Strategic Digitalization in Currency and Payment Competition

Author: Cong, L. W., & Mayer, S.; Translated by: Cao Xinyuan; Source: Journal of Financial Economics

In March 2025, the article "Strategic digitization in currency and payment competition" constructed a competitive model between central bank digital currencies and private digital currencies (PDM). The research found that countries strategically promote the digitization of their fiat currencies to enhance adoption rates and counter PDM competition. Less dominant currencies achieve digitization earlier, reflecting a first-mover advantage; dominant currencies delay digitization until faced with competition; the weakest currencies abandon digitization. Delayed digitization allows PDM to gain dominance, ultimately undermining fiat currencies. At the same time, the research also emphasizes how geopolitical factors, stablecoins, and the interoperability between fiat currencies and private digital currencies affect currency digitization and currency competition. The Institute of Financial Technology at Renmin University of China compiled the core parts of the research.

Introduction

With the acceleration of technological advancements, global economic activities are increasingly digitized. According to data from the Bank for International Settlements (BIS), the annual transaction volume of global digital payments has reached hundreds of trillions of dollars. Although bank-dominated payment systems (such as ACH, SWIFT, and credit card networks) have long held a dominant position, in recent decades, non-bank payment institutions represented by PayPal and M-Pesa, as well as large technology companies like Apple and Alibaba, have rapidly emerged, offering faster and more feature-rich payment options. This trend has prompted countries to rethink the design of their monetary systems, partially realizing the competitive landscape of private currency issuance and fiat currency envisioned by Hayek (1976).

Private Digital Money (PDM), such as cryptocurrencies, stablecoins, and decentralized finance (DeFi), has posed a challenge to the traditional fiat currency system. As a result, many countries are beginning to promote digital reforms of their monetary and payment systems, such as Brazil's Pix, India's UPI system, and the central bank digital currencies (CBDCs) launched by various countries around the world.

This study aims to explore the strategic choices and competitive landscape of different countries in the process of currency digitization against the backdrop of the rapid development of PDM. The author constructs a dynamic game model to simulate the adoption competition between fiat currencies and PDM in the payment field. The research finds that fiat currencies with a high adoption rate but relatively weak international influence (such as the RMB) are often the first countries to promote digitization, having a "first-mover advantage"; while countries with a dominant currency status (such as the US dollar) tend to digitize only when facing competitive pressure, showing a "late-mover advantage"; currencies with both low international influence and adoption rates may abandon the digitization process. This strategic delay may leave market space for PDM, thereby weakening the position of fiat currencies in the digital payment system.

In addition, the article points out that geopolitical considerations, the development of stablecoins, and the interoperability between fiat currencies and PDM will all impact the future landscape of currency digitization and payment system competition.

Literature Review

This article is closely related to multiple research fields, with its main contribution being the expansion of theoretical models concerning the competition of digital currencies. Existing research mainly focuses on the impact of CBDC on the banking system (such as deposits and loans) (e.g., Brunnermeier & Niepelt, 2019; Andolfatto, 2021; Garratt & Zhu, 2021), or structurally estimates its impact on the financial system (e.g., Whited, Wu, and Xiao, 2022). This study, however, emphasizes the dynamic competition in the payment sector between different fiat currencies and between fiat currencies and private digital currencies, while considering the strategic choices of countries in the digitalization process, especially the dynamic evolutionary paths under asymmetric conditions.

In addition, this article also responds to policy discussions on the reform of digital payment systems, echoing research on the impact of the launch of Pix on competition among Brazilian banks (Sarkisyan, 2023), as well as how government-led fast payment systems shape the financial ecosystem (Duarte et al., 2022; Kahn, 2024).

In discussing how global cryptocurrencies synchronize monetary policies differently with Benigno, Schilling, and Uhlig (2022), the core innovations of this article are: (1) the introduction of endogenous investment decisions by countries regarding the digitalization of fiat currency; (2) presenting the dynamic process of competition between fiat currency and PDM. The model also provides a perspective for the study of the international monetary system and is related to the global competition of reserve assets and safe assets (Farhi & Maggiori, 2018; Gopinath & Stein, 2021).

In addition, this article contributes to the emerging literature on geopolitical economics, emphasizing that the widespread use of currency in international payments can bring significant geopolitical influence to nations. This perspective explains why countries with "medium strong currencies" like China actively promote currency digitalization to enhance their international influence, while countries with dominant currencies like the United States delay their involvement in the digitalization process until their dominant status is challenged.

Finally, from the perspective of modeling methods, this paper draws on the literature of real options and dynamic innovation investment (such as Aghion & Howitt, 1992; Dixit & Pindyck, 1994), and introduces it into the study of monetary competition and payment systems, filling the gap in the field of monetary economics regarding the research on the evolutionary path of endogenous monetary functions.

