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Competition For The Next Generation of Cross-Border Payments Has Begun

John Galt

Updated: October 7, 2022

cross-border payments
Editor’s Note:

EDITOR'S NOTE: The notion of a central bank digital currency (CBDC) system comes not without a problematic and seemingly terminal dilemma: CBDC adoption can automatically reduce or abolish citizens’ financial privacy and freedom; yet, failing to implement a CBDC, particularly for cross-border payments, would render any nation uncompetitive in the global economy. China’s eYuan is the most widely-adopted CBDC in the world. Saudi Arabia and other gulf states are next to go “online.” The mBridge is emerging as the CBDC alternative to the West’s SWIFT payment messaging system. In short, the days of dollar dominance are coming to an end. The only way to remain globally competitive, it seems, is to implement a similar draconian monetary system that may fundamentally change the nature of American democracy. And the only way to find transactional privacy and freedom from this new hegemonic system is to hold the source that once gave all monetary systems their value: physical gold and silver.

Both see value in developing alternative to dollar-centered financial system.

Andrew Cainey is a senior associate fellow with the Royal United Services Institute, a defense and security think tank based in London, and co-author of the forthcoming "Xiconomics: What China's Dual Circulation Strategy Means for Global Business." Alessandro Arduino is principal research fellow with the Middle East Institute of the National University of Singapore.

China's digital currency project started the year with a splash of publicity and promotion at the Beijing Olympics in January where foreign athletes and attendees were invited to try out the digital yuan, or e-yuan.

Russia's invasion of Ukraine the following month, however, is likely to have a longer-lasting impact on the international prospects for China's digital currency, in part thanks to new interest from Gulf nations.

With over 250 million pilot users in China, the e-yuan today is the world's most widely used central bank digital currency. This new form of electronic money offers a digital alternative to physical fiat currency issued by national central banks and a central bank-backed alternative to volatile cryptocurrencies.

So far, the e-yuan has mainly been used for domestic retail transactions. But the People's Bank of China declared last year that the e-yuan is "technically ready for cross-border use."

Such readiness alone will do little to drive adoption, either at home or abroad. There is no simple, automatic way for China's lead in digital currencies to translate into accelerated internationalization of the yuan.

Usage will need to offer benefits to all involved and will require a precise focus rather than broad-brush ambitions of replacing the dollar in international commerce.

It is here that the interests of China and the economies of the Gulf align, with both seeing value in creating faster, more convenient and lower-cost financial payments infrastructure while reducing reliance on the dollar.

Last week, the central banks of China, Hong Kong, Thailand and the United Arab Emirates announced the completion of the Multiple central bank digital currency (CBDC) Bridge, or mBridge, project to pilot cross-currency trading in their respective incipient digital currencies. The partners said 160 transactions involving $22 million had been successfully executed.

The effort built on Project Aber, a joint initiative launched in 2019 by Saudi Arabia and the UAE to test the viability of a single dual-issued digital currency for cross-border transaction settlement.

The war in Ukraine has given added impetus to initiatives like mBridge and Aber because of U.S.-led sanctions and the structure of the global financial system.

Oil is traded in dollars. The bulk of China's trade is invoiced in dollars. And bilateral transactions between many nondollar currency pairs are settled by conversions via the dollar.

This systemic structure gives sharp teeth to U.S. sanctions that ban designated entities from trading in the dollar and block financial institutions from the dollar clearing system in New York. Due to its outsized influence, the U.S. can in effect bar institutions from the global messaging system run by the Society for Worldwide Interbank Financial Telecommunication (SWIFT).

Indeed, U.S. and EU sanctions on Russia this year have brought home their power to exclude a country wholesale from the dollar-based financial system. Even before this, the Trump administration's maximum pressure campaign on Iran had already set in motion a search for alternatives to SWIFT.

Anxiety over the potential blow of U.S. secondary sanctions has meant that Chinese financial institutions have gone out of their way to demonstrate that they are complying with sanctions on Russia. This happened before when even Chinese state-owned banks complied with Washington sanctions on Hong Kong government officials over the city's crackdown on dissent.

Digital currency initiatives such as mBridge and Aber hold out the prospect of breaking this dependence on the dollar and mitigating the risk of sanctions, especially for penalized states like Russia and Iran and their trade partners like China.

While no friends of Iran, the economies of the Gulf have an interest as well. In a multipolar world of increasing tensions between major powers, weakening the centrality of the dollar has appeal.

Moreover, China is now the largest purchaser of Middle East oil, importing more than 40% of its crude from the region. The UAE is meanwhile attracting financial flows and people from a sanctioned Russia.

A reliable bilateral settlement system between national digital currencies offers, at minimum, a workable alternative to using the dollar and, hopefully, a cheaper, faster, better way of doing business.

After all, the promise of cross-border central bank digital currency use is just that: innovation and improved productivity, rather than geopolitical gains.

Consultancy Oliver Wyman has estimated optimistically that the use of e-yuan for trade between Singapore and China could produce savings for the city-state of between $16 billion Singapore dollars and SG$24 billion ($11.15 billion to $16.72 billion) from lower transaction fees and improved corporate treasury liquidity from real-time settlement.

Today cross-border payments and trade finance are cumbersome, slow and high cost. Digitizing this would bring great benefits but will require many detailed protocols, standards and changes to be agreed upon and implemented.

The Gulf economies, together with China, have a head start here. Pursuing economic logic will lead to tighter and stronger links between the two. The benefits of such cooperation will be easier to demonstrate than those from massive Belt and Road Initiative infrastructure projects that often come with uncertain commercial returns.

It is unclear how the U.S. will respond. The digital dollar remains firmly in the planning phase, with no clear timeline or decision on implementation.

Meanwhile, competition for the next-generation of cross-border payments has started. Which systems and approaches will prevail is unclear. But in a decentralized network world, a hub-and-spoke system heavily reliant on a dollar that is at times wielded for political ends has poor prospects indeed. A market demand for alternatives is there to be met.

Originally published on Nikkei Asia.

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