The Coming Battle of Digital Currencies

We model the dynamic global competition among national fiat currencies, cryptocurrencies, and Central Bank Digital Currencies (CBDCs) among multiple countries, 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