The U.S.’s influence over dollar-denominated transactions, SWIFT, and domestic clearinghouses allows it to impose severe penalties for non-compliance, enforce sanctions, combat corruption, and track money laundering more effectively than any other country. While the U.S. does not have direct control over the SWIFT system, the U.S. was, for example, effectively able to pressure SWIFT into cutting off its services to Iran in 2018 and used data provided by SWIFT to track and freeze assets funding illicit activities after the 9/11 terrorist attacks. Once transactions enter the CHIPS system, OFAC can track them and freeze the accounts of companies or individuals and even exclude entire nations from accessing this infrastructure (as in the case of Venezuela and North Korea). In 2017, for example, U.S. authorities fined Germany’s Deutsche Bank $425 million for violating anti-money-laundering laws in a scheme that facilitated the transfer of $10 billion from Russia to banks in Cyprus, Estonia, and Latvia. Historically, U.S. authorities have been judicious in their application of economic sanctions, but since the 9/11 terror attacks, sanctions have assumed an increasingly central role in U.S. foreign policy. Under the former Trump administration, OFAC was particularly liberal in its usage of sanctions, targeting around twice as many entities per year as previous administrations. The recent increase in use of U.S. sanctions is a major catalyst driving efforts to evade U.S. control, disrupt the current international payments system, and construct a new global financial infrastructure.

The Expanding Scope of U.S. Sanctions and International Pushback

The use of sanctions as a geopolitical tool has a long history, but the impact and effectiveness with which the U.S. can use sanctions today is unique. While other countries can impose tariffs, embargoes, and other non-tariff barriers, they do not have the power to unilaterally restrict access to underlying international financial infrastructure. The U.S.’s ability to restrict access to dollar-denominated transactions grants it the ability to effectively enforce secondary sanctions—restrictions on a third-party individuals or organizations (usually banks) outside of the U.S.’s jurisdiction—thereby effectively expanding the scope of U.S. sanctions enforcement to encompass most of the globe. Since the early 2000s, the U.S. has been using its power to expand its sanctions regimes and has notably targeted sanctions at powerful countries such as China and Russia. A series of key events have served as catalysts for the expanding scope of U.S. sanctions, including the 9/11 terror attacks, Russia’s invasion of Ukraine, and the U.S.’s maximum pressure campaign against Iran. In the wake of 9/11, President Bush significantly expanded U.S. sanctions through executive orders, freezing assets on a range of individuals and organizations connected to the attacks, including Osama bin Laden and al-Qaeda. The Obama administration further expanded the use of sanctions, placing extensive sanctions on Iran in 2010 during negotiations on its nuclear program and sanctioning Russia after its 2014 invasion of Ukraine. International pushback against U.S. sanctions accelerated under the Trump administration, as Trump oversaw the most significant increase in U.S. sanctions to date, with additional sanctions placed on Iran, Venezuela, China, and Russia leading to an annual average increase of 52 percent in sanctioned entities from 2016 to 2020.

The Trump administration significantly expanded the use of secondary sanctions, used its influence in the financial system to exert leverage in negotiations to a greater degree than previous administrations, and combined the use of financial leverage with domestic economic tools such as export controls. As noted above, during the maximum pressure campaign against Iran in 2018, on top of enforcing existing sanctions, the Trump administration unilaterally pressured SWIFT into cutting off Iran’s access to interbank communications, effectively preventing Iranian banks from conducting international trade. Those measures contributed to a 6.8 percent drop in Iran’s GDP growth in 2019. In its efforts to apply economic pressure on Myanmar and Venezuela over human rights violations and to curb North Korea’s nuclear program, the U.S. similarly cut off those countries' government's access to dollar-denominated payment systems. These countries lack the geopolitical power to retaliate effectively, but U.S. sanctions on China and Russia have generated significantly stronger reactions. From 2017 to 2019, the Trump administration placed sixteen rounds of sanctions on Russian individuals or entities. They included completely cutting off Rusal, Russia’s largest aluminum producer, from the dollar payments system. (Congress has since lifted the sanctions on Rusal.) Russia responded aggressively to U.S. sanctions, cutting its share of USD reserves by 26 percent in 2018, partnering with China to promote the use of the renminbi (RMB) in international trade, and developing alternative payment messaging and settlement systems. Despite Russia’s response, the Biden administration continued this approach. In April 2021, the administration introduced new rounds of sanctions on six Russian tech companies in response to their involvement in the SolarWinds cyberattack and allegations of election interference by Russian officials.

