Ever since Bitcoin exploded onto markets, governments around the world have been exploring how to digitize their currencies. A total of 87 countries representing over 90 percent of global GDP are researching, piloting, or deploying central bank digital currencies (CBDCs): digital versions of official paper money. Their goals are varied and include ensuring the primacy of official money over unwanted cryptocurrencies, improving the efficiency with which people can make payments, and reducing the number of households that rely solely on paper money to provide for their needs. Competition between banks for payment-related services has been relatively weak, and in many countries, bank-based payments are slow, costly, and not widely available to consumers below the poverty line. Regulators hope that digital currencies could enliven competition and innovation.

But of all the states working on official digital currencies, only a single major power has made one widely available within its economy—China. Beginning in 2020, Beijing allowed groups of residents in several cities to conduct transactions using a digitized Chinese yuan, or e-CNY. In the two years since, the country has gradually expanded the number of people and businesses with access to the currency. Today, over 120 million people in China have set up e-CNY wallets, and the state is planning to make the system available to all residents.

China’s government says that the expansion of the e-CNY is driven by the same economic goals that motivate most of the world’s central banks to explore digital currencies. But China’s government has also created this new digital currency for political reasons. Beijing views the e-CNY as an opportunity to influence global norms and rules around the Internet, data security, and the overall digital economy. Or, as Chinese President Xi Jinping put it, the “community of common destiny in cyberspace.” Professors Sun Lijian and Yang Jiemeng of Fudan University described digital currencies as a “new battlefield for competition” in which China can assert technological and economic dominance. If widely utilized, the e-CNY could give the Chinese government even more insight into and power over its citizens.

For Washington, this should raise concerns. China’s leadership in digital currencies could eventually erode the primacy of the U.S. dollar in cross-border payments. The e-CNY and other payment technologies under development in China could also help Beijing avoid sanctions, making the West’s aggressive economic response to Russia’s invasion of Ukraine more difficult to replicate. And China could pass on its digital currency technology to states that might use it to spy on their own residents.

Thankfully, the United States is not unprepared. In March 2022, U.S. President Joe Biden issued an executive order on digital assets designed to kick-start a whole-of-government effort to meet the challenges of the future digital economy. This order is a strong beginning, one that has many important provisions, including an exploration of the potential for a digital dollar. But if the United States wants to remain the leader in global finance and payments, ensure the dollar’s continued dominance, and protect privacy, it will need to properly execute Biden’s order—and go further. Washington should ultimately take a leading role in setting international standards for how to use digital currencies across borders, whether they are private or official. And to do that, it must advance its own digital currency technology.

DATA POWER

According to the People’s Bank of China, the country’s central bank, Beijing has several main goals for the e-CNY. It wants to provide citizens with a substitute for paper money, one that will lead to more efficient transactions. For example, the e-CNY will be available for offline use in rural areas without cell or Internet service, using technologies such as near-field communication. China’s central bank also wants to reduce corruption by making payments easier to trace and could use the e-CNY to respond more quickly to changes in macroeconomic conditions by providing more flexible and targeted forms of liquidity. Finally, the People’s Bank hopes to cut its own costs. According to one estimate, the e-CNY might save China up to $24 billion on the annual direct and indirect expenses associated with producing and distributing physical money. 

But not all of Beijing’s aims are necessarily beneficial to China’s citizens. In recent years, many Chinese consumers have shifted from traditional state-owned commercial banks to China’s large and vibrant financial technology sector—dominated by Ant Group and Tencent—for payments, wealth management, small loans, insurance, and other financial products. In the process, these two giant technology firms gained vast amounts of personal data, undercutting the power of the state. Beijing has responded over the past year with a raft of new regulations that limit the market power of technology firms. As the Global Times, an outlet controlled by the Chinese Communist Party (CCP), put it in a July 2021 editorial, “No internet giant is allowed to become a super data base that has more personal data about the Chinese people than the country does.” And as People’s Bank Deputy Governor Fan Yifei said, “the People’s Bank will control all of the information. We can use big data to analyze transaction data and money flow.” China’s government has banned private cryptocurrencies, including Bitcoin, largely for the same reason.

China’s government apparently believes that as users adopt the e-CNY, they will turn away from private firms and back to the central government for their banking needs. Beijing could then use the digital yuan to increase its power over China’s population. Under a system that it calls “managed anonymity,” the People’s Bank of China can trace e-CNY commerce to bank accounts, ID cards, and phone numbers. Users will have complete anonymity only if they make small payments from hardware wallets that function as prepaid smart cards. This means that the central bank—and, through it, the CCP—will be able to see most transactions, freeze any targeted account, and adjust its balances. The digital yuan, in other words, could become a tool for monitoring Chinese citizens’ social and political activism and, eventually, for punishing those who run afoul of the state.

Beijing could use the digital yuan to increase its power over China’s population.
 

