- A new report from the Federal Reserve has opened the door to debate around a central bank digital currency.
- The Fed avoided taking sides for or against the idea and instead raised a number of pros and cons.
- A CBDC could boast many of the benefits of crypto without the steep price swings seen over the past year.
The rise of cryptocurrencies to global stardom has put governments on high alert. Some, like China and Sweden, are already tinkering with digitizing their own currencies. Now the
dips his toes in the water.
The Federal Reserve still hasn’t spoken for or against a central bank digital currency, but a new report outlines the potential benefits and risks of fully digitalizing the US dollar.
The Fed kicked off the debate on a US central bank digital currency on Thursday, releasing a much-anticipated report on the subject. A CBDC would serve as a purely digital version of Fed-backed money and just as publicly accessible as physical money. It wouldn’t require the same deposit insurance that banks need for liquidity, and it wouldn’t need to be backed by a physical asset.
A Fed-backed digital dollar would then provide many of the benefits touted by cryptocurrencies without their price fluctuations and user fees. In theory, a CBDC would merge the best aspects of physical and digital currencies for the average American.
A CBDC probably wouldn’t feel all that different from a regular dollar. People are already using digital cash when shopping with credit or debit cards, but in these situations the currency is backed by private sector banks. If the Fed introduced a CBDC, Americans could shop with a digital dollar backed by the country’s central bank. If that sounds strange, it shouldn’t be; physical dollar bills are already backed by the Fed, not commercial banks.
The Fed has refrained from taking a position on a CBDC, saying it aims to first engage with the public, Congress and other stakeholders on the subject. Still, Thursday’s report detailed a handful of reasons why such a currency would benefit the country and be a better way to spend than commonly traded cryptocurrencies that have seen adoption skyrocket in recent years.
A CBDC could bring safe, fast and accessible payments
Cryptocurrencies have grown in popularity in part due to their use in real-time peer-to-peer payments. A CBDC could offer the same. Transactions with a CBDC would be “final and completed in real time” and could be used for everything from buying groceries to receiving government stimulus, according to the report.
Digital money would also be free from credit risk,
risk, and, perhaps most importantly, the
this makes spending with crypto so unreliable. Stablecoins, or cryptocurrencies that seek to peg their exchange rate with a more conventional currency like the dollar, solve part of the volatility problem, but a recent report from the president’s task force on financial markets found shortcomings. in the authority of regulators to deal with certain stablecoin risks.
A CBDC would also allow for more flexible transactions, the Fed said. Payments could be scheduled at certain times and used for small transfers that traditional systems might not allow. And while services like PayPal and Venmo already have some of these features, a CBDC would allow users to make such transfers without a private third party.
CBDCs could even improve cross-border payments, but such gains would take time to materialize. International transfers of CBDCs would require new infrastructure, government coordination, and law enforcement to combat illicit finance. Still, a future CBDC network could do away with transfer fees and long settlement times.
A CBDC would come with the risks of the 21st century
A fully digitized dollar would come with its fair share of pitfalls, the Fed warned. On the one hand, allowing the Fed to support digital payments could “fundamentally change the structure of the US financial system,” according to the report. Commercial banks rely on deposits to make loans, but a CBDC could replace cash held in commercial banks with digital wallets offered by the private sector. This could make it much more difficult for people to take out loans.
The stability of a CBDC could also trigger runs on commercial banks during times of economic uncertainty, the Fed said. Traditional measures used to prevent mass bank outflows would be ineffective if people rushed to convert their bank assets into CBDCs.
Implementing a Fed-backed digital dollar could even erode the policy power of the central bank. By changing the amount of reserves in the financial system, a CBDC could affect how the Fed sets interest rates and steers inflation. The Fed would likely need to increase its level of reserves just to account for fluctuations between cash in circulation, bank reserves, and CBDC holdings.
The introduction of a CBDC, risks and all, would be “a very significant innovation in American money,” the Fed said. The central bank is expected to take comments on the issue until May 20, when it is expected to think more about the currency’s pros and cons. While the future of a digitized dollar remains uncertain, the Fed report unequivocally opens the door to such a project.