China is keen on using evolving blockchain technology that underpins cryptocurrencies to help build its digital economy and quicken adoption of its sovereign digital currency, analysts say, while avoiding the risks that decentralised virtual networks pose to the financial system. Chinese policymakers have recently ruled out cryptocurrencies as mediums of exchange but tacitly supported them as investment vehicles – as long as they serve the real economy and are not purely speculative. Growing mainstream acceptance of cryptocurrencies for investment may even boost interest in China’s fintech landscape, including its sovereign digital currency, the so-called Digital Currency Electronic Payment (DCEP) , analysts said. China prohibits cryptocurrency fundraising and trading platforms out of fear of stoking financial instability. But citizens are not banned from holding them, with bitcoin mining permitted and thriving in the country. What blockchain is, how it works and how China will lead the world Officials in Beijing also appear eager to leverage cryptocurrency research and adopt elements of the underlying blockchain technology for DCEP, analysts said. Blockchain, which is also known as distributed ledger technology, is a system that stores digital payments in “blocks”, which are accessible to all network users. When a transaction is made, it is entered into a new block. Once a block is filled, it is connected to the previous block, forming a chain in chronological order. Cryptocurrencies use the technology to keep a ledger of payments, over which no central authority has control over. Although the decentralised system is a concern for China’s central bank and others around the world, policymakers in Beijing are warming to the benefits of blockchain technology as a way of strengthening the digital yuan’s competitiveness and tapping public interest in virtual currencies. The more sophisticated cryptos become, the more source material DCEP will have to draw upon and improve their network, John Keh “The more sophisticated cryptos become, the more source material DCEP will have to draw upon and improve their network,” said John Keh, chief marketing officer of Genesis Block, a digital asset trading centre in Hong Kong. “The concept of the DCEP becomes more easily understood if Chinese people have basic knowledge of cryptos.” The appeal of cryptocurrencies has grown in recent months, with major investment houses and payments systems offering cryptocurrency-based services. The price of bitcoin, the world’s biggest cryptocurrency, has surged 740 per cent in the past year, hitting a record high of US$64,747 before dropping to current levels of around US$50,000. Sky Guo, co-founder of enterprise-focused blockchain platform Cypherium, agreed that the use of the digital yuan could be accelerated by a healthy cryptocurrency ecosystem. “ China’s population is more accustomed to digital wallets, QR codes, and mobile banking … so the pace of digital asset adoption will occur much faster than in the US,” he said. China’s reputation as a hub for cryptocurrency mining, in which vast arrays of computers solve complex mathematical formulas to obtain new currency, could also help with adoption of the digital yuan, he said. Despite concerns about financial stability, Chinese policymakers have in recent months openly discussed cryptocurrencies as investments. While traded on exchanges, cryptocurrencies are not being used as a means of exchange, in contrast to China’s digital yuan , which the People’s Bank of China (PBOC) is developing for payment in shops, restaurants and on e-commerce sites. “Cryptocurrencies are a type of investment option, they are not currencies themselves but alternative investments,” Li Bo, deputy governor of the PBOC, told the Boao Forum for Asia in April. Zhou Xiaochuan, a former governor of the central bank, said at the same event “everyone has to distinguish between digital assets and digital currencies”. “Whether it is digital currency or digital asset, it should be closely integrated with the real economy and serve the real economy,” he said. Officials in China are likely to continue endorsing bitcoin as an investment rather than a currency, clearing the way for the digital yuan to penetrate new global markets, Guo said. China is part of a research initiative with Hong Kong , Thailand and the United Arab Emirates to study the feasibility of using central bank digital currencies for cross border transfers based on blockchain technology. Although keen to promote financial innovation, regulators in Beijing, Washington and other major capitals are working on cryptocurrency rules to guard against illegal activities such as money laundering, amid concerns about threats to the existing banking system. Bitcoin, which was born in direct opposition to the dollar-centric monetary system ruled by central banks, has been linked to illicit activities like the illegal sale of arms and drugs. “It is clear that the regulations do not want to jeopardise the whole development of financial innovation,” said Raymond Yeung, Greater China chief economist at ANZ Bank. “The question is how do you apply blockchain technology to the existing financial structure but at the same time not lead to cryptocurrency problems?” I think the government is open to blockchain technology, but cautious against cryptocurrencies Zhiwei Zhang Zhiwei Zhang, chief economist at Pinpoint Asset Management, said that while both China and the US are taking a cautious stance against cryptocurrencies, Chinese officials see the underlying blockchain technology as a useful innovation. “I think the government is open to blockchain technology, but cautious against cryptocurrencies,” Zhang said. “The digital yuan [could very well be] the first pilot project on the national level to utilise blockchain technology for promoting real economic activities, instead of speculative investment.” China’s DCEP uses a two-tier system, with the PBOC issuing the currency to commercial banks, telecoms companies and other agencies without using blockchain. But these second-tier operators are allowed to use the technology for distribution to the public. President Xi Jinping said in 2019 that China should use blockchain to accelerate technology development and industrial innovation. In every category, China’s digital yuan development is leading the US Sky Guo The country is already drawing developers building on blockchain because it offers more freedom than the US, which is at risk of overregulation and becoming less competitive in fintech innovation, Keh said. In addition to its world-leading bitcoin mining operations, Chinese-funded Polkadot is the world’s largest blockchain development platform, while the largest cryptocurrency exchange, Binance, founded by Chinese-Candaian Changpeng Zhao, and was based in China before relocating to the Cayman Islands. “In every category, China’s digital yuan development is leading the US,” Guo said. “China has been working on its digital yuan protocol for some time now, while very little is known about what the US intends to do regarding a digital dollar.”