Research Content

Dynamic Model of Currency Digitization and Competition

This article constructs a dynamic model to explore the competitive process between national fiat currency and private digital money (PDM) in the field of digital payments. The core focus of the model is on the medium-of-exchange function of money, but its framework can also be generalized to the store of value and unit of account functions of money. The following are the main settings of the model:

The model setting includes three types of currencies that can be used for payment: the fiat currencies issued by Country A and Country B, and the digital currency PDM issued by the private sector. These currencies provide users with varying degrees of payment convenience, which is reflected in three dimensions: the level of acceptance (i.e., the probability of matching with a counterparty that accepts the currency), transaction efficiency (such as cost, speed, and cross-border functionality), and bargaining power during the transaction process (such as the level of privacy protection, etc.). The utility function of the user internalizes these conveniences, making the utility derived from holding different currencies comparable.

In the first phase of the lifecycle, users receive an initial endowment of a unit of goods and choose to exchange it for a certain currency, completing the consumption in the next phase. Since the model prohibits the inter-temporal storage of goods, users must complete the transfer of time through currency; at this point, the "convenience utility" of the currency becomes its sole source of functionality. Users will diversify their allocation among three currencies, ensuring that the marginal utility of each unit of expenditure remains balanced with its expected purchasing power.

Countries can enhance convenience by digitizing their national currencies, including improving payment systems, issuing CBDCs, or developing new technological channels. This process is modeled as a costly effort behavior, with the digitization process technically represented as a jump increase in convenience variables (such as Z_A, Z_B). Digitization events occur randomly, with the intensity of arrival being proportional to the effort invested by the government, and the cost function is quadratic, indicating that the cost of digitization rises with increased effort.

In other words, digitization is an irreversible event with uncertain timing but controllable probabilities. In the competitive model framework, Country A represents the dominant currency (such as the US dollar) with strong international influence and initial convenience, denoted as Z_A^L, while Country B represents a relatively weaker currency (such as the Chinese yuan or euro), with convenience denoted as Z_B^L, satisfying Z_A^L > Z_B^L. The convenience of PDM, Y_t, is set to increase with its market adoption level (i.e., the proportion of holders), presenting a typical network effect growth curve:

This setting reflects that the more users there are, the more robust the technology, services, and payment functions of private currency providers become, thereby further attracting users.

Figure 1 PDM convenience changes over time and market share

On this basis, the model defines the national objective function: the utility of the country comes from the share of its national currency adopted in the global payment system, minus the costs of digitalization efforts incurred. The optimal currency allocation on the user side is determined by a no-arbitrage condition, which states that the sum of the marginal convenience of the three currencies should be equal to their expected appreciation rates.

The strategic behavior of the country is characterized by a Hamilton-Jacobi-Bellman (HJB) equation, and solving this system of equations yields the optimal digital effort path of the country under different competitive structures and convenience states.

The state space of the entire model consists of two parts: the first is the convenience of PDM Y_t, which varies over time with the holding ratio; the second is whether the two countries have currently completed digitization, i.e., z∈{LL,HL,LH,HH}, representing that neither country is digitized, country A is digitized, country B is digitized, and both countries are digitized, respectively. The model constructs a Markov Perfect Equilibrium, under which the effort decisions of the countries and the currency holding choices of users are consistent in each state and possess time consistency.

Due to the model's structural involvement of multiple state variables, user and country interaction functions, and discontinuous jumps in state transitions, the author employs numerical methods to solve the system of equations. Through simulation paths under different parameter settings, the model can demonstrate the strategic dynamic responses of countries when facing competition from private digital currencies, including first-mover advantages, latecomer incentives, and potential "exit equilibria."

Numerical Simulation Analysis

In order to reveal the dynamic evolution trajectory of the model under theoretical settings, the author employs numerical methods to solve the HJB equation system and demonstrates the optimal response strategies of different countries in the rise of private digital currencies through simulations. This process not only validates the mechanism settings in the theoretical model but also provides a visual reference for understanding the heterogeneity of digitalization strategies in various countries in reality.

First, in the basic scenario, it is simulated that Country B (with a medium-strength currency) begins to actively promote digitalization when the convenience of PDM is still low, as at this time the convenience of B currency still has an advantage, and users have a higher willingness to hold. The efforts in digitalization further enhance its convenience, thereby resisting the penetration risk of PDM, achieving a "first-mover advantage." On the other hand, Country A (with a dominant currency) remains observant during the early growth stage of PDM, significantly increasing its efforts only when the convenience of private digital currencies approaches its currency level. This strategic delay stems from its initial convenience advantage and confidence in user stickiness, reflecting typical late-comer incentive behavior.

