By Alexander Zaitchik, Jeanhee Kim, Kelly Le and Angie Lau, Forkast.News. Part two of a series produced by Forkast.News with support from the Judith Neilson Institute's Asian Stories Project. Read Part I here.
When the first caravans of Chinese silk arrived in ancient Rome, it sparked a frenzy of fashion among women. The wives of senators and generals had never seen or felt anything so shiny. Like the Chinese elite, they adopted the material as a symbol of wealth and status, embroidering silk robes with gold and wearing them to the grave.
In 2015, China announced a Digital Silk Road (DSR) with a white paper outlining a series of technology and communications projects. But it wasn't clear what, if any, role silk would play. Now it's clear: Just as the threads spun from the silkworm's pupae spurred the growth of a global trade network, China's digital yuan could weave an international financial system. The first beginnings have already been made: developing countries have embraced the yuan, and wealthier economies in Asia and beyond are exploring their own digital fiat currency, like it or not, to remain competitive with China.
Government leaders "are looking for the light at the end of the tunnel, and the train is the light; it's coming right at them," said Don Tapscott, executive chairman of the Toronto-based Blockchain Research Institute. The stakes are high, with implications for everything from financial privacy to the global balance of power. "If China wins with their digital central bank currency, they will roll it out in Africa and Southeast Asia," he said. "The [yuan] will become the reserve currency, and that will be the end of American hegemony in the world."
Faster, cheaper money
The DSR is a key component of China's global infrastructure plan, the Belt and Road Initiative (BRI), announced in 2013. The BRI is a project of breathtaking scale - albeit without much transparency - and China's estimated trillion-dollar down payment for development and investment initiatives that span the transcontinental routes of the original Silk Road from Asia to Europe and the sea lanes that connected them in the late 18th century. According to China, 140 countries have joined.
From a project management perspective, the BRI and DSR have one major problem in common: dealing with outdated and often ineffective banking systems. Beijing sees the digital yuan as a solution to this problem and a way to mutually strengthen the reach of both projects, according to Stanley Chao, president of a Los Angeles-based firm that advises on Asian business strategies.
"In emerging markets with poor banking systems, it can take a week to process transactions, which slows everything down and causes delays," he said. "China is looking at a digital currency as a solution. Payments will be instantaneous. Transaction fees will drop to almost zero because there will be no middleman.
"At some point, I could see China making trade pacts saying, 'Let's introduce a currency. We'll save a lot of money in transaction fees because there's no third-party banking system," Chao said. "There are countries, not only in Asia, but also in Africa, Eastern Europe and South America, that could jump on this idea."
The speculation is already a reality. In December 2019, to facilitate a $54 billion U.S. project known as the China-Pakistan Economic Corridor, Pakistan announced the yuan as the new second national currency, a role long occupied by the dollar. Six months later, Turkish Telecom agreed to use the yuan for import payments.
In China's view, the digital yuan would start a virtuous cycle: As more countries realize the benefits of settling in yuan, the network effect will be greater, further expanding the sphere of influence of the Chinese economy.
Between 2000 and 2015, China's trade settlement in yuan increased from about zero to $1.1 trillion, or nearly one-third of China's total trade, according to the National Bureau of Asian Research. However, even in 2021, only 2.5% of the world's international payments will be settled in yuan, compared with 39% in U.S. dollars and 36% in euros, according to the CSIS China Project. So the yuan still has considerable room for growth.
Peer pressure
For many countries, developing their own digital fiat currency is more attractive than adopting the Chinese currency. According to a January 2021 survey by the Bank for International Settlements - the central bank of central banks - 86% of its 65 members are exploring the idea, 60% have begun experimenting and 14% have launched pilot projects.
