Recently the Federal Reserve published a relatively progressive report on the potential uses, pros, and cons of a Federally-backed “digital dollar”. This could be the dawn of a new financial age for the US, but with the benefits come some logistical and legislative challenges that could also factor in.
At the same time, privacy experts warn about the potential perils of a Fed Coin. In the hands of a benevolent and perfect government, the Fed Coin would be something to behold. Now, if it were to be pushed by a government that was authoritarian or was increasingly becoming authoritarian, that would call for a pause.
Such a centralized currency at the whims of a government with a lack of checks and balances or an increasingly deteriorating system of checks and balances would not bode for the populace.
It could be even more alarming when relating to governments that are superpowers that can censor speech and monetary movement.
While we are talking about the Fed coin, a coin that would be controlled by the central bank of the United States, similar actions by other countries like China, North Korea, and more authoritarian leading governments would mean fewer freedoms and a more compliant citizenry.
Lord Action might have said it best, “power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority, still more when you superadd the tendency or the certainty of corruption by authority.”
Let’s have a look at the recent information provided by the Federal Reserve and dive a little further into what it is pondering with a potential central bank digital currency (CBDC).
Is there a Fed Coin, or a digital dollar coming, and what does it mean for payments, banking, and the people moving forward?
It would be a fantastic idea to start with defining the Federal Reserve and what it does within the banking system.
What Is the Federal Reserve and Why Does It Matter?
The Federal Reserve is an independent entity that conducts monetary policy within the United States. Accordingly, monetary policy actions undertaken by the Federal Reserve will have an impact in the United States and globally as well.
Due to the nature of the United States, its political strength, resources, legal system, reserve currency, and other factors, its monetary policy actions can make waves throughout the global financial system.
It has several key functions; it takes these actions to support and maintain stability in the United States economy and those involved in the public economy, every single household in the United States.
What are these key functions?
- Maintain maximum employment and stable prices in the United States
- Mitigate system risks by maintaining the stability of the financial system by overseeing and participating at home and globally
- Take actions to ensure safety and soundness in the financial sector by looking at the health of financial organizations and viewing their impact on the larger financial system
- Nurture a robust payment and settlement system by focusing on safety and efficiency by working with the banking system to have seamless movement of dollar transactions
- Encourage consumer protection through a wide variety of actions
That is quite a set of core activities that certainly mean quite a bit to each participant in the economy, from businesses and individuals to banking institutions. Moreover, its actions affect the present and the future as central banking institutions, and its policies can drive positive consumer sentiment and increase spending, encourage saving, or help to foster rampant speculation through its monetary tools.
Yet if one were to look at the Federal Reserve with an objective analytical lens, by looking at the past few decades, and its track record, and in relation to its core activities, one would be of the view that it has not been a strong performer.
One could argue that the Federal Reserve has fostered several bubbles that have led to further destabilization in the economy.
The Dot Com bubble and inevitable crash in the early 2000s, the housing bubble, and the great financial crisis in 2008/2009, and tremors in the markets in 2018.
There are those who note that the financial system is less resilient today due to easy monetary policies and is now more sensitive to slight changes in monetary policy.
All the while, over the past two decades, savers of cash have not been able to earn reasonable yields by keeping money in a bank account.
This track record seems quite concerning to an increasing portion of the financial community, business leaders, analysts, and economists.
The latest proposal by the Federal Reserve seems as if it leans into becoming more involved in the system directly and effectively impacting the system with more ease.
The Fed Coin and Commercial Banks
The Federal Reserve notes that one of the key differences between a CBDC and the current system is that the money distributed and moved by individuals, small businesses and large businesses are the liabilities of banking institutions. In the new system, it would be a liability of the central bank such as the Federal Reserve.
Right now, you deposit your funds at banks ranging from JP Morgan Chase to Silvergate and Silicon Valley Bank. Once you send funds to someone, it leaves your account and goes to their respective bank account.
In the new system, the funds are stored directly at the Federal Reserve.
In this new paradigm, the commercial banks, those entities that store your funds, seem redundant and unnecessary.
The new system allows for targeted involvement in the financial system, enabling the Federal Reserve to reach your account easily. It also simplifies regulation as the funds are not held at various commercial banks but instead directly in an account at the central bank.
The rationale for the shift is that it would radically simplify banking, reduce costs (fees) in money transfers, and could allow more people to have access to the banking system.
This is where it gets a little confusing.
In its recent paper, it notes that the CBDC should:
- Offer benefits to each participant in the economy and present more benefits than risks
- Be better than existing systems and alternatives
- Be alongside current forms of money and methods for the provision of financial services
- Provide privacy
- Mitigate criminal activity
- Be in line with stakeholders
Where it gets a little confusing is where it works alongside present forms of money and methods of financial services.
Then, the provision of privacy, and being in line with stakeholders.
If it is fully centralized, where accounts are present at the central bank, all information flows through to that one entity. Privacy seems to be out of the equation in that system. Again, if centralized, how can it work with other existing systems and alternatives?
Why would one need to have applications like Paypal, Square, or other payment solutions with an account and a simple CBDC mobile application that moves money seamlessly from one party to the next?
If we look at China, we may have some ideas. China has released its CBDC or its own version of the Fed coin but it is only in the soft launch phase right now. This means that it is piloting in a few cities before deciding to expand it. In China, individuals can still go to commercial banks to input more funds to their centralized digital wallet.
