Follower of all things fintech. Plus football - football is good.
2020 was a year of unprecedented, world-changing events, some of which most people are not even aware of. Like it hasn’t been enough for one year, more news comes from China, where the government is actively testing its digital payment system called Digital Currency Electronic Payment (DCEP).
This new payment system is unique because it turns the Chinese yuan into a national digital currency. Essentially, this is an encrypted digital coin that uses Blockchain, like a cryptocurrency, but it is backed by the Chinese government and can be swapped for yuan at all times. This type of real-world currency-backed digital token is often referred to as a Central Bank Digital Currency (CBDC).
DCEP offers its users many possibilities that the USD doesn’t. For one, it can be exchanged directly without a need for a robust banking system. This will speed up international transactions dramatically and reduce costs usually brought upon by middlemen.
Let’s take international trade as an example. Making huge trades usually requires going to a broker, exchanging one currency into another, and then paying the company you’re working with through a series of banks, all of which incur some fees. It’s not ideal and DCEP could make this much easier - according to the BIS, CBDCs can even increase the efficiency of risk-management in settlement.
The digital currency can immensely speed up and simplify this process - just send someone the digital money, wait for verification, and that’s it. In theory, billion-dollar transactions would take 20 minutes and there would be a lot less money lost on banking and brokerage fees. It’s fairly obvious that DCEP compliments China’s larger plan to dominate global trade.
The same applies to personal use - a functional digital currency can remove the need for middlemen altogether. Just imagine sending money to your friends or family overseas almost instantly without incurring any fees - this is a significant step up from contemporary money transfers in most regards.
This perk of DCEP might pay off for many developing countries that are making frequent international deals - like the many countries in Africa which are very familiar with Chinese trade and investment. Over a long-enough period, some countries might even find it beneficial to use the digital yuan as a reserve currency.
Also, this is the only major government-backed digital FIAT currency in the world at the moment, giving it a huge edge over popular cryptocurrencies. However, we should expect a curveball pointed towards DCEP to come from the USA.
The USD has long been, and still is, the dominant global currency. But a fully-functioning digital currency, backed by a USD contender, might steal some of the dollar’s spotlight. An initiative like DCEP can disrupt the hegemony of the USD if the countries of the world start preferring the more practical Chinese digital currency.
The US can certainly develop a full-fledged digital dollar of its own, but how soon? The Chinese have been working on DCEP’s development for a long time before its launch, and the FED has just recently begun assessing how a digital dollar might fit into the macroeconomic picture. Thus, it’s very hard to predict when the US will start producing results.
In an interview with The Tokenist, former CFTC chair Chris Giancarlo eloquently discussed the timeline of a USD-backed CBDC:
“Creating a well-functioning and universal digital Dollar should be done in the same way that the moon was explored and the Internet was created: deliberately, cautiously and, yet, with determination. Something as complex and worthy of the US Dollar’s global importance cannot be done overnight. It should not be cobbled together in a crisis. I cannot give you a date when it will be implemented. Getting it right will take time. Nevertheless, now is the right time to get started.”
The point is clear—creating a USD CBDC will take time. We can reasonably assume it will be at least a few years before we have fully-functional digital dollars on our smartphones and computers.
But the USD cannot wait that long, or its position as the world’s most popular currency could very well be endangered, at least partially. So, the real question here is—what can the US do right now to compete with China’s emerging DCEP?
One immediate option for the US is stablecoins—blockchain-based tokens with a value based on underlying real-world assets like gold, silver, national currencies, etc. These coins have already been developed, with a collective market cap of $20 billion as of early October 2020. And unlike Bitcoin, their price follows the market price of the underlying asset, making them dramatically less volatile.
To have a competing digital currency, the US could embrace existing stablecoins based on USD. These coins have already been produced and their implementation wouldn’t take long, especially compared to creating a new digital dollar out of scratch.
If the US legislated some of the existing stablecoins into becoming a viable trading tool and backed them with “real” dollars, it could jump into the digital currency market quickly. This is one possibility the USA could try out before its native CBDC is developed.
This would be new, but not unheard of. Crypto and digital finance solutions have been gaining popularity lately. Several cryptocurrencies have already been incorporated in payment processing software for small businesses - and it’s reasonable to assume the adoption of digital currencies will continue to increase.
When it comes to CBDCs, China is in the lead, having developed a digital currency which is currently undergoing mass testing. However, if the US had a similar product, would the invisible hand of the free market favor it over the Chinese DCEP? Here are a couple of reasons why it might.
The first reason is data security. Needless to say, the US hasn’t had a great track record when it comes to the privacy of its citizens. The biggest example of this is the whole NSA debacle that Edward Snowden showed to the world, and it is far from being the only one.
However, the Chinese government isn’t exactly innocent of being interested in people’s personal data or overstepping its legal bounds. If the US offers better privacy and more legal guarantees for the users of its digital yuan, it could have an edge in this over its competitor.
The other possible advantage is the USD’s established presence and familiarity. Naturally, adopting the digital dollar is much easier for countries that have already stockpiled the USD than switching to the yuan as a reserve currency.
The USD is still rooted in the world economy - that’s why the US would benefit the most if it developed a CBDC as soon as possible.
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