China has similarly been a major target for U.S. sanctions under both the Trump and Biden administrations. Throughout its tenure, the Trump administration imposed significant economic restrictions on China, and in 2017, Treasury Secretary Steven Mnuchin threatened to completely cut off China’s access to the dollarized economy if it did not comply with UN sanctions on North Korea. In 2019, the Trump administration escalated its confrontation with China over concerns about the Chinese telecom company Huawei’s ties to the Chinese government and intellectual property theft, imposing sanctions and banning sales of Huawei and ZTE equipment domestically. In the final days of the Trump administration, the U.S. imposed an additional round of sanctions on 14 high-level Chinese officials over crackdowns on pro-democracy protestors in Hong Kong in late 2020. The Biden administration continued to pressure China by way of sanctions, export bans on U.S. technology, as well as travel bans and asset freezes on Chinese officials. In March 2021, alongside Canada, the EU, and the UK, the U.S. froze the assets of Chinese officials involved in the detention of Uyghurs in China’s Xinjiang region. The increasing use of U.S. sanctions as a geopolitical tool has prompted both China and Russia to begin pushes to end global reliance on the dollar system and develop alternatives to it.

Section 2

Challenges to the Dollar and Existing Financial Infrastructure

Over the past decade, most speculation over de-dollarization has focused on the idea that either the euro or the renminbi would overtake the dollar as the world’s reserve currency. Since the early 2000s, central banks have been increasingly diversifying their holdings, and the percentage of reserves held in dollars has decreased modestly over the past five years (from 65 percent to 59 percent). However, most central bank reserves and international transactions are still in dollars, and there is ample evidence to suggest that a change in the near term is unlikely. By the end of 2020, 59 percent of global central bank reserves were held in dollars, while the euro accounted for 21 percent, and the renminbi just 2 percent. However, in response to U.S. sanctions, China, Russia, and the EU have all begun to take measures to develop alternatives to the existing international financial infrastructure and weaken U.S. influence over the system. China and Russia are de-dollarizing their foreign exchange reserves and creating their own financial messaging and payment systems. China has launched extensive efforts to internationalize the renminbi—including issuing renminbi-denominated bonds, setting up offshore renminbi clearing centers, and signing currency swap agreements to conduct international trade in renminbi. Although these efforts are still at an early stage and have not yet made a significant dent in the role of the dollar, they are indicative of a widespread desire to diminish U.S. influence. Ongoing efforts to undermine the U.S.’s financial advantage could significantly alter geopolitical power dynamics and weaken U.S. leverage over major powers such as China and Russia while providing countries such as Iran and North Korea new opportunities to access international trade and markets.

Major Powers’ Efforts to Weaken U.S. Control Over the International Financial System

The impact of U.S. sanctions is driving countries to begin developing alternatives to the dollar system, led primarily by China, Russia, and the EU. China and Russia’s efforts are the most extensive, but there has been growing support among other nations such as India, France, and Saudi Arabia as well. The desire to use new systems is particularly strong among nations facing the most severe U.S. sanctions, such as Iran and North Korea, who have moved to using the renminbi as their primary trading currency. Efforts to undermine the dollar include the process of de-dollarizing central bank reserves, trading in alternative currencies, developing alternative financial messaging and payment systems, pushing for the internationalization of alternative currencies and, most recently, developing digital currencies. To date, both Russia and China have taken significant steps toward ending their dollar dependence and creating alternative systems that they are now pushing to internationalize.

