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As geopolitics reshape the contours of physical commerce, digital services remain one area where sovereign countries can engage between each other with relative freedom, during a period where certain nations around the world are erecting new politicized barriers, controlling, restricting, or sanctioning trade in goods like minerals, raw materials, food, through to services, semiconductors and technologies.
As countries seek to shield their supply chains from external trade disruptions — whether they stem from political, or other reasons — it is a safe bet that demand for digital services will continue to rise as the dominant transactional technology, including the use of digital currencies as opposed to traditional fiat money.
The U.S. Federal Reserve, Treasury Department, Congress, the ECB, and similar institutions within the G7 have only recently begun seriously considering the viability of a Central Bank Digital Currency (CBDC), as a legal tender national digital currency. They are focused primarily on policy issues such as potential impact on financial stability or public access services. The national security implications of CBDCs are also on the table being discussed through various prisms all of which have resulted in a lagging, unprioritized approach to implementation.
Digitized currencies are data. A Digital currency moves across international borders, upholding privacy and security standards while maintaining lawful auditability in a fully digital economic world. The United States for instance trails other nations in its consideration of a CBDC. On the other hand, countries like China, and Russia among other non-G7 nations have been working toward, even implementing their own forms of CBDC for over 5 years. This progressive lead may enable them to shape the global standards and processes governing this financial transformation. The results could transcend data privacy and unipolar security constraints.
Governments have viewed cryptocurrencies as a possible challenge to their ability to manage and regulate the economy because simply put, they are used to doing so. They must figure out how to adjust to this new paradigm and create regulatory frameworks that strike a balance between innovation and control.
New global payment exchanges could undermine components of the international financial system that enhance the financial power of the US and the aligned G7 to help them combine and control their narrative regarding norms of international behaviour. Vulnerable components include the SWIFT service, which facilitates the movement of USD across international borders and, among other things, is fundamental to the U.S. financial sanctions regime of diplomacy.
Cryptocurrencies and CBDCs
CBDCs issued by governments are stand-alone innovations. They should not be confused with cryptocurrencies such as Bitcoin or Ethereum which were launched in 2009 and 2015 respectively. The growing popularity of cryptocurrencies, their exceptional freedom of borderless movement, speed, and of course risks, have however fueled government consideration of national digital currencies such as CBDCs.
Cryptocurrencies create and maintain “sovereignless” money through decentralized, cryptographically secured digital technologies that operate independently of any government. The first cryptocurrency was Bitcoin, but as of this writing, there are over 2,200 cryptocurrencies, mostly referred to as “altcoins” that are valued at just over US$2.3 Trillion. It is a drop in the comparative global value bucket, but it is still very early days.
Anyone can potentially create and maintain private cryptocurrencies by participating in transparent and decentralized technological processes that operate independently of any government. Cryptocurrencies are mainly used for holding value and financial speculation, P2P transactions, rather than as a retail payments system. Price volatility has limited the value of the bulk of cryptocurrencies by and large, as a vehicle for savings, although it can be argued that certain cryptocurrencies can be more attractive than several weak national currencies. Still and all, the acceptance by businesses of key cryptocurrencies is a noticeable, and growing trend.
The market has looked for ways to deal with the issue of volatility by creating specialized tokens called stablecoins. These cryptocurrencies claim to be backed by reserves of a government-issued currency. Central bank officials worry that the widespread use of stablecoins could potentially impede effective management of national monetary policy, which could become even more challenging as time moves on and the technologies mature.
CBDC Design
CBDCs are legal tender digital currencies, issued and maintained by governments or central banks. A retail CBDC differs from existing “normal” electronic currency transfers in two important respects. First, retail CBDCs are for use by people, businesses, and similar entities, and can largely obviate the present use of traditional intermediary payment cards such as VISA or MC to settle for services.
Central banks have long made large electronic interbank currency transfers to commercial banks and other financial intermediaries. In the United States for example, the Federal Reserve’s Fedwire system provides real-time settlement for these wholesale interbank services, although the potential as seen with the Russian CBDC that in testing trials has shown it can handle both interbank and retail functions.
CBDCs can reduce the costs, risks, and barriers to access associated with credit cards and payment platforms like Paypal, Venmo, and AliPay (which use digital representations of fiat currencies to provide money transfer services). CBDCs could also create new options for central banks. Unlike physical cash, CBDCs can be “programmed” thatnks to blockchain technologies, to perform predetermined functionality like helping to implement a desired monetary policy. For example, central banks can use CBDCs to provide direct government payments to citizens or create incentives for private savings or spending at a speed and efficiency that is currently impossible. The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.
A national CBDC will not be completely decentralized and open to all as are cryptocurrencies. Governments could, but do not have to, use blockchain and immutable digital ledger technology for their CBDCs. Some governments are constructing their own CBDC, while others are partnering with private technology companies.
As more countries issue CBDCs, governments behind the curve may grow concerned about missing out on a major trend in global currency. China’s e-CNY has added momentum to the transition to CBDCs.
CBDCs could disrupt elements of an international financial system that has greatly benefited the United States and enhanced its global influence. The dollar’s position as the favored reserve currency provides America with massive strategic advantages, from lower borrowing costs to leverage over global norms of behaviour through enforced sanctions.
This is a big reason why CBDCs are seen as a path forward for states wishing to challenge the status quo by reducing their externally-influenced vulnerabilities such as financial sanctions. Additionally, by using CBDCs to create new localized cross-border payment systems, governments can promote commercial reliance on their national CBDC. Finally, states that lead in the use of such innovation traditionally have led the development of international standards governing those technologies, which may further erode the influence of the G7s style rules-based order in controlling financial values and flows.