This interest is shared by economies of all sizes and levels of development. In October 2020, the Bahamas announced the introduction of the "sand dollar," a central bank currency pegged to the U.S. dollar. That same month, Cambodia introduced the digital bakong, calling it a "hybrid CBDC" that supports transactions in both Cambodian riel and U.S. dollars. The governor of Indonesia's central bank confirmed in May that Southeast Asia's largest economy will introduce a digital currency. And South Korea is preparing its CBDC for an August pilot. Meanwhile, Singapore recently completed a five-year experiment with a blockchain-based financial architecture. One of the pillars was a cross-border payments model developed with U.S. banking giant JPMorgan and Singapore-based global investment firm Temasek.
"China's CBDC has really created some peer pressure here in the region," said Charles d'Haussy, Asia managing director of ConsenSys, a blockchain software company working on CBDC projects for the central banks of Australia and Hong Kong. "It's a big shift in the industry that shows there is institutional and regulatory acceptance."
However, some central banks have been cautious, realizing they will be forced to follow China's lead.
In a March 2021 speech at an annual technology summit co-hosted by the Nikkei, Bank of Japan Governor Haruhiko Kuroda called the digital yen a liability rather than a choice. "Central banks share the view that it is not an appropriate policy response to consider CBDC only when the need to issue CBDC arises in the future," Kuroda said. He also reiterated that the bank has no plans to issue a digital yen.
If Japan feels it is being drawn into the digital age of money, it is not alone. Ten years ago, India was considered an economic and political competitor to China. But even with an economy that is expected to become the world's third largest by 2030, India has failed to keep pace technologically with its regional rival.
Despite having world-class technology universities and a large pool of elite programmers, India has generally joined China's hostility to private cryptocurrencies like Bitcoin, but without also embracing its embrace of blockchain as the infrastructure of the future. Nevertheless, India has recognized the network effect and has recently - and ambivalently - entered the brave new world of state-backed digital currency.
Within a single week in February of this year, the Reserve Bank of India released a report stating that CBDC "poses a risk of disintermediation of the banking system," after which the bank's governor publicly acknowledged a few days later that the digital rupee "receives our full attention."
"Now that China and other countries are talking about digital central bank currencies, India is definitely motivated as well," said Nischal Shetty, founder and CEO of WazirX, one of India's largest cryptocurrency exchanges. He lectures widely on related regulatory issues. (In June, Indian authorities told Shetty they were investigating WazirX's use for money laundering.) He said competition between India and China in the CBDC is healthy. "I want more countries around the world to experiment with [CBDCs] so that every other country is motivated to participate," he said. Shetty predicts that India will have made substantial progress on a CBDC within two years.
The rapid move by central banks to develop CBDCs raises the question: How will the digitization of cross-border transactions and settlements affect the role of SWIFT, the dominant global network for interbank communications that has been at the center of global currency flows since 1973?
In February of this year, four central banks took a first step toward using their digital currency in cross-border trade without using the SWIFT system as an intermediary. They announced a pilot project called m-CBDC (Multiple CBDC), which amounts to a transaction bridge between the central banks of China, Hong Kong, Thailand and the United Arab Emirates. The effort, which aims to identify technical and regulatory issues in commercial digital currency transactions, is being closely watched by governments around the world.
"This is the first time four different central banks have worked on building a common infrastructure for cross-border transactions," d'Haussy said. "It's probably the most ambitious proof-of-concept in terms of digital currencies in 2021 after China's retail digital yuan.
Three months after the m-CBDC announcement, SWIFT released a joint discussion paper with consulting firm Accenture on how SWIFT could enable cross-border CBDC payments and, the subtext goes, remain relevant. Noting that SWIFT is "neutral and currency agnostic," SWIFT claimed that "there is little advantage to reinventing the wheel."
If anything, reinventing the wheel seems to be exactly the point. "Using a new kind of money in old pipes is unlikely to bring the full value proposition of digital assets," d'Haussy said. "If you reinvent money, it's a good opportunity to rethink the global ecosystem.
Coincidentally, that's exactly what concerns the United States, the country that has the most to lose from weakening SWIFT's role in the global financial order. In part three, we will explore how power and privacy might change with the new money.