Last month, an international institution that is barely known outside central banker circles released a report that should concern all U.S. policymakers seeking to preserve U.S. influence in the global financial system. The Bank for International Settlements (BIS), an organization based in Switzerland that facilitates cooperation and policy support among central banks, published an overview of a pilot project with geopolitically destabilizing implications. The project offers a glimpse of how countries eventually may conduct large-scale international trade without going through conventional banking channels—channels that currently hinge on U.S. financial institutions and access to the U.S. dollar.
The project, called mBridge, is a blockchain technology pilot supporting “real time, peer-to-peer, cross-border payments and foreign exchange transactions using CBDCs [central bank digital currencies].” The peer-to-peer feature mentioned here is for banks. These transactions are “wholesale” payments between large financial institutions rather than retail payments involving individual consumers. Still, the platform is a “bridge” where multiple CBDCs can move digitally across national boundaries. The BIS Innovation Center in Hong Kong runs the pilot jointly with the central banks of Hong Kong, Thailand, the United Arab Emirates (UAE), and China. In the latest phase of the pilot, the central banks and various commercial banks conducted $22 million worth of international transactions for real corporate customers. These financial transactions settled instantly in situations that normally would take multiple days through the correspondent banking system that is the staple of global finance today.
Many CBDC proofs-of-concept are in the works where central banks use distributed ledger software acquired off the shelf from private-sector blockchain firms. What sets mBridge apart is that the central banker technologists themselves designed the blockchain protocol, calling it the mBridge Ledger, or mBL. Each of the four central banks involved in the pilot operate a node on the mBL platform to validate all transactions. And each central bank can onboard their domestic commercial banks to connect to and transact on the system. mBridge is for central banks, by central banks. While the project currently comprises just four central banks, it aims to expand the number of participants in future work.
The pilot participants conducted three types of important trade-related transactions. In one sort of scenario, central banks issued CBDCs directly to their domestic commercial banks. This is critical. International CBDC transactions are unattainable without a clear, reliable way to get central banks’ digital currencies into their private financial institutions. In another type of scenario, a business in one country would pay a business in another country through the commercial banks, but the receiving business got the payment in its country’s CBDC (like a UAE firm paying a Chinese business so that the Chinese firm receives funds in the form of the Chinese CBDC known as e-CNY). In the third type of transaction, commercial banks traded foreign exchange directly from one CBDC to another, such as a Thai bank trading e-THB for a Hong Kong Bank’s e-HKD.
Without CBDCs, these last two scenarios usually would involve going through many more commercial banks than just the two entities on either side of the transaction. And in many cases, the trades would involve transacting—somewhere along the line—in the U.S. dollar, the euro, or the Japanese yen due to these currencies’ liquidity and stability, even though the U.S., Japan, or any European country would not be part of the trade. So, the mBridge platform allows corporate firms and banks to transact with international counterparts directly, one-to-one in their own currencies, without having to deal with third-country banks and extraneous foreign exchange markets. Such peer-to-peer banking is an undeniable win for central bank payment efficiency.
Although mBridge may be a pilot, it likely will be built upon not only by nations seeking more efficient payment infrastructure, as all central banks should, but also by U.S. adversaries strategizing for ways around U.S. geopolitical influence, like China. In fact, the People’s Bank of China (PBOC) appears to have outsized influence in the mBridge program. China has been piloting its e-CNY for a few years already, and the BIS report noted that e-CNY issuance and redemption were faster than the other CBDCs because China’s central bank had automated systems already in place, making it easier to circulate their CBDC. Other central banks had to conduct certain actions manually, causing more friction.
The PBOC’s technical success with mBridge gives it some credibility in the eyes of other central banks considering CBDC standards. China is not just at the table of multilateral collaboration. It is poised to start setting the table. (It’s notable that the cloud server housing the data for the pilot was located in Hong Kong.)
None of this is happening in secret, nor is it organized as an outwardly geopolitical move. In fact, a large U.S. consulting firm is involved in the project and the Hong Kong subsidiaries of two European global banks (Standard Chartered and HSBC) participated in the pilot’s transactions. And back in 2019, the head of the Bank of England, undoubtedly a U.S. ally, suggested at a central bank conference in the U.S. that the world should create a CBDC-based trading system to lessen the global dominance of the U.S. dollar. Monetary sovereignty is a no-brainer for every country. The global dependence on correspondent banking relationships is getting costlier. The BIS’s own data from 2020 show that correspondent banking networks have been shrinking and getting more concentrated, particularly outside of North America. The current infrastructure does not serve the rest of the world as it does the U.S. What government would not want to streamline financial rails in order to keep one’s own currency on track?
But the infrastructure of cross-border finance is systemically important. Any major reorientation in those rails would have large geopolitical implications.
