Notes 10/4: CBDC Development, An Opening for Crypto?

Central bank digital currencies (CBDC) are becoming popular among countries. According to the Atlantic Council’s CBDC tracker, 105 countries, representing 95 percent of the world’s GDP, are developing digital versions of their national currency. Eighty-one countries were exploring the use of CBDCs in their economy last August.

CBDC development accelerated in the aftermath of Russia’s invasion of Ukraine. International payment networks like SWIFT reacted swiftly to the event and blocked transfers to and from the country. The move stoked fears among emerging economies that such networks could be used as a tool to throttle economies and ratchet geopolitical tensions. It also raises important questions about dependency on the US dollar as a tool for international commerce.

Fifty countries from the latest count are in the advanced stage of CBDC development, meaning they have already launched or are close to launching a pilot to test the efficacy of a CBDC in their economy.

The Bank of International Settlements (BIS), a consortium of international banks, also recently announced the successful completion of a pilot project recently that involved the transfer and settlement of $22 million through 160 cross-border payments at 20 banks dispersed across four geographies – Thailand, China, Hong Kong, and the UAE.

These news snippets come on top of China’s embrace of CBDC. The country is running a pilot project for retail CBDCs, or digital currencies that involve direct claims on central banks. Launched in May 2020, the project involved 260 million individuals and had processed transactions worth over $12 billion since inception by this September.

Challenging The Dollar

Proponents of CBDC tout its many benefits – ease in domestic payments, financial inclusion, and faster international trade transactions – to make a case for them.

But a financial regime dominated by CBDCs might also be more fragmented than the current one. Currently the US dollar dominates global reserves and trade, accounting for 60 percent of overall reserves and just over 40 percent of international trade invoices. Competitors to the dollar’s primacy include the euro and China’s renminbi. Both are plagued by challenging dynamics and reinvention into a digital avatar might not solve their inherent problems.

The euro is a loose conglomeration of economies, an unwieldy vehicle subject to the state of economies present within its system. Adoption of the Chinese renminbi is hampered by significant capital controls instituted by its government and, in its electronic form, privacy issues that may arise from transacting with it.

Josh Lipsky, senior director of the Atlantic Council, told Coindesk this morning that developing an international set of CBDC standards that emphasize security and privacy will help the US dollar leapfrog over competitors in the nascent sector. According to him, these standards are “democratic values” that the US has exported to the rest of the world.

A Cryptocurrency Alternative

That approach, however, is still prescriptive and anchored to the diktats of a dominant reserve currency. Cryptocurrencies might offer an alternative. As I have written earlier, a fragmented international payment system is a blessing for crypto.   

The system of correspondent banking that forms the backbone of payment networks today is time-consuming and expensive. For the most part, cryptocurrencies remain subject to minimal regulation across most jurisdictions. Their technology is improving as evidenced by a growth in the number of side payment channels to reduce congestion and facilitate faster payment.

More importantly, an algorithmic alternative could delink the economic imperative of price setting and synchronization of variables, such as cross border value chains, between two currencies to facilitate cross border trade and payments.

Considering the current state of cryptocurrencies, however, it might be difficult to imagine such a future. With each scandal that plagues the crypto ecosystem, the philosophical argument for their use stands on increasingly shaky ground. Numerous hacks have also raised questions about their supposed utility, technical or otherwise.

To that end, it might be a while before we see digital currencies, even those backed by a central government, become a serious contender for reserve assets. In an earlier interview, Lipsky said it might be a decade or more before a serious challenger to the US dollar emerges in international markets.

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