Opportunities for digital assets in a fractured world

Lane, Timothy D. Working Paper Opportunities for digital assets in a fractured world CIGI Papers, No. 326 Provided in Cooperation with: Centre for International Governance Innovation (CIGI), Waterloo, Ontario Suggested Citation: Lane, Timothy D. (2025) : Opportunities for digital assets in a fractured world, CIGI Papers, No. 326, Centre for International Governance Innovation (CIGI), Waterloo (Ontario) This Version is available at: https://hdl.handle.net/10419/322469 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ CIGI Papers No. 326 — July 2025 Opportunities for Digital Assets in a Fractured World Timothy Lane CIGI Papers No. 326 — July 2025 Opportunities for Digital Assets in a Fractured World Timothy Lane About CIGI The Centre for International Governance Innovation (CIGI) is an independent, non-partisan think tank whose peer-reviewed research and trusted analysis influence policy makers to innovate. Our global network of multidisciplinary researchers and strategic partnerships provide policy solutions for the digital era with one goal: to improve people’s lives everywhere. Headquartered in Waterloo, Canada, CIGI has received support from the Government of Canada, the Government of Ontario and founder Jim Balsillie. À propos du CIGI Le Centre pour l’innovation dans la gouvernance internationale (CIGI) est un groupe de réflexion indépendant et non partisan dont les recherches évaluées par des pairs et les analyses fiables incitent les décideurs à innover. Grâce à son réseau mondial de chercheurs pluridisciplinaires et de partenariats stratégiques, le CIGI offre des solutions politiques adaptées à l’ère numérique dans le seul but d’améliorer la vie des gens du monde entier. Le CIGI, dont le siège se trouve à Waterloo, au Canada, bénéficie du soutien du gouvernement du Canada, du gouvernement de l’Ontario et de son fondateur, Jim Balsillie. Copyright © 2025 by the Centre for International Governance Innovation The opinions expressed in this publication are those of the author and do not necessarily reflect the views of the Centre for International Governance Innovation or its Board of Directors. For publications enquiries, please contact [email protected]. The text of this work is licensed under CC BY 4.0. To view a copy of this licence, visit http://creativecommons.org/licenses/by/4.0/. For reuse or distribution, please include this copyright notice. This work may contain content (including but not limited to graphics, charts and photographs) used or reproduced under licence or with permission from third parties. Permission to reproduce this content must be obtained from third parties directly. Centre for International Governance Innovation and CIGI are registered trademarks. 67 Erb Street West Waterloo, ON, Canada N2L 6C2 www.cigionline.org Credits President, CIGI Paul Samson Research Director, Digital Economy S. Yash Kalash Director, Program Management Dianna English Program Manager Jenny Thiel Publications Editor Susan Bubak Publications Manager Jennifer Goyder Graphic Designer Sami Chouhdary Table of Contents vi About the Author 1 Executive Summary 1 Introduction 2 Geoeconomic Fragmentation and the US Dollar 3 Are Digital Assets Part of the Solution? 6 Conclusion 7 Works Cited vi CIGI Papers No. 326 — July 2025 • Timothy Lane About the Author Timothy (Tim) Lane is a senior fellow at CIGI and a former deputy governor of the Bank of Canada (BoC) from 2009 through 2022. He shared responsibility for monetary policy and undertook a series of other responsibilities covering all main areas of central bank policy making. He led the BoC’s work on central bank digital currency and payments modernization, and chaired the Financial Stability Board’s international working group on stablecoin regulation. Previously, he led the BoC’s international work, serving as G7 and G20 Deputy. Before joining the BoC, Tim served for 20 years at the International Monetary Fund (IMF), where he worked on a range of issues concerning advanced and emerging market economies. He has published research on monetary policy and on a variety of other topics related to economic and financial policy. He was also a visiting fellow at the University of Oxford. Prior to his work at the IMF, Tim served as assistant professor of economics at Michigan State University and at the University of Iowa. He received a B.A. from Carleton University in Ottawa and an M.A. and a Ph.D. from the University of Western Ontario in London. 1Opportunities for Digital Assets in a Fractured World Executive Summary As the global economic and financial systems become increasingly fractured, this may undermine the US dollar’s central role in international trade and finance. Dollar dominance stems from the US economy’s weight in world trade, the depth and liquidity of its financial markets, and, more generally, trust that US dollar assets can be accessed with very limited risk of capital controls, confiscation or default. These foundations are weakening, but any potential replacement, including digital assets, would face considerable challenges. For crypto-assets such as bitcoin, the inherent instability of their purchasing power limits their usefulness for international transactions. Stablecoins, in contrast, promise stable purchasing power through their link to fiat currency — primarily the US dollar. They are beginning to have a significant role in international transactions, especially remittances. But maintaining that link implies close connections with the US financial system and requires a sound regulatory framework. Stablecoins thus seem more likely to become a vehicle for expanding the role of the US dollar, rather than enabling other jurisdictions to lessen reliance on the United States. In this context, many countries are exploring central bank digital currencies (CBDCs), including with a view to maintaining monetary sovereignty. Few economies are currently moving to launch a CBDC, but that could change. If several key countries launched their own CBDCs, recent experiments with making CBDCs interoperable could point the way to facilitating transactions outside the US orbit. But that approach would require an unusual degree of cooperation among participating jurisdictions. Introduction How will the world’s money evolve in an age of geoeconomic fragmentation?1 After decades of globalization — with the United States at the centre — the process of liberalizing world trade and finance has begun to be reversed. The world is increasingly