China is betting on the blockchain_ A special report

China is betting on the blockchain_ A special report

Long before most other nations, the Asian superpower recognized the potential of Bitcoin technology to spawn the next Internet and a new form of money. First part of a series.

By Alexander Zaitchik, Jeanhee Kim, Kelly Le and Angie Lau, Forkast.News. First in a series produced by Forkast.News with support from the Judith Neilson Institute's Asian Stories project.

There is no bigger stage than the Olympics, for either the athletes or the host country. Modern China announced its arrival 13 years ago when 2,008 synchronized drummers performed at the opening ceremony of the Summer Olympics in Beijing. In February, China is expected to use the Beijing Winter Olympics to unveil a creation that has attracted considerable international interest: the digital yuan, the first major central bank digital currency, or CBDC.

It's unlikely that consumers will notice much difference when shopping with e-CNY, as the currency is officially called. It's worth the same as cash and is activated by tapping, swiping or a QR code. But the questions this form of money raises are profound. If governments around the world eliminate physical cash, what will happen to financial privacy? How will state-sponsored digital money affect China's economy, its trade relations and, most seriously, the future of the global financial system, now dominated by the United States and the dollar?

"The question is not whether China's CBDC will upend the current rules of global trade," says Pauline Loong, director of Hong Kong-based research consultancy Asia-analytica. "The only question is how far-reaching the impact will be in terms of who controls access to and movement of capital.

But for all its consequence, the digital yuan is just a toe peeking out from a giant red curtain. Behind it is an ambitious and largely invisible infrastructure program to rewire the country and its economy with the distributed ledger technology known as blockchain. China has made a conscious decision to secure a first-mover advantage in what it believes is the future of the Internet.

If the digital yuan is Beijing's bid for digital frontiers, the blockchain initiative is its bid to build railroads.

A new money

The story of how China came to the technological frontier begins with the 2008 financial crisis. Just a month after the Summer Olympics, an under-regulated U.S. financial sector plunged the world into recession. It was a vulnerability that China was no longer willing to tolerate. As the crisis spread, then-President Hu Jintao called on like-minded nations at the G20 summit to "steadily advance the diversification of the international monetary system."

When Washington's sanctions effectively shut Iran out of the international financial system in 2010, China focused more on cross-border currency flows.

At that point, domestic concerns spurred creative thinking about monetary policy. One was how to lift 400 million unbanked Chinese out of poverty. E-commerce giant Alibaba introduced a mobile payment system in 2008, taking advantage of China's high smartphone penetration: according to the Pew Research Center, 800 million Chinese will use a smartphone by 2015. But such private payment systems left the Bank of China out in the cold and did little to help the emerging Communist Party leader Xi Jinping's anti-corruption strategy, which called for greater government oversight of money.

Around 2012, regulators began to notice strange patterns in the country's power grids. From Xinjiang to Inner Mongolia, huge amounts of electricity were flowing into warehouses crammed with powerful computers and giant servers. The processors crunched numbers to produce - or "mine" - a new kind of money called bi te bi in Mandarin. Chinese miners are believed to have produced 95% of the world's bi te bi, or bitcoin, at its peak in the late 2010s.

This money had no connection to a bank or any central authority. It was completely digital and uniquely secure. Each transaction was sent to every computer within a network for confirmation and permanently recorded in a long series of distributed ledger entries, or blocks.

Chinese authorities immediately recognized the implications of this unregulated activity. In 2014, the Peoples' Bank of China (PBOC) began exploring the possibility of a state-owned version of Bitcoin. With each passing year, the disappearance of the paper yuan from the economy made the idea more plausible. By 2019, PwC said, 96% of Chinese regularly shopped online.

"Before many governments even knew the basics of Bitcoin, Chinese authorities began to take the lead on mining-side network security," said Ian Wittkopp, vice president at Beijing-based Sino Global Capital. "This led to the development of a strong blockchain and crypto ecosystem."

By October 2020, the digital yuan was ready for a pilot test among China's mass audience. A total of 750,000 people selected by lottery received 150 million e-CNY ($23 million) to spend at about 70,000 brick-and-mortar stores and a number of online retailers.

