The 16th century Bohemian silver boom spawned a unit of currency known as the thaler, or in English, the dollar. But the US will have to master technology far more complex than a miner’s pick if the greenback is to retain its status as the world’s reserve currency.
America is certainly wise to the threat blockchain technology poses to the dollar. In March, President Joe Biden issued an executive order requiring the Treasury Department to explore the use of a wholesale central bank digital currency (CBDC) which said the move prioritised the country’s participation in the multi-country experimentation.
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Such an initiative would, according to the order, “ensure US leadership internationally to promote CBDC development that is consistent with US priorities and democratic values”.
According to one wholesale CBDC expert, who has advised central banks on how to set up their digital currency, this US' development could not come too soon.
Speaking to Capital.com before the order was published, he expressed astonishment at the slow pace of development by the American government with respect to CBDCs.
“If I just play the geopolitical game, wholesale CBDCs are going to bring some significant changes, just like bitcoin has. China has run ahead in terms of cryptocurrencies and the result will be a challenge to the dollar’s dominance and therefore in the long run to the US role in the world.
“It’s surprising that the US, which sees its national interest in so many domains, seems to be completely ok with what is happening with digital currencies. It’s mind-boggling.”
Can the digital yuan threaten the dollar?
As David Woo, a former senior Wall Street strategist says in Capital.com’s latest video, ‘Could the US dollar crash?’, the greenback currently holds a “dominant” position in the global currency markets. But could emerging CBDCs, like China’s digital yuan (e-CNY), challenge this position?
Right now the answer is no. While China’s digital yuan is being implemented at a rapid pace with the country’s central bank recently expanding its e-CNY pilot to 20 cities, it is still a retail CBDC and therefore a purely domestic instrument.
Matt Johnson, research director of strategic advisory firm Garnaut Global points out the e-CNY will make little impact on the dollar’s reserve status without relaxation of China’s capital controls, but he also says that if the project is successful it could lead to a more open Chinese capital account.
“With the digital currency’s more comprehensive data and ability to supervise financial flows in real-time, Chinese authorities could gradually gain more confidence to begin relaxing monetary controls,” he says.
“Nearly everything will depend on fundamental changes in the People’s Bank of China’s (PBOC) macroeconomic policy, as well as on foreign demand [for the e-CNY].”
Is bitcoin an alternative to the dollar?
But the e-CNY is not the only digital currency on the blockchain. Naeem Aslam, chief market analyst at broker AvaTrade says ongoing geopolitical tensions are threatening the status of the dollar as the reserve currency and encouraging countries to look at alternatives such as bitcoin.
But bitcoin also appears unlikely to be a threat to the US dollar hegemony. So far only El Salvador has made BTC legal tender, while the tiny Pacific island state of Tonga has set out a timeline to follow suit in 2023.
Other nations including Paraguay, Panama and Guatemala have indicated that they too may make the bellwether cryptocurrency legal tender, while a recent CoinMarketCap reader’s poll indicated that Venezuela is also a likely candidate to go this route.
Collectively, this bloc of countries is unlikely to threaten the dollar’s reserve status. Latin America's second largest economy Mexico is another matter. With a GDP of over $1trn the emerging market country carries - a relative - amount of economic clout.
Speaking at the Bitcoin 2022 conference in Miami on 7 April,Mexican Senator Indira Kempis said that the government will propose legislation to make bitcoin legal tender. If successful, the law would make Mexico the largest country to adopt Bitcoin as legal tender and the first to do so in North America.
Despite the senator's enthusiasm for BTC, Michael Reeves, a Tokyo based expert on blockchain in the financial services sector, says there are a number of problems with using bitcoin for trade.
Reeve's spoke to Capital.com ahead of the senator's speech but primarily, he says the volatility in bitcoin and other digital currency markets means companies in major economies will be reluctant to sign contracts inked using a non-fiat currency as the settlement price.
Reeves says the lack of price formation in digital currency markets result in levels of volatility that are not observed in efficient spot foreign exchange markets.
“There are some fundamental issues with settling trade using bitcoin. And the biggest one is that firms that are selling stuff have their bills to pay in traditional currencies.
