Asia | Bitcoin & Crypto | China | Monetary Policy & Inflation
2021 Grey Swan #8: China’s CBDC First-Mover Advantage Weakens Dollar Dominance
- By Dominique Dwor-Frecaut
- 3 min read
China’s retail central bank digital currency (CBDC) has received strong media attention. Yet its impact will be mainly domestic, challenging the duopoly of the two private operators, Alipay and WeChat Pay, which together own 94% of the mobile payments market. China’s other CBDC experiment, the Inthanon-LionRock project, has received much less attention despite being much more consequential for global markets.
Inthanon-LionRock is a joint venture between the Bank of Thailand and the HKMA. It aims to implement a cross-border payments system based on Distributed Ledger Technology (DLT) that links each country’s existing DLT-based financial infrastructure. Cross-border payments are notoriously slow, expensive and non-transparent because they involve a chain of intermediaries. The chain has several ‘pain points’ such as time gaps, liquidity needs, settlement risks, multi-jurisdictional regulatory compliance, and limited transparency. Completing a transaction requires numerous back-and-forths between the various parties involved and can take several business days.
By contrast, DLT-based payments systems are better suited to handle complex, multi-step transactions such as cross-border payments. This is because they apprise all network participants of transactions simultaneously. On the other hand, the infrastructure required is much more complex and costly than that for a conventional, centralized ledger-based system. That is why settling simple transactions such as peer-to-peer retail domestic money transfers is more efficient with a conventional architecture based on current technology. For instance, AliPay and WeChat Pay rely on conventional infrastructure largely because one based on DLT would, currently, be unable to handle their transaction volume.
The Inthanon-LionRock pilot was completed in December 2019, providing proof of concept for wholesale, CBDC-based, payment-versus-payment cross-border payments. The pilot demonstrated this was achievable with competitive FX pricing, efficient liquidity management, compliance with both jurisdictions’ regulations, and at much greater speed than in a traditional architecture. In its assessment of the pilot, the HKMA stated that ‘While it only tests a THB-HKD corridor with 10 participating banks from Thailand and Hong Kong, the model is designed to be scalable and can be further extended to other jurisdictions or markets’.
In September 2020, the project’s second phase was announced. Only limited details are available, but it seems this next phase is to involve corporates and securities exchanges as well as banks. Also, it is to handle actual trade and capital market transactions. And additionally, a multi-CBDC platform is to be built. Ethereum developer Consensys has been hired (Ethereum is an opensource DLT used to process complex transactions). FORMS HK, a wholly owned subsidiary of listed, mainland, financial IT firm FORMS, has also been hired. And so has PriceWaterhouse, possibly to look at global legal and regulatory issues. The HKMA expects second-phase results to be available in Q1 2021.
Inthanon-LionRock could support the internationalization of the CNY in several ways. First, China has often used HK as a laboratory for free-market experiments. The inclusion of FORMS in the contractors suggests Beijing is keen to ensure that the technology gets transmitted to the mainland.
Second, while there are other CBDC-based cross-border payments systems under development, notably in the euro area and the Eastern Caribbean, HK’s is the most advanced. Consequently, China could build a strong first-mover advantage and establish a dominant global standard. China would then be offering cross-border settlement more cheaply and efficiently than the current, largely dollar-based correspondent banking system. And it could leverage this advantage to push for greater global CNY use.
Third, China could try to exploit synergies between its DLT-based cross-border payments and its international trade (currently largely invoiced in USD) as well as its investment and aid abroad. And that includes its Belt and Road Initiative. For instance, PBoC and HK-based eTradeConnect have set up DLT-based trade finance platforms. Participating banks could easily be brought into the DLT-based cross-border payment system.
Fourth, a China-sponsored, DLT-based cross-border payment platform could help countries evade US controls by making it easier to stay out of the dollar, particularly when it comes to trading with countries subjected to US sanctions.
China’s cross-border CBDC therefore has the potential to weaken the global role of the dollar, starting with trade invoicing. And, as Barry Eichengreen stressed, historically greater use of a currency in global trade has often been a first step towards full dominance of the global financial system.
According to the BIS, alongside the HKMA and Thailand there are currently eight central banks implementing CBDC pilots and many more involved in CBDC studies. A conspicuous laggard is the Fed. It is currently focused on standing up a retail Real Time Gross Settlement (RTSG) system, FedNow, and believes it does not require a CBDC. A domestic DLT infrastructure, however, is needed to support a cross-border CBDC. The risk is that if the dollar fails to keep up with global technological innovation, its global dominance could decline.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)