Four Signs A Digital Dollar Is Coming (And Why You Should Care)

Introducing a “digital dollar” central bank digital currency would radically change how the world interacts with money, and based on recent developments, the US seems open to the idea.

What are the central bank’s digital currencies?

Money in the United States currently comes in three forms: central bank money, which represents an obligation to the Federal Reserve; commercial bank money, which is an obligation of the commercial banking sector and the most used form of money by the public today, and non-bank money, which is an obligation held by non-bank financial institutions (such as payment processors such as PayPal).

All three types of money have different levels of credit and liquidity risk. For example, central bank money has zero credit and liquidity risk because the Fed can create money ex nihilo. Commercial bank money or bank deposits, on the other hand, have medium risk because banks can fail or run into liquidity problems – although these risks are mostly mitigated by federal deposit insurance and banks’ on-demand access to central bank liquidity. Non-bank money or credit in payment processor accounts lacks the full protection of bank deposits, so it is generally considered the riskiest.

Cash or physical currency is the only type of central bank money available to the general public in the United States today. The other type of central bank money comes in the form of “bank reserves”, which are only available to the commercial banking sector and are completely unavailable to the general public. The most widely used money by the general public today is commercial bank money, which comes in the form of bank deposits created ex nihilo when commercial banks create loans.

The idea behind CBDCs is therefore to introduce a new form of money that resembles commercial bank money in that it is purely digital and directly accessible to the public, but at the same time is issued by and represents a liability of the Fed (like cash). ) instead of commercial banks (as bank deposits). Therefore, this form of money will – in theory – be both the safest and most easily transferable form of money available to the general public in the future.

While there are many differences between CBDCs and cryptocurrencies such as Bitcoin and Ethereum, perhaps the most fundamental is that CBDCs are still someone’s responsibility – in this case, debt that the central bank technically owes to the CBDC holders – while Bitcoin and Ethereum are carrier assets. which is not anyone’s responsibility and represents pure ownership.

Signs that a digital dollar is coming

Although the United States has not yet officially committed to creating and issuing a digital dollar in the form of CBDC, there have been several signals from the past two years that suggest the government is seriously considering the possibility.

On a number of occasions, Fed Chair Jerome Powell and Treasury Secretary Jenet Yellen have highlighted the government’s need to focus on this problem and increase research and development efforts. “In light of the tremendous growth in cryptoassets and stablecoins, the Federal Reserve is examining whether a digital currency from a U.S. central bank would enhance an already safe and efficient domestic payments system,” Powell said in his welcoming remarks at the International Roles of the International. American dollar conference in June.

A year earlier, Yellen said in an interview with The New York Times interview that it was “sensible for central banks to look at [CBDCs],” explains that the US has a problem with financial inclusion and that a digital dollar could help with that. “I think it can result in faster, safer and cheaper payments,” she concluded.

Perhaps the most telling signs that a digital dollar may be coming are contained in the US Treasury Department’s September 2022 report titled The future of money and paymentswhich came in response to President Biden’s executive order on “Ensuring Responsible Development of Digital Assets.” In March, President Biden ordered several government agencies, including the Treasury Department, to submit reports on potential US crypto regulation, including consideration of a CBDC. The subsequent reports indicate that the agencies are mostly supportive of the idea.

The US Treasury is supporting the CBDC effort

In its response to the White House, the US Treasury urged the Fed to “continue its research and technical experimentation on CBDCs, including efforts to analyze possible choices of technology and other design elements of a CBDC,” and suggested that issuing a digital dollar may be a desirable goal if “determined to be in the national interest”.

In support of the Fed, the Treasury Department also noted that it would create and lead an interagency task force to support responsible CBDC development. In the report, the Treasury Department pointed out that although it may take several years to establish a US CBDC, it is necessary for the government to do so in order to ensure the primacy of the dollar in the international financial order.

The Fed is already working on a US CBDC

In a January discussion article titled Money and Payments: The US Dollar in an Age of Digital Transformation, the US central bank said it is “exploring the implications of and options for issuing a CBDC.” And while the Fed has yet to make any explicit policy recommendations, such as whether or not the government should issue a digital dollar, it has revealed that it is studying CBDC from various angles, including through technological research and experimentation.

Specifically, the Federal Reserve Bank of Boston is working with the Massachusetts Institute of Technology to explore potential technological solutions for a “retail CBDC” that would 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 work on a “wholesale CBDC” to be used only for interbank payments. Both of these initiatives prove that the Fed is serious about creating a digital dollar.

The White House is very much in favor of a digital dollar

Last month, six months after President Biden signed the Electronic Assets Order, the White House published its first-ever comprehensive crypto regulatory framework. In the paper, the White House urged the Fed and the Treasury Department to continue researching and developing a digital dollar and published its first policy goals for a US CBDC system. “A US CBDC system, if implemented, should protect consumers, promote economic growth, improve payment systems, provide interoperability with other platforms, promote financial inclusion, protect national security, respect human rights, and align with democratic values,” the goals state.

Beyond providing broader regulatory guidelines for digital assets, the framework represents the first official public endorsement of the idea behind developing a US CBDC and the clearest sign that the digital dollar may soon become a reality.

Crypto increases external pressure

The main reason why the US has increased its CBDC research and development efforts in the last two years – and another argument why a digital dollar may come sooner rather than later – is the pressure from the rapid global spread of cryptocurrencies and the rapid development of competing CBDC is.

Various regulators and legislators have explicitly noted the rapid growth of stablecoins as the main reason behind the need to innovate and improve the existing fiat payment systems. While dollar-pegged stablecoins drive additional demand for dollars internationally, they still represent a risky form of money domestically. Beyond that, the US and the Fed are lagging behind on the CBDC front, carrying considerable pressure to conform. According to the Atlantic Council CBDC tracker, 11 countries have launched CBDCs, 15 are running pilot programs, and 26 are under development. The USA and 45 other countries are still in the research phase.

Why should you care?

Perhaps the best way to explain CBDCs and why they matter is through a quote from Bank for International Settlements CEO Agustin Carstens. Explaining the difference between physical cash and CBDCs during an IMF panel in 2020 discussion on cross-border payments, Carstens so:

“We don’t know who uses a $100 bill today, and we don’t know who uses a 1,000 peso bill today. The key difference with CBDC is that the central bank will have absolute control over the rules and regulations that will determine the use of this expression of central bank responsibility, and we will also have the technology to enforce it.”

Beyond having absolute control and complete insight into every financial transaction, the introduction of a digital dollar could completely change how the Fed conducts monetary policy. Instead of using indirect instruments such as open market operations (quantitative easing and tightening) and lowering and raising the federal funds rate to control the money supply, with CBDC, the Fed can control the interest rate on credit or the money supply across many individual accounts directly.

Also, having all transactions in the economy recorded on a single ledger can give the Fed almost perfect insight into the direction the economy is headed. By combining CBDC with AI and machine learning, the central bank can much better predict the behavior of individual users and the economy as a whole, potentially moving it from a market to a more centrally planned economy.

By virtue of being programmable, CBDCs also give the government the power to put an “expiration date” on money. It would essentially allow them to artificially force people to spend and drive economic activity. China already has experimented with this feature with its digital yuan.

It is hard to believe that introducing a more centralized and censorable form of bank liability money will reduce the demand for non-custodial and uncensorable hard money assets like Bitcoin or Ethereum. If anything, the appeal of certain cryptocurrencies as stores of value or even “safe heaven” assets should grow as governments begin to embrace CBDCs.

Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.