“And if you have workers in Japan, for example, you’re paying them yen and because of the volatility in BTC’s price you don’t want to be paid for your goods in crypto.”
Restraints on trade
Reeves points to a second order issue relating to the lack of price formation in crypto markets – it restricts the development of derivatives that could be used to hedge against crypto price fluctuations.
The Tokyo-based blockchain expert also points to the issue of tax. In Japan, as well as a number of major economies including the US, crypto is treated as an asset, rather than a currency.
This means that a tax event is triggered when payment is made in, say, BTC or ETH. If there has been a gain in the “assets” price since it was bought as it will be designated by the tax authorities as a sale, this tax will be payable in the domestic currency, again bringing up the issue of crypto’s price volatility.
“This whole area is a lot more complicated than it first looks and using BTC for trade is certainly more difficult than paying in traditional currencies.”
Bitcoin is not a sovereign currency
According to Makoto Takemiya, co-founder and CEO of Japanese crypto tech firm Soramitsu, El Salvador’s decision to make bitcoin legal tender brings another range of problems aside from the practical issues outlined by Reeves.
The Japanese firm has provided the technology for Cambodia’s retail CBDC, the digital bakong, and is also working on a similar project with fellow Southeast Asian country Laos, as well as leading a feasibility study to launch a similar instrument in a number of island states in the Oceania.
The key difference between Soramitsu’s retail CBDC projects and El Salvador’s use of BTC, Takemiya tells Capital.com over a video call from his Dubai base, is that the former are trying to strengthen their sovereign currencies while the central American country has simply swapped one foreign interest for another.
“So bitcoin is still a foreign currency to El Salvador, just like the US dollar was, only instead of being tied to, American interests, they’re beholden to some random miners and crypto enthusiasts who they have to beg for investment from,” says Takemiya.
The tech CEO says bitcoin is not the correct option for a sovereign country, which should either opt to use its own currency or instead supranational currency over which it has governance powers.
“So while I am really excited to see what will happen in El Salvador, it’s frustrating to see the government spending money buying bitcoin when they should be investing in their economy to create new goods and services in their country,” he says.
Cambodia’s success in de-dollarising
Cambodia’s digital bakong was launched in 2020 and has been successful in reducing the dollar’s use in the domestic market. Until very recently the Southeast Asian country’s currency, the riel, was only used for transactions of less than a dollar.
Try and buy a smartphone or a TV in Cambodia in 2019 and the merchant would require payment in USD. But this is slowly changing, says Takemiya whose firm has been working on the digital bakong with the Bank of Cambodia since 2017.
He says that de-dollarisation is one of the project’s two main goals, along with increasing financial inclusiveness and that it has been successful on both counts.
“The digital bakong user base is growing quite fast with something like a fivefold increase in 2021, and the pace of growth is getting faster. And within the system, the use of the Cambodian riel is much higher in comparison to physical cash or bank transfer transactions.”
Even if full de-dollarisation was achieved in all the countries Soramitsu is active in, the impact on demand for the greenback would be limited, given that the European Central Bank estimates that roughly 40% of global trade was settled in dollars in 2021.
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But Syed Musheer Ahmed, founder of the Hong Kong Fintech Association points to the potential of multicurrency CBDCs (MCBDCs) to reduce global demand for dollars among much bigger economies.
“That’s where MCBDCs kick in. Now you have a mechanism that doesn’t require countries to have dollar holdings for imports and exports, it can instead be based on taking the domestic currency rate.”
This is particularly true of Asia currencies, the majority of which are capital controlled and are difficult to exchange.
MCBDCs ‘will reduce’ dollar use
Musheer points to the example of India and Vietnam, both of whose currencies are kept on a tight leash by their respective central banks, and which according to India’s Ministry of Foreign Affairs conducted trade worth over $11bn between them in the financial year ending April 2021.
“But if you have an MCBDC project that is token-based, then it is possible to settle trades via the two central banks. If that happens then there’s a mechanism in place which will reduce demand for the dollar.”
This is purely an example: There is no suggestion that the Indian and Vietnam central banks are working on such project.
This project explored how a common platform for MCBDCs could emerge and included participation from the Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore and the South African Reserve Bank.
The report concluded that while there were a number of issues, principally related to governance, that could stymie a global MCDBC, the potential exists for regional projects to succeed.
