This should be a triumphant week for central bank digital currencies (CBDCs). Facebook’s Diem project, the most high-profile attempt by Big Tech to build a ubiquitous digital currency, has announced that it is closing shop in the face of staunch regulatory opposition.[1] Meanwhile, the eyes of the world will be on the Beijing Winter Olympics, where only three payment mechanisms will be accepted: Alipay, WeChatPay and the government’s own e-CNY digital currency.
While China’s ‘Covid Zero’ policy means that very few foreign fans will experience e-CNY at the games, Covid won’t be to blame if the games don’t boost the new currency as the People’s Bank of China hopes. Rather, the e-CNY is likely to suffer from a much more pedestrian problem for new digital products: a lack of product-market fit. Genuine CBDC will have many applications beyond payments, but central bank digital deposit money (CBDDM), like e-CNY, will struggle to achieve product-market fit with its current payments use case.
Marc Andreesen, co-founder of renowned venture capital firm Andreesen-Horowitz (now, more digestibly, A16z) defines product/market fit as “being in a good market with a product that can satisfy that market.” Without product-market fit, you are constantly pushing product into the market, but once you achieve product-market fit “the market pulls product out of the start-up” because the product meets a fundamental need in the market.
I decided to write my recent book, Chain Reaction: How Blockchain will Transform the Developing World, because I saw that emerging markets were pulling product out of blockchain. I kept meeting EM companies, from stockbrokers in Africa to multinational corporates in Latin America, that were having problems with Bitcoin volatility because they used Bitcoin as a currency. In the book, my co-authors and I describe this as Bitcoin being good enough to be an alternative to existing currencies and payment systems in developing countries, even if it is far from ready to challenge existing currencies and payment systems in the developed world.
By contrast, if you don’t have product-market fit, you will struggle no matter how good your product is or how good your team is. I know this from experience, having once built a business with great people and a great product that met customer needs, but in a narrow market. In the course of writing the book, we saw plenty of examples of committed teams building sophisticated products without product-market fit. For new blockchain projects to succeed, they need a clear use case that addresses human needs, not just technology challenges.
Some companies without product-market fit are still able to grow, but they typically grow by overspending on user acquisition, what in Silicon Valley is known as “giving away dollar bills for 50¢.” We see this trend in the rapid grocery delivery segment today, where new start-ups are offering huge discounts on initial orders. They will sign up plenty of customers looking for the initial discount, but I question how many of those customers will continue to pay for the service at full price. Many challenger banks have seen a similar evolution: gaining large numbers of customers with attractive pricing or a single outstanding feature, but then failing to offer a sufficiently compelling proposition to be those customers’ primary banking relationship. This has left them stagnating with large numbers of small accounts with limited activity.
With respect to digital currencies, whether blockchain-based or CBDDM, digital payments alone are not a sufficiently strong use case for product-market fit. Almost all emerging markets already have compelling digital payments systems, whether driven by banks or telcos, and the sector is rapidly expanding with new IPOs and the opening of Nigeria to mobile money. If a new initiative is going to enter the digital payments space, it’s likely to have to push into the market rather than be pulled in by market need.
Despite being backed by the People’s Bank of China rather than a Silicon Valley VC, e-CNY appears to have been doing exactly that: giving away digital yuan for free in lotteries. Very few people will say no to free money, especially when your authoritarian government tells you to take it, but the pattern emerging with e-CNY looks very similar to that with the stagnating challenger banks. E-CNY had 261mn users at the end of 2021, but transactions and volumes remain low. This is unsurprising, given that it is focused on the payments use case, for which China already has two highly mature platforms: Alipay and WeChatPay.
A comparison with Alipay evidences the lack of product-market fit: although e-CNY has one-third of the users of Alipay, eight times more merchants accept Alipay. Free money has bought the users, but the use case does not appear compelling enough to engage the merchants.
Figure 1: The failure of merchants to follow the public in adopting e-CNY indicates weak product-market fit
Obviously, e-CNY has a tool to drive adoption that is much more powerful than anything that even the largest venture capitalists can bring to bear: the power of the Chinese state. State pressure has helped to ensure that e-CNY is accepted on most major platforms. Meituan, a food delivery and leisure booking platform with 660mn users, became the latest to accept e-CNY. The next step for the government to drive the adoption of e-CNY for payments could be to tax transactions through Alipay and WeChatPay, creating a pricing advantage for e-CNY.
The issues surrounding e-CNY highlight the weaknesses more generally of CBDDM, in which the money is held on a central ledger at the central bank and transacted through the central bank, and I’ve written before about the many reasons why a government would want to implement CBDDM, including:
Improve financial surveillance, whether for macro policy or to track individual transactions;
Reduce digital payment friction;
Accelerate the removal of cash from the economy;
Offer digital payments without the involvement of fintechs and mobile money providers;
Provide digital payment options for the unbanked;
Introduce programmable money (eg stimulus payments that expire if unspent or welfare payments that can only be spent on food and lodging).
For CBDDM to succeed it will need to find product-market fit. In practice, I see three ways to do this:
CBDDM would be compelling where existing payments options fail because they are either too limited, too expensive or lack deposit insurance and, therefore, are too risky.
CBDDM would also be compelling if the government tilts the playing field in its favour, using the policy benefits above to justify intervening in the payments market.
CBDDM could achieve a new use case in which it has compelling product-market fit.
Genuine CBDC, in which the unit of value is a cryptographic token on a blockchain that can be freely traded across borders, would have many uses beyond digital payments, including the cross-border payments for both companies and individuals making remittances and strengthening monetary policy credibility by baking monetary policy rules into the CBDC itself. Other emerging markets considering implementing CBDCs, including India, which announced that the e-rupee will launch in the 2022-23 financial year, should learn from the e-CNY experience and think carefully about the use case and product-market fit that will cause the market to pull in the new digital currency. In the meantime, western sanctions against Russia over Ukraine could create a new, and compelling, use case for e-CNY as a means for Russia to make cross-border payments to China while avoiding SWIFT.
Figure 2: Other countries considering adopting CBDCs will learn from the e-CNY experience (map updated November 2021)
[1] Diem has sold its assets for US$182mn to Silvergate Capital, which intends to use Diem’s technology to develop a stablecoin within a regulated Federal Reserve member bank, presumably its subsidiary Silvergate Bank.