Russia began de-dollarizing its central bank reserves in late 2013 in efforts to ameliorate the economic fallout from impending U.S. and NATO sanctions imposed for its offensive in Ukraine. Between 2017 and 2018, Russia replaced $101 billion of dollar reserves with renminbi and euro reserves, and in June 2021, Russia’s central bank (Bank of Russia) announced that it would remove all dollar assets from its sovereign wealth fund. After Visa and MasterCard suspended their services from Russian banks blacklisted by the U.S., in 2014, Russia introduced the National Payment Card System (now known as “Mir”). Mir acts as a clearing center for processing card transactions within Russia and is owned by the Bank of Russia. Although Mir is still accepted primarily only in Russia, the government is now pushing for broader international acceptance, most recently testing expansion into the UK. In addition, in 2015, Russia developed a domestic SWIFT alternative, the financial messaging system of the Bank of Russia (SPFS), which in 2020 handled 13 million messages among more than 400 member banks (primarily within Russia). Russia has had success in de-dollarizing its reserves, and it is starting to move its foreign trade activity away from dollars by signing currency swap agreements with like-minded countries such as China, Iran, and Turkey. (Currency swaps enable countries to trade in local currencies instead of dollars.) Despite these efforts, Russia’s alternative infrastructure has not been broadly adopted outside of Russia, and the ruble is not widely held as a reserve currency. Due to these limitations, Russia has expanded its efforts by working alongside China and supporting its efforts to develop alternatives to the dollar system.

China has pushed to internationalize the renminbi since the 2008 financial crisis, launching its first round of international renminbi clearing centers for international trade in 2009. China has begun to house renminbi clearing centers in major financial hubs such as the UK and Singapore, although nearly 75 percent of renminbi transactions are still cleared through Hong Kong. China is also promoting the use of the renminbi in international trade, signing 33 currency swap agreements for trade with foreign governments since 2009, the most of any country. (The U.S. has signed the second-most with 14.) These efforts have managed to increase the renminbi’s share of foreign exchange reserves and payments to roughly 2 percent of the global total, still miniscule but a strong start. In 2015, China broadened its efforts by introducing a domestic alternative to the SWIFT system, the Cross-Border Interbank Payment System (CIPS). Integrating CIPS into China’s Belt and Road Initiative (BRI)—China’s sprawling global trade and infrastructure development plan—has allowed it to expand rapidly, and it is currently in use by 980 financial institutions across 47 countries. Despite this success, CIPS still only processes $19.4 billion per day, compared to up to $6 trillion per day on SWIFT. Like Russia, China is decreasing its holdings of dollar reserves, while Russia has increasingly transferred cash into renminbi holdings. Most recently, in April 2021, China launched a digital renminbi, which it could use to facilitate international renminbi adoption.

While China and Russia are spearheading the most extensive efforts to circumvent the dollar system, efforts from the EU and other nations have picked up since 2018. After the U.S. cut Iran out of the SWIFT system in 2018, France, Germany, and the UK launched a SWIFT alternative in January 2019. The Instrument in Support of Trade Exchanges (INSTEX) was created to allow EU states to continue trading in a limited capacity with Iran, despite U.S. sanctions. In November 2019, six additional EU countries (Finland, Belgium, Denmark, Netherlands, Norway, and Sweden) joined INSTEX in effort to maintain the conditions of the Joint Comprehensive Plan of Action (JCPOA). To date, INSTEX has only been used to send financial messages facilitating the transfer of food and medicine and has not had a significant impact on the broader financial system. However, it has sparked renewed debate within the EU on moving away from the dollar system. A draft policy paper presented to the European Commission in January 2021 outlined steps for the EU to increase its monetary independence from the dollar, citing the unilateral sanctions imposed on Iran by the U.S. as one of the main drivers. The current draft calls for boosting the role of the euro internationally, curbing reliance on foreign clearing houses, and exploring the possibility of launching a digital euro. The European Commission also plans to increase trade in euro-denominated debt and commodities in order to move market activity outside of the purview of U.S. sanctions.

