Beijing is ahead in the race for establishing a global digital currency standard
(FPRI) — At the Beijing Olympics—in addition to showcasing a 60-foot snowman and an ambitious (if controversial) environmental initiative—China is debuting its newly minted central bank digital currency, or CBDC. The country had hoped to make a splash by having thousands of international visitors experience the high-tech convenience of downloading currency directly to a smartphone wallet or a dedicated card, bypassing the ATM or foreign exchange bureau. Sadly, foreign spectators will not be permitted to attend this year’s games.
Still, the coming of age of the e-CNY, as the digital currency is known, is a significant development. It should also constitute a serious cause for concern among the U.S. and its allies.
China has a substantial lead in developing a CBDC which has important strategic implications. The U.S. government exerts outsize influence overseas thanks in part to the U.S. . These levers enable Washington and its allies to enforce economic sanctions, fight crime, punish military adventurism, and promote ideologies such as democracy, human rights, and liberal capitalism.
The Chinese government—being often on the receiving end of U.S. pressure—has sought to undermine Washington’s soft power by promoting its own currency, technological infrastructure, and technology standards. Over the past year, China has made substantial progress toward this goal by advancing and internationalizing the e-CNY. Additionally, the e-CNY will enable Beijing to embed surveillance and control mechanisms deep into the fabric of tomorrow’s economy. Having built a comprehensive system of surveillance and repression at home, China has the capacity through the e-CNY to internationally scale core elements and functions of its police state.
To be sure, it is unlikely that China will succeed in quickly toppling America’s dominance over international finance. The renminbi does not even circulate internationally in a meaningful way, and China, as its steward, suffers from trust and transparency issues. Moreover, although the U.S. is behind in developing a CBDC, it is a world leader in the complex technologies needed to launch one, and it has begun researching the alternatives. Last week, the Boston Fed published its work on an open-source CBDC (“OpenCBDC”) with MIT researchers that includes “selected concepts from cryptography, distributed systems, and blockchain technology to build and test platforms that would give policymakers substantial flexibility in the potential creation of a CBDC.”
Nevertheless, China’s e-CNY successes amount to a Sputnik moment for the U.S.— an alert that a formidable competitor has taken steps to weaken or even usurp a key strategic advantage.
The e-CNY Comes of Age
As mentioned in my previous articles on the e-CNY, the People’s Bank of China (PBOC) began researching the development of a CBDC in 2014. At the behest of President Xi Jinping, work accelerated in the second half of 2019 after Facebook announced plans to launch its own digital currency, the Libra (renamed Diem in 2020, then dismantled altogether a few weeks ago). In 2020, the PBOC launched pilot tests in four cities and expanded that to twelve locations last year.
While those tests have been successful, the e-CNY is facing friction. Notably, China already has two private payment networks—Alipay and WeChat—that are widely used for everyday transactions and have more than a billion combined users. Both networks have announced that they would enable users to fund their accounts via e-CNY wallets (rather than direct links from their bank account). Yet skeptics ask, what will motivate users to do this, or to switch from the existing payment networks to using an e-CNY wallet directly?
While the answer to that question may be unclear, if government statistics are accurate, China has made quick progress in proliferating the e-CNY. The PBOC released an e-CNY wallet app on smartphone stores on January 4, 2022. It became the most downloaded app on China’s Apple iOS app store on January 8, and it kept that position for five days. Within the first two weeks, 261 million users had installed the app, according to a Chinese press event, although only those in the 12 pilot locations are currently able to use the wallet.
That pace of uptake stretches credibility. Research by Sensor Tower, cited by Reuters, found that the app had been downloaded To date, e-CNY transactions worth more than 87.5 billion yuan (US$13.78 billion) have been made, according to government figures. Additionally, by November, more than 10 million corporate wallets had been created, according to Mu Changchun, Director of the PBOC’s Digital Currency Institute.
The e-CNY: An Enticing Export
Among the locations in the pilot program, several have launched efforts to expand the e-CNY abroad. The Qianhai district, adjacent to Hong Kong, about US$1.5 million each year to motivate enterprises to develop cross-border uses of the e-CNY and to support e-CNY research. The Guangxi autonomous region and Hainan province are planning similar promotions.
Numerous senior Chinese officials—including business leaders, PBOC representatives, academics, and researchers—have publicly hailed the advancement and internationalization of the e-CNY. In October, Li Lihui, head of the Blockchain Research Working Group at the National Internet Finance Association of China and former president of the Bank of China, said, “China’s central bank digital currency experiments lead the world and should strive for a dominant position in the process of globalizing the central bank digital currency.” As his priorities, Lihui mentioned using the digital currency to clear international financial institutions’ payments, building a digital international financial center, and creating a digital international wealth center.
Far from the Olympics or the flurry of domestic activity surrounding the newly minted e-CNY app, perhaps the most worrying development has been an initiative that would enable China to trade the e-CNY directly with other countries, a project known as the Multiple Central Bank Digital Currency Bridge, or mBridge for short. China joined the initiative last year, in partnership with Hong Kong, Thailand, the United Arab Emirates, and the Bank for International Settlements’ Innovation Hub (BISIH).
The mBridge, which is in a pilot phase, promises various benefits that appeal to businesses and governments. It would allow international transfers to occur in seconds; these take several days using the existing network of commercial banks. The cost to users of such transactions could be reduced by up to half. Payments could occur at all hours of day and night, eliminating the time zone mismatches that render payment on delivery of goods impractical in transcontinental transactions. By enabling real-time verifiable payments, the mBridge would dramatically reduce the risks and administrative burden inherent in global commerce.
