But how does a CBDC relate to other digital assets? The answer seems to depend a lot on the context. In some situations, the term “digital assets” has been used quite specifically to refer to cryptocurrencies such as Bitcoin and Ethereum. Yet, seen from another perspective, the term “digital assets” can be applied much more broadly. After all, money in the United States was stored and transferred digitally long before the advent of cryptocurrencies. Commercial bank reserve balances at the Fed have long been held and transferred digitally. The same is true for consumer current accounts in commercial banks. For years, people have been regularly paying their utility and other bills using online apps with funds from their bank accounts.
The volume of digital payments has also increased significantly thanks to online payment services, such as digital wallets. Venmo, which is owned by PayPal, processed $230 billion in payments in 2021, a 44% increase from the previous year. Zelle, owned by a consortium of commercial banks, processed $490 billion in payments in 2021, a 59% increase from the previous year.
Cryptocurrencies differ from these other forms of digital currency in several ways. For one thing, as privately-issued mediums of exchange, their value is based primarily on the forces of supply and demand rather than a financial institution’s promise to redeem a set amount of dollars. . Moreover, they are differentiated by their technological foundations and governance systems. The most prominent cryptocurrencies, Bitcoin and Ethereum, use blockchain technology, which enables direct peer-to-peer transactions on a network without the need for a central clearing authority, such as the Fed or a private clearing house.
Stablecoins are a recently introduced form of cryptocurrency whose value is “tied” to another asset, usually a sovereign currency. As with any pegged asset, the stability of a stablecoin’s value depends on the ability and willingness of the issuer or other parties to maintain peg by standing ready to redeem the stablecoin at its pegged value. For this reason, policymakers are concerned that stablecoins, like pegged sovereign currencies, could destabilize races – i.e., consumers could rush to cash out their holdings of a stablecoin if they don’t. they hear negative rumors about it, perhaps overwhelming the ability of its backers to support its value. The run on TerraUSD in May is a good example.
Arguably, the advent of cryptocurrencies provided much of the impetus behind the possible creation of a US CBDC. Academics and policy makers are intrigued by the potential of the various technologies associated with cryptocurrencies. But that doesn’t mean that a possible US CBDC would necessarily look like a cryptocurrency. Indeed, an American CBDC might employ little or none of these technologies. Instead, it may end up looking a lot like forms of digital currency that long predated the introduction of cryptocurrencies.
An American CBDC could have a variety of different features, depending on the design choices of the decision makers. One possible model is the Bahamian Sand Dollar, which is available to residents of the archipelago through authorized financial institutions. The Central Bank of the Bahamas issues the CBDC, maintains a centralized registry of individual holdings, and provides authorized financial institutions with a secure application that allows them to offer digital wallets to their customers. Another example is the model pursued by China, where cash has already been largely replaced among consumers by mobile payment apps like Alipay and WeChat Pay, and a CBDC would likely compete with these mobile payment services. The digital yuan was launched in pilot form in 2019. Like the sand dollar, it is held by consumers in digital wallets and is more like payment apps like Venmo or Zelle than cryptocurrencies like Bitcoin and Ethereum.
Hopes of central banks. . .
Central banks have identified several possible benefits that could arise from the creation of a CBDC. The first is the possibility of reducing costs for consumers and improving the efficiency of the payment system, both domestically and for cross-border transactions. This would place the introduction of a CBDC in the tradition of previous Fed initiatives to improve the U.S. payments system, such as the Automated Clearing House (ACH) system, a national network used for direct payroll deposit. and social security checks and automated bill payment. . Another example is Fedwire Funds Service, a real-time funds transfer system between participating institutions.
A CBDC can also offer private sector innovators the opportunity to create new payment services that consumers can use for CBDC payments. It can also stimulate competition in the financial sector – between banks and credit card companies. “Incumbent financial firms have been very reluctant to move to real-time payments and reduce credit card interchange fees,” says Harvard Law School’s Howell Jackson, who recently taught a course on the issues of design of CBDCs. “We are really spending more of our national income on payments than we should.”
Certainly, progress has been made. In 2017, for example, The Clearing House, owned by a consortium of commercial banks, launched its real-time payment platform – known as RTP – to speed up the clearing and settlement of payments. The Fed is also rolling out a new instant payments service, the FedNow service, which will launch in 2023. But some observers think more can be done. “A central bank digital currency could kick-start payment competition,” Jackson says, “and it could get us faster to real-time, high-speed payments, which most people think is a good thing. could also exert strong competitive pressure on Visa and Mastercard.”
Another potential benefit of a CBDC is that it could encourage financial inclusion for the relatively small fraction of US households – around 5% – who do not have a bank account. The hope is that the launch of a CBDC will reduce barriers to financial inclusion by encouraging the private sector to provide greater access to low-cost electronic transaction accounts. A closely related potential benefit is that creating a CBDC could facilitate tax transfers, such as IRS stimulus payments, to people who are currently unbanked.
Some analysts have pointed to a possible defensive motive for establishing a CBDC: it would reduce the risk that the US payments system would lag behind technical advances in other major economies around the world and thus help maintain the status of the dollar. US as an international reserve currency. “An important motivation for considering a CBDC is to future-proof the US payment system against the rise of private and foreign digital currencies,” says Richmond Fed economist Zhu Wang, who has conducted extensive research on payment systems. “Private or foreign digital currencies, if not effectively regulated, could raise major concerns over issues such as payment fragmentation, user privacy, market power, monetary policy and financial stability. Policy makers need to prepare on different fronts by improving our nation’s infrastructure and keeping it on the cutting edge of technology.” (See also “Is dollar dominance uncertain?”)
. . . and fears
Central banks have also identified several risks associated with the introduction of a CBDC. One is how it might change the structure of financial markets. Banks now rely heavily on deposits to fund loans. Since a CBDC would serve as a close substitute for bank deposits, its introduction could cause consumers to withdraw funds from their bank accounts. This, in turn, could increase banks’ funding costs and negatively affect the availability and cost of bank credit for households and businesses.
Policymakers are also concerned about the possible volatility in demand for a CBDC. In this context, one of the suggested advantages of a CBDC – its lack of credit and liquidity risk – could turn out to be a double-edged sword. During times of financial turmoil, the relative safety of a CBDC can cause risk-averse individuals and businesses to significantly steer away from other forms of currency, increasing the risk of runs on financial firms such as money market mutual funds and commercial banks. While deposit insurance would dampen bank depositors’ motivation to withdraw their money in response to bad news, there are concerns that it may prove insufficient to prevent large transfers from traditional bank accounts to CBDC accounts during the downturns. periods of extreme stress.
Such a flight to quality would complicate the Fed’s task. Banks would be forced to rush to find other sources of funding, and the Fed would feel compelled to provide liquidity to institutions in order to fulfill its financial stability mandate and prevent a spike in short-term interest rates. .
“I think what’s often overlooked in these discussions is that the demand for CBDCs could potentially increase extraordinarily rapidly during times of distress,” says Bill Nelson of the Bank Policy Institute, who conducts research and advocates for interests of the banking sector. “If the Fed were to offset declining bank reserves, the Fed’s balance sheet could skyrocket.”
In addition to these concerns related to financial market structure and monetary policy, policymakers are also concerned about how the establishment of a CBDC would affect the resilience and cybersecurity of the payment system in light of the possibility of piracy. Additionally, some observers worry that a CBDC, if not properly designed, could create new avenues for illegal activities, such as money laundering and terrorist financing.