Geopolitical fallout of central bank digital currencies

China might lead the charge into the digital economy, but will being the first major economy to launch a CBDC be enough to win global reserve currency status?

China’s Digital Currency Electronic Payment system is at the forefront of news around central bank digital currencies, or CBDCs. As China will be the first nation to launch a CBDC, the changes a digital yuan promises for global economics and the role this plan plays in pushing for a “currency war” keeps its project in headlines.

For its part, the proposed currency not only poses a threat but is intended to threaten, and potentially unseat, the U.S. dollar for the top position of global reserve currency. However, to understand how successful a digital yuan may be in this endeavor, it’s important to understand the current hierarchy of reserve currencies.

Related: China and US must learn from one another and collaborate on CBDC

Global clout

Countries have been vying for global reserve currency status since the 1450s. This status comes with great benefits: Not only do nations serving as reserve currencies have lower trade costs due to a lack of foreign exchange fees, but they also generally receive access to lower borrowing rates. While this increases access to capital for further expansion, it can also backfire when these loans are overdrawn. Most importantly, because the loaning parties can exert power through sanctions and tariffs, they hold significant political power globally.

The U.S. dollar has been the global reserve currency since the 1920s, following World War I. Now, 100 years into reserve currency status, tension over its dominance is coming to a head. Many countries are tired of living under the reign of the United States, and they have history on their side, with no global reserve currency managing to hold the position for more than 111 years.

China has been at the forefront of the de-dollarization campaign for years. Given the yuan’s rapid ascension in global markets, from 12th place to fourth in just three years, it could pose a serious threat. Now, the yuan continues to hold an important role in global finance, but remains separated from global reserve status by a large gap. In the first quarter of 2020, 61.99% of global reserves were held in dollars, while only 2.02% were in yuan, according to the International Monetary Fund.

However, a serious move to derail the dollar will impact far more than just the U.S., with the currencies sitting between the yuan and the top spot particularly positioned to feel the fallout.

Related: Digital cold war? United States and China vie for blockchain supremacy

Will a digital Yuan be enough?

While the Chinese CBDC is closely watched by all, few feel that it will be enough to unseat the dollar. However, that’s not to say that it won’t degrade the position of both the dollar and the euro — the two most important currencies today.

CBDCs offer faster and cheaper remittance and programmability, amid other benefits. If trade can be streamlined and costs cut with new currencies, invoicing in CBDCs will undoubtedly follow. While trust still needs to be shored up for this new technology, a successful launch could quickly ascend the ranks of reserve currencies. With China far ahead of any other major economy toward launching their digital currency, a digital yuan merits attention.

Related: China’s digital yuan CBDC is close, but many details remain unknown

Yet, between the benefits that a CBDC promises and China playing off its position as the world’s top exporter to increase use, the yuan still has several barriers to dominating global markets.

The yuan’s first barrier is the sheer size of the gap between itself and the dollar. However, given the yuan’s rapid ascension and China’s position as the world’s top exporter, the capability of this currency to make major jumps should not be underestimated. Additionally, with rising political instability in the U.S. and skyrocketing unemployment rates, the fallout of COVID-19 and other crises could be great for this superpower.

However, the other major issue that China faces is political. While the nation’s bid to unseat the dollar is inherently political — aimed at raising the quality of life to lower the risk of another revolution and reducing U.S. political clout — the global opinion on China’s government is not one of total trust.

Moreover, the very factor that allowed China to move on its CBDC so much faster than other nations (how unified the government is) is also limiting outside interest.

There are already concerns around privacy in China that could be heightened upon a national move to remove cash, although the undertaking is likely quite far off. Further, while controllable anonymity is part of the proposed DCEP system, the People’s Bank of China would still have access to all identity and trading information. The chances of U.S. and European businesses, among others, using a currency that could cede so much information while stepping on their global market shares is minimal.

But that’s not to say that by providing a faster, cheaper and more convenient payment system, a digital yuan won’t entice some of the market share into its corner.

Second best?

A digital yuan may not win the top spot, but with growth of the euro slowed twenty years after its launch, could the yuan win the second spot?

The European Central Bank, or ECB, has been far less aggressive than China in pursuing greater heights. Now, with the launch of a digital yuan on our doorstep (although no one is quite certain exactly when it will take place), the euro could suffer far more than other currencies.

As Philipp Sandner, professor and head of the Frankfurt School Blockchain Center, told dGen, the “ECB’s reaction has been too slow.” He added:

“Given Libra and the DCEP, the ECB has to react quickly to keep its geopolitical position.”

If a digital yuan is able to move up the ranks of reserve currencies quickly, the euro could slip from its position by maintaining its 20.05% share of reserves in Q1 2020, according to the IMF.

While this might affect European nations mildly, European businesses will feel the shock of being less favored and valued in international trade.

Further, taking the euro out of the mix for global powers could portend a real currency war. If it comes down to it, the dollar remains in a strong position and is still relied on by the majority of the world. However, if a new currency offers faster and cheaper trade settlements, the next decade may see a battle between the two, with every nation scrambling to catch up to China’s progress.

Looking forward

While concerns about China’s government remain, the amount of power that global reserve currency status carries will always make the top position both highly coveted and regarded with trepidation.

However, given our increasingly digital lives and the improvements that digital currencies promise, steps need to be taken to bring our lagging financial system into the future. With the digital yuan imminent in the next 10 years, other top currencies will have to follow suit or be left behind as relics of a bygone era.

While we don’t expect that a digital yuan will be enough to counteract the current perception of the Chinese government, it will bite into market shares. Being the only major economy with a CBDC could be enough for the yuan to surpass the euro.

Based on analysis by dGen, if Europe does not launch its own digital currency in the next 10 years, a digital yuan and continued dollar-dependency will force the euro out of prominence.

Globally, even if the digital yuan might not make it to first place, a direct contest between China and the U.S. for the spot will only increase a currency war. If other major nations launch competitive payment systems, though, that war could be disrupted and diversify, meaning the coming digital economy may herald even uglier global tensions.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.