The Coming Battle of Digital Currencies

We model the dynamic competition among national fiat currencies, cryptocurrencies, and Central Bank Digital Currencies (CBDCs), whereby a country’s fiscal strength and currency strength are mutually reinforcing. The rise of cryptocurrencies hurts stronger fiat currencies (e.g., USD), but can benefit weaker fiat currencies by reducing competition from stronger ones. Regulatory reserve requirements on stablecoins pegged to a fiat currency (e.g., USDT and USDC) can mitigate the adverse effects of cryptocurrencies on that currency. Countries strategically implement CBDCs in response to competition from emerging cryptocurrencies and other currencies. Our model reveals the following pecking order: Countries with strong but non-dominant currencies (e.g., China and India) have the highest incentives to launch CBDCs to gain technological first-mover advantage and potentially mitigate extant adverse dollarization; countries with the strongest currencies (e.g., the United States) are the next in line and benefit from developing CBDC early on to nip cryptocurrency growth in the bud and to counteract competitors’ CBDCs; nations with the weakest currencies forgo implementing CBDCs and adopt cryptocurrencies instead. Overall, strong fiat currency competition and the emergence of cryptocurrencies spur financial innovation and digital currency development. Our findings help rationalize recent developments in currency and payment digitization, while providing timely insights into the global battle of currencies and the future of money. rencies hurts the stronger currency, but may benefit weaker currencies by reducing fiat competition and dollarization. Reserve requirements on stablecoins mitigate the impact of cryptocurrencies on the fiat currencies they are pegged to. Our findings suggest that the U.S. and the U.S. dollar can potentially benefit from regulation that requires U.S. dollar stablecoins to be backed by U.S. dollar reserves, so as to seize part of the seigniorage from stablecoin issuance. Because countries’ strategic decisions to implement CBDCs reflect the competition from both emergent cryptocurrencies and other fiat currencies, a pecking order for digital currency development emerges: Countries with strong but non-dominant currencies (e.g., China) tend to have the highest-powered incentives to launch CBDC first so as to attain a technological and cumulative first-mover advantage; countries with dominant currencies (e.g., the U.S.) are motivated to launch CBDC early on both to nip cryptocurrency growth in the bud and later to counteract a competitor’s CBDC; nations with the weakest or without a sovereign currency may opt for cryptocurrencies or stablecoins pegged to a basket of currencies or a consumption index to avoid (digital) dollarization. In general, weaker national currencies imply a vacuum in the currency space and so favor the emergence of cryptocurrencies as competitors and boost countries’ incentives to implement CBDC, both spurring valuable financial innovations. Our findings help rationalize recent developments in the digitization of money and payment innovations, while offering insights into the future of money and the global battle of both digital and conventional currencies.