Blockchains are only one part of the future of finance

Hey folks, for a change of pace, rather than getting all the boomers at Blockworks, you're getting someone relatively younger from the Blockworks Research team today.

On Tuesday, our favorite bald CEO, Brian Armstrong, tweeted out a link to this Politico article, "China's move to control the blockchain." You're probably thinking: hold up, hasn't China tried to ban Bitcoin mining a hundred times, made ICOs illegal in 2017, and generally given the population a tough time for owning or interacting with cryptocurrencies?

Well, yes. But that doesn't mean they don't have a separate crypto strategy, like Harvey Dent in Batman. The article states China is taking two approaches to crypto.

Back on the mainland, you have the law & order obsessed Dent, with Beijing taking a strong anti-crypto stance. But offshore, in Hong Kong, the reality could not look any different.

In Hong Kong, you have the goody two shoes lawyer gone rogue Dent. Home to expensive car park lots and delicious dim sum, Beijing has secretly, or not so secretly, taken a strong pro-crypto stance. You've seen HSBC Hong Kong launching support for BTC and ETH ETFs, Hong Kong wanting HSBC, StanChart, and Bank of China to open doors to crypto clients, along with a virtual asset framework that will allow retail investors to trade certain tokens. One may wonder, why the stark contrast?

Going back to Armstrong's tweet, is the US really losing "blockchain" to China, or is it something more than that?

It's something more than that.

It shouldn't come as a surprise, but what is at stake isn't simply control over the future of blockchain technology, but the financial rails of the future.

China's CBDC - eCNY

For one, China's CBDC, eCNY is by far the most advanced out of any central bank. Until October 2022, transaction volume has crossed over $14B and is now being piloted in 23 cities. CBDCs may still seem like a dystopian future, but they are here, and definitely sticking around in China.

CBDC development across the world demonstrates a stark difference between the East and the West. The West mainly has CBDCs in the development and research phases, whereas the East has multiple countries piloting CBDCs.

Today, eCNY has a reach of 260 million users and is actively being tested in over 200 scenarios such as public transit, stimulus payments, and e-commerce. China is putting on an absolute masterclass in CBDC implementation.

That is no small part thanks to China's unprecedented adoption of mobile payments. Throughout the 2010s, Chinese consumers skipped credit cards and adopted mobile/internet payments as their preferred payment rails, enabled by cheap smartphones, and the rise of super apps such as WeChat.

Here's what that growth looked like. Mobile payment transaction volume increased from $1T in 2013 to $40T in 2019. As a comparison, card payments value in the US was only $9.43 trillion in 2021.

To further put the growth of China's payment systems into context, consider the following graph that shows the average growth rate of volume of cashless payments worldwide, never crossing more than 12% YoY growth. Having grown up in Shanghai, China essentially transitioned from a cash-only society to a cashless society in less than two years.

If you scroll back up to the world map, you would notice that many of the countries piloting a CBDC are geographically close to, or even bordering China. What happens if all those countries piloting CBDCs decide to create an interoperability solution with China to facilitate CBDC FX transactions? Or what happens when the rest of the world sees China's successful implementation of a CBDC and decides to implement its own CBDC based on China's?

In 2021, I wrote a paper titled "China's Central Bank Digital Currency" in an MBA class I was enrolled in called "Chinese Economy and Financial Markets". Granted, I did not pay the most attention in that class, as this was the peak of the bull market, but it was still one of my favorite classes ever.

Anyways, that's not the point. The point is that regardless of the fact that a CBDC will infringe on the fourth amendment in every way possible, it is quite simply better tech.

A central bank could set expiration dates for stimulus checks, force consumption in specific sectors facing deflationary pressure, and give itself much more granular control over monetary policy and the economy. The rest of the world will catch on at some point, and the US would hate to see fellow central banks following in China's footsteps when developing their CBDC.

Belt and Road Initiative

There are currently 148 countries that have joined China's Belt and Road initiative (BRI) under a Memorandum of Understanding. In what is perhaps the most ambitious modern undertaking in global infrastructure development, the initiative includes a vast network of railways, highways, energy grids, and energy production facilities. To give you a sense of the scale of this initiative, take a look at the map below. It might as well be every developing nation on planet Earth, and certainly covers the near entirety of Africa.

China has already spent $1T on the initiative, and experts have predicted that China's expenses over the life of BRI could reach as much as $8T. A portion of the overall expense is in the form of loans made to participating countries. For example, Argentina has received $111.8B, Pakistan $48.5B, and Egypt $15.6B.

As part of managing and repaying these loans, China has chosen to "force" countries to adopt its SWIFT competitor, Cross Border Inter-Bank Payments System (CIPS). In 2022, CIPS processed $14T, with 1427 financial institutions in 109 countries connected to it. As reported in 2021, SWIFT carries $140T in a year and is used by more than 11,000 institutions in over 200 countries, so China's CIPS is still a little far off.

But 30 years down the road, when many of these countries in Africa and South East Asia achieve exponential growth with a burgeoning middle class, and these countries still owe China hundreds of billions in debt, what payment rails do you think they'll use? Perhaps China may give them a discount on interest payments if they choose to adopt CIPS for inter-bank payments instead of SWIFT.

China rarely cancels issued debt. What they have done in some cases is write off debt in exchange for land such as 1,156 square kilometers in Tajikistan or take a large equity stake in important infrastructure projects such as an 85% equity stake in a Sri Lankan port.

Final Thoughts

Tying back to China's crypto strategy in Hong Kong, given Hong Kong's pro-crypto regulatory environment, it should come as no surprise to US politicians if transaction networks and future financial standards come out of Hong Kong. And perhaps at that point of a new paradigm, the globally adopted systems and infrastructure used to raise capital and trade assets/liabilities may be built, or partially influenced by China.

The US may very well lose a critical component of its developed and well-regulated financial markets to overseas innovation. This isn't just about controlling the blockchain; it's about controlling the financial and monetary rails of the future.

It is not a question of what if, it is a question of to what extent. And this is one move in the grand strategy game of geopolitical chess you do not want to be caught napping on.

I'm not going to go ahead and say the CNY will be the new reserve currency when you wake up tomorrow — or that suddenly the Chinese economy is going to dominate the world and have the greatest public markets. But in the current equilibrium, it looks as though the US is inching closer to getting checkmated with every passing day.

Your move, US.

– purplepill

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