hinrichfoundation

JUNE2021

advancingsustainableglobaltrade

CentralBankDigitalCurrency:

Aboontotheglobaltradingsystem?

BYSTEWARTPATERSON

RESEARCHFELLOW,HINRICHFOUNDATION

2

ThePeople’sBankofChinahas

combinedwiththeHongKong

MonetaryAuthority,thecentral

bankoftheUnitedArabEmirates,

andtheBankofThailandtoexplorethepotentialformakingCBDCinter-operablebetweenplatforms.

TheEPDCtakesonconsiderable

significanceasapotentialcurrencyfortheworld’ssecondlargesteconomyandlargesttradingnation.

Introduction

ThedebateoverCentralBankDigitalCurrencies,orCBDC,hasbecomemore

prominentamongpolicymakersandinthemediasincethepublicationofthe

HinrichFoundation’sprimer

report

onthesubject.AccordingtotheBankof

InternationalSettlement(BIS),morethan80%ofcentralbanksaroundtheworld

arenowstudyingthefeasibilityofthisnewformofdigitalcentralbankmoney.

DevelopmentsinChinaaregainingparticularattention.China’sCBDC,knownasElectronicPayment/DigitalCurrency(EPDC),hasundergonesignificanttrials.

LocalgovernmentsinChengdu,Shenzhen,andSuzhouhaveissuedmillionsof

dollars’worthofthedigitalcurrencythroughalottery.E-commercegiantJD.comalsoparticipatedinthetrialbyallowingsomepurchasestobepaidwiththedigitalyuan.ThetrialhasaddedprivatebankZhejiangE-CommerceBankinZhejiang

provincetoitsrosterofsevenbankstotestthedigitalyuan.

Forcross-bordertransactions,thePeople’sBankofChina(PBoC)hascombined

withtheHongKongMonetaryAuthority,thecentralbankoftheUnitedArab

Emirates,andtheBankofThailandtoexplorethepotentialformakingCBDCinter-operablebetweenplatforms.Thegoal:tofacilitatecross-borderpaymentsusingmultipledigitalcurrencies.1

Theserecentdevelopmentspromptthequestion:Willcentralbankdigitalcurrencieshelptoadvanceorhinderfutureglobaltrade?

China’sdigitalyuan

China’sEPDCisnotthefirstCBDC.Inlate2020,theBahamaslaunchedtheSandDollar,theworld’sfirstdigitalcurrency,afteryearsofdevelopment.

ThedigitalyuanisdifferentfromBitcoin.TheCBDCwillbelegaltenderinthe

samewayasphysicalcashandholderswillbeabletomeettaxliabilitiesusing

digitalyuan.Fornow,thecurrencywilloperateona“two-tiersystem”,withthePBoCdistributingthecurrencytodomesticcommercialbankswhopassitontocustomers.Usersholdadigitalwalletontheirphonesorelectronicdevicesandtransactforgoodsandservicesbypassingtheelectroniccurrencytooneanother.

China’sEPDCisthefirsttobetrialedinamajorglobaleconomy.Moreaccurately,theEPDCtakesonconsiderablesignificanceasapotentialcurrencyfortheworld’ssecondlargesteconomy,largesttradingnation,andmanufacturingpowerhouse.Formorethan120nations,Chinaistheirmostimportanteconomicpartnerin

termsoftrade.Chinaisalsoarguablythegloballeaderinfinancialtechnology.

Chinahasbeenarapidadopterofelectronicpayments.AsofDecember2020,

about852millionpeopleinChinausedmobilepaymentmethodsforhundredsofbillionsoftransactions.

Authoritiesarekeentostressthatthemotivationbehinditsdevelopmentis

primarilydomestic.Theseobjectivescanbebrokendownintothreeparts.Thefirstobjectivemaybetoprovidecompetitiontotheoligopolistice-paymentsystemsthatcurrentlydominateretailpaymentsinChina–AlipayandWechatpay.Theseprivatepaymentsystemshaveabouta90%marketshareofChina’se-paymentsmarketandareperceivedasposingathreattotheState-runfinancialsystem.

