The Future of Central Bank Digital Currencies in the U.S.

Comments pouring into the Fed and other authorities over the CBDC issue expose deep fault lines between traditional banks and payments institutions and fintech players eager to exploit a completely new digital money opportunity. The Federal Reserve is at the center of the scrum.
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Even though the distance between a central bank digital currency in the U.S. in concept and in reality is wide, the viewpoints of different parts of the financial services industry towards the possibility of a Federal Reserve “digital dollar” have begun to solidify.

Broadly, the traditional banking and credit union industries see an American CBDC as a threat — indeed, many seem to see it as an existential threat. Among fintechs, on the other hand, a CBDC is being seen as an opportunity to grow participation in what in theory could become a major part of the payments mainstream.

Payments organizations like Visa and Mastercard have also been weighing in, in part clearly trying to maintain a role for companies like themselves in any future system where a digital dollar becomes a reality.

While the Federal Reserve leads the way on CBDC, other parts of the government, including the Treasury Department and the Department of Commerce, have been involved, notably since the Biden administration issued an executive order on digital assets, which covered CBDC development.

Policymaking During a Storm:

The continuing debate concerning a CBDC for the U.S. comes during a crossroads time for private cryptocurrency and for the stablecoin industry.

The future of a U.S. central bank digital currency has three major fronts.

First, there’s the policy debate concerning the need for it, its role, and what shape it would take. Second, on the technology side, how to make an entirely new form of money work is incredibly complex. Third, because nothing exists in a vacuum, there is debate over the impact on the rest of the banking and payment systems that is hardly an academic discussion. Interestingly, while it was one reason more banks began to look at crypto, the Novi crypto digital wallet from Meta is being shut down in September 2022.

Policy Implications of a U.S. Central Bank Digital Currency

The Fed’s line so far has been not to endorse creation of a CBDC — which it has maintained must be mandated by Congress — but examining the potential benefits of creating one.

“Given the foundational role of fiat currency [government issued money], there may be an advantage for future financial stability to having a digital native form of safe central bank money,” said Fed Vice-Chair Lael Brainard in an address to a Bank of England Conference in early July 2022.

In May 2022 House testimony, Brainard noted that “commercial bank money,” created through the deposit and lending activities of banks and credit unions, obtains public confidence from deposit insurance, banks’ access to Fed liquidity assistance, and the whole framework of bank regulation and supervision.

While much of commerce occurs electronically, most of that traffic consists of messages concerning payments. A key element of a CBDC is that the electronic blips are the money. Over 100 central banks worldwide are in some stage of exploring CBDCs.

After long delays, in January 2022, the Fed published “Money and Payments: The U.S. Dollar in the Age of Digital Transformation.” The paper set out the CBDC issue in broad terms and asked for public comment by late May 2022.

PayPal, in comments to the Fed, urged the U.S. to “take a leadership role” in CBDCs and suggested that “a digital dollar could be a logical next iteration to futureproof the U.S. dollar.” Often backers of CBDCs stress the dollar’s role as the key global currency and the risk that this could change, in part if other nations like China pulled far ahead in digital currencies.

Notably, PayPal wants “in.” It talked up the idea of extensive private sector roles in CBDC development. And it promoted the idea that Americans would need a digital wallet to manage their money if the U.S. went even partially to a CBDC.

“Non-bank financial services providers like PayPal and Venmo typically offer free onboarding and carry no minimum balance [requirement],” PayPal stated in comments to the Fed. “Additionally, PayPal’s two-side platform connects both consumers and merchants in a seamless manner. Our services provide a favorable experience for the consumer and entrée into a digital marketplace that does not typically accept cash or checks.”

More directly, PayPal stated that “given the ability of non-bank fintechs to reach broader populations, it is critical that a U.S. CBDC be offered and distributed through both regulated banks and non-banks.”

On the other hand, Visa, in a white paper, says “The decision to introduce a central bank digital currency is not one that needs to be made hastily.” The payments giant says further that it is appropriate for all parties to ask, “Do we really need to do this? What problem would we be solving?”

