G communications, which could potentially challenge the American technological advantage, the consequences of China’s blockchain binge are still unclear. The technology is still in its infancy and the use cases are still in the process of being understood..

At present, blockchain seems to be a workable solution without a problem. Many blockchain initiatives haven’t shown to be successful: China’s Academy of Information and Communications Technology noted last May that only eight percent of the 80,000 blockchain projects launched were still active, with a lifespan of a little more of a year. China’s other potential uses of blockchain, such as advancing health care and public services, have a hard competitor — other “hot” technologies such as solar panels, bike-sharing, electric vehicles and robotics similarly did not play out strongly for investors.. And existing technologies already provide these services efficiently — why would someone ask for a slower version of what you already have? Because of these reasons, Gartner predicted that 90 percent of blockchain-based initiatives globally will be scrapped within four years.

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The real challenge for China, it seems, isn’t using the blockchain. It’s figuring out where a hot technology is actually useful.

Natalia Cote-Munoz is a research associate at the Council on Foreign Relations. You can follow her on twitter at @ncotemunoz. Sean Silbert is an interim research associate at the Council on Foreign Relations. He has previously written for the Los Angeles Times and CNN.