Q&A: The U.S. is at a policy crossroads for digital currencies
As central bank digital currencies take flight globally, a new report that draws on the multidisciplinary expertise of scholars at Stanford and beyond presents sweeping recommendations to the U.S. government on how America and its partners can grapple with this challenge.
Darrell Duffie, the Adams Distinguished Professor of Management and Professor of Finance at Stanford Graduate School of Business and a senior fellow at the Stanford Institute for Economic Policy Research (SIEPR), co-directed the yearlong investigation that lead to the report, along with China scholar Elizabeth Economy. Both are senior fellows at the Hoover Institution, which published the report earlier this month.
Participants included SIEPR senior fellows John Taylor and Monika Piazzesi, other Hoover-affliated scholars, as well as other distinguished experts from various disciplines, including national security, finance, central banking, technology policy, and computer science.
Here, in an interview, Duffie describes the project and how China’s aim of internationalizing its renminbi by expanding the use of its digital yuan (called e-CNY) and its cross-border payments systems would have major international security implications.
The e-CNY could eventually contribute to undermining the dominance of the U.S. dollar in international payments. In addition, the e-CNY would allow China’s security agencies to surveil the financial activity of not only its citizens but also any foreign individual or firm conducting business in China.
Duffie argues that there is much that can be done to improve the efficiency of American and cross-border payments systems. He also asserts that although the U.S. government should support the development of its own digital currency technology, it is not yet clear whether the U.S. should deploy a digital dollar. That decision should rest on the outcome of technology and policy development. Meanwhile, the United States can make significant enhancements to its bank-railed payment systems through improved regulation, with a focus on increasing competition. The U.S. government should also take the lead in establishing standards and principles for cross-border payments.
Will you describe the genesis of this project?
The idea for this project came from Larry Diamond and Glenn Tiffert, who co-chair the project on China’s Global Sharp Power at the Hoover Institution. They believed that China’s new CBDC would be worthy of a serious investigation by a cross-disciplinary group of experts, including Hoover senior fellows. They asked Elizabeth Economy, who is a world acclaimed China expert, and me to codirect this project and to coedit the resulting report, which has been a year in the making. We have had administrative meetings on a weekly basis among our core team and numerous cross–working group meetings, as well as in-depth conversations with outside experts. We have been exchanging notes almost daily in our efforts to formulate clear policy recommendations to the U.S. government.
The working group members are notable experts from a wide range of fields. And the extent to which this research is cross-disciplinary is quite unusual. The scholars, market participants, and former policy makers in our working group provided enormous contributions to the report, drafting chapters, providing insights, and conducting primary-document research. Stanford scholars and student research assistants who speak native Chinese were of immense help in translating Chinese-language reports.
It was a long and deliberative process. At the end of it, we arrived at a policy road map of recommendations for the U.S. government, firmly grounded in evidence-based research.
What is a central bank digital currency (CBDC)?
It is a simple concept. A central bank digital currency is simply a digital version of paper money. A CBDC can be stored on a cloud server or on a personal electronic device. Just as you would take a $20 bill out of your pocket, you can tap your iPhone or Android phone and pay for goods and services.
The working group’s position is that China is the most powerful authoritarian state in the world and has taken a lead role in developing its own CBDC, called the digital yuan, or e-CNY. Will you describe the depth and breadth of China’s presence in the digital currency arena?
China has been moving ahead faster than any other large economy—in both private digital payments systems and now with the issuance of an official digital currency, the e-CNY. They are way ahead of the United States. Over 90 percent of urban consumers in China are using WeChat Pay or Alipay, their two premier digital payment service providers. There are now more than 100 million people in China who have digital wallets on their mobile phones that enable them to hold and pay digital yuan.
China’s central bank, the People’s Bank of China (PBOC), has been formalizing standards for the use of digital currencies. The PBOC is also introducing technology that allows CBDCs to be used in cross-border payments. For example, they will be rolling out a service that would allow you to walk into a store in Hong Kong, tap your iPhone, and pay digital yuan out of your phone wallet. The merchant will instantly receive the equivalent value in Hong Kong dollars.
China has built up a very robust ecosystem of digital payment technology, supporting the e-CNY. It certainly isn’t perfect, but it's impressive relative to where the United States is right now.
Does China have the capacity to expand its digital currency footprint beyond Hong Kong?
China would like nothing better than to internationalize the renminbi. It is an enormous benefit to China if businesses make payments to one another across borders in China’s currency. This has been a headline project for the People’s Bank of China over the past two decades.
In 2015, China introduced a cross-border bank payment system (the China Interbank Payment System, or CIPS), as an alternative to the Western dominated SWIFT (Society of Worldwide Interbank Financial Telecommunications), which you have heard about recently because of sanctions against Russia.
China would like a lot of countries around the world to use an alternative to SWIFT in order to better position itself to escape the impact of sanctions imposed by the United States and partners around the world. That would no doubt happen, for example, if China were to attack Taiwan. The e-CNY is not necessarily the primary method by which China might evade sanctions, but it is another arrow in the quiver for China’s goal of internationalizing the renminbi.