Banks in CBDC Crosshairs?:

Clearly, the debate over CBDCs is seen as an opportunity to expand fintechs' turf, but the banking industry's concerns seem to be much more basic. For many it is about survival, not payments competition.

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Bank Groups Aren’t Keen on CBDCs at All

A coalition of banking and credit union trade associations — including the Bank Policy Institute, The Clearing House, the Credit Union National Association and others — spoke of the risks of creating a CBDC. The CBDC concept, not spelled out for the U.S. yet, can include a retail version, in which consumers have federal wallets and hold deposits directly with the Fed. There are other variations.

“The issuance of a CBDC would fundamentally rewire our banking and financial system by changing the relationship between citizens, financial institutions, and the Federal Reserve, leading to a reduction in the availability and increase in the cost of credit,” the coalition wrote.

The reasoning here is that classic private intermediation by banks multiplies deposits into a greater amount of commercial and consumer credit. The coalition worries that Fed deposits would be seen as more secure than private banking deposits, especially in a troubled economy.

Déjà Vu?:

Espousing the idea of consumer accounts with the Federal Reserve to replace private banking is part of what prevented law professor Saule Omarova from being confirmed as Comptroller of the Currency.

“If the intended objective behind issuing a CBDC is to realize the benefit of technological innovation, we should look to leverage novel developments in private money,” the coalition stated, “like real-time payments systems and well-regulated stablecoins.”

Commenting on its own, the Independent Community Bankers of America addressed a possible variation, where the Fed would issue CBDC through accounts administered through private banks and fintechs. ICBA stated, “Community banks may not be able to offer CBDC wallets as cheaply or conveniently as larger-scale, less-regulated financial technology providers. Because CBDC wallet balances will not be able to be lent against, some community banks will likely choose not to offer CBDC wallets at all because the business case is not sustainable.”

Read More: Surging Use of Digital Wallets Threatens Traditional Credit Card Market

Technology Developments for a U.S. Central Bank Digital Currency

In early 2022, after the Fed issued its policy paper, the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology Digital Currency Initiative issued a report covering the first phase of their “Project Hamilton.” The project is intended to experiment with various ways a U.S. CBDC would function.

The report is a beginning, a description of an early phase that tested some early ideas. What was released is a very early prototype that officials have made clear is far from ready for implementation.

“We don’t have a seatbelt, we don’t have an airbag, we don’t have rollbars, and all that kind of stuff that we need to make money safe and secure.”

— Robert Bench, Federal Reserve Bank of Boston

In late June 2022, Bench, Assistant Vice President at the Boston Fed and former Associate General Counsel at Circle, issuer of the USDC stablecoin, gave an update on the technical side of the district bank’s part of Fed research on CBDCs in a webinar.

“Project Hamilton is technology research, and research alone,” said Bench. “This is not an effort to build a production-grade system. This is an effort to better understand technology, and to better provide data to policymakers and leadership, and in the open source [software realm] to understand how this could work, and to also understand how it shouldn’t work.”

The sheer number of transactions a CBDC system would have to be capable of moving per second, as described by Bench, is mind-boggling.

Bench described the second phase of Project Hamilton as building on the learnings of the first. Interoperatbility of the blueprint with existing payments systems is one focus. Among the others are the ability to program CBDC payments to enable “smart payment” technology and ways to ensure privacy while striking a balance with law enforcement needs in money laundering and related contexts.

How would consumer CBDC spending function? Bench didn’t go into technical depth, but explained it conceptually: “This could work a lot like cash, or it could work a lot like other forms of payments. You can have person-to-person, including offline person-to-person. You pay me $5 and we click phones and that could work. Consumers can pay for things. This happens currently in China, where you can go to your local Walmart and use e-CNY to buy goods.” (The New York Fed is working on wholesale CBDC research, under “Project Cedar.” Other technical work is underway with the main Fed’s TechLab.)

States Visa’s paper: “At the outset, central banks will need to explain to the public the value of CBDCs and why they are building it. Consumers also need to have a choice between payment methods and networks, enabling them to make use of the features most important to them when they want.”

Also this, from Visa: “For the innovation promise to be realized, a CBDC must offer a great consumer experience and widespread merchant acceptance.”

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