Since it is taking a more gradual approach, we are not certain if that will be the same process with Chinese citizens moving forward.
Another interesting aspect of the e-yuan or China’s version of the Fed coin is that it is not easy to gain adoption. Chinese citizens are increasingly on Alipay or Wechat, these payment platform providers have made it easy to send payments and it makes little sense for consumers to make the switch to a CBDC unless forced to do so.
Further, the Chinese government cracked down on its big technology companies, the providers of Alipay, Wechat, and other firms during the initial roll out of its CBDC.
This brings us to the last point.
How does the US government obtain the support of all stakeholders within the current financial system? If it would make them obsolete, then they are unlikely to support it.
Again, we see that there are various answers we would want from the Federal Reserve before any movements are made on a CBDC like the Fedcoin.
Fedcoin Vs. Commercial Banks
Individuals would have more choice and flexibility with a wide variety of commercial banks, community development banks, and other banks in their respective areas.
This choice is not only present in the bank and its level of service. It is also present in the type of activities that it would allow. For instance, one banking entity may not flag money transfers to an online gambling site, conversely, another may halt the transaction.
In another situation, while one bank may not provide you with a loan to open up a new business or to obtain your first home, another one might.This range of stringent or conservative banking to more liberal and open banking allows individuals to have more access to opportunity.
But if you cut out this range of choice and move toward the proposed fully centralized banking, does that create further difficulties for the average economic participant?
Can it lead to the invasion of privacy, censorship, and other issues?
Even more so, does it create more financial meltdowns like those experienced in 2000/2001and 2008/2009? Does it impede private markets and price discovery in the markets?
These are the questions that have yet to be answered as the Federal Reserve and stakeholders analyze the central bank digital currency project.
The Benefits Of A Digital Currency On A Federal Level
These are a few of the benefits of a central bank digital currency.
Easier Financial Tracking
The digital dollar would be issued by federal entities and would be stored in a citizen’s “e-wallet”, or a secure piece of hardware that can store their information. When purchases are made or transactions occur, there would be an instant transfer of funds, just like using cash.
Since the network will be federal, all transactions involving official digital currency would be tracked. This may have huge impacts on taxes and financial transparency nationwide.
If it is more centralized to where accounts are directly at the central bank exclusively, it would have further transparency in money transfers domestically and globally. When thinking about it from a global standpoint, it would mean transfers coming into US accounts and transfers going out to external accounts.
Improved Technology and Additional Security
The monetary system would require more updates. This would potentially spur more technological advancement and help to bring about more efficiency. A crucial part of this more advanced system would be more security.
To be secure enough, it would likely need to involve a secure blockchain, which would then become publicly visible to a similar extent as other similar blockchain information.
Centralization & Counterfeit Resistance
Unlike decentralized cryptocurrency blockchains, the network for any potential Fed Coin would be fully-centralized just like our modern monetary framework. Not just anybody would have the ability to “create” new money as the Fed would, and using existing blockchain frameworks could eliminate counterfeiting of digital assets.
However, national dependence on a single national transactional network also raises potential liability concerns and questions of how it’s going to be adequately secured. Having even a single breach or outage could be catastrophic for the nation, so implementation would need to be flawless.
Potential Difficulties & Challenges
Since other countries have already begun to establish standards on digital national currencies, the US may need to undertake significant efforts to contribute to international digital monetary standards or risk the entire financial future beginning to take shape without them.
This won’t be an easy task, however, and the US will face some hurdles to being able to do so.
At the same time, it is important to note that it is not solely an incremental move in technology that provides the United States with its current status in the world.
It is agreements such as the Bretton Woods agreement, different forms of legislation, supply and demand of United States dollars globally, its reserve status, and its perception as a democratic nation, a safe haven and an economic powerhouse.
That is to say that as long as the United States has these other various qualities, an incremental move from its current monetary framework to the adoption of a CBDC system in the near future does not make a large impact.
For the United States, it is not only about improving its monetary technology system but rather also preserving its current status in the world.
One large challenge to any move toward a cashless model will be the challenges from those who oppose the loss of privacy that a centralized, digital currency may bring.
Cash transactions can be done with a high degree of privacy, and there are little to no laws that restrict everyday cash transactions between private citizens.
Migrating to a cashless society is a long way off, but beginning that process will be a step that will face a lot of resistance from various groups that oppose digital currencies & multinational monetary collaboration. This challenge is likely to become easier to surmount in coming generations, but the 2020s and possibly 2030s will likely see significant opposition.
What’s The Outlook For A US “Digital Dollar”?
This is the speculative aspect of it. While the idea has certainly been considered, there are not going to be advancements any quicker than most other legislative actions, and it will likely take longer than most legislation because there is a significant technological factor to it.
Some estimates put digital dollars into citizens’ e-wallets before 2030. This would require nothing short of a massive public push, and necessary allocation of development funds to be the case, however. More conservative efforts say that it will be at least 10 years before the technology, development, and public opinion of it have advanced to a point of practicality.
The digital national currency has already been pioneered by other countries, both with state-regulated stablecoins as well as with Bitcoin becoming a nationally-endorsed monetary system. The US will eventually be forced to develop a digital currency as well, but answers to some of the more detailed questions relating to privacy and more, may not be available for several years. One thing is for sure, however, the Fed Coin will exist in one form or another.