Trade Networks and the Rise of a Dominant Currency

Abstract

We develop a model where currency issuers provide liquidity, while users in a trade network choose currency usage for trade settlement. We identify a feedback mechanism where a user's currency preference spillovers to others and increases the issuer's commitment to liquidity provision, which in turn increases the adoption of the currency. Our findings highlight not only the advantage of the incumbent issuer in maintaining dominance, but also the conditions that lead to the rise and fall of dominant currencies. Our framework offers testable implications for the share of global settlement currencies, the network structure, and the strategy of issuers.