On March 9, 2022, US President Joe Biden placed “highest urgency” on research and development efforts into a possible US central bank digital currency
Source: Sarah Silbiger via Getty Images

The sanctions against Russia show how far behind Western governments have been in developing digital currency and how that lag could weaken future blacklists.

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The United States, United Kingdom and the Eurozone are only studying or studying central bank digital currencies, or CBDCs, while countries such as China and Russia have launched pilot programs. This mismatch could leave Western nations on the sidelines as a new global payment system emerges, making it harder for them to develop standards and regulations, including applying sanctions.

“It’s important to be at the start of this game,” said Maria Shagina, a visiting fellow at the Finnish Institute of International Affairs, where she studies monetary policy and dedollarization. “At the moment, the US and the EU are not even in the game.”

CBDC-based payment systems could undermine sanctions because they would reduce the use of the dollar in the global financial system and reduce reliance on two key tools for imposing blacklists – the global payment network Swift and the use of banks as intermediaries. These concerns have sparked interest in government-created digital currencies, even in Western countries that previously saw little need to look beyond their existing, well-functioning networks.

“The current conflict and sanctions have significantly changed those calculations,” said Sabyasachi Kar, a Reserve Bank of India professor at the University of Delhi’s Economic Growth Institute, where he studies CBDCs. “The West now realizes that without CBDC it will be very difficult for them to ensure that their interests are safeguarded.”

The US government is now examining how foreign CBDCs could contribute to sanctions evasion and other crimes, and potentially pose a threat to the nation’s central role in the global financial system. President Joe Biden’s executive order in March, which prompted the work, also placed “urgency” in developing a potential US CBDC. Yet the nation has yet to decide whether to issue one.

The European Central Bank is further ahead as it develops design and delivery models for a digital euro work that will last at least until 2023 and could be followed by a pilot project. The Bank of England is still evaluating the merits of a CBDC and plans to launch a consultation this year.

CBDCs are based on technology similar to cryptocurrencies such as bitcoin, but are issued directly by a central bank, so their value is fixed.

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The US Federal Reserve, Bank of England and ECB declined to comment on the impact of the dispute on their central bank digital currency strategies and whether a CBDC could help enforce sanctions.

Momentum for CBDCs

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Earlier this year, Russia launched a pilot of its digital ruble, which the central bank says will make the country more resilient to foreign sanctions. A CBDC could be more successful in this regard than previous “go-around” attempts – such as Russia’s Financial Message Transfer System or China’s Cross-Border Interbank Payments System – because it has the potential to operate outside the banking sector, Kar said. .

Sanctions on Russia will also accelerate work in China on its e-CNY program, according to Shirley Ze Yu, a political economist and fellow at the Ash Center at Harvard Kennedy School. The nation, which has been working on a CBDC since 2014, added 11 more cities to its pilot initiative in early April.

“Geopolitical risks have become a concern and incentive” for the development of CBDCs, Yu said. China’s e-CNY facilitated more than $300,000 in daily transactions during the Beijing Winter Olympics in February, according to a Chinese central bank official quoted by Reuters.

China is already working with countries like Thailand and the United Arab Emirates on a cross-border CBDC payment network, known as mBridge, which could potentially compromise the effectiveness of international sanctions, according to Shagina. China could expand the use of its CBDC through its global Belt and Road infrastructure development program, especially among countries seeking to reduce reliance on US systems, Shagina said.

The People’s Bank of China did not respond to a request for comment.

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Reinforcement of powers of sanction

Globally, 80 countries or currency unions have active CBDC projects, according to the Atlantic Council’s CBDC tracker. According to the think tank, nine countries including Nigeria and mostly Caribbean countries have deployed full systems, while 15 others, including China and Russia, have live pilots.

The financial crackdown on Russia will be a “major catalyst” for the development of digital currencies, especially in countries that want to make themselves less exposed to Western sanctions, said Michael Sung, a fintech professor at Fudan University in China.

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Yet the United States retains key advantages that could offset the slow development of a CBDC. The nation enjoys a solid position in international markets, helped by the status of the dollar as the dominant reserve currency. The rapid rise in private-sector dollar stablecoins also reinforces this position, even if the government is moving more slowly, Sung said.

The Fed can “afford to take its time” in developing a digital dollar, Sung said. China is still years away from finalizing and then internationalizing e-CNY, even after eight years of work, he said.

Well-designed CBDCs could even help Western governments enforce sanctions because these coins are programmable, allowing the issuer to control access to the network of users, according to Alisa DiCaprio, chief economist at blockchain firm R3. This would make it faster and easier for regulators to find and freeze assets held by rogue actors.

“Having wholesale programmability and CBDC would give any issuer more control over what happens,” DiCaprio said. Wholesale CBDCs are used to settle transactions between financial institutions.

The strength of these assets may motivate the development of Western CBDCs and stimulate more research into how digital assets can support sanctions, according to Ananya Kumar, deputy director of digital currencies at the Atlantic Council.

“Blockchain-based systems provide traceability benefits that can make it easier to find and crack down on sanctions evasion,” Kumar said.