Furthermore, as the convenience of PDM continues to improve and approaches the level of Currency A, the model simulates a possible dynamic path: users massively shift towards PDM, causing Country B to gradually lose its advantages in convenience, network effects, and user acceptance, even though it has already achieved digitalization. The adoption rate continues to decline, ultimately leading to a "strategic exit" from the payment competition. Therefore, digitalization efforts are not a sufficient condition; if the timing and path choices are inappropriate, being a first mover may also translate into a high-cost but ineffective strategy.

Figure 2 Evolutionary trajectory of PDM convenience path and currency share of countries A/B over time

In addition, the simulation revealed the welfare shift caused by "institutional asymmetry": although Country A invested less in the early stages, it can still reap the benefits of convenience through mechanisms such as technological synergy, stablecoin outsourcing, and platform compatibility after PDM becomes increasingly convenient, and other countries either fail to enter in time or have exited. This indicates that in the global payment network, path dependence, platform structure, and user network effects constitute an asymmetric digital competitive advantage.

Finally, the author conducted a parameter sensitivity test on the model. The results indicate:

1. If the cost of digitization decreases and countries make significant progress in their digitalization efforts, the survival space for PDM will be compressed.

2. If the convenience of PDM grows faster, the country is more likely to give up on digitalizing its currency and retreat directly;

3. If the gap in currency convenience between the two countries narrows, it becomes easier to enter a mixed-use equilibrium state, where PDM, Coin A, and Coin B exist simultaneously in different regions and are used by users in a layered manner.

Model Expansion

After establishing the basic model, the author further expands the framework to incorporate richer real-world factors to enhance its explanatory power. These extensions cover stablecoins, exchange rate and interest rate mechanisms, the absence behavior of extremely weak currencies, and the strategic delay decisions of policymakers, thus presenting a more complete picture of the competition in currency digitalization.

First, researchers introduced the substitution and complementary relationship between stablecoins and sovereign currencies. In many real-world scenarios, stablecoins, although issued by the private sector, are often pegged to a certain sovereign currency asset, especially the US dollar. This means that when stablecoins gain widespread adoption in global payments, the pegged currency indirectly benefits as well. Therefore, a government may not need to directly promote the digitalization of its local currency but can achieve "outsourced digitalization" by tolerating or even supporting the development of stablecoins. The model shows that this mechanism is particularly significant in the US dollar-dominated global financial system—widespread use of stablecoins may weaken the urgency for the US to promote a CBDC while simultaneously enhancing its global payment influence. This indirect path reflects the dual role of cooperation-substitution between sovereign currencies and private digital currencies.

Secondly, the author expands the model to include nominal interest rates and exchange rate mechanisms, capturing the effects of actual holding costs and cross-border capital flows. In reality, the returns between different currencies depend not only on convenience but also on interest rate levels and exchange rate expectations. At the same time, interest rates do not always fully transmit to the user level; in a deposit market dominated by the banking system, high policy rates may not effectively increase deposit returns. After incorporating the imperfection of interest rate passthrough into the model, it is found that high interest rates may actually raise holding costs, thereby reducing the relative convenience and user adoption of that currency. This result overturns the traditional intuition of "high interest rates = attracting funds" and highlights that in the competition of digital payments, user experience may be more decisive than financial returns.

The model also analyzes the behavior of countries with extremely weak currencies, which often face issues such as high inflation, low trust, and insufficient technological capability. Even with the advancement of digitalization, the potential for improving currency convenience in these countries is limited. In the model, even after digitization, the convenience of such currencies is unlikely to catch up with PDM or strong sovereign currencies, leading to a stronger motivation for users to turn to alternative currencies. This results in almost no incentive for these countries to make digital investments, leading to a phenomenon of "strategic exit." This mechanism reveals that the global currency digitization process may not be balanced, presenting a trend of "hierarchical digital currency order."

Finally, the author discusses the time preferences of policymakers and strategic waiting behavior. Some countries may place greater emphasis on short-term goals, such as rapidly expanding payment influence or curbing private currency expansion, and therefore enter the digitalization process earlier. In contrast, countries with a long-term strategic vision may choose to delay decisions, observing the policy effects and user acceptance in other countries before deciding when to follow up. When digitalization has positive spillover effects (such as technology sharing, user education, and the development of payment habits), latecomer countries can leverage the experiences of pioneers to reduce their own costs, thereby forming a "waiting equilibrium." Although this strategy may seem rational in a static sense, from a global efficiency perspective, it may lead to an overall delay in the digitalization process and reduce social welfare.

