The Need for Active Participation in the Evolution of Central Bank Digital Currencies

Central bank digital currencies (CBDCs) are gaining traction worldwide, with over 110 countries exploring the concept of digital cash. Among the G20 economies, 18 have progressed beyond research and are now in the development or pilot stage.

The establishment of standards concerning privacy, cybersecurity, and combating illicit finance is underway. Any jurisdiction wishing to contribute to these standards must comprehend the intricate trade-offs involved in creating a CBDC and actively participate in global cross-border testing.

In the United States and the euro area, progress is still in the early stages. As of 2023, the US has not made significant headway in defining the characteristics of a retail digital dollar. Political disagreements, including speeches from presidential candidate Ron DeSantis, have hindered policymakers in Washington from advancing on the issue.

Nonetheless, progress is being made in other areas. The New York Federal Reserve is currently engaged in cross-border testing of wholesale CBDCs, enabling near-instant settlement between banks across borders. This testing demonstrates the potential for cross-border applications of CBDCs to bypass the dominance of the dollar and euro, which should be a primary concern for those worried about competition from China.

In the euro area, considerable strides have been made in shaping the design of a digital euro to best serve consumers. The European Central Bank (ECB) is on the verge of launching a full pilot later this year. However, the ECB has devoted less attention to the cross-border aspect, despite its potential significance for the international role of the euro.

Therefore, both sides of the Atlantic need to make further progress. The G20 countries widely agree on the necessity of improving cross-border payment systems. Consequently, it is sensible to concentrate efforts on this aspect in the near term while individual governments determine the feasibility of implementing a retail digital currency.

The current global settlement system is ill-equipped to handle the escalating volumes of financial flows resulting from globalization. Cross-border payments, primarily conducted in dollars, rely on a limited number of correspondent banks and are often slow and inefficient. In 2022 alone, businesses transferred approximately $23.5 trillion across borders, incurring over $120 billion in transaction processing costs. CBDCs in wholesale payments, alongside upgrades to traditional systems, offer significant time and cost savings. Every country stands to benefit from expedited and cheaper economic transactions.

The advent of cross-border digital currency payments has the potential to reshape the financial system. Testing involving China, the United Arab Emirates, Hong Kong, and Thailand has demonstrated the imminent possibility of transferring large sums across borders without relying on the dollar as an intermediary. Settlement between any two currencies could occur within seconds, with liquidity potentially drawn from a network of non-dollar and non-euro currencies.

This would signify a revolutionary shift from the current system. Although the dollar (and to a lesser extent, the euro) may remain attractive for pricing due to their strength and stability, their settlement infrastructure may become less essential. The global appeal of the dollar and euro for trade and their ability to enforce sanctions could diminish. Consequently, both the US and the euro area have a lot at stake.

Active participation by these two jurisdictions is therefore crucial during this transformative phase. The goal is not to prevent countries from developing CBDCs or alternative payment networks, as such a move would be impractical and undesirable. However, during the creation of a new system, early adopters have the opportunity to set the standards and better protect their strategic interests. Given the incumbent advantages of the dollar and euro, coordinated action by the US and the euro area could establish a new international standard that other nations would be inclined to adopt. Without this leadership, increased financial fragmentation is the most likely outcome.

Setting these standards poses various challenges, including recognition of legal structures, addressing counterparty risk, and developing systems resistant to cyberattacks. Sanctions imposed on Russia following its invasion of Ukraine have compelled many countries seeking to continue trading with Russia to explore alternatives. It is not coincidental that the number of countries interested in bank-to-bank CBDCs has doubled since the invasion. For the US and the EU, it would be a strategic mistake to let others take the lead in these advancements.

By fLEXI tEAM