The introduction of a “digital dollar” central bank digital currency would dramatically alter how the world interacts with money. Recent events indicate that the United States is open to the concept.
What Are Central Bank Digital Currencies?
There are currently three types of money in the US:
- Central bank money is a liability of the Federal Reserve.
- Commercial bank money is a liability of the retail banking sector and the form of money most commonly used by the public.
- Non-bank money is a liability held by non-bank financial institutions.
The credit and liquidity risks associated with the three distinct types of money vary. For instance, central bank money has no credit or liquidity risk since the Federal Reserve may generate money from nothing. Commercial bank money or bank deposits, on the other hand, represent a medium level of risk due to the possibility of bank failure or liquidity concerns. However, these risks are largely minimised by federal deposit insurance and banks’ access to central bank liquidity on demand. Non-bank money or credit on payment processor accounts lacks the protection of bank deposits and is therefore regarded as the most precarious.
CBDCs provide a new form of money that resembles commercial bank money in that it is fully digital and directly available to the public but is issued and represents a liability of the Federal Reserve (like cash) instead of commercial banks (like bank deposits). In principle, this currency would be the safest and most easily transferrable form of money available to the public in the future.
The most fundamental difference between CBDCs and cryptocurrencies such as Bitcoin and Ethereum is that CBDCs are still someone’s liability, in this case, debt that the central bank technically owes to CBDC holders. In contrast, Bitcoin and Ethereum are bearer assets that are not anyone’s liability and represent pure ownership.
Signs a Digital Dollar is Coming
While the United States has not yet formally committed to producing and issuing a digital dollar in the form of CBDC, multiple signals from key government departments and officials over the past two years indicate that the government is seriously exploring the issue.
The US Treasury Supports CBDC Efforts
In response to the White House, the US Treasury urged the Federal Reserve to continue its research and technical experimentation on CBDCs, including its work analysing the possible choices of technology and other design elements of a CBDC, suggesting that the issuance of a digital dollar could be a desirable objective if determined to be in the national interest.
To support the Fed, the Treasury stated that it would organise and lead an interagency working group to facilitate the creation of CBDCs reasonably. Treasury noted in the report that, even though establishing a US CBDC could take several years, the government must do so to maintain the dollar’s preeminence in the international financial order.
The Fed is Working on a US CBDC
The US central bank is exploring the implications and options for issuing a CBDC. And while the Fed has not yet made any explicit policy recommendations, such as whether the government should give a digital dollar, it is studying CBDCs from multiple perspectives, including technological research and experimentation.
Specifically, the Federal Reserve Bank of Boston is partnering with the Massachusetts Institute of Technology to study potential technology solutions for a retail CBDC to be available to the public. At the same time, the Federal Reserve Bank of New York has teamed up with the Bank for International Settlements to develop a wholesale CBDC used only for interbank transfers. Both projects suggest that the Fed is serious about creating digital money.
The White House Favours a Digital Dollar
Six months after President Biden signed the executive order on digital assets, the White House released its first-ever complete crypto regulator framework last month. In the document, the White House urged the Federal Reserve and the Treasury to continue investigating and building a digital currency. It outlined its initial policy objectives for a US CBDC system. If implemented, a US CBDC system should protect consumers, promote economic growth, improve payment systems, allow interoperability with other platforms, advance financial inclusion, preserve national security, respect human rights, and accord with democratic principles.
In addition to offering broader regulatory restrictions on digital assets, the framework is the first official public endorsement of developing a US CBDC and the clearest indication that the digital dollar may soon become a reality.
Crypto Is Boosting External Pressure
The pressure from the rapid global proliferation of cryptocurrencies and the rapid development of competing CBDCs is the primary reason the US has increased its CBDC research and development efforts over the past two years. This is also an argument for why a digital dollar could arrive sooner rather than later.
Multiple authorities and legislators have cited the rapid expansion of stablecoins as the primary cause for the need to innovate and enhance existing fiat payment systems. While dollar-pegged stablecoins increase international demand for the dollar, they remain a dangerous form of money locally. Beyond this, the United States and the Federal Reserve are falling behind on the CBDC front and are under enormous pressure to react.
Why Should It Matter?
Agustn Carstens, the head of the Bank for International Settlements, is the best person to explain CBDCs and why they are significant. Carstens explained the distinction between cash and CBDCs during a 2020 IMF panel discussion on cross-border payments.
The introduction of a digital dollar might alter how the Federal Reserve conducts monetary policy, as it would grant the central bank complete control and visibility over every economic activity. Instead of using indirect instruments such as open market operations and lowering or raising the federal funds rate to control the money supply, the Fed could use CBDCs to directly control the interest rate on credit or the money supply across many individual accounts.
In addition, having all economic activities recorded in a single ledger might provide the Fed with near-perfect insight into the economy’s path. By integrating the CBDC with AI and machine learning, the central bank might significantly improve its ability to forecast the behaviour of individual users and the economy as a whole, which could lead to a transition from a market economy to a more centrally planned one.
Because CBDCs are programmable, the government can impose an expiration date on money. That would allow them to coerce individuals to spend and artificially stimulate economic activity. With its digital yuan, China has already experimented with this characteristic.
It seems unlikely that introducing a more centralised and censorable form of bank liability money would reduce demand for non-custodial and uncensorable hard money assets such as Bitcoin and Ethereum. As governments begin to embrace CBDCs, the appeal of certain cryptocurrencies as value stores or even haven assets should increase.