Policy implications

Through the construction of the above model and the expansion of mechanisms, the author proposes a series of policy implications. Firstly, for the countries with dominant currencies, although the existing payment convenience is high, it should not lead to "inertia and wait-and-see". The model shows that the continuous expansion of private digital currencies will gradually erode their payment dominance. Once the window period is missed, even if resources are subsequently invested in digitalization, it will be difficult to re-establish the original dominance. Therefore, these countries need to examine the digitalization path from a strategic perspective and proactively design their own CBDC policies and international payment structures rather than passively.

For non-dominant but potential currency countries, such as the Eurozone and China, the model clearly indicates that they possess the strongest first-mover incentives. If these countries can take the lead in establishing a high-quality digital currency system with mature technology, a large user base, and policy support, they are expected to expand their influence globally and achieve a "leapfrogging" of payment rights. Policymakers should take advantage of this window of opportunity to formulate supportive regulations, platform interconnections, user incentives, and other measures to seize the institutional high ground in the digital financial ecosystem.

In contrast, the real constraints of extremely weak currency countries in terms of digitization are more severe. Due to the very poor convenience of the local currency, even digitization struggles to gain user favor, resulting in insufficient actual incentives. The strategic focus of such countries should shift towards cross-border payment connectivity, regional cooperation frameworks, and foundational user education, rather than isolating the advancement of technology.

In addition, the model emphasizes the high external dependency among countries in the choice of digitalization paths. Due to the significant influence of other countries' adoption and platform structures on the convenience of local currencies, if each country acts independently, it may lead to a "digital delay equilibrium." Therefore, international organizations such as BIS and IMF should play a coordinating role in promoting a globally unified framework in standard setting, technology sharing, regulatory recognition, and interoperability design, reducing fragmentation and duplicated construction, and improving overall welfare.

Conclusion and Discussion

This article presents a systematic theoretical framework from the perspective of dynamic games to explain why different countries exhibit heterogeneous digitalization strategy choices in the face of challenges posed by private digital currencies. The model centers around "convenience" as a core currency attribute, incorporating user behavior feedback, national digitalization efforts, and the growth path of private digital currencies (PDM) into a unified structure, depicting the medium- to long-term dynamic competitive mechanism between sovereign currencies and private payment tools.

The results of the numerical simulation indicate that there are significant differences in the incentive structures of countries regarding whether and when to promote the digitization of fiat currency. Countries with moderate levels of convenience have the strongest first-mover advantages, as their local currency still has certain advantages. If digitization can further enhance convenience, they are likely to solidify or even expand their market share. In contrast, dominant currency countries tend to have late-mover incentives due to existing network effects and user stickiness; they will only initiate the digitization process when the convenience of PDM significantly increases and poses a marginal threat. In comparison, countries with very weak currencies, due to their low levels of convenience, find it difficult to reverse the trend of marginalization even if they attempt digital reform, displaying characteristics of strategic withdrawal.

The model further reveals that, under the premise of convenience having network externalities, once PDM crosses a critical point, it may form a self-reinforcing growth path. In this scenario, even if the state subsequently increases its digitalization efforts, it may find it difficult to re-establish monetary dominance due to factors such as platform incompatibility and user migration inertia. This mechanism highlights the importance of strategic timing for entry, meaning that if digitalization efforts are not implemented within a critical window, they may lose policy effectiveness and ultimately fall into an "exit equilibrium."

In addition, this paper has made several key extensions to the basic model framework, further enhancing the theoretical explanatory power over real structures. Firstly, after introducing the stablecoin mechanism, the model indicates that even if a country does not directly promote the digitalization of its currency, it can still achieve indirect convenience enhancement through the anchoring of private stablecoins, forming a "digital outsourcing" path. This setting helps to understand the "observe-utilize" strategy adopted by currently dominant currency countries (such as the United States) in the context of the rapid development of stablecoins. Secondly, the incompleteness of the interest rate transmission mechanism may trigger a reverse substitution between monetary convenience and bargaining power in transactions, reinforcing the nonlinear characteristics of user migration. Thirdly, strategic waiting behavior may delay the arrival of equilibrium when multiple countries face digitalization choices simultaneously, leading to a long-term suboptimal state of the global payment system.

This study provides a structurally complete theoretical analysis tool for characterizing the strategic behavior of sovereign currencies in digital competition, and also offers institutional logic and timing judgment basis for strategy formulation for different types of countries. The model results emphasize that digitization is not a linear growth process, and that effort costs, platform structure, and path dependence will significantly affect policy effectiveness. Therefore, for policymakers, identifying intervention windows, designing incentive mechanisms, and understanding the impact of institutional heterogeneity on the future monetary landscape will be core tasks in formulating long-term payment strategies.