Theirmonopolisticbehaviorhasalsobeencriticizedaspotentiallydamagingtoconsumerinterests.

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AconfigurationapproximatingtoarenminbiblocmightemergeincountrieswithdeepeconomicandinvestmentrelationshipswiththePeople’sRepublicofChina.

AccordingtotheBankofEngland,

thesizeofthecross-borderpaymentmarketisaboutUSD150trillion,or

about1.8timesofglobalGDP.

Thesecondobjectivemaybetoharvestinformationpertainingtothemacro

economythatinturncanbeusedtobetterfinetunemacroeconomicstabilizationpolicy.Thismaywellinclude,butisnotlimitedto,informationpertainingtothecreditworthinessofbothindividualsandcompanies.Thiswouldbeusefulto

banks,themajorityofwhicharestate-owned,inmanagingtheirloanportfolios.Thiswill,tosomeextent,leveltheplayingfieldbetweentheprivatee-pay

companiesandthestate-ownedbanks.

Thirdly,onegoalmaybetoincreasefinancialinclusion,bymakingastate-

sponsoredmeansofelectronicpaymentwidelyavailableatzero(ornearzero)costtousers.

TherearetwointernationaldimensionsofChina’sCBDC.Thefirstrelatesto

relativelysmallpaymentsassociatedwith,forexample,tourismore-commerce.ThesuccessofAlipayandUnionPayininternationalizingtheirsystemsinthewakeofincreasedoverseastravelfromChinaisperhapsindicativeofthedigitalyuan’sprospects.Thecurrencymightgainacceptanceabroadtofacilitatepayments

byChinesevisitorsorworkersemployedoverseasbyChina’sBeltandRoad

infrastructureprojects.Aconfigurationapproximatingtoarenminbi(RMB)blocmightemergeincountrieswithdeepeconomicandinvestmentrelationshipswiththePeople’sRepublicofChina.

Thesecondinternationaldimensionispotentiallymoresignificantfortradeaswellasgeopolitics.China’sCBDCmaybeusedwholesaleforthesettlementoflarge

tradeorinvestmentrelatedtransactions.UnderlyingthedesiretointernationalizetheRMB–thatis,theexpansionofitsroleininternationaltransactionsand

potentiallyasareservecurrency–isthepossibleaimtosupplanttheUSdollarastheglobalreservecurrency.AlthoughChinesemoneystockisnowlargerthanthatoftheUnitedStates–in2019,China’sM2stoodattheequivalentofUSD28trillionversusUSD16trillionintheUnitedStates–foreignexchangereservesremain

theoverwhelmingassetonthePBOC’sbalancesheetandthesecontinuetobedominatedbyUSdollarsdespitesomediversification.

IfChinasucceedsinsupplantingtheUSdollar,itwouldincreasetheseignioragethataccruestotheParty-Stateandchallengewhatisoftenreferredtoas

America’s‘exorbitantprivilege’.Linkedtothisis,presumably,thegoalof

immunizingtheChineseeconomyandimportanttradingpartnersandpoliticalalliessuchasIranandNorthKoreafromthepossibilityofeconomicsanctions.

Whatiswrongwithcurrentarrangementsforcross-borderpayments?

Followingthestartofadvancingglobalizationinthe1980s,theworldwitnessedtherapidgrowthoftrade,foreigndirectinvestment,internationalportfolio

investment,andremittances.Theinternationale-commercesectorcannowbeaddedtothislistofdriversofgrowthofcross-bordertransactions.E-commercehasledtoanexplosioninthesizeofthecross-bordermovementofmoney.

AccordingtotheBankofEngland,thesizeofthecross-borderpaymentmarketisaboutUSD150trillion,orabout1.8timesofglobalGDP.2Furthermore,thesizewillincreasetoaboutUSD250trillionoverthecomingfiveorsixyears.Giventhesizeofflowsinvolved,modestimprovementsinefficiencycouldhavealargeimpact,betheyinvolvelowercosts,greatersecurity,orspeed.ThisiswhytheG20hasprioritizedcross-borderpaymentsasanareaforinvestigationandimprovement.

