A U.S. Central Bank Digital Currency? The Federal Reserve Opens the Discussion

The Board of Governors of the Federal Reserve on January 20, 2022, published a discussion paper (the “Paper”) concerning the possibility of creating a central bank digital currency (“CBDC”). The Paper discusses the uses, functions, benefits, and risks of utilizing a CBDC, as well as public policy considerations. The Federal Reserve requests comment from stakeholders concerning potential creation of a CBDC, including, but not limited to, possible designs and public policy considerations. The comment period will remain open through May 20, 2022 and interested stakeholders should collect and prepare responses by that date. Central banks throughout the world have been exploring CBDCs. On January 4, 2022, China’s central bank, the People’s Bank of China (the “PBOC”), launched a pilot version of the digital yuan (“e-CNY”), allowing users in 11 areas including Shanghai and Shenzhen to use the new e-CNY. This project was announced in 2014 and was piloted in four cities beginning in April 2020. Notably, the e-CNY was introduced in time to act as a form of payment at the Beijing Winter Olympics. Despite the PBOC’s great effort to raise awareness and usage of e-CNY, it faces tremendous competition from private company payment systems such as Alibaba’s Alipay and Tencent’s WeChat Pay, which are dominating the mobile payments market. Similarly, in the United States, the focus on “stablecoins” has increased, with growing calls for regulation from various government agencies and members of Congress. In the last year alone, the market capitalization of stablecoins has grown from approximately $42 billion to approximately $173 billion.  The Paper recognizes the rising popularity of digital assets in recent years and underscores stablecoins as having the potential to “support faster, more efficient, and more inclusive payment options”, by quoting the recent report published by the President’s Working Group on Financial Markets (the “PWG”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Office of the Comptroller of the Currency (the “OCC”)¹. In addition to recognizing the potential benefit of stablecoins, the Paper notes that an increased use of stablecoins as a means of payment raises concerns related to the potential for destabilizing runs, disruptions in the payment system, and concentration of economic power.  While the Paper does not focus on stablecoins, these new forms of payment are one of many factors the Federal Reserve is taking into consideration as it opens the discussion on the introduction of a CBCD.

The Discussion Paper

CBDC

For the purpose of the Paper, a CBDC is defined as a digital liability of a central bank that is widely available to the general public.²  The Federal Reserve’s initial analysis suggests that a U.S. CBDC, if one were created, would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable, and identity-verified.

Privacy-protected: Consumer privacy is a critical concern that needs to be balanced appropriately with affording the transparency necessary to deter criminal activity.

Intermediated: The CBDC model will be operated under an intermediated model where the private sector would offer accounts or digital wallets to facilitate the management of CBDC holdings and payments while keeping the CBDC itself as a liability of the Federal Reserve. 

Widely Transferable: A CBDC would need to be readily and seamlessly transferable so that the payment system would be more efficient. 

Identity-verified: The identity of a person accessing CBDC would need to be verified by a CBDC intermediary to prevent money laundering and the financing of terrorism. 

Potential Benefits

The Paper identifies a number of potential benefits of a CBDC: 

Safely Meet Future Needs and Demands for Payment Services. Because a CBDC is free from credit risk and liquidity risk, it could provide a safe foundation for private-sector innovations to meet current and future needs and demands for payment services. A CBDC could also level the playing field in payment innovation for private-sector firms of all sizes and might generate new capabilities to meet the evolving speed and efficiency requirements of the digital economy. 

Improvements to Cross-Border Payments. A CBDC has the potential to streamline cross-border payments by using new technologies, introducing simplified distribution channels, and creating additional opportunities for cross-jurisdictional collaboration and interoperability, although such potential depends on significant international coordination.  

Support the Dollar’s International Role. A U.S.-issued CBDC might help preserve the international role of the dollar by lowering transaction and borrowing costs for U.S. households, businesses, and government and enabling the U.S to maintain its influence over standards for the global monetary system.  

