2020 International Monetary Fund DIGITAL MONEY ACROSS BORDERS: MACRO- FINANCIAL IMPLICATIONS IMF staff regularly produces papers proposing new IMF policies, exploring options for reform, or reviewing existing IMF policies and operations. The following document(s) have been released and are included in this package: The Staff Report prepared by IMF staff and completed on September 22, 2020. This report prepared by the IMF staff was presented to the IMF Executive Board in an informal session on October 8, 2020. The views expressed in this paper are those of the IMF staff and do not necessarily represent the views of the IMFs Executive Board. The IMFs transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities policy intentions in published staff reports and other documents. Electronic copies of IMF Policy Papers are available to the public from imf/external/pp/ppindex.aspx International Monetary Fund Washington, D.C. October 2020DIGITAL MONEY ACROSS BORDERSMACRO-FINANCIAL IMPLICATIONS EXECUTIVE SUMMARY Rapid ongoing progress with digital technologies has increased the prospects for adoption of new forms of digital money for both domestic and international transactions. These include central bank digital currencies (CBDCs) and the so-called global stablecoins (GSCs) proposed by large technological companies or platforms. This paper explores the complex interactions between the incentives to adopt and use CBDCs and GSCs across borders and discusses the potential macro-financial effects. The use of currencies internationally reflects the economic weight of issuing countries and broader geopolitical factors. In addition, strong network effects and synergies across the three functions of money (unit of account, means of payment, and store of value) act as self-reinforcing mechanisms: Once a currency is dominant, it has tended to stay dominant. Moreover, the use of foreign currencies for domestic transactions (“currency substitution”) depends on the degree of monetary stability and other country circumstances, including legal frameworks and regulation. However, digitalization could drive international use of currencies in ways that are distinct from traditional dynamics. CBDCs and GSCs potentially lower transaction costs by increasing competition, widen access to services and promote financial inclusion through mobile devices, and open the possibility of complementary services offered on social networking and e-commerce platforms of global scale. The economic consequences and policy challenges depend critically on the degree of adoption. Since the latter is difficult to predict, this paper presents different stylized adoption scenarios to examine potential consequences. These range from niche use for small cross-border payments, to pervasive adoption in a subset of countries, to global adoption of a single GSC, or a multipolar world featuring intense competition between a few major CBDCs and GSCs. The purpose of presenting scenarios is to illustrate and explore the possible implications of adoption. This is not an effort to forecast specific outcomes or judge their desirability. The benefits of using CBDCs and GSCs for cross-country transactions are conceptually clear, although difficult to quantify at this stage. Making a payment or transferring September 22, 2020DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS 2 INTERNATIONAL MONETARY FUND funds across borders could be just as easy as sending an email. This could reduce transaction costs to the benefit of end users, especially for small transactions. Perhaps more importantly, it affords the prospect of access to a wide range of other cross- border financial services leveraging the big data generated from individual transactions. At the global level, currency competition due to the adoption of CBDCs and GSCs could lead to improved risk-sharing in the longer term. Digital money adoption across borders also entails risks and policy challenges. Foreign CBDCs and GSCs could raise pressures for currency substitution and worsen vulnerabilities from currency mismatches. They could reduce the ability of local authorities to run monetary policy. Without appropriate safeguards, they could facilitate illicit flows and make it harder for regulatory authorities to enforce exchange restrictions and capital flow management measures. In the case of GSCs, there are additional challenges relating to their governance. In addition to domestic advantages, cross-border use of CBDCs could help firms and households in issuing countries better manage risks (e.g., by issuing debt denominated in their own currency). But to the extent that it meaningfully increases financial integration without a commensurate development of financial markets and institutions, the issuing countries could have increased exposures to global shocks. Overall, the paper finds that CBDCs do not qualitatively change the economic forces that lead to the international use of currencies but quantitatively could reinforce the incentives behind currency substitution and currency internationalization. GSCs that do not represent independent units of account are similar to CBDCs in terms of monetary effects but could affect financial stability as they may suffer from bouts of confidence crisis. GSCs that represent new and independent units of account could similarly offer improved financial services but have a potentially more fundamental impact on global monetary and financial stability. With its universal membership and mandate for safeguarding international monetary and financial stability, the IMF is uniquely positioned to consider the macro-financial effects and policy implications of these developments in both bilateral and multilateral surveillance, and capacity development.DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS INTERNATIONAL MONETARY FUND 3 Approved By Tobias Adrian Gita Gopinath Martin Mhleisen Rhoda Weeks-Brown Prepared by an inter-departmental staff team led by Dong He, Tommaso Mancini-Griffoli (both MCM), Giovanni DellAriccia, Maria Soledad Martinez Peria (both RES), Vikram Haksar (SPR), and Yan Liu (LEG), and comprising Itai Agur, Gareth Anderson, Wouter Bossu, Yan Carriere-Swallow, Hee Kyong Chon, Julia Faltermeier, Jose Garrido, Dirk Jan Grolleman, Shushanik Hakobyan, Alina Iancu, Annamaria Kokenyne Ivanics, Marcello Miccoli, Adina Popescu, Nadine Schwarz, Natalia Stetsenko, and Nobuyasu Sugimoto. Federico Grinberg, Nigel Jenkinson, Tanai