Thecurrentsystemisbasedonanetworkofcorrespondentbanks,theSWIFTmessagingsystem,andavarietyofpaymentandsettlementsystemssuchas

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Followingthebail-outofvarious

bankingsystems,regulatorswerekeentoring-fencebankstolimitthecoststotaxpayersoffuturecrisis.

Internationaltransactionsareon

average70%moreexpensivethandomestictransfers.

CHIPS.Themulti-layeredsystemhasevolvedoverthedecades.Currencydoes

notcrossborders.Instead,accountsaredebitedandcreditedineachjurisdictionuponreceiptofinstructions.Transfersbetweenlargeeconomiesandinliquid

freelytradedcurrenciescanbeveryquickandefficient.AUSDandEurotransfer,forexample,willbecheapandfast.Problemsariseandcostsescalateasthechainofintermediarieslengthens.TransferringmoneybetweenBrazilandThailandmayinvolveseveralcorrespondentbankingrelationships.

Intheaftermathofthe9/11attacksontheUnitedStatesandagainafterthe

globalfinancialcrisisof2009,regulationsthatimpactinternationalmoneyflowshavebeentightened.Effortstomonitorglobalpaymentsrelatedtocounter

terrorismfinancinginitiativesandanti-moneylaunderingpolicy,togetherwith

toughpunishmentsforbanksfoundinbreachoftherules,haveresultedingreaterfrictionandareductioninthenumberofcorrespondentbanks.

Therisksofthecross-borderpaymentsindustryhaveincreased.Consequently,therewardsoftheindustryneedtobegreatertocompensatefortherisks,orbankswithdrawfromthemarket.In2020,WestpacBankinAustraliawasfinedAUD1.3

billionforbreachesofAnti-MoneyLaunderingrules.In2014,BNPParibaswasfinednearlyUSD9billionforprocessingcross-borderpaymentsonbehalfofclientsthatwereinbreachofUSeconomicsanctionsagainstIran,Sudan,andCuba.

Theglobalfinancialcrisishasalsoimpactedtradefinancingandcross-borderpayments.Followingthebail-outofvariousbankingsystems,regulatorswerekeentoring-fencebankstolimitthecoststotaxpayersoffuturecrisis.Thishasincreasedthecapitalintensityofinternationaloperationsandinfluencedthereductioninthecorrespondentbanknetwork.

Thecostofcross-borderfinancialtransactionsishigh,relativetodomestic

transfers.AccordingtoMcKinsey,cross-bordertransactionsaccountforabout

16%oftotaltransactionsbyvalue.However,therevenuefromsuchtransactionsaccountsfor27%ofthetotalrevenueofthepaymentsindustry.

Therefore,internationaltransactionsareonaverage70%moreexpensivethan

domestictransfers.Attheextreme,theIMFestimatestheaveragecostofa

remittancepaymenttobe7%ofthetransfervalue–andcanbeashighas15%to20%insomecorridors.Remittancepaymentstendtobesmall,whichmakesthecostsrelativelyhigh.ForeconomiessuchasthePhilippinesorBangladesh,whereremittancesarelargerelativetothesizeoftheeconomy,thesepaymentsimposeaseriouscost.

Incontrast,businesstobusinesstransfers,whichconstituteabout80%ofcross-borderpaymentsbyvalue,costabout0.1%ofthetransfervalue.Forthebanks,thisamountstoapproximatelyUSD125billioninrevenuestream.

Itcanbearguedthat,broadlyspeaking,themainoutstandingissueswithhigh

valuecross-borderpaymentsbetweendevelopedmarketsistheirpotentialto

becheaperandfaster.Ithaslongbeenthecasethatsmallandmedium-sized

enterprises,orSMEs,accountforasmallershareofcrossborderpaymentsthan

theydoofoveralleconomicactivity.Thismaybeindicativeofbarriersthatsmallerscalepresentstointernationaltrade.Themostcostlyandlengthytransferstendtobeofsmallvalueandalongunder-servicedcorridorstoemergingeconomies.Thisiswherepotentiallythegreatestgainslie.

