With Hong Kong likely to issue its electronic Hong Kong Dollar (e-HKD), this month, U.S. policymakers need to anticipate what a successful issuance of Hong Kong’s digital fiat means for the existing global financial order. An examination of why Hong Kong may want its own central bank digital currency (CBDC), its fintech development strategy and its diminishing political openness leaves plenty of room for U.S. national security concerns.
The e-HKD is Hong Kong’s bid amid a Cambrian explosion of central bank digital currency projects around the globe. Hong Kong started exploring a CBDC in 2017. U.S. policymakers may applaud the HKMA’s care in designing its CBDC. The e-HKD’s Bank for International Settlements (BIS) paper discussing different CBDC issuance models is thoughtful, covering the design trade-offs between operational division of labor and data security. If the “safety, privacy and flexibility” principles of the pilot actually manifest in the e-HKD, it would be wonderful news to U.S. policymakers. However, it is important to consider why Hong Kong wants to issue the e-HKD in the first place.
Emily Jin is a research assistant at the Center for a New American Security. This opinion piece is part of CoinDesk’s Crypto 2023 outlook.
Typical drivers for issuing digital central bank money, such as enhanced financial inclusion and reduced credit risk, seem good on paper, but are not convincing when considered in Hong Kong’s financial context. Since the under-banked population is negligible in Hong Kong, financial inclusion alone is not a compelling rationale to promote the e-HKD (and even the HKMA policy paper agrees). The second motivation of mitigating credit risk during financial instability has more mileage. Introducing CBDC like the e-HKD to the public means they can hold central bank money in electronic form. Because the e-HKD is the liability of the central bank it is not tied to the failure of commercial entities, which then reduces credit risk. Granted, Hong Kong’s status as an international financial center is on shaky ground given mainland China’s firm grasp on Hong Kong’s political liberty and democratic governance. Nevertheless, there does not seem to be a systemic credit event on the horizon that would warrant issuing a CBDC as a preemptive response.
I believe Hong Kong’s real motivation for issuing its own CBDC is it wants to determine how tomorrow’s alternative financial pipelines are built. There are potential network effects as more central banks adopt CBDCs. Academics have argued that a multi-CBDC future would likely be decentralized. In contrast to the current global financial network, which is centralized around the U.S. dollar and U.S. financial leadership, the future CBDC network might have many central banks, or “nodes,” connecting to each other via CBDC-to-CBDC platforms. In a CBDC future, many central banks could ostensibly tip the financial power imbalance away from the U.S. and other developed economies by adopting CBDCs early and influencing CBDC standards. It is to no one’s surprise that a financial hub like Hong Kong would not want to miss out on this CBDC “Sputnik moment.” In October Eddie Yue, the chief executive of the HKMA, remarked that “more is more” when it comes to adopting new platforms for payments and cultivating network effects.
HKMA is one of the first monetary authorities to test out CBDC-to-CBDC interoperability. The mBridge project, the most extensive cross-central bank effort to date to test out a blockchain-based CBDC-to-CBDC platform, bloomed out of a collaborative project between the HKMA and the Bank of Thailand in 2019. The project then morphed into Project mBridge in 2021, with the addition of the People’s Bank of China (PBOC), the Central Bank of the United Arab Emirates and the BIS Innovation Hub in Hong Kong. A multi-CBDC platform would naturally entail CBDCs from other jurisdictions to participate. The mBridge allows banks to move wholesale CBDCs across borders, as long as flows are verified by each of the participating central banks’ mBridge ledger (mBL). While the HKMA and other central banks are preoccupied in testing potential future financial pipes, central banks from the developed economies such as the United States and Europe are notably absent from this effort.
This brings us to the geopolitical elephant in the room.
As a financial hub that previously thrived under democratic processes, Hong Kong today looms in the shadow of mainland China. The HKMA released a Fintech 2025 vision document, outlining five ambitious goals spanning financial technology innovation, labor force supply, regulatory environment, data infrastructure and developing cross-border capabilities. There is no smoking gun evidence that the PBOC had any direct influence over the HKMA’s fintech development trajectories. Nevertheless, the HKMA’s goals strive to digitize and leverage the productivity of Hong Kong’s economy, which resonate with the two fintech development plans out of the mainland in the last few years. The Fintech 2025 plan’s goal of “creating next-gen data infrastructure” mirrors similar sections in the PRC’s 2022-2025 Fintech Development Plan. Though the HKMA claims these data infrastructures will be distributed ledger technology-based, it is unclear whether and exactly how the central authority would build in sufficient data security and privacy safeguards.
Though Hong Kong is rolling out its broader e-HKD pilot imminently, it is unclear when the e-HKD will be fully implemented. But lack of an official delivery date should not justify inaction. The instructive takeaway from Hong Kong and other financial hubs’ move to explore CBDCs (such as Singapore’s Project Orchid) should be that the U.S. government needs to monitor collaborative CBDC efforts. In addition to monitoring, the U.S. Federal Reserve should be present at these significant efforts in building alternative pipelines. This does not necessarily mean the United States must develop its own CBDC, but it certainly puts a premium on U.S. participation in standard setting activities. On top of proactive engagement from the U.S. government, government agencies such as the Department of Commerce should set up information-sharing processes with private sector participants in Hong Kong, which may include financial institutions and private-sector firms that may be required to transact in e-HKD. For example, financial institutions that operate under correspondent banking models are likely paying close attention to the developments out of Hong Kong. The U.S. government would be well-advised to get on-the-ground intelligence from them.
Looking more broadly beyond the e-HKD, mBridge may over time shape the contours of alternative financial plumbing. Yes, proliferating CBDCs across borders could just be a pipedream of many central banks. But should the U.S. leadership really sit around to find out, or should it preemptively engage other central banks in an emerging alternative financial ecosystem? BIS has extended the invitation for other central banks to join the effort, so the Federal Reserve should be there influencing the ground rules. The mBridge consortium of central banks have already agreed on the principles of “do no harm, compliance, and interoperability.” However, depending on how CBDC-to-CBDC projects such as mBridge pan out, the principles may change.
To safeguard U.S. leadership in the global financial order, the U.S. government should be monitoring CBDC developments, and proactively shape the agenda of the meetings taking place in the nine international organizations under the Bank for International Settlements, along with discussions happening at other standard-shaping institutions, including the Financial Stability Board, the Organisation for Economic Co-Operation and Development, the International Organization for Standardization, the Group of Seven, Group of 20 and other bodies.