China’s Digital Currency and CME’s Bitcoin Micro Contract

This week we feature a guest post from John Browning, founding partner of Hong Kong commodity and financial futures broker BANDS Financial. In reporting on the state of and statistics on the Chinese economy, Browning follows the development by the People’s Bank of China (PBOC) of a so-called “digital yuan.” We last wrote about it here.

The PBOC’s effort is gaining enough mainstream attention that The Wall Street Journal covered it this week. Politico, for its part, raised the geopolitical implications in its coverage, “U.S. dollar at risk as China rases ahead on digital yuan.”

In this post, Browning shows how digital currencies are shifting international trade on the ground and at the exchange. If the PBOC can disrupt international payments with a central-bank digital currency, why can’t the Chicago Mercantile Exchange do the same with bitcoin as trading collateral?

Last December, the Hong Kong Monetary Authority announced that it was collaborating with the PBOC to use digital yuan (DECP) in “technical pilot testing” for cross-border payments. Indeed, it is believed the PBOC’s digital currency research institute has joined the HKMA’s digital currency research project to facilitate this effort. For those that have forgotten, DECP is in effect holding the cash notes in your wallet on your phone. Similar to your wallet, to use it you do not need a bank account or internet connection, just proximity to your payee.

According to official reports in the Shenzhen Special Zone Daily, the PBOC recently conducted a one-day test program where residents of Hong Kong using the PBOC-developed digital currency were able to buy goods in Hong Kong’s closest mainland neighbor Shenzhen. Now, buying goods in Shenzhen is not a large piece of news but for those of us who watch for these nuances, it is in fact, enormous.

Firstly, how were they able to do this? Traveling to Shenzhen is impossible because of virus-related travel restrictions. One must assume these buyers remained in Hong Kong and used a mobile app to execute their purchases in China. This means the DECP app must work on non-Chinese registered phone numbers, over non-mainland phone networks and without a Chinese ID card registration.

So the revelatory issue is this: What if this app works the other way around? Residents of China could buy goods in Hong Kong without using Hong Kong Dollars. Residents of HK could hold RMB as DECP balances without using a bank at all, and the problems associated with cross-border fund transfers ― their high costs, complex regulatory and compliance issues ― start to fall away.

The next step would be for these cross-border payment/transactions to move up from the retail to the wholesale level, which would seem to be an act of permission rather than technology. Let’s not forget that perhaps the most salient feature is that using DECP for cross-border payments is that one steps outside the Western-oriented SWIFT network for international banking transfers.

While we are looking at currency in an abstract sense, there’s this: The Chicago Mercantile Exchange (CME) will launch Micro-Bitcoin Futures on May 3, where one micro contract equals 10% of one full bitcoin. The new micro contract value would be around USD $6,000 at current levels, significantly smaller than the current CME futures contract which is based on 5 bitcoins.

I imagine the micro will be enormously successful as high-speed traders aggregate the multiple OTC bitcoin venues across the globe and be able to fine-tune the offset of their exposures into the CME micro. However, it raises the question: As investors can trade bitcoin on the CME platform, when will the CME allow brokers to post bitcoin as acceptable collateral to fund client initial margin requirements?