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ThereislittlepointinreducingtradebarriersonamultilateralbasisthroughtheWTOorplurilaterallythrough

regionaltradedealsifthefinancialinfrastructuretofacilitateassociatedpaymentsisnotinplaceoristoo

costly.

China’sdistinctionastheonlymajor

economytopursueaCBDConatrial

basisisnosurprise.Itisnotimpossibletohaveanewmultilateralcross-borderpaymentsystem,orindeedmorethanone.

Amoresustainableglobaltradingsystemrequiresgreaterparticipationfrom

developingcountries.Costly,slow,andriskyinternationalpaymentspresenta

barriertotradeandsubsequentintegrationintotheglobaleconomy.Thereis

littlepointinreducingtradebarriersonamultilateralbasisthroughtheWTOorplurilaterallythroughregionaltradedealsifthefinancialinfrastructuretofacilitateassociatedpaymentsisnotinplaceoristoocostlytobeeffectivelyutilized.

Sourcesoffrictionininternationalpayments

Theinternationalpaymentssystemhasseveralsourcesoffriction.UnderstandingthesefrictionsisaprerequisiteindeterminingtowhatextentnewtechnologymightreducethemandwhetherCBDCwillbeapartofthesolution.Themajorsourcesoffrictionandsubsequenthighcostsandslowdelivery,asidentifiedbytheBIS,are:

–Fragmenteddatastandardsthatleadtoalackofinteroperabilitybetweenparticipants

–Oversightregulationspertainingtoanti-moneylaunderingandcounteringthefinancingofterrorism

–Complexitiesrevolvingarounddataprotectionstandardsindifferentjurisdictions

–Differentoperatinghoursacrossdifferenttimezones

–Outdatedlegacytechnologyplatforms

–Barriertoentry

–Fundingcosts/capitalintensity

TheG20haschallengedtheCommitteeforPaymentsandMarketInfrastructure(CPMI)oftheBISandtheFinancialStabilityBoard(FSB)toprepareaplanto

overcomethefrictionsinthecross-borderpaymentssystemandincreaseitsutility.Theirreportinghasthreesections:thefirstidentifiestheproblems;thesecondidentifies19buildingblocksforanupdatedeco-system,andthethird

outlinesaroadmapforachievingthegoals.3

Therearefivefocusareasinthebuildingblocks:

–Thepublicandprivatesector’sjointcommitmenttoenhancecross-borderpayments

–Thecoordinationofregulatory,supervisoryandoversightframeworks

–Improvementofexistingpaymentinfrastructuresandarrangementstosupporttherequirementsofthecross-borderpaymentsmarket

–Strengtheningofdataqualityandstraightthroughprocessingbyenhancingdataandmarketpractices

–Explorationofthepotentialroleofnewpaymentinfrastructuresandarrangements

AccordingtotheCPMIandFSBreports,incrementalchangestotheexistinginfrastructureanddesigncouldbeexpeditedoverthenextoneortwoyears.

However,afundamentalchangeinthetechnologyused,suchasdistributedledgertechnology(DLT)andthereforepossiblyCBDC,issomewayoff.

China’sdistinctionastheonlymajoreconomytopursueaCBDConatrialbasisisnosurprise.Itisnotimpossibletohaveanewmultilateralcross-borderpaymentsystem,orindeedmorethanone.Thecurrentsystemoperatesonseveral“rails”

andthefutureislikelytobethesamewithcompetingtechnologies.Thequestionis:IfintenyearstheCBDCiswidelyusedinmultiplejurisdictions,willithelp

overcomethefrictionsinthesystem?

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IffinancialinclusionisthesolegoaloftheCBDC,atokenizedformthatavoidstheneedforfinancialintermediaries

altogetherwouldbethebestchoice.

Distributedledgertechnology&CBDC

Asisalreadywellunderstood,digitalcentralbankmoneyalreadyexists–almosteverywhere–intheformofbankreservesatthecentralbank.WhatiscommonlythoughtofasCBDCisperhapslessofabreakwiththepastthanisoftenthought.Inaddition,commercialbankmoneyisalsodigitalized.