China, Russia, and the EU have launched the most high-profile alternatives to the dollar system, but other countries are also seeking alternatives in limited capacities. India joined the EU in efforts to find alternative ways to trade with Iran, and it has supported joining a BRICS (Brazil, Russia, India, China, and South Africa) payment system that would support trading in local currencies among member nations. Saudi Arabia has also raised the possibility of moving its oil trade out of dollars, a move that would significantly weaken U.S. influence over global trade flows and boost the prospects of nations such as China and Russia, which have long sought to use their domestic currencies for trading oil. Previous attempts to undermine the dollar’s influence (such as China’s attempts to internationalize the renminbi) have not gained significant traction while existing alternative systems are in their infancy and do not yet have widespread adoption. China is still in the process of making necessary reforms that would facilitate internationalizing the renminbi, such as relaxing its capital controls, promoting its domestic financial markets, and enhancing financial regulation. Internationalizing the euro faces similar challenges, as the incomplete integration of EU banking sectors and capital markets has hindered wider international adoption. Due to these challenges, unseating the dollar will not be easy and will take time, but the proliferation of countries seeking an alternative to the dollar system shows a clear desire for change.

The Current Status of the Dollar and Challenges to Dollar Supremacy

Traditionally, a country’s economic dominance has been a key factor in determining the strength of its reserve currency. At present, the dollar remains the principle currency of international commerce—roughly 60 percent of foreign exchange reserves are in dollars, and approximately half of all cross-border loans and international debt securities are dollar-denominated. The market for U.S. government securities remains the deepest and most liquid in the world, and during the 2008 recession and the more recent economic shocks associated with COVID-19 in 2020 the dollar served as a safe haven asset for international investors. Foreign governments hold over a third of outstanding U.S. government securities, a proportion much greater than in other developed economies. Nevertheless, the U.S. economy’s ever-shrinking proportion of global output and disruptions to the financial system are prompting fundamental questions about the dollar’s staying power as the global reserve currency. The U.S.’s share of global GDP fell from 40 percent in 1960 to 24 percent in 2019, and over the same period, China’s output increased from 4 percent to 16 percent.

Today, the dollar has three main rivals: the EU’s euro, Japan’s yen, and China’s renminbi. Accounting for 21.2 percent of official foreign exchange reserves, the euro is arguably the second-most important currency in the world. The euro has several attributes that make it an attractive alternative to the dollar. For example, the euro’s Economic and Monetary Union (EMU) has a large internal economy and is central to global trade. Europe’s deep and liquid financial markets, as well as the policy predictability afforded by the European Central Bank (ECB), make the euro a compelling international medium of exchange. Yet, the euro faces structural weaknesses that complicate its ability to challenge the dollar. The eurozone’s unique institutional structure as a monetary area without a corresponding fiscal union undermines the supervisory and regulatory power of the ECB. The yen, which constitutes six percent of official foreign exchange reserves and is the world’s third-largest reserve currency after the euro and the dollar, faces similarly substantial barriers to internationalization. These barriers include onerous regulatory requirements, uneven liberalization of domestic financial markets, and ongoing economic stagnation. In addition, raw materials—which today still tend to be invoiced in dollars—constitute a significant share of Japan’s imports. For these reasons, barring significant unforeseen geopolitical or technological developments, neither the euro nor the yen is likely to challenge dollar hegemony anytime soon. The same cannot be said for the renminbi.

According to most metrics used to evaluate a currency’s international importance, China’s renminbi remains well behind the dollar, euro, and yen. At the end of 2020, only 2.2 percent of official foreign exchange reserves were held in renminbi, lower than not only the dollar, euro, and yen, but also the pound sterling. Yet, the renminbi is viewed as the dollar’s greatest long-term threat because of China’s record of robust economic growth since the 1980s, its rapid integration into the global economy, and its centrality in international trade. (China is now a larger trade partner than the U.S. in 128 countries.) As evidenced by the creation of CIPS, the launching of the digital renminbi, and previous attempts to internationalize the renminbi, China’s efforts to undermine the dollar are also more aggressive and explicit than those of other countries. The IMF’s decision to include the renminbi in its basket of Special Drawing Rights (SDR) currencies in 2016 suggests that these efforts are beginning to bear fruit. (The SDR is an international reserve asset that the IMF distributes to supplement member nations’ existing reserves; its value is determined by five currencies—the dollar, the euro, the yen, the renminbi, and the pound.)

