Commentary / World

China's digital currency could threaten dollar's dominance

by Sayuri Shirai

Since bitcoin was launched in 2008, the first crypto asset with its own unit of account based on blockchain technology, more than 3,000 crypto assets with a diverse range of features have entered the digital currency market. Yet regulatory authorities around the world have thus far largely indicated they are not threatened by crypto asset growth since the extreme volatility in their value hampers their widespread use as a medium of exchange and a store of value. This reflects their lack of intrinsic value and lack of a mechanism to stabilize their value, such as a circuit breaker in the case of stock transactions.

In recent years, however, new types of crypto assets called stablecoins have emerged that are more resistant to volatility problems.

One of the original stablecoins is tether, issued by Tether Ltd. in Hong Kong in 2014, with its own unit of account called USDT that guarantees a one-to-one conversion ratio with the dollar. Tether is pegged to the dollar with 100 percent underlying reserves comprised of dollars and equivalents.

The company functions solely as an issuer of tether, a custodian of reserve assets and a manager to integrate with existing blockchain wallets and exchanges, as well as an operator of a wallet that enables convenient user transactions. Tether is transacted at various exchanges so that the arbitrage will lead the value of tether closer to the dollar. Many tether transactions are reportedly conducted by Chinese-related exchanges and by investors in mainland China. While the size of tether’s market capitalization is the largest among stablecoins, it remains only 3 percent of bitcoin’s market size.

Facebook’s announcement in June about its planned global crypto asset Libra has captured more attention than any other stablecoin, offering smartphone holders convenient, fast, low-cost payment and funds-transfer services as well as a new tool to store value.

Libra is a stablecoin stabilizing against a basket of reputable fiat currencies such as the dollar and euro, and reserve assets will be maintained in bank deposits and short-term treasury securities denominated in those currencies.

Libra will be far more influential than any other stablecoin given Facebook’s 2.4 billion users. In addition to the anti-money laundering and data privacy issues Libra brings to the forefront, the Group of Seven and many central banks are signaling increasing concern about the risk posed to financial stability given that the public may shift funds from retail deposits managed by local banks, or cash issued by central banks, to Libra due to the relative ease of capital flight.

A shift from domestic fiat currencies to Libra may not only erode the effectiveness of monetary policy but also promote substantial depreciation and lead to foreign debt crises.

The possible emergence of attractive private sector-issued stablecoins like Libra may spark anxiety among emerging economies and prompt some central banks to develop their own central bank digital currency (CBDC) that can be transacted globally at low cost.

China has been considering CBDC issuance for many years. It recently launched a joint project with large commercial banks and tech firms to explore possible implementation this year based on a two-tier system where the central bank will issue digital currency indirectly through them.

Given that China’s economy now accounts for about 15 percent of global GDP and its influence is expanding rapidly in emerging economies with the Belt and Road initiative, China’s CBDC may boost the internationalization of the yuan. It may also reduce dollar dominance in trade and financial transactions, which has been excessively large given that the U.S. economy accounts for only a quarter of global GDP and its relative influence continues to drop.

A dominant dollar has been a source of instability in emerging economies due its wide use as a trade invoice currency and an external debt currency, as noted by Bank of England Gov. Mark Carney. The disproportionately large spillover effects from changes in U.S. monetary policy weakens autonomous monetary policy in these economies.

Carney has suggested that the introduction of a “hegemonic digital currency” or a basket of CBDCs issued by several central banks could reduce the dollar’s dominance and promote diversification of international currencies. But it is not clear whether this approach would reduce dependence on the dollar if the basket includes a dollar CBDC.

Moreover, a single CBDC may be preferred over a basket of CBDCs due to simplicity and habits. China’s CBDC alone may generate significant impact globally in emerging economies if supported by the enhanced BRI, greater efforts to expand currency swap arrangements, and gradual liberalization of financial markets and capital controls.

Sayuri Shirai is a visiting scholar at the Asian Development Bank Institute and a professor at Keio University.