WhatisdrivingretailCBDC,asbeingtrialedinChina,isacombinationofthe

growthine-commerce,theproliferationofprivateelectronicpaymentvehicles,andtheadvancesinledgertechnology(distributedorcentralized)forrecord

keeping.Thisistakingplaceagainstabackdropofwideadoptionofsmartphonesbythepopulation.

ItisworthnotingthatChina’stwo-tierCBDCdoesnotuseblockchainasits

ledgertechnology.Advancesinledgertechnologyhavethepotentialtoimprovetheefficiencyofthecross-borderpaymentssystems.However,thereisagood

argumentforsayingthatincorporatingthebenefitsofledgertechnologydoes

notinitselfrequirearetailCBDC.Banksalreadyhaveaccesstocentralbankdigitalmoney,whileconsumershaveaccesstodigitalcommercialbankmoney.One

considerationwouldbetowidenaccesstocentralbankdigitalmoneytoavarietyofnon-banksinvolvedinpaymentssuchasmoneytransferoperators.

ThenumberofprivatecompaniesdeployingDLTorothertechnologiestomakecross-borderpaymentsmoreefficientismultiplying.FintechcompanyRipplehasbeenoperatingintheMexico-UScorridorusingDLT,withconsiderablecostandtimesavings.CirclepayisdeployingDLTforpeer-to-peerpayments.SWIFTis

exploringDLTtooverhaulB2Bpayments.

ThedesignofretailCBDCinvolvesmakingchoices;forexample,accountbasedversustokenized.Thedesignchoicesimpactdirectlyontheutilityandcharacteroftheendproduct.IffinancialinclusionisthesolegoaloftheCBDC,atokenizedformthatavoidstheneedforfinancialintermediariesaltogetherwouldbethe

bestchoice.Fromasecurityandlawenforcementperspective,however,cash-likeanonymitywithoutthebulkofphysicalcashortheriskofdestructionbyfireorwaterposesaseriousproblem.

Ifreducingfrictionsincross-borderpaymentsisthegoal,theFSBandCPMIreportscallforpayingcloserattentionduringthedesignstageofaCBDCforitspotentialinteroperability.Yetharddesignchoicesaremadewithtradeoffs.Different

societieswithdifferentprioritiesandvaluesmaywelloptforverydifferentdesigns.ThedegreetowhichthisreducestheuseofCBDCincross-borderpaymentsis,atpresent,unknown.

Interoperabilityandthegeo-economicsofcrossborderpayments

Therecentreportsintothefrictionsofcross-borderpaymentscontinuouslyrefertotheproblemsofinteroperabilitybetweensystems.Therearemultiplereferencestoa“commonvision”;“commonstandards”,“standardizedprotocols”,andsoforth.Whenvalueisbeingtransferredbetweenonedomesticsystemtoanother,clearlyinteroperabilityiskey.Indeed,theBISInnovationHubhasmodeledthreescenariosforinteroperability.ThefirstmakesmultipleCBDCsystemscompatible.Thesecondlinksdifferentsystems.ThethirdcreatesonesystemformultipleCBDCs.

Thepotential“elephantintheroom”hereisthatthereisnocommonvisionofwhattheworldshouldlooklikefromacross-borderpaymentsperspective.Theriseofgeo-economics–theuseofeconomictoolstopursuegeopoliticalends–

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China,Russiaandothernationsmay

preferfortheinternationalpaymentssystemtoevolvebeyondthecontrolofanyonecountryandforitsoperationtoallowanonymoususewithaccesstotheUSdollar.

Thosecountriesthatcurrentlyfindthemselvesexcludedfromcheap

andfastcross-borderpaymentsmaywellfindsuper-powersfallingoverthemselvestoimprovetheiraccessasmultiplenetworkscompetefordominance.

meansthatcross-borderpaymentsandtheinternationalfinancialarchitecturearepotentiallybeingfoughtoverforgeo-strategicreasons.

ThePRC,Russia,andeventheEUhavemadenosecretoftheirconcernovertheperceivedcontrolofSWIFTandtherailsalongwhichinternationalpaymentsflowbytheUnitedStates,inadditiontothecountry’sfrequentwillingnesstoimposeeconomicsanctions.Thisperceivedpowerimbalancehasservedasmotivatingfactorsinattemptstobuildanalternativeinfrastructure.