The renminbi still faces several economic and political challenges to widespread international adoption as a global trade, investment, and reserve currency. Currently, China assertively controls its capital account, meaning that there are strict conditions and some outright restrictions placed on flows of foreign capital into and out of the country. A country’s capital account (sometimes referred to as “financial account”) consists of the financial flows generated from foreign direct investment, portfolio investment, cross-border loans (and other investments), and the country’s use of foreign reserves as it relates to the country’s currency exchange rate. In China’s case, the central bank also intervenes to control the renminbi’s exchange rate, buying or selling renminbi to keep its exchange rate below what its free-floating market value would be. (This, in turn, makes Chinese exports cheaper and more attractive.) These factors contribute to investors’ hesitation to trade in renminbi and limit its ability to become an international currency. A lack of market-determined interest and exchange rates, mature and liquid financial markets, and predictable legal frameworks continue to undermine the renminbi’s ability to become a more attractive investment vehicle than the dollar.

China also faces the challenge of an uncertain future in Hong Kong. Hong Kong serves as the main channel through which foreign investment enters the Chinese market, with two-thirds of overall foreign direct investment capital flows moving into and out of China through Hong Kong. Hong Kong is the world’s largest offshore renminbi center, providing clearing, settlement (over 70 percent of global renminbi transactions are settled in Hong Kong), financing, and asset management services in renminbi. China’s introduction of its National Security Law in June 2020, and the subsequent protests, have created an uncertain future. Under the National Security Law, individuals and companies can be legally tried in mainland China, a move that vastly expands the CCP’s influence. In response to the law’s passing, international companies are considering moving operations from Hong Kong, with the American Chamber of Commerce finding that over 40 percent of international companies, led by financial firms, are now considering moving operations out of Hong Kong. A diminishing role for Hong Kong as an international financial center would significantly set back China’s efforts to internationalize the renminbi and globalize its economy.

Formidable as these challenges may be, China’s, Russia’s, and the EU’s sustained attempts to seek alternatives to the dollar are slowly making headway, and the introduction of central bank digital currencies (CBDC’s) could significantly bolster their efforts. Additionally, questions over the ability of centralized systems such as SWIFT to keep up with technological advancements have emerged. In 2016, a string of cyberattacks targeted banks by subverting their SWIFT accounts. The most successful attack resulted in the theft of $81 million from the Bangladesh Central Bank. Despite new cybersecurity measures adopted in 2018, fraud and cybercrime through SWIFT have continually risen steadily since 2016, with four out of five SWIFT members reporting at least one incident of fraud since 2016. Security concerns over existing systems and the potential for digital currencies to both increase transaction speed and lower costs (by cutting out the need for intermediaries) are driving interest in expediting their adoption. A widespread transition to the use of digital currencies could diminish dependence on the current dollar-dominated global infrastructure, even without a country directly overtaking the U.S. economically. For China, the recent pilot launch of a digital renminbi could expedite capital account liberalization and financial market development, while providing a vehicle to trade directly in renminbi and circumvent international intermediaries such as SWIFT. Russia and the EU are both exploring launching digital currencies of their own, creating novel opportunities to move away from dollar reliance. While the existing CBDC infrastructure is in its infancy, concurrent and sustained efforts over time from China, Russia, and the EU hold the potential to erode the influence of the dollar in the long run.

