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, but can benefit weaker fiat currencies by reducing competition from stronger ones. 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 have the highest incentives to launch CBDCs to gain technological first-mover advantage; countries with the strongest currencies are the next in line to 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. We further extend the framework to understand the role of stablecoins in currency competition, and study the effects of currency competition and cryptocurrencies on financial innovation. Our findings help rationalize recent developments in currency and payment digitization, while providing insights into the battle of currencies and the future of money.