Apps, smartphones and the blockchain could mean the end for paper money
Over a thousand years ago, Chinese people living in the Tang Dynasty didn’t realize they were among the first in the world to use paper currency. But today, many young Chinese believe they could be the first to stop using cash.
Xiao Yue, 26, who works as a civil servant at Beijing, leaves her home with her iPhone and house key—she can’t recall when she last brought any cash. Most restaurants, supermarkets and even metro stations now accept mobile payment. “My finance professor used to tell everyone that cash is king. But now, at least literally, it no longer is,” says Xiao.
In 2016, China’s mobile payments hit $5.5 trillion, accounting for 40% of retail payments and roughly 50 times the size of the US’s $112 billion market, according to Beijing-based consultancy firm iResearch. In cities such as Beijing, Shanghai and Hangzhou, over 80% of supermarkets allow consumers to pay with Alipay or WeChat Pay, the two dominant mobile payment platforms owned by tech giants Alibaba and Tencent, respectively.
Pushed by these non-bank service providers, mobile payments penetrated people’s daily lives in a very short time. Back in 2006, China still lagged behind other countries, with cash use accounting for 13% of GDP, compared to 6.4% in the US and 3.5% in the UK at that time.
Unlike people in the West, who have long enjoyed using credit cards, China did not issue its first credit card until 1985. A Goldman Sachs report released in August shows that each Chinese person has an average of 3.6 debit cards, but only one third of them have a credit card.
That turned out to be an advantage. Chinese consumers did not need to get rid of any habits to pick up mobile payments. As described by David Wolman in The End of Money, “the mobile money revolution underway in developing countries is something technologists refer to as a leapfrog scenario.” Less-developed economies are fast movers who never had developed infrastructure, and so “there were minimal obstacles preventing the implementation and adoption of a superior system,” Wolman writes.
A global survey by KPMG asked whether people are willing to use mobile wallets to pay, and the results show that globally 66% of people would like to use mobile payments, while in China 84% of those polled said yes.
The convenience of mobile payments is obvious: take out your smartphone, open the app, the relevant party scans the code and the transaction is done.
In addition, digital payment advocates argue that cash’s anonymity makes money laundering, illicit drug deals and tax avoidance easier.
But even so, cash has certain advantages over digital payments and China cannot enter a so-called cashless society abruptly. With cash, we don’t need to worry about leaks of personal information and there are no additional transaction costs. For elderly people, tourists and people who don’t have access to fast mobile internet, they don’t need to rely on digital technology and local apps.
“It is still too early to say if China will be cashless, but it is a path that we have already embarked upon, and we will go through many steps—with mobile payment being just one of these,” says Henry Cao Huining, professor of finance at the Cheung Kong Graduate School of Business.
A bottom-up revolution
Before Alipay and WeChat Pay become ubiquitous, most cashless payments were done through debit cards and UnionPay, China’s bank card payment clearing monopoly, which was formed in 2002. But it did not start the digital payment revolution.
Around 2005, the transition to online payment coincided with the take off of e-commerce. At that time, the commercial banks, which had developed their own online payment systems, were still taking the lead. With online shops, consumers could pay with different bankcards, but which meant online merchants needed to open and manage several bank accounts.
Yet for the non-bank financial service providers, it was an opportunity to slip in. Having formed partnerships with commercial banks, they provided a unified payment gateway, regardless of bank, that connected consumers and online shops, and processed all dealings with the commercial banks backstage.
Meanwhile, Chinese mobile phone use, a prerequisite for people to transition from PC to mobile payments, grew to 500 million in 2012. Only one year later, the number of 4G users reached 386 million.
In turn, thousands of PC software firms opened mobile apps, and shopping on them marked the start of the adoption of mobile payments. As of this June, China has an estimated 751 million internet users, with 96.3% of them accessing the Internet through their mobile.
In 2013, WeChat, which had 400 million users at that time, formally launched its payment unit. The following Chinese New Year, people upheld the tradition of giving so-called lucky money, but this time used WeChat to send digital “red envelopes”—a process that made people link their bank account to WeChat. Adding to the adoption was the social pressure for reciprocity.
Indeed, the red envelope exchanges became another milestone after the popularization of e-commerce and greatly drove mobile payment use in China. And now that most Alipay and WeChat users had money in their accounts, the next step was to go from online to offline markets.
Thanks to the QR code, it is much easier for merchants to receive payments from buyers by mobile than with a point-of-sale machine. Be it a fancy shopping mall or a shabby vendor, shoppers just need to have a QR code sign to receive money from consumers.
As people put more money in these non-bank platforms and use them more frequently, the tech firms behind them have started to offer an “interest rate” on the amount in people’s accounts. Ant Financial, Alipay’s operating company, further tapped into the fintech sector by launching Yu’ebao, a monetary fund boasting no entry barriers, such that even the smallest investors could get a higher interest rate than from bank deposits.