The e-CNY will not just empower the CCP at home. The currency could also increase Beijing’s international position. In the years to come, transactions with central bank digital currencies will likely be integral to the global economy. China has an early chance to set the standards and create the infrastructure for central bank digital currencies—an opportunity it has been quick to leverage. The People’s Bank of China has already proposed international principles for digital currency transactions and is working with the Bank for International Settlements and the monetary authorities of Thailand and the United Arab Emirates to create cross-border infrastructure for exchanging the central bank digital currencies of different countries.

Beijing could use its leadership in this sector to further challenge U.S. economic power. The fraction of cross-border payments made in dollars could decline. China’s government could also acquire the ability to evade and undermine Western sanctions. China has long chafed at the sanctioning power of the United States and Europe, but because China’s economy remains heavily dependent on access to U.S. banks and SWIFT payment messaging, the country has had little choice but to allow its banks to adhere to most Western sanctions. When Washington sanctioned Hong Kong Chief Executive Carrie Lam for fighting the city’s democracy movement, for example, the Hong Kong government was forced to pay Lam in bundles of paper cash because no banks would provide her with account services. Since Russia was sanctioned for its invasion of Ukraine, most banks in China have been reluctant to provide countervailing assistance to Russian firms and banks, given the risk of secondary sanctions by the United States and European countries. But Beijing could eventually reduce its exposure to sanctions if it sufficiently expands its own cross-border payment messaging system, the Cross-Border Interbank Payment System, or if it can develop a method of making cross-border payments using the e-CNY that does not rely on SWIFT. In that case, China’s government and its businesses could conduct many international transactions without the need to go through Western financial institutions, reducing Beijing’s vulnerability to the demands of Washington and Europe.

CHECKS AND BALANCES

The U.S. government is aware of what the digital yuan could mean for the dollar, for data privacy, and for Washington’s ability to impose far-reaching sanctions. And it has begun to outline its own vision for how to integrate digital currencies into the global economic order. In early 2022, the Federal Reserve set out basic principles that it would likely apply to a U.S. digital dollar, should one emerge. In his executive order, Biden directed the government to investigate the design of such a currency.

The Federal Reserve and the White House should carefully investigate the parameters and the advantages of the digital dollar before committing to its broad use. A digital currency that maintains the privacy of Americans, guards against illegal transactions, and creates a competitive, inclusive, and innovative payment system will not be easy to develop. But because it will take some time to reach these objectives, the United States should respond to Biden’s order by starting a well-resourced research-and-development effort that engages the innovative strength of the U.S. private sector and the intellectual capital of its universities. Project Hamilton, a digital dollar research partnership between the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology, found that a digital dollar could meet “the robust speed, throughput, and fault tolerance requirements of a large retail payment system.” There are significant remaining technology gaps, however, and as Biden noted, the United States will need systems that protect privacy, allow unbanked households to access the new currency, and are resilient to cyberattacks. To close these gaps effectively, the federal government should establish a series of contracts with private-sector firms and universities.

Washington must set international standards for digital currencies.

The White House has called for researching and then creating regulations for digital payment systems. The United States currently lacks a clear regulatory framework for private and public payment systems, hampering innovation and helping shield legacy banks from market forces. The United States should instead regulate in favor of greater competition. For example, the Fed could leverage the power of its forthcoming fast-payment infrastructure, FedNow, by encouraging people and firms to use it as a common payment platform, accessible to all consumers, merchants, and payment service providers on a fully interoperable basis. This would simplify most common payment tasks and lower fees by forcing banks and other providers to compete more directly with one another.

Finally, as Biden’s order noted, Washington must work to set international standards for digital currencies. In practice, that will mean drawing up and seeking agreements on clear, actionable, digital currency standards for privacy, financial crimes, financial stability, and the protection of each country’s monetary sovereignty from foreign digital currencies—whether they come from other central banks or the private sector. Washington and its allies should also assist countries interested in developing their own central bank digital currencies or other digital payment systems. This can be done by directly providing technology or through grants. For example, the Build Back Better World partnership, a G-7 initiative, will provide developing countries with infrastructure funding that could be used for these purposes. Other vehicles for international assistance include the U.S. International Development Finance Corporation, the U.S. Agency for International Development, and the World Bank.

Digital currencies can simplify the everyday lives of consumers, lower their costs, and increase their access to banking services. New digital payment systems can enable emerging consumer technologies, such as smart contracting and the Internet of Things, that will connect money to emerging Internet applications that call for safe automatic payments. The U.S. government has a significant opportunity to improve the lives of Americans and people around the world by advancing competition and payment-system innovation. But to do so, Washington must assume leadership over digital currency developments and offer support and technology to other countries. Otherwise, China could assume a more dominant role in setting the global agenda for payment technologies—and create standards that endanger privacy and benefit its own currency at the expense of the dollar.

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  • DARRELL DUFFIE is Adams Distinguished Professor of Management and Professor of Finance at Stanford University’s Graduate School of Business and a Senior Fellow (by courtesy) at the Hoover Institution. He is a co-editor of Digital Currencies: The U.S., China, and the World at a Crossroads (Hoover Institution Press, 2022), from which this essay is adapted.
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