Why the U.S. and Europe trail China in central bank currency race

Proponents of central bank digital currencies are under pressure to demonstrate the economic benefits of their projects before they can counter China’s digital yuan.

Both the EU and U.S. face pressure to digitize their currency because of China’s relatively faster progress on a digital yuan, which is already being tested with retail chains and could threaten the influence of the U.S. dollar and the euro. Meanwhile, the U.S. Federal Reserve and European Central Bank are conducting lengthy projects just to determine the possible structure of a CBDC before final legislative votes, a process that will likely add years to overall development.

There’s also a concern that the digital yuan could be a means of surveillance — this worry prompted U.S. Sens. Marsha Blackburn, R-Tenn.; Roger Wicker, R-Miss. and Cynthia Lummis, R-Wyo., to ask the U.S. Olympic and Paralympic Committee to bar American athletes from using the digital yuan during the summer games. A more bipartisan group of Senators in June pushed for privacy as part of a U.S. digital dollar, again contending that China’s using its digital currency for spying.

“Some of our senators are very concerned regarding China’s CBDC, especially regarding privacy, and its potential spread of the CBDC’s mobile wallet into the U.S.,” said Tim Sloane, vice president of payments innovation at Mercator Advisory Group.

The digital yuan, also called E-CNY, is already being tested at the Olympics and other venues. U.S. and EU digital currency projects are months — if not years — behind.


Despite this sense of urgency, legislators have struggled to agree on matters as simple as who would approve a central bank digital currency — let alone what the CBDC would do.

Central bank digital currencies can address systemic payment problems such as reducing reliance on cash, streamlining government disbursements, keeping private cryptocurrency at bay, or improving financial inclusion. But these are all separate challenges that don’t require the same solution, according to Jodie Kelley, CEO of the Electronic Transactions Association, which works with a range of banks, fintechs and payment companies and has released “guiding principals” for CBDCs.

“When people say ‘CBDC’ they are thinking about different problems and different use cases,” Kelley said. “There isn’t a clear consensus at this point. And much greater clarity is needed on what the benefits and risks are.”

Legislative affairs

The European Parliament and the U.S. Congress will likely need to vote to establish their respective central bank digital currencies. But it’s still not clear who will vote, when they will vote, or what they will vote on.

In the U.S., Federal Reserve Chair Jerome Powell, who has advocated for a gradual approach to developing a digital dollar, has pushed for Congress to pass a law authorizing a U.S. CBDC, rather than relying on interpretations of existing regulations.

In a recent hearing, Sen. Elizabeth Warren, D-Mass., suggested CBDCs could improve the safety of the financial system and counter the risks of cryptocurrencies, but would need to be structured properly.

The Fed’s work is focused on a digital dollar, stablecoins and cryptocurrency, with Powell suggesting in a recent hearing that stablecoins should be regulated similar to money market funds and bank deposits. Powell also said a U.S. CBDC could make stablecoins and cryptocurrency less necessary, an argument that hints at the political pushback against private-sector cryptocurrencies and stablecoins.

U.S. Sen Sherrod Brown, D-Ohio, recently called on the OCC to stop approvals for cryptocurrency businesses, citing lack of proper oversight. Treasury Secretary Janet Yellen has said cryptocurrency poses a danger to consumers and investors. And the Facebook-affiliated stablecoin Diem has faced nearly constant political opposition since its initial announcement as Libra in 2019. The Fed referred requests for comment to testimony from Powell: “We want to begin a major public consultation across many different groups, including Congress of course, on a CBDC and also on stable coins and crypto.”

Why the U.S. and Europe trail China in central bank currency race

The Governing Council of the European Central Bank just launched what it calls a two-year “investigation phase” of a digital euro project. The ECB hopes to address design and distribution, and ensure that a digital euro would complement cash but not replace it.

EU academic research has determined that a digital euro could work within a real-time payment scheme such as the Eurosystem TARGET Instant Payment Settlement (TIPS), and the volume of transactions would not harm the environment. (Some activities adjacent to digital currency, such as Bitcoin mining, use large amounts of energy and have caused political pushback.)

A separate European experiment involving Eesti Pank (Estonia’s central bank), the ECB and other central banks in the euro area on July 26 announced a blockchain could support simultaneous CBDC payments through several central banks with a smaller carbon footprint than a card-based system. Eesti Pank worked with the ECB, Spain, Germany, Italy, Greece, Ireland, Latvia and the Netherlands. The experiment vetted how a digital euro could support digital identity and privacy.

Jason Blick, CEO of EQIBank, a Dominican digital bank, is not certain TIPS has the bandwidth to support limitless digital euro transactions, a problem that may require regulations that constrict the digital euro or a complex technology project to upgrade the EU’s real-time payment rails. Since CBDC digital wallets will need to effectively integrate into the instant payment settlement system, Block said there could be limits in the amount of digital euros that can be in digital wallets, with excess amounts deposited in a traditional bank account.