The mBridge’s benefits may sound like minor incremental changes. They are not. The current system of international exchange is outdated. It requires numerous manual touches and is vulnerable to fraud and even large-scale theft. Think of China’s approach as the high finance and international commerce version of Venmo. In comparison, the reigning U.S.-led system is akin to mailing a check. If the mBridge is scaled as planned, it would dramatically facilitate and accelerate the cross-border movement of money.
The mBridge has several characteristics that advance China’s interests at the expense of the West. Because the mBridge works on distributed ledger technology (DLT), it allows regulatory requirements to be streamlined while accommodating nuanced differences in national CBDC protocols. While this could have beneficial applications—such as expanding international compliance with anti-money laundering regulations—it could also have nefarious ones. For instance, mBridge would allow China to extend the reach of its centralized economy well beyond its borders, enabling it to enforce capital flow restrictions on an international scale. China would also use the mBridge as a fig leaf for extending its surveillance network internationally, delivering an ocean of exquisite and granular intelligence on economic, political, and strategic activities across the globe. Add in China’s leading edge in artificial intelligence (AI), and the totality of the strategic problem is clear, given China’s prodigious appetite for digital repression. More than half of the world’s closed-circuit television (CCTV) cameras are in China, and the country is home to sixteen of the top twenty most surveilled cities. The government uses facial recognition technology broadly, with applications ranging from catching and publicly shaming jaywalkers to identifying and oppressing racial minorities.
As alluded to above, the mBridge would make it more difficult for the West to enforce economic sanctions and investigate crime by creating an alternative means of international exchange. The existing dollar-based system of international exchange relies on a global network of correspondent banks and a communications network known as SWIFT. Because the U.S. and its allies dominate this system—consider this a hub-and-spoke infrastructure where most of the hubs depend on a presence in the West—they are able to enforce sanctions and monitor for money laundering and other crimes. Any bank that does not diligently comply with Western demands risks being cut off from the system, with potentially major business implications.
As an encrypted and opaque channel external to western jurisdictions, the mBridge would provide a work-around. In addition to weakening the West’s sanctions power, the mBridge would incrementally advance China’s long-held goal of establishing the yuan as a reserve currency and a dominant medium of exchange for international trade, eventually rivaling the U.S. dollar.
In fact, the mBridge explicitly seeks to seize ground currently held by the U.S.-dominated financial order. According to the BIS, the mBridge project aims to create a system that “can support the full process of international trade settlement and, in due course, other use cases proposed as part of the project.” It is welcoming more central banks and private sector firms to participate: “As central banks around the world increase their [CBDC efforts], the issue of interoperability and linkage of national systems is critical.”
The mBridge project has made significant progress. As of 2021, twenty-two large international banks—including Goldman Sachs, UBS, Standard Chartered, and Société Général—had identified fifteen advantageous mBridge business uses: international trade, capital market transactions, digital-native corporate bond issuance, supply chain finance, and programmable trade finance. Beginning in 2022, Goldman Sachs will test tokenized bond issuance, and HSBC will test programmable trade finance. Already, eleven industries in the four participating countries have begun testing sample trade settlement transactions.
While some users may be drawn to using the mBridge by convenience and utility, China could boost adoption and internationalize the e-CNY by requiring countries in its Belt and Road Initiative (BRI) to link their own CBDCs to the mBridge and use it for transactions. With more than 2,500 projects valued at $3.7 trillion, BRI is “a major driver of project activity globally, with many roads, railways, ports and other connectivity infrastructure planned or underway.”
The mBridge is not the only project in Asia that stands to weaken U.S. dominance of cross-border finance. In January, the Asian Development Bank launched a project to improve the speed, efficiency, and security of cross-border securities transactions among investors in China, Japan, Korea, and ASEAN countries. Currently, like foreign exchange, such transactions are routed through custodians and correspondent banks in the U.S. and Europe. ADB is working with ConsenSys, Fujitsu, R3, and Soramitsu to enable the transactions to occur directly via blockchain technology.
A Global Response
To reiterate, it is hard to imagine the proliferation and internationalization of the e-CNY rapidly overtaking the substantial financial hegemony exercised by the U.S. Instead, the effort is an example of China’s “salami-slicing” approach—the slow accumulation of changes, none of which in isolation would cause a geopolitical outcry, but which, aggregated over time, result in seismic strategic change. In the near term, China could use the currency and related infrastructure to circumvent U.S. sanctions. A blockchain-based direct currency link could facilitate commerce and support in places like Iran, Venezuela, and North Korea. It would also alleviate the pressure of sanctions on Russia, which has been dumping its USD reserves for years in anticipation of this moment. Undoubtedly, Putin is less fearful than ever about enduring the U.S. sanctions campaign that would follow an invasion of Ukraine.
The excellent work published by MIT and the is the right start. But the Fed can only go as far as Congress empowers it to. Right now, the U.S. must wake up to the evolution in digital money that is happening all around us, and policymakers must educate and immerse themselves in this brave new world. At its essence, the efficacy of any money is deeply rooted in the trust of its users, and so as the custodians of the world’s preeminent currency, U.S. leaders should not feel cowed into reacting in some tit-for-tat fashion to the e-CNY. However, the starting gun has sounded, and the race is on for establishing the new standards for what money will be in the twenty-first century and beyond.
Washington’s strategic advantage in the global economy is clearly slipping, and the stakes for defending its position against new challengers are getting larger every day. The U.S. cannot afford to be cavalier about the threat because all indicators point to the threat as being a deeply ideological one that challenges traditional western values on several fronts: centralized economies vs. free markets; state-owned data vs. data privacy as a human right; totalitarianism vs. self-determination.
In 2020, China committed to spending $1.4 trillion on “next generation” digital infrastructure by 2025. The free world awaits Washington’s strategy to compete.