As crypto markets continue to gain attention and digital technologies threaten to disrupt the entire financial system, governments and reserve banks are eager to hold on and reassert themselves. Some including India, Nigeria, and turkey, have proposed to ban decentralized crypto assets due to the risk of money laundering and tax evasion. At the same time, a lot – especially china – explore how they could leverage digital technologies to create their own centralized central bank digital currencies (CBDCs) and potentially challenge U.S. monetary hegemony and the value proposition of decentralized crypto assets.

U.S.-Chinese competition in particular is intensifying, with China taking steps to disrupt and outperform the US dollar-centric global financial system, in particular by investing massively in the global fintech revolution, by using a alternative to the SWIFT systemand throw a digital currency at the 2022 Winter Olympics.

The US Federal Reserve released a paper and is currently consulting on the need for a US CBDC. Civil servants have largely raise the shoulders the threat the advantage of the leading Chinese player in digital currencies could pose a problem to the reserve status and central role of the US dollar in the global economy. But disruptive innovation tends to punish the pride and inaction of incumbent operators. The hegemony of the dollar provided huge benefits for the United States, including ease of borrowing and the ability to enforce sanctions, terrorist financing and money laundering laws. The United States will not want to endanger him.

Governments are right to denounce the risks associated with new technologies that threaten to overthrow the financial system on which we depend. The most cited risks often relate to tax evasion, money laundering, terrorist financing, sanction evasion and systemic financial risk. As an example, China and Iran seem to prioritize bitcoin mining as a means of bypass US sanctions.

Exaggerated risks of cryptocurrencies

In reality, however, only 0.34% of all cryptocurrency activity in 2020 was linked to criminal activity, according to Chainalysis’ 2021 report, significantly less than the UN estimate the proportion of money laundering in the global economy. Indeed, while cryptocurrencies appear anonymous, chain analysis methodologies can often reveal who owns a wallet in order to identify illicit activity and sanctioned entities. Otherwise, Know your customer Type Regulatory Requirements (KYC) require intermediaries and exchanges to collect tax and identity data to ensure compliance.

That said, currencies and privacy-focused assets like Monero and Zcash obscure the public ledger, but unlike cash, they still provide some form of transfer record minus the details of the source, amount. or destination and fit within the financial regulatory structure used by the United States Financial Crimes Enforcement Network (FinCEN), Financial Action Task Force (FATF) and others.

Legitimate risks of centralized digital currencies

CBDCs can come in two forms, wholesale or retail, which determine whether they will be disbursed through banks or bypassing banks altogether. Wholesale CBDCs would only be accessible to financial institutions and thus preserve the status quo while making wholesale financial systems faster, cheaper and more secure. However, retail CBDCs would allow the general public to hold deposits directly with central banks, withdrawing deposits and transactions from traditional banks and payment intermediaries, thereby endangering their operating models.

In addition, the central banks of developing countries concerned about third party stablecoins as a key threat to their monetary sovereignty. These are pristine cryptocurrencies, such as Tether or Facebook’s Diem, that do not have the backing of a central bank. Contrary to what their name suggests, they are not necessarily as stable and could still draw consumers away from fiat currencies, further weakening the central bank’s ability to conduct monetary policy.

With COVID-19 accelerating the shift from physical cash payments to digital payments, privacy advocates have also warned that a The cashless and intermediated economy is also a surveillance economy. Navigating the trade-off between privacy and abuse will be essential in keeping societies open. This requires a mature regulatory framework, which keeps state power in check and respects privacy – a major concern with a centralized Chinese CBDC.

Possibility of extending the American bank to the decentralized world

With a well-governed and trusted CBDC, the United States has the opportunity to deepen its role in the global financial system and to overtake China’s digital currency efforts by expanding American banking power to the world and supporting the next generation of financial innovation and inclusions.

With 7.1 million families considered to be underbanked and a stated goal of improve financial inclusion and fight poverty, there are already strong national arguments in favor of the development of a CBDC by the Federal Reserve. In addition, a US dollar CBDC could provide a reliable and stable currency for cross-border transactions and help strengthen innovation in decentralized finance (DeFI) by allowing consumers to get into a stable asset. It could turn every phone into a bank account and bank terminal, capable of performing complex domestic and international transactions and attracting crypto capital from around the world.

The digital dollarization of the United States would pose a similar threat to small reserve banks as stablecoins; however, the United States has the opportunity to set the global regulatory agenda by working with the International Monetary Fund or the Bank for International Settlements to mitigate this risk.

While the United States may prefer the status quo, China’s digital currency and other decentralized financial innovations threaten its position. The United States has no choice but to compete by exploring its own CBDC and crafting a new governance framework if it is to maintain its leadership role in the global financial order.

Arjun Bisen is a Fulbright researcher, technology policy advisor, former Australian diplomat, and affiliate of the Technology and Public Purpose Project at the Belfer Center for Science and International Affairs at Harvard Kennedy School. Follow him on Twitter @ ArjunBisen1