Geopolitics at Stake in US Response to China’s Digital Yuan: Report

Technology
  • While not many technical details of China’s plans for its central bank digital currency (CBDC) are publicly available, the digital yuan is already raising concerns around privacy, national security and political power.
  • The Digital Currency/Electronic Payment (DCEP) system would give the Chinese Communist Party the powerful ability to monitor in real time the minute financial dealings of its citizens.
  • The U.S. needs to accelerate its development of tools for dealing with CBDCs on the global stage.

China is leading the world in the development and piloting of a Central Bank Digital Currency (CBDC). With that lead comes increased scrutiny and concerns over the downstream effects a digital yuan might have regarding privacy and political power. 

A new report from the Center for New American Security (CNAS) not only lays out in stark terms the history and state of China’s CBDC system but also reviews what few technical details of it are available and recommends policy steps the U.S. should consider in an escalating CBDC conflict. 

“This CBDC system, which the Chinese government calls Digital Currency/Electronic Payment (DCEP), will likely enable the Chinese Communist Party (CCP) to strengthen its digital authoritarianism domestically and export its influence and standard-setting abroad,” reads the report. 

“By eliminating some of the previous constraints on government data collection of private citizens’ transactions, DCEP represents a significant risk to the long-held standards of financial privacy upheld in free societies.”

Privacy risks of China’s digital yuan

The privacy concerns arise largely from the massive amount of insight a CBDC would give Chinese authorities into its users’ financial data and behavior, as well as information about anyone who interacts with those users – including, potentially, American citizens. 

“DCEP would give the Chinese Communist Party something that no government has ever had in history: The ability to monitor in real time the minute financial dealings of its citizens,” said Yaya J. Fanusie, an Adjunct Senior Fellow at CNAS and co-author of the report, in an email to CoinDesk. His research focuses on the national security implications of cryptocurrencies. 

He said that while much of the world transacts digitally today, that transactional data is not accessible wholesale by government authorities because the government has to go through financial institutions to acquire the data. 

The DCEP design deviates from this model, putting the data directly in the hands of the CCP without having to go through intermediaries. Anyone using a digital yuan pretty much concedes his or her financial privacy directly to the Chinese government, according to Fanusie. It’s not yet clear how accessible DCEP would be outside China, but if it is, this has implications for other governments. 

“The U.S. government needs to assess whether DCEP use should be blocked in the United States,” said Fanusie. “But private-sector U.S. tech companies should also be thinking about whether they will allow the DCEP application to be accessible on their platforms, such as app stores.”

The report notes that officials of the People’s Bank of China have said the CBDC will have “controllable anonymity,” meaning the central bank could observe and monitor transactions taking place while the transacting parties would remain private. However, the central bank has also said it would be still able to analyze transactions to monitor “crimes.” 

Taken in conjunction with China’s loose-knit social credit system, information gleaned from digital yuan transactions could be used to wield punitive power against Chinese citizens. Additionally, any metadata collected could give insight into users’ personal and device movements, according to the report, further rounding out a body of significant personal data. 

“PBOC modeling of DCEP shows that each digital currency token held by users would be constructed with a cryptographic algorithm expression, with various data inputs such as information on the owner of the token,” reads the report. “Not all of the data will be available to those transacting in DCEP, but they will all be available to the central bank, according to its early proposed design sketches and most technical reports about DCEP.”

The PBOC will thus become a possessor of a significant data trove to combine with its tools for censuring and surveilling individuals.

The political power of CBDCs

Related to privacy concerns are the ways a lack of privacy coupled with the use of big data can be used to deprive individuals of political power and even change their behavior. 

The parable of the panopticon is one way of looking at this. In it, a central observation tower is placed within a circle of prison cells so guards can see every cell and its occupant, while inmates are unable to see into the tower. Never knowing if they are being watched or not, prisoners assume they are being surveilled and behave accordingly – that is, the way authorities want them to act. 

While certainly simplistic when it comes to the complications of the digital age, it’s a basic model for understanding that information and surveillance are forms of power that can be wielded in the service of a specific set of outcomes.  

In the U.S., the founders created the Fourth Amendment to the Constitution precisely because it was understood that if the government had access to everyone’s private possessions (such as their papers at home), it would lead to government repression, according to Fanusie. 

“This dynamic continues to exist, and places like China which don’t have this standard built into their governing system are more likely to abuse their citizens and hinder their ability to advocate for their interests or redress grievances,” he said. 

The report notes the PBOC is already testing a digital yuan as “a way to disburse government salaries and subsidies.” The centralized monitoring and control of DCEP wallets would make it easier for the government to cut off a person’s ability to transact than if it had to attempt to do so through other third parties. 

Cryptocurrencies have been attractive to some parties as a means to engage in a financial world beyond the reach of the state. Some case studies of the benefits of this are clear in places like Nigeria, where groups protesting police violence were able to receive funds via bitcoin after the government froze their bank accounts, and in Belarus where protestors against the country’s latest illegitimate election were supported by bitcoin grants after being fired from their jobs for protesting

CBDCs bring the idea of a digital currency squarely under state control and may seem in conflict with the ethos of cryptocurrencies. But Fanusie said CBDCs probably won’t directly impact cryptocurrencies’ ability to flourish “unless financial authorities technically try to ban cryptocurrencies, which is not feasible.”

CBDCs could be seen as a way for citizens to have the functionality of digital money instead of permissionless cryptocurrencies.

“So, there’s certainly an element of governments wanting to compete with crypto,” said Fanusie. “But one big possibility is that by developing the infrastructure for digital wallets, programmability and microtransactions via CBDCs, governments might actually make cryptocurrency adoption easier.”

Policy recommendations

The report concludes with a set of specific policy recommendations from Fanusie and his co-author, Emily Jin, a research assistant for the Energy, Economics, and Security Program at CNAS. 

These include things such as pursuing a diplomacy campaign urging Chinese government transparency and restraint in using DCEP for punitive measures, monitoring any DCEP data collection on U.S. citizens, making CBDCs a key part of U.S. national security concerns and examining the private sector in the U.S.’ ties to “China’s digital financial authoritarianism.” 

Finally, the report suggests the U.S. lead CBDC standard-setting going forward, conduct more research into the economic impact of CBDCs, and look at economic statecraft possibilities for combatting CBDCs, including evaluating “whether and how the United States can apply sanctions tools to CBDCs.”

CBDCs aren’t a question of if at this point, but rather when. The sooner key considerations such as these are taken into account and seen as an integral part of geopolitics, the sooner countries can consider the risks and benefits they offer. 

“The U.S. should raise this as an important issue in diplomatic channels and also emphasize the privacy component in intergovernmental discussions on CBDC, such as with the Bank for International Settlements, but also the Financial Stability Board, the G7, and G20,” said Fanusie.

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