A Possible Future for CBDCs International Network Development

Heng Wang – University of New South Wales;

Simin Gao – Tsinghua University

-- Afternoon Keynote Paper, Machine Lawyering Conference 2021, Day Three -- Central bank digital currency (CBDC) is a digital form of fiat currency with dramatic differences from paper currency, including in the generation of data and numerous associated issues (e.g., questions of technological design, cyber security, privacy). China is actively piloting its own CBDC, with 13 million transactions having been processed using the currency, and is predicted to become the first major economy to issue CBDC. A number of other countries, such as Sweden, are also carefully considering the possibility of issuing CBDC.

CBDC is anticipated as a future game changer in the international financial system, since it is likely to generate competition among different currencies (both fiat and private currency). This could partially explain why, as time moves forward and countries like China draw nearer to introducing CBDC, even more economies, including the US, are investing in research or planning regarding CBDC.

As more and more economies turn to CBDC, the process of developing, issuing and managing CBDC by each state will necessitate a great degree of interaction among states, especially where CBDC is used in international and cross-currency payments. These interactions can be expected to give rise to a CBDC network, connecting each CBDC-issuing economy as “nodes” or actors within the network.

In our recent paper, “The Future of the International Financial System: A CBDC Network and Regulatory Outlook,” we have examined what shape the potential CBDC network may take. While many factors are up in the air, and will remain so even after major economies first begin issuing CBDC, it is worthwhile to draw on network theory to explore how CBDC may be managed on the international stage, as well as the implications it could have for the future of the international financial system as a whole.

We consider that a CBDC network is likely to be a decentralized network, as opposed to a distributed network like the internet, where the links between nodes are fairly evenly distributed, or a centralized network like the current global financial network (GFN), where one or more states sit in a more central place than others. In the case of CBDC, even distribution of links would be unlikely, given the varying positions and capacities of different countries within the GFN. Meanwhile, it is difficult to identify at this stage which states, if any, could sit at the centre of the network, as the US still appears to be a long way from introducing a CBDC and China’s economy and position in the GFN are still developing. A decentralized CBDC network is also more likely to emerge given the lack of a consistent, fully-developed position on CBDC across states at present.

Flowing from this, the potential CBDC network can also be expected to take shape as a network-as-structure, rather than a network-as-actor which is characterized by coordinated action to further specific goals, and often emerges due to the efforts of a strategic actor. In a network-as-structure, by contrast, the behavior of actors in the network is uncoordinated, but instead depends on their relationships, or ties, with other actors in the network. While some coordination is likely to emerge within a CBDC network, for example as a necessity to allow for cross-border transactions, it is likely that the fundamental divergence in the characteristics and motivations of differing economies in introducing a CBDC, among other factors, would hinder significant collaboration.

Because of the decentralized, network-as-structure shape the potential CBDC network is likely to take, it can be anticipated that it would bring policy diffusion effects, for example by promoting learning from and the adaptation of other states’ policies, but may not necessarily lead to convergence in regulation. Instead, states would probably behave largely instrumentally due to factors like currency competition, which may create conflict that in turn results in greater fragmentation in the international monetary system.

We turn then to the question of how a CBDC network would affect the GFN. Although the GFN is currently a centralized network, with the US at the center, a decentralized, network-as-structure CBDC network may challenge this structure by affecting the existing power differentials. CBDC is likely to reduce reliance on existing infrastructure, and may speed up what some have already observed to be a gradual transition of the GFN towards a flatter network. However, there are many undetermined factors at play which mean this outcome is not a certainty. For example, if the US introduces its own CBDC, this would very likely slow down the shift towards a flatter network, while there is also the possibility that more central nodes may emerge within the CBDC network itself.

Essentially, the development of a potential CBDC network, as well as how it may affect the GFN network over time, are dynamic processes and the future remains largely unclear. In the meantime, it will be crucial to address conflict within the CBDC network to prevent a lose-lose outcome, and to avoid a race to the bottom. Legal changes need to be prepared well in advance, including how to deal with foreign CBDCs, how accommodative the rules will be to foreign CBDCs, and how to ensure coherence with the exchange control mechanism if any. One needs to find a balance between safety and efficiency.

The structure of the CBDC network could enable or constrain actors, while the actors will in turn affect the network. As CBDCs and the CBDC network are moving targets, the trends, risks and regulatory response of CBDC deserve close attention going forward.

In addition to the above SSRN link, our paper is also available for download at Research Gate.

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