In the summer of 2019, Bank of England Governor Mark Carney delivered a striking speech. The United Kingdom, an ally of special status to the United States, stated publicly that a “Synthetic Hegemonic Currency (SHC)” supported by the world’s central banks could dampen the “domineering influence of the U.S. dollar on global trade.” This seemingly direct attack on the USD as the global reserve currency, the main currency for trade and sovereign debt issuance, was delivered in reaction to plans from the Facebook-backed Libra (now renamed Diem) Association to launch a global stablecoin, a move policymakers feared would dilute sovereign monetary control. However, despite the focus of the West on private threats to their global monetary regime, China was already one step ahead.
Over 80% of central banks are now researching or developing their own central bank digital currency (CBDC). The Federal Reserve Bank of Boston announced a collaboration with Massachusetts Institute of Technology (MIT) to research digital currencies, the Bank of France began testing a CBDC on the public blockchain Tezos, and global consulting firm Accenture announced a joint paper on CBDCs with the global clearinghouse network SWIFT. But despite the global consensus around CBDCs and the tangible steps taken, it is now evident that China has finished its digital research and development, built a technology platform and launched a live version of a digital yuan, officially called e-CNY but also known by its original project name of DCEP (Digital Currency, Electronic Payment). So what does this mean for everyone else, are they too late?
U.S. and China
Despite China’s strict control of the yuan, digital transformation policies catalyzed a fintech payments revolution through the adoption of WeChat and Alipay, enabling its population of 1.3 billion to go cashless. Such revolutions can be effectively executed with technology policies by China’s government, as Chinese culture is traditionally steeped in deference towards authority and conformity. An industry is considered bona fide in the eyes of the Chinese public once the government issues its stamp of approval. This provides a strong cultural and political mandate for China’s government to accelerate a faster digital transformation of its economy on a national scale. China is now at the forefront in actively piloting CBDC trials across cities such as Chengdu, Shenzhen and Suzhou, where the public is incentivized to test the technology. China is also rolling out a mass communication effort, by announcing the release of the digital yuan by the 2022 Winter Olympics, boosting public awareness and setting a hard deadline for its implementation.
In contrast, the U.S. government has taken a hawkish approach to the concept of a U.S. digital dollar. U.S. policymakers are maintaining the direction of free and efficient markets driven by the private sector, by enabling USD-backed stablecoins (e.g. USDT, USDC, and DAI) issued by the private sector, to be used by financial institutions to back payments, settlements, and transactions. Stablecoins like USDC are seeing rapid adoption, with about US$21 billion in circulation as of publication time.
As the world’s primary reserve and most-traded currency, the U.S. dollar enjoys global dominance. Over 85% of global currency trades happen only on seven currency pairs that are all dollar-denominated: EUR/USD, USD/JPY, GBP/USD, AUD/USD, NZD/USD, USD/CAD, and USD/CHF. To enhance sovereign currency competition, China’s CBDC adoption plans could be internationalized through the nation’s Belt and Road Initiative — a global development strategy with many counterparties in Asia and Africa.
In addition to raising sovereign currency competition, central banks are also exploring the economic cost of implementing CBDCs as compared to printing physical money. According to a Mastercard study, it is estimated that the cost of printing money ranges from 3.2% to 4.5% of global GDP.
Further, the Mastercard study shows that a 1% increase in the use of digital payments resulted in an average annual increase of US$104 billion in the consumption of goods and services. Digital payments help increase the velocity of money in circulation, increasing GDP growth. Growing a digital payments economy will help governments to benefit from higher job growth, reduce costs of transporting physical cash, and increase commercial activity from streamlined payment and settlement systems.
A CBDC refers to the digital form of fiat money issued by a central bank. CBDCs are backed by an appropriate amount of monetary reserves (such as commodities or cash equivalents). As a means of payment, a unit of account and a store of value, each unit of a CBDC is a new tool for central bankers and monetary policymakers. Policymakers understand that a digital currency, backed by fiat money and controlled by a national monetary authority could be used to streamline transaction efficiencies, supplant the rush of users to non-state digital currencies, and offer nations an opportunity to break free of the status quo of global monetary order.
CBDCs can also be utilized as a monetary policy tool by central banks, to complement their arsenal of controlling interest rates or increasing the money supply. In particular, the properties of blockchain technology that stablecoin issuers are harnessing (e.g. fractionalization of ownership, programmable currencies, smart contract verification) can significantly enhance CBDC functionality and help mitigate inflation risk of sovereign currencies. The U.S. Fed has continued its “quantitative easing infinity” policy to prop up the U.S. economy, with more than US$5 trillion in stimulus packages approved by Congress. Some argue that QE infinity policies, heavy debts and fiscal deficits would threaten dollar dominance as the world’s reserve currency in the long term.
As the U.S. dollar supply increases and digital currencies retain their scarcity (Bitcoin supply is capped at 21 million), there is increased market demand for digital currencies. Algorithmic stablecoins issued by the private sector are swiftly building financial bridges between sovereign currencies in the global economy. Technology players have issued U.S. dollar-backed stablecoins, such as Circle’s USDC, Winklevoss-founded crypto exchange Gemini’s GUSD, and Facebook’s Diem. J.P. Morgan has issued its own JPM Coin to enable clients to transfer USD held on deposit with J.P. Morgan. These USD-backed stablecoins are not part of the money supply, and only require the backing of an existing sovereign currency. This enables the value of a U.S. dollar to travel digitally in smart contract code, acting as a forex conversion token between digital currency pairs. This led to the rapid rise of stablecoins, and the creation of a new global infrastructure for seamless fiat-crypto conversions and settlements for crypto trading markets. Like forex markets, crypto markets operate 24/7, and it currently stands, as of publication time, at US$1.7 trillion in market capitalization just slightly over a decade since Bitcoin was created in 2009.
What’s next for sovereign digital currencies?
As a digital technology tool for central bank governance, CBDC functionality presents creative opportunities for central bankers to maintain systemic financial stability through financial and legal innovation. CBDCs enable sovereign currency competitiveness as an asset for global trade, a challenge that China and G7 countries are fully embracing. It is now up to countries in emerging markets around the world to make a decision; build your own technology or embrace someone else’s — a question China is hoping to answer for them.