What investors need to know about DCEP and China's digital currency

In our latest report, we take a closer look at China's digital currency and blockchain initiatives. Find out more about DCEP and discover our view on what this means for your investments.

07 May 2020

What is DCEP and why does China want to develop it?

Major innovations are currently underway in China and we are at the cusp of another major digital revolution. The country is set to launch a national digital currency (DCEP) and blockchain-related initiatives. Along with other emerging technologies like artificial intelligence, the Chinese government has identified blockchain technology development as an issue of national importance. We believe the imminent launch of DCEP and the ongoing rollout of a blockchain network should further support China's global technology ascent.

In our "Information technology" report, we discuss the rising tide of accelerating fintech industry innovation and how this should benefit key stakeholders in the near term. We also share our view on how these initiatives should further support China's ongoing digital ascent and its strong fintech ambitions. We see many implications that are largely positive across macro and leading sectors in China, continue reading to find out more.

 

A closer look at DCEP

DCEP is a by-product of years of research and innovation by China on digital currencies, which are a digital form of fiat money. The blockchain networks are a result of prioritizing investments to build a strong domestic distributed ledger ecosystem. We are positive on the long-term growth prospects of both initiatives, as we expect them to generate significant economic value over a period of time across industries like financials, healthcare, manufacturing, etc., and stimulate further innovation in the country. The question is how should investors position to benefit from these trends.

What is China's DCEP?

It has been widely reported in the media that the People's Bank of China (PBoC) will soon issue the world's first central bank digital currency (CBDC), known as the Digital Currency/Electronic Payment (DCEP). A screenshot leaked in mid-April showed that the Agricultural Bank of China, a state-owned bank, launched a digital currency wallet mobile app to commence internal tests. They involved whitelisted citizens in four pilot cities: Suzhou, Shenzhen, Xiong'An and Chengdu.

Put in a simple way, China's DCEP is regarded as the digitalization of physical cash (i.e., paper cash, coins and banknotes); or in other words, the substitution of money in circulation (M0).

What is China's Blockchain Service Network?

China’s Blockchain Service Network (BSN) is led by the State Information Center, a government agency under the National Development and Reform Commission, as well as state-owned telecommunication giants including China Telecom, China Unicom and payments firm China Union Pay. The BSN is a cross-cloud, cross-portal, cross-framework public network that enables developers to easily and affordably develop, deploy, operate and maintain blockchain applications and nodes.

The BSN is targeting 100 city nodes at the time of launch with potentially nodes in other countries in Southeast Asia and Europe. According to media reports, 2,000 participants have signed up for the beta testing of the network for almost six months, with a third of the participants being enterprises and the rest individual developers In our view, the BSN should be seen as information infrastructure that promotes low-cost development, deployment, operations, maintenance and regulation of consortium blockchain applications.

How does DCEP work?

Central bank digital currencies are a new form of currency and, as a result, there is a significant interest in the underlying technology architecture of DCEP. According to the Bank of International Settlements, there are various design choices for such currencies, including on access (widely vs restricted), the degree of anonymity (ranging from complete to none), operational availability (offline or online and the uptime) and interest-bearing characteristics.

Based on our understanding, DCEP seems to take the most flexible route, by giving itself more options to maneuvre based on further technological developments.

The flexibility of DCEP is highlighted by its two-tier mechanism, unlike most cryptocurrencies that leverage blockchain technology and the consensus protocol mechanism.

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How does DCEP and blockchain affect key sectors in China?

While we believe the ongoing digital currency and blockchain initiatives would affect many industries in China, there is a disproportionate impact on internet firms and banks, which we address in the full version of the report. During the past few years, China has been steadily marching toward a cashless society. Mobile payments are now ubiquitous in China. More than 80% of smartphone users use their mobile devices to pay for point-of-sales transactions on a regular basis, the highest mobile payment adoption rate in the world.

High-profile Chinese internet giants are reported to be among the organizations working with the PBoC to develop China's DCEP, as their deep know-how in back-end infrastructure, superior user interface and consumer application scenarios are invaluable for the PBoC to move toward DCEP adoption. With its advantages clearly highlighted, we believe such cooperation should broaden DCEP's application to many areas.

While bears may argue that DCEP's rise will weigh on the fintech ambitions of Chinese internet majors, in the near term, we do not see a significant impact. Mobile payment services generate an insignificant contribution to bottom lines, and the pilot is only going to start in select cities from May before gradually rolling out in the coming quarters or even years.

However, in the long term, we foresee DCEP to challenge the electronic payment status quo, as its arrival removes intermediaries and introduces digital wallets as a means of payment instead.

Mobile payment user penetration in China, 2019–2023E

Source: eMarketer, UBS, as of October 2019

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What are the key investment implications?

We see multiple ways to participate in ongoing digital and fintech trends.

  • First, we believe the current status quo in major industries like internet and banking may not materially change in the short term. As a result, we continue to prefer internet leaders and select retail banks.
  • Second, despite limited near-term impact, China's ongoing digitalization efforts should get a further boost from increased investments. This should be supportive for our smart city theme.
  • Third, China's significant fintech progress should spur more innovation in the global fintech industry. This should support the broader fintech theme, where we like industry leaders.

Despite these opportunities, investors need to closely monitor the long-term disruptive trends, as further significant policy changes may dislocate the current industry structure. For more information, we invite you to download and explore the full report "Information technology".

Information technology

For a deeper read, download the full version of the report

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