becoming fractured along economic and financial as well as political lines. Does that spell the end of the US dollar’s dominance? If so, does that create opportunities for digital assets to take its place? These questions are related to the trust that is fundamental to all money and payments: trust that money can be transferred freely and accepted with a stable purchasing power. Internationally, the dominance of the US dollar relies on the currency’s stability as a means of payment for imports. It also depends on the openness of the US financial system, with confidence that US-based assets can be used and transferred without interference.2 While trust among nations is always limited and conditional, it is now deteriorating. World trade is becoming increasingly segmented with mounting trade restrictions and the rejection of the rules-based framework for international trade (Gopinath 2023). The increasing application of financial sanctions that are not supported or respected by many key trading countries has weakened confidence that US-based assets can be transferred freely and raised questions about the use of US-centred financial infrastructure. These trends were already in play prior to this year, but they have been accelerated by the current US administration’s actions and pronouncements — including erratic trade policy announcements, belligerence toward US allies, fiscal irresponsibility, and challenges to the Federal Reserve’s independence and to the rule of law more generally. These forces may undermine the US dollar’s central role as a reserve and trading currency. 1 The term “geoeconomic fragmentation,” used by Gita Gopinath (2023) and Ahn et al. (2023), seems best to characterize this set of developments. 2 Despitethegeneralopennessofmajoreconomiestofinancialflows, cross-borderpaymentsremainnotoriouslyexpensive,slowandlacking intransparency.TheGroupofTwentyhasdevelopedaroadmapfor addressingtheseproblems,butprogresshassofarbeenslow(Financial Stability Board [FSB] 2024). 2CIGI Papers No. 326 — July 2025 • Timothy Lane In theory, this scenario could create opportunities for digital currencies, which are designed to be trust-free. Crypto-assets were originally motivated by the libertarian vision of eliminating the need for trusted third parties, such as the central bank and commercial banks, replacing them with an algorithm that creates an incentive mechanism to maintain the crypto asset’s value and validate transactions. Could this be part of the solution to the breakdown of trust associated with geoeconomic fragmentation? This paper discusses how geoeconomic fragmentation may undermine the role of the US dollar. It then examines the potential role of digital assets, including crypto-assets, stablecoins and CBDCs. It concludes that none of these is yet in a position to supplant the US dollar as the world’s money of the future. Geoeconomic Fragmentation and the US Dollar The US dollar is the dominant means of payment and invoicing unit in international trade, as well as the main international reserve currency. Likewise, global payments rely largely on infrastructures such as SWIFT (the Society for Worldwide Interbank Financial Telecommunication) that are subject to substantial US influence and control. The dominance of the US dollar arose in the context of the unrivalled size and strength of the US economy in the aftermath of the Second World War. It has continued despite the declining US share in the world economy and global trade, and despite the emergence of other large currency areas. In the early 2000s, some observers expected the euro to take on a much larger international role given the economic weight of the euro area. Then, in the last decade, China’s emergence as the world’s secondlargest economy, and rapid growth, seemed to set the stage for the renminbi (RMB) to challenge US dollar dominance. But neither of these currencies has made substantial inroads on the supremacy of the US dollar. In particular, despite China’s active promotion of the internationalization of the RMB, marked by the International Monetary Fund’s 2016 decision to include the RMB in the currency basket for the special drawing rights, China’s currency still accounts for a small share of trade invoicing and payments and international reserve holdings, relative to the country’s economic weight. There has been much analysis of the dominance of the US dollar — termed “exorbitant privilege” as it enables the United States to spend beyond its income and borrow at lower market rates. Some key factors are the importance of the United States in world trade in the context of globalization, together with the depth, liquidity and openness of the US financial markets and the US government’s strong creditworthiness, which has made US Treasury bonds the ultimate safe asset. There is a virtuous circle, in which invoicing of trade in US dollars and holding assets in that currency are mutually reinforcing (Gopinath and Stein 2021). Underpinning it all is confidence that US dollar assets can be accessed under all circumstances — with very limited risk of capital controls, confiscation or default. How is this environment changing in an age of geoeconomic fragmentation? Globalization began to be reversed in the aftermath of the 2007–2008 global financial crisis. The fragility of supply chains in the wake of the COVID-19 pandemic further fuelled talk of reshoring or friendshoring, with heightened perceptions that the world is dividing into trading blocs. While trade between blocs continues to be enormous, this trade has been diverted through more roundabout channels, stretching the links with the United States (Fajgelbaum et al. 2024; Qiu, Shin and Zhang 2023). Another challenge to US dollar dominance is the return of the “Triffin paradox” of the 1960s. The logic is that a reserve currency country needs to run balance of payments deficits to meet growing world demand for reserves, but those deficits can be viewed as a negative sign of the reserve currency country’s economic health. The current US administration’s obsession with bilateral trade deficits, and threats to impose tariffs to eliminate them, runs up against this paradox.3 A further contradiction is the threat to 3 Inprinciple,eveniftradewerebalanced,theUnitedStatescouldprovide reserveassetstotherestoftheworldwhileacquiringforeignequityand other risky assets — and, indeed, this does happen to some extent. But financialfragmentationandgeopoliticalriskmaylimitsuchoffsetting portfolioflows(Catalán et al. 2023).