And with the shopping records it has accumulated, Ant Financial also allows people to have a virtual “credit card” called Huabei, which means “check later”, with no requirement to connect any real bank accounts. JD.com, another e-commerce company, launched a similar function called IOU, granting users a credit line up to RMB 15,000.
These new forms of digital money have further contributed to cashless spending. But it also poses challenges for both commercial banks and the government.
Back in control
For banks, a direct hit is the drastic fall in savings. In the first half of 2017, personal savings and cash in circulation fell from RMB 33.64 trillion to 30.52 trillion, according to central bank data.
And unlike in the US, where Amazon does not pose a major threat to credit card networks such as Visa, in China a possible expansion of Tencent and Alibaba’s payment platforms could bring major risks, Goldman Sachs says in a recent report.
For regulators, a lot of mobile money transfers are outside of their supervision. For example, when one transfers money from one Alipay account to another, the process is completed on the same platform and the central bank will not be aware of the transfer.
Such transfers that never leave the fintech platform pose a threat to the profits of a traditional clearing institute, in this case the UnionPay, and it hurts both the central bank and commercial banks by eliminating access to online financial data—an even bigger loss.
As a result, the People’s Bank of China (PBOC) has required all third-party payment institutions to channel transactions through a newly established central clearing platform, the Nets Union Clearing Corp, which will begin operations on July 1, 2018. Then, all third-party payment firms will no longer be able to connect to banks directly—for whatever deals or transactions they facilitate, they have to connect to the Net Union first, and then to consumers and merchants.
This new clearing institute will charge banks and companies a fee for using its clearing network, just like UnionPay does.
Although the online platforms all claim this change neither creates troubles for users nor imposes an extra fee, the de facto transaction cost is certain to rise.
Future: from electronic payment to digital currency
But the current situation is not the end point for cashless payments, as people still use “cash” in their bank accounts.
Given familiarity with mobile payments, people won’t find it hard to accept completely digitalized currency, which is underpinned by a new technology: the blockchain, a digital, distributed ledger system. Professor Cao of CKGSB believes that cash will eventually phase out and the current model of digital payments transferred via a third party will disappear.
“Eventually every consumer will have an account in a system based on the blockchain and there will be no need for any third party to process the transactions,” says Cao, adding that a real cashless society would have a legal digital currency.
In an operating system based on the blockchain, every deal is transparent, non-changeable and recorded on a public database. And because “trust is established automatically with the blockchain, current institutions that offer trust and act like middleman, such as Alipay, will not be needed in future transactions,” Cao adds. “So there is also no need to worry about their temporary dominance or monopoly by the two companies (Tencent and Alibaba)”.
The blockchain technology, if maturely developed, will help create an efficient cashless economy, according to Vivek Ramachandran, global head of product and proposition management at HSBC. “Today, many activities in a trade transaction are manual and paper-reliant. Blockchains offer the promise of automating transactions and replacing document checking with data checking,” he told the South China Morning Post.
However, it might still take a long time for Chinese regulators to allow cryptocurrencies—digital money, such as bitcoin, whose transactions are secured using cryptography—to be freely used in everyday life. In 2016, nearly 90% of bitcoin trading took place in China, but then at the end of that year, China banned no-fee trading.
In its most recent move in the sector, the PBOC ordered a freeze on fundraising through initial coin offerings (ICOs), which see technology startups issue their own crypto-currencies, or “tokens”, to investors in exchange for currencies such as bitcoin.
This year, 65 ICOs in China raised RMB 2.62 billion from 105,000 investors, according to a report from the National Committee of Experts on the Internet Financial Security Technology. Meanwhile data from Chinese trading platform Huobi showed the value of bitcoin had jumped 59% in August alone.
“China now has a very weak legal basis for digital currency, and neither regulators nor investors are prepared for a complete digital currency operation system … unregulated ICO and bitcoin exchanges only offer chances for money laundering and scams,” Sun Guofeng, director general of the PBOC’s research institute, wrote in a recent article published in China Finance magazine, an internal publication of the PBOC.
But while the central bank is cracking down on ICOs, it doesn’t deny the possibility of having a digital currency. “The blockchain itself is a good technology, and an ICO is not the only way through which one can carry out research into it,” Sun adds.
This July, the PBOC formed a currency research institute to focus on digital currencies and blockchain technology. One of its leaders, Yao Qian, said that “the purpose of a central bank issuing digital currency is to replace cash and lower the cost of paper currency issuance and circulation, boost market energy and increase transparency of economic activities.”
Although there is no timetable for China to actually issue a digital currency, a draft plan has gone through two rounds of discussion and amendment, Yao revealed.