The Federal Reserve has finally dropped its long-awaited central bank digital currency report and it is … careful.
Nonetheless, the report, Money and Payments: The U.S. Dollar in the Age of Digital Transformation, does give a window into the U.S. central bank’s thinking on the subject.
Most notably, the Fed’s thinking is to make very, very clear that it is in no way advocating for or against the creation of a digital dollar. It is, the third sentence in the report states, “the first step in a public discussion.”
A central bank digital currency, or CBDC, would be a digital dollar — legal tender just like a paper bill.
See also: For all of PYMNTs.com CBDC coverage
More specifically, it would be “a digital liability of a central bank that is widely available to the general public,” the report said. “In this respect, it is analogous to a digital form of paper money.”
And, like paper money and its current digital counterpart, a CBDC would not be issued directly by the Fed to the public.
While a few small countries have launched CBDCs, it is China’s drive to create a digital yuan that has kickstarted the discussion in nearly 100 countries and the European Union. The digital yuan has been extensively tested and could launch formally — at least some degree — before the Beijing Winter Olympics begin next month.
A CBDC would very likely be built on blockchain technology. The report also punts on the issue of privately issued, dollar-pegged stablecoins, pointing instead to the President’s Working Group on Financial Markets’ recent paper.
For the People
The Fed’s paper focuses on a retail CBDC used by the general public rather than a wholesale CBDC that would be used by financial institutions for back-end settlement — a version that is being looked at with interest in a number of capitals, including Thailand, Singapore, Canada, the U.K., France, the EU and Japan, among others.
The closest it comes to an opinion is saying that its “analysis to date suggests… [it] would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable, and identity-verified.”
Starting with intermediated, the Fed noted that federal law did not permit it to offer accounts to individuals, so it would have to be distributed through private institutions such as commercial banks and regulated financial service providers. The broader CBDC debate has come up with the idea of central banks providing direct-to-consumer DDA accounts, but this invariably runs up against two problems: First, it would gut the existing financial system by taking away the deposits that are banks’ primary source of liquidity.
Second, there would be enormous privacy concerns as the government would effectively be able to look at anyone’s finances and spending habits in great detail.
The privacy issue is one of the biggest challenges CBDCs are facing as a category, particularly in China, where the government has come up with the term “controllable anonymity” — which boils down to a “trust us” by an authoritarian government.
That said, any CBDC would have to strike a balance between protecting privacy and not preventing “the transparency necessary to deter criminal activity,” the Fed said. Of course, that would inevitably make it more trackable than paper currency.
And realistically, to comply with anti-money laundering (AML) and countering the financing or terrorism (CFT) regulations, the financial intermediaries would have to know customers’ identities — just like current ones do.
Besides, it’s been pointed out that Americans routinely give enormous amounts of personal data to merchants, credit card issuers, social media networks, telecoms — so there’s some question about how big a problem this would actually be.
Usable Anytime, Anywhere
For a CBDC to work, it would have to be “readily transferable” meaning usable anytime with anyone. Part of that would be making sure the digital dollar has exceptional cybersecurity. That’s especially true given the cryptocurrency industry’s long and ignoble history of leaving software flaws exploitable by bad actors — most recently this past Monday, when a leading cryptocurrency exchange, Crypto.com, saw $34 million looted from nearly 500 customers when the two-factor authentication system failed. While the exchange covered the losses, it’s very far from the first time.
According to blockchain intelligence firm Chainalysis’ 2022 Crypto Crime Report, Thieves stole $3.2 billion in 2021, up more than 500% over 2020. Then there’s ransomware, which accounted for more than half of the $14 billion in illicit crypto last year. Remember last May, when the Colonial Pipeline, a key supplier of gas to the Southeast, was shut down for a week by ransomware? Now imagine that happening to the digital dollar.
This is why the Fed identified operational resilience and cybersecurity as a big hurdle. And it’s not all crime. Ever try using a credit card in a blackout when the terminals are offline?
The Good Stuff
A digital dollar would have a number of potential benefits, the Fed said, noting that as it is issued by the Fed, it would not need deposit insurance like a bank or a currency reserve like a stablecoin to provide a foundation of public confidence.
Among them, it could, the report said:
On the payments front, the report said that a CBDC could help “level the playing field in payment innovation for private-sector firms of all sizes. For some smaller firms, the costs and risks of issuing a safe and robust form of private money may be prohibitive. A CBDC could overcome this barrier and allow private-sector innovators to focus on new access services, distribution methods, and related service offerings.”
And, a CBDC could support the dollar’s role on the international stage, where it remains the world’s reserve currency. One of the arguments for a digital dollar has been that the digital yuan would give China a tool to challenge this primacy.
The final point the Fed made — frequently — is that it would not act alone. Aside from soliciting answers to 22 questions about CBDC benefits, risks, policy considerations, and design through May 20, it made clear that it would need guidance from the President and Congress — preferably a law — before moving ahead.