Ifthedigitalyuananditspaymentssystemweretoprovideincreasedefficiency,fastersettlement,andlowertransactioncostswithclearingthroughacentralbankpotentiallywithpaymentguarantees,itcouldbethecasethatitoutcompetes

theincumbentsystemofinternationalpaymentsanditsassociatedinstruction

network.Hence,geo-politicalrivalriesandaclashofideologiesarebifurcating

theglobaleconomy.Itwouldbenaivetoassumethattheinternationalpaymentsinfrastructurewillprovetobeanexception.

Onthecontrary,China,Russiaandothernationsmaypreferfortheinternationalpaymentssystemtoevolvebeyondthecontrolofanyonecountryandforits

operationtoallowanonymoususewithaccesstotheUSdollar.Conversely,theUnitedStateslikelyprefersanarchitecturethatcedescontrolandvisibilityto

themandallowsthecontinueduseofeconomicandmonetarysanctions.This

clashofinterestssuggeststhatseveralecosystemswillcontinuetoexist,possiblyincompleteisolationfromoneanother.

Suchadevelopmenthasbroadimplicationsforthewaycross-borderpaymentsevolveandwell-meaningattemptstoreducefrictionalcosts.Geopolitical

considerationswillnodoubtbeafeaturewhenitcomestodatasharingand

theenforcementofdifferentjurisdictionsregulationsandlaw.EffortstosimplifyregulationsrelatedtoKnow-Your-Customerguidelines,Anti-MoneyLaundering,andCounter-TerrorismFinancingenforcementmightdependoncooperationandtrustthataresimplynotexistent.

Thatsaid,intheabsenceofcomparablecompetitorsinthedigitalcurrencyspace,Chinaissteppingforwardtoproposerulesandstandards.MuChangchun,DirectorGeneralofPBoC’sDigitalCurrencyInstitute,proposedataBISseminarinMarch2021forinteroperabilityand‘synchronized’informationflowsbetweenCBDC

systemsofdifferentjurisdictionsandexchange.

Competitionmightprovetobeaboontothirdcountries.Inanypayments

system,networkeffectsarecruciallyimportant.Thosecountriesthatcurrentlyfindthemselvesexcludedfromcheapandfastcross-borderpaymentsmaywellfind

super-powersfallingoverthemselvestoimprovetheiraccessasmultiplenetworkscompetefordominanceoratleastmarketshareintheglobalpaymentsmarket.

Conclusions

TheG20haveprioritizedmakingthecross-borderpaymentsystemmoreefficient,especiallyforemergingeconomiesthathavefoundthemselvesdisadvantagedbyhighcostsandslowdeliverytimes.Internationalpaymentsthatarefaster,cheaper,andmoresecure,andbroaderandmoreinclusiveaccessshouldbringsubstantialbenefitstothosecountrieswherepaymentcostsrepresentabigbarrierto

internationaltrade.

Astheprivatesectorisdemonstrating,distributedledgertechnologycanreducefrictionsassociatedwithinformationflowsandpotentiallyreducescosts.Itisnot

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Suchnetworks,however,mayfindtheirefficiencycompromisedbygeopoliticalconsiderationsandthebattlefor

controlovercross-borderpayments.

yetclearwhetherretailCBDCwillactasamajorenablerofbetterinternational

paymentsforlargescalebusinesstobusinesstransfers.ItismorelikelythatCBDC,inasimilarformattothatdevelopedbyChina,willbecomeameansofpaymentsinindustriessuchastravelandretaile-commerce.

Newpaymentsplatformsandnetworksarelikelytodevelopinthecomingyearsand,tosomeextent,replacesomeofthemultilayersystemthathasevolvedinpastdecades.Suchnetworks,however,mayfindtheirefficiencycompromisedbygeopoliticalconsiderationsandthebattleforcontrolovercross-borderpayments.

***

Abouttheauthor

StewartPatersonisaResearchFellowattheHinrich

FoundationandtheauthorofChina,TradeandPower:

Wh