Financial Inclusion. A CBDC could reduce common barriers to financial inclusion and could lower transaction costs, which could be particularly helpful for economically vulnerable households and communities. 

Extend Public Access to Safe Central Bank Money. There has been a global trend of digital payments rapidly supplanting cash. A CBDC would extend consumers’ access to the digitalized central bank money that has no credit or liquidity risk attached to it. 

Potential Risks and Policy Considerations

Despite a wide range of potential benefits to U.S. consumers and the broader financial system, the Paper recognizes that there are complex policy issues and risks that will require additional research and analysis: 

Changes to Financial-Sector Market Structure. A widely available CBDC could possibly substitute for commercial bank money, which would reduce the aggregate amount of deposits in the banking system and thus increase bank funding expenses and reduce credit availability or raise credit costs.  A non-interest-bearing CBDC design could potentially mitigate such concern as it would be less attractive than commercial bank money. In addition, a central bank might limit the amount of CBDC an end user could hold. 

Safety and Stability of the Financial System. The ability to quickly convert other forms of money into CBDC could make runs on financial firms more likely or more severe in the event of financial panic.  Similarly, a non-interest-bearing CBDC design could potentially mitigate such concern, but depositors may still prefer CBDC over bank deposits because a CBDC, as a liability of the central bank, is “essentially riskless.”

Efficacy of Monetary Policy Implementation. The introduction of a CBDC could impact monetary policy implementation and interest rate control by changing the supply of reserves in the banking system. The potential for substantial foreign demand for a CBDC could further complicate monetary policy implementation. 

Privacy and Data Protection and the Prevention of Financial Crimes. A CBDC would need to balance appropriately between safeguarding consumer privacy rights and affording the transparency to deter criminal activity. 

Operational Resilience and Cybersecurity. A CBDC faces operational disruptions and cybersecurity risks like existing payment services. Designing a CBDC with offline capacity could potentially enhance the “operational resilience of the payment system,” but further research needs to be done on whether offline payments are feasible. 

Discussion and Analysis

Market participants should note that the Paper does not by itself promulgate policy or favor particular policy outcomes. The Paper emphasizes that unless there is broad support from the public as well as both the legislative and executive branches, the Federal Reserve does not intend to move forward with a CBDC proposal. In addition to requiring broad support, the Federal Reserve makes clear that development of a CBDC will move forward only if research indicates that the benefits for households, businesses and the economy at large will exceed the risks and that a CBDC is superior to alternative methods.

Although the Paper does not favor any specific design for a CBDC, observers should note the Federal Reserve’s initial conclusion is based on the Federal Reserve’s recognition that it does not have the authority under the Federal Reserve Act to make direct accounts available to individuals and, therefore, a potential CBDC would be intermediated through the current financial system, rather than function independently. In this scenario, financial institutions in the private sector would issue wallets to individuals, rather than have individuals possess accounts with the Federal Reserve. Further, the Paper highlighted transferability of a CDBC between different intermediaries as a policy consideration. If enacted, this could require financial institutions to coordinate with each other to ensure convenient access for consumers to transfer the currency between financial institutions or adhere to uniform requirements for wallets and transfers. In any event, the Paper makes clear that the implementation of any CBDC is something that should not be expected in the short term. Interested parties should monitor legislative positions as Congress begins to consider the issue, as several members of Congress have raised policy considerations for possibly opposing an intermediated CBDC in favor of an unmediated version.³

The authors would like to thank Cindy Wu and Paul Leonardo Capuano for their contributions to this article. 

Footnotes

1. Report on Stablecoins, The President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency (Nov. 1, 2021), available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.  

2. Money and Payments: The U.S. Dollar in the Age of Digital Transformation, Board of Governors of the Federal Reserve System (January 2022), available at https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf. 

3. Fed kicks off debate on issuing its own digital currency with new white paper, Reuters (January 20, 2022).