China flooding exposed risks in Beijing’s plan to launch digital currency

When flooding inundated a central Chinese metropolis over the summer, the calamity dented a key plank of the country’s much-watched bid to replace paper money with digital currency: reliability.

Heavy July rains pushed rivers over their banks in the city of Zhengzhou, causing widespread electrical outages that immobilized cellular service. Because urban Chinese typically use mobile-phone payment apps like Tencent Holdings Ltd.’s WeChat and Ant Group Co.’s Alipay instead of cash, suddenly inoperable networks meant many in the city of 12 million had no money, on top of no way to reach emergency responders and loved ones.

China is the global pacesetter among large nations in creating a digital version of its currency. Four days before the Zhengzhou floods, the central bank had published an official strategy for its rollout and cited success with trials so far. Then, the Zhengzhou outages paralyzed the digital-payment infrastructure that forms the backbone of its plan.

Lacking cash, some in Zhengzhou turned to barter, including a man who paid for vegetables with cigarettes, one of thousands of examples shared on Chinese social media about what happens when digital money goes on the fritz.

A 25-year-old dairy company employee, Zhao Jun, says the floods left her stranded far from her Zhengzhou apartment and she sought refuge in a hotel for the night—then realized she had no way to pay for a room without Alipay and WeChat and no way to contact the outside world. “I was very anxious," she said.

The financial interruption was a relatively brief, but stark, illustration of a risk nations may face by adopting digital currencies—money dependent on working cellphones. Add cellular reliability to hacks of digital wallets and online exchanges as vulnerabilities as governments get into the volatile sphere until now occupied by bitcoin and other cryptocurrencies.

The kind of shock experienced during the floods would wreak havoc with any modern digital economy. In Zhengzhou, online maps didn’t work and electric cars shorted out. An electronic version of the yuan will only deepen China’s embrace of technology. An increasingly cashless society has already caused societal problems like elderly people being practically unable to hail taxis without the right apps.

The flooding episode ran counter to specific commitments Beijing made in its July strategy paper that its digital-currency system will have built-in defenses in cases of a natural disaster.

“The lowest common denominator that affects everyone is the power grid," says Luke Deryckx, chief technology officer of Seattle-based Ookla LLC.

In tracking internet outages after natural disasters, Mr. Deryckx said, his firm has seen power stations and cellular operators get their central operations restored quickly, only for consumers to disappear from networks as their phone batteries die because there is no place to recharge.

The central bank says the e-CNY—the digital yuan’s official name—had been tested in more than 70 million real-world transactions since early 2020, with no sign of major snafus in the technology.

The People’s Bank of China didn’t respond to questions about whether the Zhengzhou disaster would have an impact on its digital-currency plans; nor did Alipay and WeChat, or cellular operator China Mobile Ltd. Government officials in China described the floods as a once-in-a-century disaster, while others saw them as a harbinger of climate change.

Many nations, including the U.S., are watching Beijing’s rollout for indications of whether it makes sense for them to also digitize their currencies.

Beijing is typically cautious with financial innovations and so far hasn’t committed to a timetable for formally issuing its digital currency. There is no sign the problems in Zhengzhou have altered the planning, but analysts said Beijing may be on a less hurried timetable to launch than suggested by its extensive testing.

“The bar is extremely high. You have no margin for error with this kind of system," says Martin Chorzempa, research fellow at the Peterson Institute for International Economics in Washington. “It’s really a lot of unknowns here and that’s why I think they want to be careful and not rush it out."

The Chinese central-bank official guiding the e-CNY project, Mu Changchun, told an online conference in March that the digital currency is designed in part as a backup to the WeChat and Alipay systems, which together handle 90% of mobile transactions in China.

“If something bad happens to them, either financially or technically, that will definitely bring negative impacts on financial stability in China," Mr. Mu told the Bank for International Settlements conference in March.

It isn’t clear how the digital-currency system could have functioned much better during the floods. The People’s Bank of China has made it clear the e-CNY will require apps, including one of its own along with WeChat and Alipay. During the floods, financial regulators in Henan province issued emergency notices ordering banks to respond rapidly to customers affected by the inability to pay with mobile phones—in particular by making cash available. The digital yuan appears designed to one day replace physical money, though China’s central bank said in its July report that cash will remain in circulation as long as people want to use it.

China says the digital currency has been tested in a range of circumstances, with some solutions designed for users who lack a mobile internet connection. But the offline capabilities appear designed for a relatively small subset of users, like less tech-savvy elderly people, not millions cut off by a natural disaster.

Mr. Chorzempa said making a digital currency work without an internet connection will be one of the knottier technical challenges of the e-CNY, since the system needs to ensure the same yuan isn’t spent twice. “A payment system keeps track of who has what at what moment," he says.

A widely touted benefit of a digital currency is the potential for authorities to quickly zip aid money to people affected by a natural disaster—though that too would presumably hinge on cell service.

To restore partial telecommunications service to the Zhengzhou area during the over four days it took to repair 62,000 flood-damaged mobile base stations, the government scrambled a squadron of Wing Loong-2H drones from Aviation Industry Corp. of China into the skies as airborne cellular relay stations. Authorities called it an emergency operation that required the drones to fly 750 miles, or four hours, to reach Zhengzhou, where they were able to connect fewer than 650 cellular users at a time, according to state media reports.

To secure herself shelter in the Zhengzhou hotel, Ms. Zhao found a workaround with the help of a stranger. Today, she says doesn’t leave home without the cash she got back as her room deposit when she checked out.