Section 3

The Domestic and International Implications of China's Digital Renminbi

In April 2020, China became the first major economy to launch a central bank digital currency (CBDC), introducing a digital version of the renminbi, formally named the Digital Currency Electronic Payment (DCEP). The DCEP is a direct digital substitute for liquid renminbi currency now in circulation. Despite still only being available domestically, and in limited supplies, the launch of DCEP already has widespread implications both within China and internationally. China will now serve as a test case for other countries’ adoption of CBDCs, and, if successful, the DCEP could accelerate renminbi internationalization, strengthen China’s existing alternative financial infrastructure, and give the country a first-mover advantage in developing the underlying technology and standards for future CBDCs. Critically, in the long-term, it could provide an alternative source for financing international trade and business for China and other nations facing U.S. sanctions. China has already started to create the necessary infrastructure for rapidly bringing foreign countries into the DCEP ecosystem. Adoption of the DCEP will also help China enforce greater domestic control­—transactions can be centrally tracked and traced, and the DCEP could be integrated into existing technologies and systems that China uses for domestic surveillance, such as smart cities and the social credit system. Today, China exports its surveillance tools to a wide range of nations around the globe, such as its facial recognition technology. In addition to the financial attributes of digital currencies, the technology underlying the DCEP could serve as a tool and framework for other governments seeking to enhance their domestic surveillance capabilities. To date, the U.S.’s response has been cautious and slow, and the Fed is only now beginning to explore the idea of introducing a digital dollar.

Breaking Down China’s Digital Renminbi

Currently, over 80 percent of the world’s central banks are exploring the possibility of introducing a digital currency, but the People’s Bank of China (PBoC) is the first major economy to do so. (The Bahamas and Cambodia have also launched digital currencies.) Inspired by the emergence of decentralized digital currencies, such as Bitcoin, China’s central bank began exploring the possibility of launching a domestic digital currency in 2014. Unlike other digital currencies, which allow anonymous decentralized transactions and have free-floating value, China’s digital currency has a centralized governance structure, is pegged to the renminbi at a one-to-one ratio, and allows the PBoC complete transaction oversight. In April 2020, China began a limited domestic rollout of the DCEP, distributing small quantities of digital currency through a lottery system across four cities—Shenzhen, Suzhou, Chengdu, and Xiong’an (a satellite city of Beijing)—that resulted in 4 million transactions totaling 2 billion renminbi ($300 million). China is now conducting larger-scale trials, distributing 40 million renminbi ($6.2 million) in digital currency to Beijing residents in June 2021. Continued success of the DCEP is unlikely to immediately impact the international standing of the dollar, but there are still many wide-ranging domestic and international consequences from its launch.

The DCEP significantly enhances the ability of the CCP to oversee and control its financial system, collect data, and set standards and patent technology for the development of future CBDCs. It creates a Chinese alternative to decentralized digital currencies (cryptocurrencies), stablecoins (cryptocurrencies whose value are pegged to a fiat currency), other foreign CBDCs, and China’s domestic payment services, such as Alipay and WeChat, which move control of financial flows away from the CCP. Cryptocurrencies are extremely popular in China, which generates an estimated 75 percent of global bitcoin mining activity, and the launch of the DCEP coincides with the government’s crackdown on cryptocurrency activities. One of the major draws of decentralized currencies is the ability to transact anonymously largely due to the underlying blockchain technology, which allows for a decentralized governance structure. (Cryptocurrencies will be broken down and analyzed in Part II of this series.) In contrast, although the DCEP will likely make use of blockchain technology, its transactions are fully traceable, and data is collected and stored across three central data centers. The authentication center stores the identities of all DCEP users, the registration center stores ownership and transaction records, and the big data analytics center uses historical and real-time data to analyze and track financial flows. China has referred to this structure as providing “controlled anonymity,” meaning that transactions could be hidden from commercial banks and other third parties but that the currency issuer (the PBoC) would ultimately have visibility into every transaction. In practice, by moving financial flows toward this centralized architecture, the CCP would ultimately have complete oversight into any financial activity conducted using DCEP, both domestically and internationally.

