The Digital Dollar Comes into Focus

By Craig Colgan

As digital technology plays a larger role in how banks and customers interact, and with surging price volatility driving attention to increasing interest in private digital currencies, central banks globally continue to explore creation of digital currencies of their own.

A group from the Federal Reserve Bank of Boston has expanded its work with the MIT Media Lab on a digital dollar research project at the same time that China is finalizing its efforts to expand its digital yuan, a true central bank digital currency, or CBDC.

Advocates of CBDCs say they promise to realize a broad range of new capabilities, including direct government disbursements to citizens, frictionless consumer payment and money-transfer systems and a range of new financial instruments and monetary policy drivers. CBDCs have also inspired a host of challenging technical goals and design questions that are different from those in existing government and consumer payment systems.

“A well-functioning CBDC will require an extremely resilient, secure, and performant new infrastructure, with the ability to onboard, authenticate, and support users on a massive scale,” notes a report from the Brookings Institution in Washington.

Three CBDC scenarios

Analysts tend to break down CBDC implementation across several scenarios when considering its direct impacts on banks.

In what is generally considered an unlikely arrangement, a U.S. CBDC would essentially take over the banking industry and all loans would be required to be made in it. Since banks would not process payments anymore and the CBDC would not be available to make loans, the typical business of banking would be totally upended. This scenario tends to exist mostly in the writings of theorists.

In a second scenario, the central bank creates its own digital currency, but it competes alongside the existing structure. This arrangement is likely more palatable to policymakers, as it would not be replacing an entire payments industry.

“A CBDC in this scenario is more of a competitive product than a total replacement for U.S. payment systems,” says Steve Kenneally, ABA SVP for payments policy. “Customers would still have an account at your bank, but they would also have a CBDC account where they would keep some sort of balance. So there would be some amount of money sitting outside your bank and in this CBDC. The questions are: How much money? And at what point does that impact banks’ capability to make loans?”

A third scenario is if CBDCs are divided into retail and wholesale, with CBDCs limited to just wholesale transactions—that is, interbank settlement, allowing bank-to-bank payments to be made 24/7/365.

The Federal Reserve is “looking very carefully” at whether and how it might issue a digital dollar, Fed Chairman Jerome Powell told members of Congress in February. In testimony before the Senate Banking Committee, Powell noted that it is “something we are investing time and labor in across the Federal Reserve System,” and that as the issuer of the world’s reserve currency, “we have a responsibility to get this right.”

“There are significant both technical and policy questions to do with how we would go about doing that,” he said. “We’re committed to solving the technology problems and to consulting very broadly with the public and very transparently . . . as to whether we should do this.”

He also noted that the Fed would carefully weigh potential benefits of a digital dollar—such as helping to promote financial inclusion—against potential implications for the banking system. “You want to avoid creating things that might be destabilizing or draw funds away from the banking system,” Powell said. “We have a banking system that intermediates between savers and borrowers. We want to be careful about what the implications are.”

Treasury Secretary Janet Yellen also spoke favorably about the idea. “Too many Americans don’t have access to easy payments systems and banking accounts, and I think this is something that a digital dollar, a central bank digital currency, could help with,” Yellen said at an event in February. “There’s a lot to consider here, but it’s absolutely worth looking at.”

CBDC challenges

One drawback for many users may drive a larger benefit for the financial system as a whole. A CBDC would likely mean less privacy than for those using cash or digital payments. As CBDC users effectively hand the government direct access to their transaction history, this transparency would be expected to discourage money laundering.

Another challenge policymakers are wrestling with is access, as the use of a CBDC would require use of digital devices.

ABA’s Kenneally notes that other obstacles remain. “It would also be working against FedNow, the payment product the Fed is trying to launch that it started working on in 2019,” he says. “They don’t expect to get that up and running even on a basic level until 2023 or ’24. That gives you an idea about these big technological projects. A CBDC is out there. It is percolating. But it is not happening tomorrow.”

For bankers who wonder about whether such change makes sense for their banks and their customers, Kenneally has a suggestion.

“Try to make your digital payments system as good as it can be,” he says. “As fast as you can. Because then that will lessen the desire to make something different.”

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Craig Colgan

Craig Colgan is a staff writer at the ABA Banking Journal.