China's Virtual, e-Commerce Currency

 |  Includes: BIDU, CHL, EBAY, MA, NTES, SINA
by: Shaun Rein

American government officials and economists from Secretary of the Treasury Hank Paulson to Senator Chuck Shumer to Paul Kruger have focused on balance of trade issues with China, the RMB-USD exchange rate, and China’s huge foreign reserves. But few mainstream economists or Government officials have looked at new forms of currency emerging in China that already is beginning to greatly affect China’s underlying economy – virtual currency.

Investors should not fail to look at this sector. Xinhua News has reported that the volume of virtual currency has reached several hundred million USD a year in China. My firm estimates the size to grow 30% in 2007.

Virtual currency started in China when companies like IM and online game giant Tencent or QQ wanted to let gamers buy virtual Q coins at 1 Q Coin per RMB to buy clothes and weapons for their game personas. This was a huge hit for Chinese youth and gamers who go crazy for online games and spend more time online per week, about 18 hours, compared with their American cohorts at 12 hours.

China’s major internet portals are battling with each for command of the market. Aside from Tencent, SINA (NASDAQ:SINA) has U coins, Netease (NASDAQ:NTES) has POPO coins, and Baidu (NASDAQ:BIDU) also has its own currency. Right now the Q coin is the most widely used form of virtual currency in China in part due to QQ's large stickiness factor because of its commanding lead in the instant-messaging and blog services.

Q coins can be used to buy virtual products such as items to use in games, or accessories for the avatar that they use for instant messaging conversations. The virtual currency can also be used to vote for real world talent contests, and allows users to play online games, purchase electronic greeting cards, and use antivirus software. Baidu currency can be used to watch feature length movies on Baidu’s website and to download music, and Sina’s U coins can be used to purchase real goods from Sina’s online mall.

Q coin users can purchase coins using QQ cards, bank cards, telephone cards, and by playing online games. Users of certain virtual currencies can also buy money using their mobile phones. China Mobile (NYSE:CHL) users can purchase Baidu currency by sending an SMS from their phones.

A huge potential problem is that while the currency is not meant to be exchangeable back into RMB sites have popped up to provide such a service. Tencent recently filed suit against Taobao, China’s number one C2C auction site that defeated Ebay (NASDAQ:EBAY) in China. Operated by Alibaba (NASDAQ:YHOO), Taobao was sued because its auction platforms have facilitated the sale of Q coins for real money. Virtual money is now convertible with real money and this creates a huge economic headache for China’s government as the virtual world becomes more real, but without some of the security and regulations that govern the traditional economy.

There have been accounts of hacking into other peoples accounts to steal virtual currency. Moreover, there is a possibility that if virtual currency is accepted at more online stores, virtual currency can start to impact money supply and influence the actual Chinese RMB.

But what does all this mean for investors? Aside from buying shares in the internet companies whose virtual currency are most in demand – it would be interesting if someone set up virtual currency exchange rates so that investors could see which internet companies’ coins were worth the most – the clear demand for virtual currency shows Chinese youth’s interest in e-commerce.

My firm interviewed Chinese youth between the ages of 14-24 in Shanghai and analyzed blogs and BBS to see why they use virtual currency and to see if they would be willing to use credit cards if given the opportunity.

Users of virtual currency said that they use it because it is “convenient” to buy things online. They prefer using virtual currency over credit cards because with virtual currency they do not have to go through all the paperwork and wait in “ridiculously long lines” at banks like Bank of China, China Construction Bank, and ICBC. The majority said that if they were to get a credit card, they would want one from China Merchants’ Bank because it was the “best-run” Chinese bank.

They would be “willing” to use a credit card like a Mastercard (NYSE:MA) or American Express (AMEX) if it was easier for them to apply and get a “real credit card”, not one that was a Visa card linked to an actual bank account. They are “worried about thieves emptying out their bank accounts” with these credit cards linked to actual accounts.

What this means is that Chinese youth are willing to buy things on-line if it is convenient. This bodes well for e-commerce as I have written about in the past. The obstacles for growth come from the Chinese Government if the Government decides that virtual currency poses a legitimate threat to the RMB. They may put in place and enforce restrictions that will cripple virtual money as tender in online transactions.

What is certain is that Chinese youth are willing to buy tings on-line if it is convenient for them. They will do so either with virtual currency if its acceptance by merchants become more widespread or with credit cards as adoption of credit card services gets easier. Bottom-line: look for credit card and e-commerce to boom in China in the coming years.

Note: CMR analysts Natalie Zhu and Ben Cavender contributed to this article.