The CCP views the ability to oversee financial flows as critical to maintaining national security and pursuing its policy goals of fighting corruption, money laundering, terrorist financing, and tax evasion. Of course, it would also be a crucial tool in gaining greater political and economic dominance as it seeks to strengthen its role as a global superpower. The tremendous amount of data generated could be used to improve AI systems and, indeed, prevent fraud and counterfeiting, and improve fiscal and monetary policymaking. For example, China could use data-driven analysis to surgically target stimulus packages to low-income groups or more accurately adjust interest rates. However, what the implementation of those policies will look like in practice has raised concerns, due to the CCP’s interpretation of how these activities are defined. For example, the CCP has justified the repression of its Uyghur minority in Xinjiang as a terrorist- prevention measure, and widespread adoption of the DCEP would allow the government to surgically target specific financial activities, even beyond China’s borders. (For example, the CCP could prevent remittances from Uyghurs who have left the country). The ability to collect financial data could also be integrated into existing infrastructure, such as China’s social credit system.

Critically, to date, China has filed more than 80 patents related to technology used in developing the DCEP with China’s patent office, the China National Intellectual Property Administration (CNIPA). Establishing CBDC standards on privacy, security, transparency, central bank coordination, tax disclosure, and the degree of state control for financial technology would help China lay the groundwork for pushing renminbi internationalization as well as ultimately establishing alternatives to the current U.S.-dominated system. There are still significant hurdles toward achieving these objectives, particularly concerning cross-border payments and international adoption, and the DCEP is still in the early stages of its development. Additionally, attempts to internationalize the DCEP are likely to receive significant pushback eventually, particularly from the U.S. if it begins to perceive the DCEP as a threat to the dollar’s dominance.

Integrating the Digital Renminbi Internationally and the Potential of Central Bank Digital Currencies

China has several advantages in launching a CBDC that could speed adoption domestically. It is already one of the most cashless economies in the world, thanks to the ubiquity of e-payment companies WeChat and Alipay. Its governance structure also allows it to face fewer regulatory hurdles regarding privacy. Finally, China has one of the most advanced domestic fintech industries. The DCEP is being rolled out through a two-tiered system, in which the PBoC issues digital currency, but its distribution leverages Chinese banks and e-payment providers. (Alibaba and Tencent have already partnered with the PBoC to distribute digital currency and Huawei has developed a digital wallet for DCEP on its phones.) Established transmission channels and the ability to integrate the public and private sectors will aid domestic distribution, but internationalizing the DCEP will be a significantly larger challenge.

There are numerous mechanisms through which China could promote international use the of the DCEP. China has worked to established trade relationships with over 60 countries through the BRI, and Chinese investment in those countries is estimated to be over $200 billion. China could leverage those trade relationships to speed international adoption by forcing or incentivizing BRI trade contracts to be settled in DCEP. China is partnering with other countries and traditional institutions such as SWIFT to promote the DCEP. (The PBoC is partnering with SWIFT on a joint business venture, the Finance Gateway Information Services Co., focused on information system integration and data processing.) In February 2021, China began discussions on developing protocols for the cross-border use of digital currencies with central banks in Hong Kong, Thailand, and the United Arab Emirates. China has also been in discussions with Russia about developing a digital currency transaction ecosystem within the BRICS countries, and its 2021 Free Trade Agreement (FTA) with Mauritius integrates the development of an renminbi clearing and settlement facility, which could potentially serve as a gateway for introducing DCEP transactions into the country, and eventually into Africa more broadly. The Asian Infrastructure Investment Bank (AIIB), established by China in 2016 and currently lending $96 billion across its 86 member countries, could serve as an additional vehicle for lending DCEP internationally. China could begin denominating loans through the AIIB in DCEP or integrating DCEP trade provisions into bilateral trade deals. Finally, the PBoC has partnered with payments systems WeChat and Alipay to launch the DCEP domestically, and both companies have plans to expand globally.

An internationally accepted Chinese digital currency could allow China to circumvent the SWIFT system, evade U.S. sanctions, and eventually compete directly with the dollar. International adoption would allow China to begin circumventing U.S. sanctions even if the U.S. dollar maintains its dominant position. With physical currency transactions, the messaging and settlement elements of a transaction are separate, creating the need for intermediaries such as SWIFT. The DCEP would allow for both messaging and settlement capabilities in renminbi, eliminating the need for a third-party intermediary. With digital currency, transactions would be settled directly between the two transacting parties. Thus, the U.S. would be unable to interfere in transactions between China and countries using DCEP.