Regional CBDC projects are feasible
“Given the complexity of having multiple central banks sharing critical financial infrastructures and the unique requirements of each jurisdiction, a common multi-CBDC platform may be more likely to be implemented as a series of regional platforms rather than as a single global platform,” the BIS said in its report.
And these regional platforms are starting to emerge. Musheer points to the mBridge project, which is backed by the BIS, and aims to build an interoperable payment system between the four countries involved – China, Hong Kong, Thailand and the United Arab Emirates.
The BIS says that the m-Bridge CBDC project, known as Lionrock in Hong Kong and Inthanon in Thailand, “will foster a conducive environment for more central banks in Asia as well as other regions to jointly study the potential of DLT [distributed ledger technology] in enhancing the financial infrastructure for cross-border payments”.
Despite the small number of countries involved, even a limited project of this nature could see substantial amount of trade settled directly between central banks. Chinese exports to Thailand were worth $50bn in 2020, according to data from the UN.
Digital currencies threaten the dollar
Musheer says that MCBDCs could arrive in the near future. While he previously estimated that it would take three to five years to overcome the technical challenges involved in these projects, the timeline is becoming shorter because of the level of government support for these projects and the work done by the BIS.
“Soon countries will know which kind of protocols and mechanisms can be used for an MCBDC and building the required infrastructure won’t take too much time. Irrespective of the US coming up with a CBDC in record time, it’s just a natural progression that the dominance of the dollar will reduce over the coming years.
“My expectation is there will be a move towards Asian currencies, it won’t necessarily be the yuan, but other currencies will have their own say,” says Musheer.
Open source supranational currencies?
Soramitsu’s Takemiya says there is also an alternative to MCBDCs. He is currently part of a project backed by a number of cryptocurrency enthusiasts called Sora.
Launched in 2020, and now in its second version, Sora is a decentralized MCBDC that the CEO describes as a “fun project” but one with real-world implications. It is separate from Soramitsu’s work with central banks and is based on the Polkadot blockchain.
The open-source Sora project is intended to work as a supranational digital currency.
“We’re trying to create the future of money, it’s not just a payment system because the potential for blockchain is so much more than that, it enables new types of monetary policy. Studying on-chain activity will enable central banks to discover the key drivers of their economies.
“We are talking to several countries about getting them to use Sora. And if they do that then it’s not ours anymore, because this is a decentralized concept, which means the users will have governance rights,” says Takemiya.
Russia enters CBDC race
The sanctions placed on Russia could however prove to be a double-edged sword for the US in terms of the dollar’s role in global trade and may instead spark the creation of the type of large scale digital platform that Norrlöf describes.
Indeed the current conflict in Ukraine appears to have spurred Russia into action in the digital currency sector. In January, the Russian Central Bank published a consultation paper, which said cryptocurrencies were a risk to domestic financial stability.
But the central bank rapidly changed its mind on the issue and in mid-March, it issued Sberbank with a digital assets licence and the sanctioned bank quickly issued a new cryptocurrency – Sbercoin – which had been in development since 2020.
The reason for this about-turn is obvious. Just over a week before Russian forces entered Ukraine, the Bank of Russia and a number of local banks started testing the digital rouble platform and completed the first digital rouble transfers between individuals.
So far volumes have been low. While blockchain data platform Chainalysis has tracked tens of millions of dollars of cryptocurrency sent from Russia-based whales to other addresses since the start of hostilities, trading volumes of Sbercoin have been a modest $4.5m according to CoinMarketCap.
Could Russian sanctions drive de-dollarisation?
However, the central bank has not confirmed when digital roubles will be widely available or when users outside Russia will be able to conduct transactions with the digital currency.
The exact trajectory of Russia’s digital currency may be difficult to predict but Reeves says that one likely result of the current financial sanctions regime against Russia is a bifurcation in the global currency market, with Russia driving de-dollarisation.
He says that by cutting Moscow off from the global financial markets it will incentivise the country to create its own system, one which is completely independent of US influence.
“So it’s almost a matter of the harder the Americans push others away, the more likely they are to create successful competing infrastructure.”
Additional reporting, Paul Golden.