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The Relevance of Central Bank Digital Currencies in Geopolitics

By Raghav Chawla

Abstract

Putin’s war in Ukraine has disrupted numerous supply chains and worsened the global economy. The geopolitical tensions have triggered a race among nations to launch an unusual innovation that may have the potential to disrupt the global financial system: central bank digital currencies (CBDCs). This column explores the geopolitical role of central bank digital currencies, with a focus on China’s e-CNY.

Introduction

To understand its geopolitical relevance, first, we need to understand central bank digital currencies. Central Bank Digital Currencies (CBDCs) are legal tender digital currencies issued and maintained by governments or central banks. There are two key ways in which a retail CBDC is distinct from existing digital currencies.

Firstly, retail CBDC is accessible to the public. They cannot be employed by private financial institutions for commercial services. Large-scale digital transfers have been undertaken by central banks, commercial banks, and other financial institutions for a long time. Real-time payment solutions for wholesale services are offered in the US by the Fedwire system of the Federal Reserve. On the other hand, retail CBDC can be used directly by individuals, companies, and other private entities. Second, unlike fintech platforms, CBDCs give the public the freedom to use digital legal tender on their own. Instead of partnering with third-party services like payment systems, the consumer can directly engage in any financial transaction without any charges. 

China’s e-CNY

China was among the first nations to explore and develop CBDCs. There aren’t many high-level specifications available for China’s emerging e-CNY technology. A “two-tier” or “intermediary” system, in which tokens are issued through commercial banks and other institutions, has been introduced by the People’s Bank of China. The public and businesses will, thereafter, receive the e-CNY from these institutions. Since the e-CNY software is classified, it is impossible to ascertain how China developed its e-CNY platform. Crucial requirements like user privacy are still missing.

The U.S. Dollar and International Finance System

In technology, the “first mover” advantage has the potential to influence the global economy and international trade. CBDCs have the potential to challenge aspects of the international financial system, which has benefited the US and strengthened its global influence. The US benefits strategically from the dollar’s status as the preferred reserve currency, lower borrowing costs, and the ability to influence international norms through the imposition of sanctions. Additionally, governments might encourage business reliance on their national currency by leveraging CBDCs to develop new localized cross-border payment systems. The trials of e-CNY in China have raised concerns in the United States and the European Union because they may serve as a model for other countries to follow. Moreover, a CBDC might be strategic in accelerating China’s efforts to internationalize the Yuan.

We should take into consideration the fact that today, most global financial transfers are facilitated by the Society for Worldwide Financial Telecommunication (SWIFT), which has been accused by Beijing and Moscow of helping the United States expand the effectiveness of its financial sanctions, giving the latter an extra-territorial reach. With a digitized currency, China can easily circumvent the SWIFT system, effectively bypassing it and making itself less vulnerable to US sanctions (if enough nations accept digital payments in the digital renminbi). In order to achieve this, China’s central bank has launched the m-CBDC bridge project, which is designed to facilitate cross-border payments between China, Hong Kong, Thailand, and the United Arab Emirates.

Data: Privacy and Security

CBDCs give central banks access to a digital ledger of currency transactions. That digital ledger includes details such as the amount, time, source, and destination of each financial transaction. Governments must carefully consider questions of data privacy and security as they create their CBDCs, so they can mitigate the vulnerability of this vast trove of data. Questions about the type of transactions, the limit of data collection, tracking and monitoring, and the effect of privacy regulations like GDPR on CBDC transactions remain unanswered. 

China’s digital yuan will establish a leading framework, and the government has defined its approach to privacy protection as “managed anonymity.” The Chinese government has claimed that its e-CNY “collects less transaction information than traditional electronic payments,” and they tout the security and privacy protocols. Unfortunately, the implementation of policies for privacy and data security remains opaque. The scope of privacy protection hinges on the governing and legal authorities; for example, in China, the Chinese Communist Party controls the content and scope of laws and regulations. In China, “cyber security law” requires private sector companies to share information with the government for national security purposes. The Chinese government’s use of data for political repression, surveillance, and suppression of dissent is well documented. There is no reason to believe that financial data will be exempt from these practices.

Data security is primordial in any government’s design of a CBDC. In a world where data theft has become a standard practice in geopolitics, CBDC records would be high-value targets. For example, China-based fintech providers could provide the CCP access to new sources of foreign financial information. Hacking CBDCs could provide adversaries with strategic information. In addition to protecting citizens’ personal information, governments must prevent nation-state adversaries and criminal actors from gaining access to sensitive domestic economic data.

Conclusion

CBDCs pose several questions and concerns, from governance to between nations. We live in a world where governments and banks are studying and experimenting with the development and implementation of this innovative but potentially disruptive technology. Policymakers have yet to engage stakeholders from commercial banks to privacy advocates. China, with its upcoming e-CNY, is well established to lead international efforts to develop standards and payment systems that could largely undermine the security and economic interests of other nations. 

So where does India’s RBI stand in all this? Though the central bank released a concept note, it is “non-committal”. However, RBI still promises to implement CBDC in the future in a phased manner after testing it through multiple channels. Finally, policymakers should factor in geo-political stakes along with domestic interests as they develop a potential CBDC.

About the Author

Raghav Chawla is a third-year student at the Jindal School of International Affairs pursuing a major in International Relations with a specialization in Economics and Foreign Policy. His interests include International Economics, Financial Markets and Political Risk Management.

Image Source: QuoteInspector.com

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