Khiaonarong, and Fabiana Melo also provided input. The team benefited from comments by Professors Markus Brunnermeier and Rodney Garratt. Donna Tomas provided administrative assistance. CONTENTS Glossary _ 5 INTRODUCTION _ 6 Overview _ 6 What are CBDCs and GSCs _ 9 ADOPTION AND USE SCENERIOS _ 12 Factors Affecting CBDC and GSC Adoption _ 12 Hypothetical Scenarios _ 15 MACRO-FINANCIAL CONSEQUENCES _ 18 Monetary Policy Transmission _ 18 Financial Stability _ 21 Capital Flows _ 25 International Reserves _ 26 POLICY IMPLICATIONS_ 28 Macroeconomic Policies _ 28 Exchange Restrictions and CFMs _ 29 Legal Frameworks _ 31 Regulatory Policies _ 32 Structural Policies _ 33 CONCLUSIONS _ 34DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS 4 INTERNATIONAL MONETARY FUND BOXES 1. Money and Currency: Legal Definitions _ 11 2. CBDCs, GSCs, and the Structure of Financial Intermediation _ 22 FIGURES 1. Evolving Landscape for Cross-border Payments _ 7 2. Terminology of Digital Money _ 9 3. International Use of Currencies _ 13 4. Stylized Scenarios _ 16 ANNEXES I. Current Landscape of Cross Border Use of Currencies _ 37 II. The Extent and Dynamic of Currency Substitution _ 39 III. Glossary of Technical Terms _ 41 References _ 42DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS INTERNATIONAL MONETARY FUND 5 Glossary AML/CFT Anti-Money Laundering and Combating the Financing of Terrorism BIS Bank for International Settlements Big Techs Large technological companies or platforms CBDC Central Bank Digital Currency CFM Capital Flow Management Measures CPMI Committee on Payments and Market Infrastructures DLT Distributed Ledger Technology E-Money Electronic Money FATF Financial Action Task Force FSB Financial Stability Board GSC Global Stablecoin ICO Initial Coin Offering IMS International Monetary System IMF International Monetary Fund OECD Organization for Economic Cooperation and Development RegTech Regulatory Technology SupTech Supervisory TechnologyDIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS 6 INTERNATIONAL MONETARY FUND INTRODUCTION Overview 1. New forms of digital money are increasingly capturing policymakers attention. These include central bank digital currencies (CBDCs) currently envisaged by some countries, and the so- called global stablecoins (GSCs) proposed by large technological companies or platforms (“Big Techs”). Potential motivations for the introduction of CBDCs and GSCs vary. Some see them as payments solutions facilitating peer-to-peer or peer-to-business transactions, especially across borders. Others view them as complements to large e-commerce ecosystems. More recently following the COVID-19 pandemic crisis, governments are also exploring CBDCs as a fast and direct means to provide fiscal assistance to vulnerable populations during the emergency, including to the unbanked. 2. Digitalization of money and payments has the potential to shock the organization of the international financial system. Recent breakthroughs and cost reductions in digital technology such as cloud computing and the proliferation of mobile devices have dramatically increased the accessibility by individuals and firms to payment instruments previously used only by financial institutions (e.g., real time transfer of balances maintained at central banks). At the same time, distributed ledger technology (DLT) such as blockchain has made it possible to use digital tokens to transfer value over a peer-to-peer system without necessarily going through a central party (for example, commercial or central banks). 1 Making a payment overseas could be just as easy as sending an email. As a result, the present international monetary landscape, which is based on connecting banking systems spread around the globe in different locations and time zones, could be reconfigured (Figure 1). 3. CBDCs and GSCs could make cross-border payments less costly and make it easier for households and small firms to have access to financial services. Based on a sample of 112 countries, Bank for International Settlements (BIS) (2020, p. 84) reports that the average total cost of a US$200 bank-based cross-border remittance is over 10 percent of the remittance value. Remittances to developing countries exceeded US$550 billion in 2019 surpassing FDI and portfolio flows. At the same time, the share of adults without access to a bank account stands above 50 percent in parts of the developing world, such as Sub-Saharan Africa, North Africa and the Middle East (BIS, 2020, p. 72). As a result, a majority of the population do not have access to banking services, including cross-border payments. Much of the aforementioned costs reflects service charges and cost recovery by financial intermediaries. Hence, while it is difficult to quantify the benefits, it is clear that CBDCs and GSCs have the potential to lead to significant efficiency gains by flattening the multi-layered correspondent banking structure and shortening the payment chains. 4. At the same time, foreign CBDCs and GSCs could make it harder for country authorities to run independent monetary policies and control domestic financial conditions. By increasing the accessibility of foreign currencies for domestic use, CBDCs and GSCs could raise 1 See Annex III for an explanation of the technical terms used in this paper.DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS INTERNATIONAL MONETARY FUND 7 pressures for currency substitution and worsen risks of currency mismatch. Without appropriate safeguards, they could facilitate illicit flows and make it harder for regulatory authorities to enforce exchange restrictions and capital flow management measures (CFMs). While the application of digital technology in regulation and supervision (“RegTech” and “SupTech”) may empower authorities in enforcing compliance, their effectiveness remains a work in progress. Figure 1. Evolving Landscape for Cross-border Payments Source: IMF staff. 5. The scale and scope of CBDC and GSC adoption will be subject to strong network effects but will also depend on design features, country circumstances, legal frameworks, and regulation. Digitalization has the potential to disrupt existing equilibria of cross-border use of currencies. Some of the attributes of these new forms of digital money could drive adoption in ways that are distinct from existing dynamics. They lower transaction costs by reducing reliance on banks, widen access to services and promote financial inclusion through mobile