The mBridge is really phase one in the multilateral exploration to reorient the global financial order. And although this exploration is multilateral, it could parallel the Sputnik moment. The $22 million worth of transactions is small change in the scale of international trade, but taken to its logical conclusion, it would be revolutionary. America’s economic statecraft depends on the leverage its currency and financial institutions provide. If the U.S.-led global infrastructure becomes too expensive, the incentive increases for others to find a new way. And with the availability of blockchain and fintech innovation allowing central banks to experiment with payment systems, it is becoming more feasible that a new way could be made in China, or at least overseen by the communist country.
For the past two years, my colleague at the Center for a New American Security, Emily Jin, and I have been researching the People’s Republic of China’s domestic CBDC work. I’ve also been tracking the PRC’s broader blockchain research and development. These fintech projects make it clear that the Chinese Communist Party (CCP) sees financial digitalization as key to its own geopolitical leverage in a future world where money is inextricably linked to the economy of the internet. Data is a main factor of production in this vision. The CCP is planning accordingly, bringing data from as many transactions as possible within the monitoring of the state.
The U.S. is not an authoritarian regime, thankfully, and cannot centrally plan its future. But U.S. policymakers must think ahead, anticipate what is coming around the technological corner, and strategize accordingly. In 2022, the U.S. started in this direction. The Biden administration in March issued an executive order on “Ensuring the Responsible Development of Digital Assets,” tasking the government to assess the risks around quickly evolving cryptocurrency and fintech innovation. The interagency responded, most notably with the Treasury Department releasing a report in September titled “The Future of Money and Payments.” That report recommends that the U.S. study the feasibility of an American CBDC to determine whether creating one would even be in the U.S.’s interest. It also calls for the U.S. to improve payment efficiency, including for cross-border transactions, which are all very necessary steps for the administration to take.
Most of the government reports responding to the executive order focus on the risks around digital asset innovation. One exception is the Department of Commerce, whose report emphasizes fostering digital competitiveness and seeking economic opportunities through U.S. digital asset research and development. In fact, Commerce has a Digital Attache Program that deploys “digital trade officers” to U.S. embassies around the world with the goal of helping the U.S. engage with the increasingly digital global economy.
But in general, there is a big shortcoming in the current U.S. framework for digital asset development: It is more defensive than visionary. The White House explained that the recommendations from the reports following the executive order will “protect consumers, investors, businesses, financial stability, national security, and the environment.” Protect is the key word here. This posture signals defensiveness, safeguarding the U.S.’s current standing in the global economy. This is important, but it does not convey a vision for what the economy should look like when technological shifts are upending the analog order.
Understandably, it is difficult to map out a vision for new technology when the old technology has served you well. And there is little incentive to imagine new rails when the old ones are well under your control. U.S. policymakers may need to do a thought exercise in three steps. First, they need to identify the values that must be upheld in the domestic and international economy. (China has done this, and it starts and ends with the values of the CCP.) Second, they should imagine different infrastructure possibilities for financial transactions and cross-border trade. (When China did this, it identified fintech and blockchain innovation as priority research and development areas.) Third, policymakers should map out how the U.S. can move toward an economic future that upholds those values, using the target technologies, and then experiment with it. (China is doing that with mBridge as well as with its domestic fintech development that supports state surveillance.)
What is the American vision of the future economy? Right now, it appears to be simply protecting the U.S. from the risks ahead. Risk aversion is great for defense. It is bad for capturing economic opportunity.
A U.S. approach to the changing headwinds of central banking will have to consider U.S. strengths. One of our biggest is the flexibility that comes with innovation led by the private sector. If countries are going to create revolutionary cross-border payment infrastructure, running it on government infrastructure might actually be a recipe for innovation-killing bureaucracy. Imagine a world where a software upgrade to the operating system requires an act of Congress.
There is a rising debate in U.S. policy circles about whether or not the U.S. should launch a CBDC. And to its credit, although the Federal Reserve Board of Governors is internally conflicted on this issue, the Fed is conducting some important early-stage research into the technical possibilities of digital dollars. The New York Fed just launched a 12-week pilot with several large financial institutions to simulate wholesale payments. But they won’t be processing real-life transactions just yet. This could be seen as the West’s version of mBridge, albeit a year or two behind. And earlier in the year, the Boston Fed published its initial research on a possible U.S. CBDC design, in collaboration with the Massachusetts Institute of Technology’s Digital Currency Initiative. Their work scopes out some of the critical privacy issues that technologists and policymakers need to figure out before creating a U.S. digital dollar.
The Soviet Union put a man in space first. But that space race was won not by the initial milestone, but by how the U.S. responded during the years in its aftermath. So the likelihood that China and its mBridge partners will get to multi-CBDC interoperability first may not matter all that much. To win in this global competition of digital finance, the U.S. must first realize that the race has already started and a plan is needed. The race won’t be won by doing what is easy, but by doing the visionary things that are hard.
