Digital Currency Wars: A National Security Crisis Simulation

Digital Currencies: The Basics

• What is a digital currency?

  A digital currency is any type of currency that exists in digital form (versus bills and coins). Think credit cards, Venmo, and your Starbucks gift card -- these are all ubiquitous forms of digital money. In addition, there are two broad categories of emerging digital currencies: government-issued versus privately-issued currencies.

  A government-issued digital currency is commonly referred to as a Central Bank Digital Currency (CBDC). It is simply the digital form of a country’s fiat currency. Instead of printing paper bills and minting coins, the central bank issues unique digital tokens, whose value is backed by the full faith and credit of the government. So how is this different from your credit card or Venmo balance today? CBDCs (like cash) are the liability of the central bank, which would typically maintain reserves, deposits and accounts, rather than a private firm.

  Non-government digital currencies are commonly referred to as virtual currencies. These may also be centralized, i.e., issued and regulated by an administrator, for example Amazon Coin. Decentralized virtual currencies are commonly known as cryptocurrencies, for example bitcoin. Cryptocurrencies run on distributed-ledger technology, which basically means that instead of a central authority, many devices maintain independent records of transaction activity and use consensus models to decide which copy is correct. Cryptocurrencies also employ a number of algorithms and cryptographic techniques to ensure that they are secure.

• Why might a country want a Central Bank Digital Currency (CBDC)?

  Central banks are still in the early stages of exploring the use cases for CBDCs. According to the IMF, a key reason that advanced economies may be considering CBDCs is to counter the growth of private forms of digital money. Essentially, as users demand the convenience and low-cost of digital payments, governments may be asking the question, ‘if not us, then who?’ As these economies become increasingly cashless, apps like Venmo, WeChat, and M-Pesa are facilitating greater payments volumes, raising concerns about consumer protection, data privacy, and operational risks. Recent proposals like Facebook’s Libra currency may further encourage policymakers to explore a solution before users adopt an alternative over which the government has limited control. In emerging economies, CBDCs are primarily being considered as a means to increase financial inclusion, by allowing governments to include unbanked populations in the digital economy. Finally, CBDCs could offer efficiency benefits, like faster, more secure, and cheaper payments and more effective mechanisms to implement monetary policy.

  Of course, there are plenty of risks too. CBDCs could  give governments the capability to surveil users – good for tracking criminals, but a concern for the privacy of ordinary citizens. There may be implications for financial stability; for example, business models for banks and payments platforms would need to change if people are using government-provided digital cash. And, the CBDC system would be a critical point of vulnerability to cyber attacks and other operational risks.

• Where are we in the development of digital currencies?

  We’ve come a long way since bitcoin brought digital currencies into the mainstream in 2009. Today, about 3,000 digital currencies have a total market value of over $250 billion. Of these, bitcoin ($170 billion market cap), ethereum ($20 billion), and Ripple ($13 billion) are the three largest. The overall value of digital currencies is tiny compared to the $1.7 trillion U.S. dollars in circulation. Nonetheless, a few proposed projects stand out for their ambition and potential impact.

  As far as CBDCs go, the People’s Bank of China (PBoC) has proposed releasing a digital yuan as early as 2020. Details are sketchy, but the currency would replace cash yuan, be governed by the PBoC, and be available on major payments platforms like AliPay and WeChat. In a country where annual mobile payments volumes are nearly $800 billion (10x U.S. volumes), a digital currency could see rapid adoption.

  Meanwhile, Facebook has proposed introducing its own digital Libra coin, backed by a basket of fiat currencies and governed by a consortium of private companies. Given Facebook’s 2 billion-plus users and cross-border reach, Libra has the potential to become a dominant form of payment around the world.

• Why does this matter for U.S. national security?

  When bitcoin first hit the scene, the novelty was that no one was in charge – through a complex system of distributed ledgers, consensus protocols, and cryptography, the currency could exist in a peer-to-peer network with no central administrator. The most promising digital currency projects today are very different. The Chinese government will manage the digital yuan, and Facebook – though it claims to be working toward a decentralized system – is very much at the helm of Libra. Wide adoption of these or similar digital currency projects would place a lot more power in the hands of the currency operators, and away from the U.S. government.

  What’s more, much of the global payments infrastructure today – like messaging, clearing, and settlement systems – are under the purview of U.S. authorities. If alternative systems were developed to support these digital currencies – such as China’s Crossborder Interbank Payment System (CIPS), the U.S. could lose the ability to monitor and regulate payments flows.

  Here are just a few of the national security implications:

  Sanctions: Few experts expect the U.S. dollar to lose its dominant status, but competing global currencies and payments infrastructure could reduce the impact of U.S. policies like economic sanctions, since adversaries could simply switch to a different currency.
  Illicit activities: Most digital currency transactions are unlikely to be anonymous, but U.S. authorities would need to coordinate with the Chinese government, Facebook officials, or other currency operators to gather information on illicit transactions.
  Data privacy: Digital currencies will ultimately generate a lot of data on how individuals spend their money, raising concerns about surveillance, data manipulation, and other privacy breaches.
  Data security: Digital currencies face security vulnerabilities like any other technology. Cyberattacks and security breaches could lead to stolen currency and personal data, and even bring economic activity to a standstill.