On January 20, 2022 the Federal Reserve Board published a paper that it described as the first step in a public discussion between the Federal Reserve and stakeholders about central bank digital currencies (CBDCs). The paper, after providing a brief overview of existing forms of money and the U.S. payment system, goes on to outline the essential features of a potential U.S. CBDC. The paper then analyzes the main benefits, risks and policy considerations relating to the adoption of a U.S. CBDC and concludes with a request for comments. Comments, to be provided in the form of answers to specific questions listed in the paper, can be submitted until May 20, 2022.
In the paper, the Fed clarified that it does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of an authorizing law.
The essential features of a U.S. CBDC
The Fed describes a potential U.S. CBDC as a digital liability of the Federal Reserve that would be widely available to the general public. The Fed highlights that a CBDC could provide households and businesses with an electronic form of central bank money. This is a “highly significant innovation in American money” because there are currently two other forms of central bank money in the U.S.: physical currency issued by the Federal Reserve and digital balances held by commercial banks at the Fed.
The Fed identifies certain essential features for a CBDC to best serve the needs of the public in the United States:
- Privacy-protected: Privacy is a paramount concern that needs to be balanced with the need for transparency to deter criminal activity.
- Intermediated: A CBDC would need to be intermediated by private sector entities such as commercial banks and regulated nonbank financial service providers that would offer accounts or digital wallets for the management of CBDC holdings and payments. The Fed explains that the Federal Reserve Act does not authorize direct Federal Reserve accounts for individuals, and such accounts would represent a significant expansion of the Federal Reserve’s role in the financial system and the economy.
- Transferable: A CBDC would need to be readily and seamlessly transferable in order to become an efficient payment system widely used across the economy, including in cross-border transactions.
- Identity-verified: A CBDC would need to be designed to comply with anti-money laundering and anti-terrorism financing rules largely centered around identity verification requirements.
The benefits of a U.S. CBDC
The Fed identifies a number of benefits of a U.S. CBDC:
- The Fed stresses the ability of a CBDC, as currency free from credit and liquidity risk, to foster innovation to create new payment services. A CBDC (unlike existing digital money, including stablecoins and other cryptocurrencies) would not require payment services to implement mechanisms to reduce liquidity risk and credit risk and would not require smaller firms to issue their own form of private money in order to create new payment services. These two features would, according to the paper, support private-sector innovation.
- With proper international coordination, the Fed feels that another benefit of a U.S. CBDC is the potential to streamline costly and slow cross-border payments.
- The paper also notes that issuing a U.S. CBDC would be essential to preserving the dominant international role of the U.S. Dollar. If foreign countries introduce CBDCs more attractive than existing forms of the U.S. Dollar, the global use of the dollar could decrease, endangering the reserve currency status of the U.S. Dollar and raising transaction and borrowing costs for U.S. households, businesses, and government.
- Finally, a U.S. CBDC could promote the financial inclusion of low-income and unbanked households by facilitating access to financial services and saving opportunities and lowering transaction costs relating to taxes, wages, and other payments.
Risks and Policy Considerations relating to a U.S. CBDC
The Fed also identified several risks relating to the issuance of a U.S. CBDC:
- A U.S. CBDC might fundamentally change the structure of the U.S. financial system. A CBDC could replace money held at commercial banks, lowering bank deposits and decreasing the funds readily available for commercial banks to provide loans. Subsequently, bank funding expenses would increase, credit availability would be reduced and credit costs for households and businesses would rise.
- The introduction of a U.S. CBDC could affect monetary policy implementation by complicating the Fed’s ability to manage reserves and influence interests rates.
- Finally, the operational and cybersecurity risks that threaten existing payment systems would be even more challenging for a U.S. CBDC because a CBDC network could potentially have more entry points than existing payment services. Therefore, the infrastructure for a U.S. CBDC would need to be extremely resilient to such threats and the operators of such infrastructure would need to devote significant effort and resources to security.
Questions and Conclusions
In exploring the risks and benefits associated with a CBDC, the Fed expressly stated that it will not make any imminent decision about the issuance of a U.S. CBDC. The release of the paper shows that the Fed has a real interest in engaging in a dialogue with stakeholders. The Fed lays out a set of questions relating to its examination, seeking responses by May 20, 2022. In particular, it solicits input on additional risks and benefits and whether there are alternative solutions that would yield some or all of the benefits presented by a CBDC. Finally, in addition to a series of detailed questions, the Fed seeks CBDC design ideas that may mitigate some of the stated risks.
In releasing the paper, the Fed acknowledges the demands that fast-moving technological capabilities, driven by the blockchain revolution, are having on market realities. For now, parties interested in the policy outcomes that are sure to involve Congress, the Executive Branch, and the Fed, would do well to consider the paper carefully and provide feedback in the face of a rare opportunity to inform such a significant discussion.