Six months later, new trials allowed open participation. This was the first controlled release of the digital yuan in the wild. In June, nursing homes in Chengdu taught elderly residents how to use the new money.

Such care and effort are necessary to ensure the Olympic debut is as well rehearsed as the 2,008 drummers, says Peter Cai, who studies China's economy and trade policy at the Lowy Institute in Sydney. "The cost of getting things wrong here is enormous," he said. "Chinese officials are right to talk about digital currency as if it's a new frontier. What are the implications for financial, banking and payment systems or the conduct of monetary policy? I don't think anyone really has a handle on that. And that goes for China as well."

The Next Internet

In its two decades of historic economic growth, China has had a mixed record in high technology. It has struggled to achieve self-sufficiency, let alone supremacy, in the production of semiconductors and chips. The country was ahead of the curve in 5G broadband, but lags behind the West in areas of arguably greater strategic value, such as artificial intelligence.

In blockchain, China appears to have taken a leadership role in a technology of great consequence. After President Xi promised in 2019 that blockchain would "lead the next wave of China's digital transformation," thousands of companies have reportedly launched blockchain projects covering everything from retail banking to global shipping and supply chains. This plethora of activity continues. Wittkopp said, "It's a field of one. No other country is even close.

These projects are transforming a digital ecosystem that was already among the most developed in the world, according to a recent McKinsey study. China has 850 million Internet users and accounts for more than a quarter of the world's most successful startups. One of them is Hangzhou-based Ant Group. The financial services giant has more than 50 blockchain-based decentralized applications (dapps) in areas such as shipping, insurance claims processing and charity donations. Internet search company Baidu, the Google of China, has 20 dapps, including one that has processed 35 million pieces of electronic evidence for China's "Internet court."

It's not just tech companies staking out territory on the blockchain frontier. A division of the Industrial and Commercial Bank of China has developed dapps for retailers and businesses. Insurance giant Ping An is using them to finance public construction projects. An app used by China Construction Bank has helped local banks make $134 billion in loans.

"Blockchain will make our technology and our society work better," said Yifan He, blockchain evangelist and CEO of engineering firm Red Date Technology. "It can make all IT systems in the world communicate as if they were in one room. He predicts that in 10 years, all transactions that require more than two parties will be based on blockchain.

The state of blockchain today is comparable to the Internet in 1993, he said. Back then, most companies could not afford the entry costs of the nascent Internet (which began as a public infrastructure project overseen by the U.S. Department of Defense).

In April 2020, China formalized its bet on blockchain by establishing the Blockchain-based Service Network (BSN) managed by Red Date. This is an infrastructure platform that enables private entities, especially small and medium-sized enterprises, to overcome the two biggest barriers to entry: Interoperability and prohibitive cost.

"We've already built everything for you; you just need to plug in and work on your smart contract," said He, who claims that the development cost for a simple dapp within BSN could be as little as 1% of the cost of a commercial blockchain.

As of its first anniversary in April 2021, BSN had attracted 20,000 users and more than 2,500 projects in 120 "nodes" across China, as well as in Johannesburg, Northern California, Paris, São Paulo, Singapore, Sydney and Tokyo. S-Labs, a Beijing startup, has used it to develop applications that have helped more than 5,000 SMEs find more than 500 million yuan in loans during the pandemic. Li Ming, chief technology officer of S-Labs, said BSN is easy to use because it meets Chinese government standards and helps them find customers. "The biggest advantage of BSN is its brand effect".

And if he has his way, today's youth will be the first blockchain-savvy generation. That skill is already being developed in high schools, where BSN is exploring how to teach students, including through programming contests with cash prizes. "Blockchain should be a basic skill," He said. "The idea is to help more people get comfortable with the technology."

In June, Red Date closed $30 million in Series A funding, which was notable for its global reach. Major investors from Saudi Arabia, Switzerland and Thailand were involved.

Part two of this series will explore how China is using technology - particularly the digital yuan - to drive initiatives that intertwine economics and geopolitics, span concrete and virtual infrastructures, and encompass hemispheres from Cambodia to the Caribbean.