Will you describe a scenario in which China could inoculate itself from sanctions by expanding the use of e-CNY and digital payments systems?
Operating through CIPS, China already could circumvent SWIFT-enabled sanctions with countries like Iran, Russia, or North Korea, with which they have banking relationships. To some extent, they're already able to do that. Realistically, Chinese banks could process payments to Russia, which is currently under sanctions from SWIFT. However, such a decision would come with substantial economic risks for banks in China that help with the evasion of sanctions, because these banks could be knocked off the SWIFT system. Therefore, banks in China have, until now, largely been willing to cooperate with U.S. sanctions. China’s authorities are very much concerned about this and last year introduced aggressive legislation banning the cooperation by China’s firms with foreign sanctions that China declares to be illegitimate.
If China were able to expand the reach of its own payment systems and reduce the importance of SWIFT and the U.S. dollar as the world reserve currency, then it would be in a much better position to avoid the impact of U.S. sanctions. China isn’t there yet. At this point, if the People’s Republic of China were to attack Taiwan, China’s banks would have difficulty making an end run around sanctions imposed by the United States and the European Union.
With that said, the West’s sanctions regime isn’t foolproof. Chinese and Russian central banks can already arrange to make some number of payments between each other that would mitigate the impact of sanctions. Smaller banks or unsanctioned banks in China and Russia, for example, can exchange payments with one another, even today, but they are at risk if they are discovered to have made payments for sanctioned customers.
What are some of the other security implications of using e-CNY?
Anyone using the e-CNY should be warned that China’s central bank can see your payment activity. It knows your identity and can see who paid you and whom you paid. The only exceptions are for the smallest e-CNY wallets, such as physical smart cards. Otherwise, you should assume that if you’re using the e-CNY, your data will be stored by the People’s Bank of China. And if China’s Communist Party, acting through state security agencies, were to demand data from the People’s Bank of China, the PBOC would be required to comply.
Today, there are just a few cases in which Americans would make payments in e-CNY. However, American firms that operate in China are already being pressured to use or accept e-CNY. Thus, they too are subject to surveillance in that sense.
In order to compete with China, should the United States create its own digital currency?
Competition with China would be only one of the motives, among many others, for creating a U.S. digital-dollar technology. There’s hope that a U.S. digital dollar could improve the efficiency of the American payment system, which currently is not good. It’s expensive and slow to move money in the United States. Moreover, many Americans don’t even have bank accounts. The U.S. could also benefit from digital-dollar technology by being in a better position to lead in the development of global standards for cross-border payments, such as privacy protection. It’s harder for the U.S. government to provide leadership in the international community if the U.S. itself does not have the technology.
Our report reaches the conclusion that while the U.S. should move aggressively with the development of CBDC technology, it should not necessarily deploy a digital dollar, at least until the technology is much further developed and until data-privacy protections, interoperability, and other regulations are in place. The U.S. government also needs to become comfortable that U.S. banks will not be stressed by a run from bank deposits into digital currencies.
If not a U.S. central bank digital currency, would it be good policy to promote the use of private digital currencies?
International dominance of US dollar stablecoins, among cryptocurrencies, could lower concerns that China’s digital currency would erode the preeminence of the U.S. dollar.
However, this is a double-edged sword. If U.S. dollar stablecoins were to dominate internationally, they could invade the monetary systems of smaller open economies. It might also become more difficult to control illegal payments or make sanctions effective, depending on the design and regulation of the stablecoins. The U.S. should get busy on regulating stablecoins so that they can reach their potential for providing better payment services under the rule of law. The President’s Working Group on Financial Markets recently issued a report on stablecoins that does a good job of laying out the costs and benefits of their use.
In what other areas can the United States improve its payments systems?
Banks do not have sufficient competition for payment services, and they’re not innovating rapidly enough. There is also too much regulatory uncertainty facing fintech entrants to payment service markets. For example, Meta’s Diem stablecoin payment system operator recently gave up because it wasn’t given a sufficiently clear set of rules.
The U.S. can also make traditional bank-railed payments much faster and more interoperable. Currently, for example, money doesn’t move when a customer swipes his or her credit card or a bank wire transfer is requested. There are significant delays, not to mention hefty fees.
The Fed will soon introduce a “fast payment system,” called FedNow, that will be used to move money instantly, seven days a week and 24 hours a day, at a very low cost. This improvement doesn’t require a new digital currency. Unfortunately, banks have little incentive to deploy FedNow services in direct competition with their most profitable payment franchises, nor to make FedNow into a highly interoperable platform on which customers could do many payment-related activities with different banks and merchants. Banks will likely prefer to provide their own financial services to their customers, within their bank.
By allowing money to move more easily throughout the financial ecosystem, banks would need to compete harder with each other and with fintech firms and reduce the profitability of deposit taking, credit card payments, and other services. I expect that this concern would also apply to the way that banks provide digital-dollar services to their customers, if the U.S. were to introduce a CBDC. Simply having FedNow or a digital dollar available will not be enough. There will also need to be regulation in support of competition in payment services.
This is an abridged version of a Q&A that was originally published by the Hoover Institution.