“This limitation materially restricts the innovation of digital euro and represents an uneasy balance of economic viability and political ambition,” Blick said, adding his firm still projects a digital euro will result in up to euro 400 billion in economic growth and 2 million jobs within the EU. “The move to a digital euro will add an array of unique benefits to retail customers including simplifying and streamlining payment rails and meeting a policy objective of inclusion and accessibility,” Blick said.

The European Central Bank did not return a request for comment. In a statement on the ECB’s website, Fabio Panetta, a member of the executive board of the ECB, said that while people in the European Union have access to a universally accepted means of payment in the form of cash, this should also be true for digital and online payments.

“A digital euro would reduce the cost of transactions,” Panetta said. “It would foster financial inclusion by aiming to make digital payments available to those who currently don’t have access to financial services.”

Private sector

Legislatures are divided on the role of private-sector companies, including banks. Liberal-leaning legislators favor a more direct connection between central banks and consumers. Conservatives, who see CBDCs as a threat to banks, are pushing for banks to have a greater role.

Private stablecoins such as the pending Facebook-affiliated Diem and Circle’s USDC are also pushing governments to develop digital currencies. These stablecoins have raised concerns over negative impacts on central bank monetary policy.

“This EU move signals the ECB’s intent to keep control over the euro as a medium of exchange. In the last few years, we have seen stablecoins growing in importance,” said Yves Longchamp, head of research at SEBA Bank, a Swiss bank that specialized in transferring funds between digital and traditional currency. “From a central bank point of view, privatization of coin issuance by unregulated entities is a direct threat to the central bank privilege of being the sole entity to issue domestic legal tender.”

While Powell has downplayed the idea that the potential digital dollar is an answer to the digital yuan, some members of Congress are pushing a more adversarial approach to China.

The People’s Bank of China recently released its own  research report stressing anonymity for digital yuan transactions. “An independent review of the mobile wallet software would go a long way towards our understanding of just how invasive that software is and what data it collects,” Sloane said.

A CBDC that has a chance to pass Congress will depend on the projects’ architects making it clear why the currency is being digitized, according to the ETA’s Kelley, adding there will also need to be evidence that these use cases don’t adversely impact existing banking models, or that the benefits of a CBDC aren’t possible via other government projects or bank technology.

There are also different types of CBDCs, which will need to be more clearly addressed, according to Kelley. Wholesale CBDCs designed for transactions between large banks are simpler and progressing faster, while consumer-focused retail CBDCs are making less progress and are more prone to political divide.

MIT’s CBDC synopsis lays out the potential benefits of digital currencies. A CBDC is a liability on a central bank, which means the holder does not have counterparty risk similar to payments in existing channels, according to MIT. For some versions, the holder is not reliant on a financial institution to store and transfer value, which could open payment systems, reduce cost and encourage innovation, according to the MIT project’s statement.

Among consumers, central bank digital currencies are popular. Sixty-four percent of adults in 10 countries, including the U.S. and nations in Europe and Asia, said they would likely use a CBDC, with 33% saying they would be very likely, according to research from Estonian blockchain company Guardtime, adding only 10% said they would never use a CBDC.

“With central banks across the world working on digital currencies, it’s natural to ask if they will unjam these global bottlenecks to our financial system, introducing truly seamless global flows of money and assets for both individuals and institutions,” said Luukas IIves, head of strategy at Guardtime, in an email.

“For this to work, they will need to be interoperable with the rest of today’s financial plumbing and, across borders, with each other. But interoperability can only be achieved with infrastructure that is scalable and tokenized.”

Any CBDC will need to work with digital currencies in other countries, a challenge given different regulations and payment structures across the numerous jurisdictions that are working on CBDCs for both institutional and consumer use.

The Reserve Bank of India last week announced it is working toward a phased implementation of a central bank digital currency, adding it could help fill gaps in parts of the country where cash is still prevalent despite the growth of the national United Payments Interface national digital payment system.

Like the U.S. and EU, the U.K.’s CBDC is also developing slowly, partly due to the complexity of fitting digital money into financial systems that have been in place for centuries. Along with the considerable political hurdles, the pace isn’t surprising, according to Kelley.

“With something that complicated that has real risk and real benefits, two years probably isn’t that long,” Kelley said.

MIT adds there are numerous economic and policy questions that need to be addressed through extensive, separate policy progress that considers the limits of the technology. These limitations include how CBDCs fit into real-time payment schemes.

CBDCs will also need to demonstrate how they will fit in with other efforts to speed processing to accommodate digital commerce. There’s some concern in Washington that a digital dollar could adversely impact the Federal Reserve’s FedNow faster payment rail, for example, by creating redundancy. In Europe, there’s concern about bandwidth to accommodate CBDCs and real-time payment rails.

There is even doubt as to whether any digital currency is necessary. Fed Vice Chairman for Supervision Randal Quarles recently said the benefits are unclear and a digital dollar could undermine the U.S. banking system.

The concern is that a CBDC could cause consumers to transfer funds out of traditional banks in favor of “Fed accounts,” though it’s likely that banks will play a role in disbursement given support for a direct-to-consumer, or a “public peer-to-peer” digital wallet to disburse digital currencies.

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