78 Digital Currency Wars? Us-china Competition and Economic Statecraft

the new economic instruments of digital currencies are increasingly important flashpoints for global competition.

The importance of digital currencies is rising in a variety of economic relations across the world, ranging from basic payment systems such as Bitcoin to alternative central bank currencies.

These new economic instruments are increasingly important flashpoints for global competition, with evidence of growing ‘digital currency wars’ among great and middle powers, write Vinod K. Aggarwal and

Tim Marple.

BY MANY ACCOUNTS, the United states and China are engaged in an emerging Cold War.1 Yet the contours of this war are markedly different than the Us-ussr competition from the 1940s to the 1980s. China and the Us are highly economically interdependent.2 Both countries have also engaged in active economic statecraft. each seeks both economic and strategic gain through an array of trade and industrial policies and investment regulations to bolster high technology industries.3 We believe that one area, digital currencies, will be a key area of future competition and conflict between the two countries. this conflict will also likely spill over to other countries and private actors.4

With respect to digital currencies, analysts and policymakers have focused primarily on the technological, economic and regulatory implications of cryptocurrencies such as Bitcoin. Yet this focus ignores the rapid development of other important digital currencies.5 governments increasingly support digital currencies through economic statecraft such as China’s digital yuan. More generally, governments seek to regulate and sometimes intentionally displace the private actors who originated private digital currencies like cryptocurrencies.

We focus on two issues here: first, we look at the national-security implications of digitalcurrency competition. second, we examine the factors that drive state intervention to create or regulate digital currencies. if successful, the digital yuan stands to challenge the Us privilege in borrowing, a unique freedom the country has leveraged to avoid political and economic issues of trade adjustment costs. digital alternatives to the Us dollar may also undermine the capacity of the Us to enforce sanctions across the world. An alternative reserve currency opens the possibility of new debt regimes, evidenced by China’s explicit goal of linking the digital yuan to its already-expansive network of Belt and road initiative lending partners. Beyond these factors, digital currencies also open new attack surfaces in hostile interstate relations, especially given the cybersecurity concerns associated with digital ledgers. to analyze government motivations to address these concerns, we examine a set of factors that will likely drive economic statecraft in digital currencies, including technological and market factors, domestic structures, and system and international regime characteristics.

We begin with a brief history of digital currencies. We then turn to a detailed examination of the national-security characteristics of digital currencies that are relevant to global competition. next, we explore how an economic statecraft lens can help us better understand the motivations and prospects for intervention in this sector. We conclude with a discussion of how this emerging digital currency war will likely affect Us-chinese relations, and the related implications for other countries and private actors in the global economy.

THE EVOLUTION OF DIGITAL CURRENCIES

in the midst of the global financial crisis of 2008, an anonymous individual published the proof-of-concept for Bitcoin, the first actualized cryptocurrency, online, promising a radical form of money requiring no interpersonal trust or government oversight.6 in the 12 years since, Bitcoin has seen prolific adoption as a payment system and store of value, and more importantly, it has triggered rapid evolution in alternative forms of cryptocurrencies across the world.7 digital currencies have now scaled beyond initial use cases like Bitcoin and other private cryptocurrencies to adoption and innovation among firms and banks, and most importantly, by sovereign governments. in January 2019, 70 percent of central banks responding to a survey by the Bank for interna-

Without mutually agreed constraints on creating, managing and regulating digital currencies, we are still in the ‘Wild West’ phase of the market. The absence of accepted regional or global regulatory mechanisms is therefore likely to increase government incentives to use economic statecraft to gain an edge on competitors.

tional settlements indicated ongoing or planned work on sovereign digital currencies.8

this trend toward sovereign digital currencies is due in large part to pressures that have arisen from other kinds of digital currencies, like cryptocurrency. Cryptocurrencies have evolved in technical design over time, iteratively responding to the economic externalities and government responses to prior versions. for example, early decentralized cryptocurrencies like Bitcoin raised government concerns around criminal financing and money laundering, as well as skepticism around their use as a store of value given their market price volatility.9 in response, rather than simply accepting decentralized cryptocurrencies for payment, companies began issuing initial coin offerings, a private digital asset which allows firms to offer digital coins for goods or services, in lieu of stocks, to raise money.10 new firms also emerged offering “stablecoins,” cryptocurrencies designed to maintain a stable price against a fixed target currency or asset, in explicit response to government concerns on price volatility.11

Whereas the Us and other Western countries have seen the proliferation of private applications, as with cryptocurrencies and initial coin offerings, China has made by far the most progress on its sovereign central bank digital currency.12 these trajectories of digital currency development have had two-way spillovers linked directly to the broader Us-china economic conflict. Libra, facebook’s proposed private digital currency, placed pressure on China to hasten its digital currency pilot.13 similarly, China’s research into a sovereign digital currency has pressured the Us federal reserve and many other central banks to start pilots of their own.14