Digital currency coin on top of Chinese Yuan showing privacy protection for Digital Yuan

China’s Digital Yuan Offers Privacy Protection for “Small Transactions”

The People’s Bank of China has announced that its variation of cryptocurrency, the “digital yuan,” will allow anonymous transactions in small amounts. The move is meant to address the inherent contradiction between individual privacy protection and government needs found in a nationalized cryptocurrency, but it remains to be seen whether this protection will extend to any degree beyond third-party access to transaction records.

Digital Yuan looks to stem influence of independent cryptocurrencies, keep government eyes on transactions

Given that the primary appeal of cryptocurrency is decoupling from the fiat currency system and the ability to cut government out of transactions, it might be initially puzzling as to why so many countries are looking at creating their own versions. Particularly the government of China, which takes domestic surveillance to a unique level and does not have a history of caring much for the concept of personal privacy protection.

One reason is that it’s simply a desperate bid to divert as many users as possible away from the independent cryptocurrency market. For some countries, it’s also a way to essentially create money from nothing (other than the cost of compute power). But for China, it’s simply an extension of an already widespread digital payment system; the country has already moved strongly toward a cashless state. There seems to be a particular focus on uptake in rural areas, where tens of millions still do not have access to the banking system. It is also a long-term bid to create a framework that major financial institutions in other countries might adopt for cross-border business; the Chinese central bank has already engaged in talks of this nature with banks in the UAE, Thailand and Hong Kong.

A number of countries are at least experimenting with the idea of a national cryptocurrency supported by the banking system, but China’s digital yuan (also referred to as the Digital Currency Electronic Payment or DCEP) is the farthest along of all of these initiatives. Trials with select services, such as food delivery and rideshare apps, were conducted in Shenzhen and several other cities in late 2020 and were considered to be successful. But in terms of privacy protection, the digital yuan is not strictly a cryptocurrency as it is not blockchain-based. The system is run and secured by the national government, which has full access to all transaction records.

However, the Chinese government does appear to be willing to make at least some small concessions in order to drum up interest in the digital yuan. The country has stated that full anonymity is off the table due to the standard reasons of terrorist funding, tax evasion and money laundering. But the government is promoting a concept it calls “controllable anonymity” that will provide certain enhanced privacy protections to transactions that are beneath a certain value threshold.

What “privacy protection” looks like in the Chinese banking system

It is unlikely that the government would give up much internal visibility into transaction records, as that’s a planned feature of the system. But it has stated that the country’s telecoms operators (even those involved in the development of the digital yuan) will not be able to disclose the phone numbers and personal data of users to any third parties, the central bank included. Information would also be encrypted (via a digital wallet) prior to being passed on to third-party e-commerce and payment tools. The central bank also described a “loose coupling of accounts” in terms of a connection between the user’s standard bank account and their digital yuan wallet.

The “controllable anonymity” privacy protection scheme would allow digital yuan users to provide only a phone number so long as transactions are kept below a certain amount (the exact number has yet to be specified). However, the phone number must be registered with one of the Chinese telecom operators, which in turn would require a government-issued photo ID for account creation. Once a user reaches a certain deposit limit, they are required to provide more personal information to keep the account open.

Though still somewhat thin on details, the planned privacy protection elements have already triggered a response from other countries. Most notably from the United States; Fed Chair Jerome Powell said that any similar digital currency would have to provide its users with better privacy protection than the digital yuan offers to succeed. The Federal Reserve is in the very early stages of drafting a US digital dollar proposal, in partnership with researchers from MIT. A number of other countries have pilots or experiments slated to run between now and 2022: Brazil, Russia, Japan and Sweden are among the biggest names. Additionally, Canada is actively developing the framework for a digital currency but has yet to announce specifics or any plans for trials.