While the CIPS system allows countries to transact directly in renminbi, the direct transactions possible using DCEP will be both faster and cheaper. These elements could serve to attract countries and incentivize them to transact in DCEP, particularly in low-income countries. The path to internationalizing a digital currency is likely to face pushback from the U.S. if it begins to see it as a threat to the dollar. However, beyond the technological innovation used in the DCEP, China is today significantly better positioned to promote renminbi internationalization than in 2009—it is now a larger and more global economy with a stronger banking sector and financial system.

While there has been discussion amongst economists and policymakers that the DCEP could potentially speed up renminbi internationalization, the DCEP is likely to face the same fundamental economic hurdles: China’s capital account is still tightly controlled by the CCP, the renminbi is not fully convertible, China’s exchange rates are not completely free-floating, and Chinese capital markets are much less developed than those in the United States. Despite these challenges, the DCEP would provide China with major international advantages, even if it were only used in a limited capacity. DCEP allows complete insight into monitoring international transactions denominated in the currency, and the data generated from these transactions will be immensely valuable. Additionally, China could be more willing to liberalize its capital account if the CCP were granted greater insight and control over DCEP-denominated financial inflows and outflows. In this sense, the DCEP could potentially provide China a route toward liberalizing its economy, while simultaneously gaining more control over its financial sector. The DCEP’s success would allow China to gain these advantages gradually, without needing to completely replace the dollar as a reserve currency. Even if the dollar continues to be used as the primary reserve currency, the existence of significant viable alternatives would weaken the U.S.’s ability to use this status to enforce sanctions and use financial leverage in negotiations.

Conclusion

The emergence of China as a global economic power, the development of breakthrough new financial technologies and declining U.S. influence are driving geopolitical shifts and generating new challenges to the international financial system. Fifty years after President Nixon ended the gold standard, the world is once again experiencing transformative shifts in both the dollar’s international role and the way money is fundamentally understood. Driven by perceived U.S. sanctions overreach, many countries are seeking traditional alternatives to the dollar system. While progress has been slow in this regard, new technologies are being explored by the world’s central banks, and the digitization of global currency and international transactions is beginning to accelerate. China is the first major economy to launch a digital currency, but many powerful countries will likely follow soon. Notably, the U.S. has been slow and hesitant to embrace the idea of a digital dollar. While the Fed is now exploring the possibility of doing so, its approach and tone toward adoption have been significantly more cautious than those of other major economies. While CBDCs hold transformative potential, they are far from the only digital currencies competing for widespread international adoption.

The development of blockchain technology and the rise of the de-centralized cryptocurrencies it enables, such as Bitcoin and Ethereum, poses a separate, and potentially groundbreaking, new threat to the current financial order. Widespread adoption of cryptocurrencies could undermine government control of the money supply and move major segments of international economic activity out of government purview. The ability to transact anonymously with cryptocurrencies, outside of regulatory or government oversight, has led to widespread crackdowns on cryptocurrencies in China. (The DCEP is in part designed to outcompete cryptocurrencies.) Other actors have embraced cryptocurrencies. Countries such as El Salvador and Paraguay are encouraging their widespread use, and numerous private-sector actors have moved to develop their own cryptocurrencies, such as Facebook’s Diem. As government and private-sector actors use emerging technologies to redefine the very nature of money, the future of the global financial system is more uncertain than ever. While the dollar remains the world’s dominant currency today, geopolitical and technological forces are colliding to pose new and unprecedented challenges. In Part II and Part III of FP Analytics’ The Future of Money Power Map series, we will explore and analyze de-centralized cryptocurrencies, private-sector digital currencies, and CBDCs’ ability to redefine the global financial landscape and determine what the future of money will hold.

Written by Christian Perez, with research and interview support from Ian Hutchcroft. Edited by Allison Carlson. Copyedited by David Johnstone. Art direction and design by Sara Stewart. Development by Andy Baughman and Ash White. Creative direction by Lori Kelley. Illustration by Doug Chayka for Foreign Policy.