The Board of Governors of the Federal Reserve, on January 20, 2022, released a discussion paper (the “Document”) regarding the possibility of creating a central bank digital currency (“CBDC”). The document discusses the uses, functions, benefits, and risks of using a CBDC, as well as public policy considerations. The Federal Reserve invites input from stakeholders regarding the potential creation of a CBDC, including, but not limited to, possible designs and public policy considerations. The comment period will remain open until May 20, 2022 and interested stakeholders should collect and prepare responses by that date.
Central banks around the world have explored 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 regions, including Shanghai and Shenzhen, to use the new e-CNY. This project was announced in 2014 and was piloted in four cities starting in April 2020.
Notably, e-CNY was introduced in time to serve as a payment method for the Beijing Winter Olympics. Despite the PBOC’s tremendous efforts to increase awareness and usage of e-CNY, it faces stiff competition from private enterprise payment systems such as Alibaba’s Alipay and WeChat Pay. Tencent, who dominate 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 past year alone, the market capitalization of stablecoins has grown from around $42 billion to around $173 billion. The document acknowledges the growing popularity of digital assets in recent years and points out that stablecoins have the potential to “support faster, more efficient and more inclusive payment options”, citing the recent report published by the working group of the Chairman of the 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 acknowledging the potential benefit of stablecoins, the paper notes that increased use of stablecoins as a means of payment raises concerns related to the potential for destabilizing races, disruptions to the payment system, and concentration of power. economic. Although the paper does not focus on stablecoins, these new forms of payment are one of many factors that the Federal Reserve takes into consideration when opening the discussion on the introduction of a CBCD.
The Discussion Paper
For the purposes of this document, 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 created, would better serve U.S. needs by being privacy protected, intermediated, widely transferable, and identity verified.
Protection of private life: Consumer privacy is a key concern that must be appropriately balanced with the transparency necessary to deter criminal activity.
Intermediated: The CBDC model will operate under an intermediated model where the private sector would offer digital accounts or wallets to facilitate the management of CBDC assets and payments while keeping the CBDC itself a liability of the Federal Reserve.
Widely transferable: A CBDC should be easily and transparently transferable so that the payment system is more efficient.
Identity verified: The identity of a person accessing the CBDC should be verified by a CBDC intermediary to prevent money laundering and terrorist financing.
The document identifies a number of potential benefits of a CBDC:
Securely meet future payment service needs and requestss. Because a CBDC is free from credit risk and liquidity risk, it could provide a secure foundation for private sector innovations to meet current and future payment service needs and demands. A CBDC could also level the playing field in payment innovation for private sector businesses of all sizes and could generate new capabilities to meet the changing speed and efficiency demands 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 collaboration and interoperability between jurisdictions, although this potential depends on significant international coordination.
Supporting the international role of the dollar. A U.S.-issued CBDC could help preserve the international role of the dollar by reducing transaction and borrowing costs for U.S. households, businesses, and the government and allowing the U.S. to maintain influence over standards of the global monetary system.
Financial inclusion. A CBDC could reduce common barriers to financial inclusion and reduce transaction costs, which could be particularly helpful for economically vulnerable households and communities.
Expand public access to secure central bank money. There has been a global trend of digital payments rapidly supplanting cash. A CBDC would expand consumer access to digitized central bank currency that poses no credit or liquidity risk.
Potential risks and political considerations
Despite a wide range of potential benefits for U.S. consumers and the broader financial system, the paper acknowledges that there are complex policy issues and risks that will require additional research and analysis:
Changes in the market structure of the financial sector. A widely available CBDC could eventually substitute for commercial bank currency, which would reduce the total amount of deposits in the banking system and thus increase bank funding expenditures and reduce credit availability or increase credit costs. A non-interest bearing CBDC design could potentially alleviate these concerns as it would be less attractive than commercial bank money. Additionally, a central bank could limit the amount of CBDC an end user could hold.
Security and stability of the financial system. The ability to quickly convert other forms of money into CBDCs could make runs on financial companies more likely or more severe in the event of a financial panic. Similarly, a non-interest-bearing CBDC design could potentially alleviate these concerns, but depositors may still prefer CBDC over bank deposits because a CBDC, as a central bank liability, is “essentially risk-free.”
Effectiveness of monetary policy implementation. The introduction of a CBDC could impact the implementation of monetary policy and the control of interest rates by altering the supply of reserves in the banking system. The possibility of substantial foreign demand for a CBDC could further complicate the implementation of monetary policy.
Privacy and data protection and financial crime prevention. A CBDC should strike an appropriate balance between protecting consumers’ privacy rights and providing the transparency necessary 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 capability could potentially improve the “operational resilience of the payment system,” but more research needs to be done to find out if offline payments are feasible.
Discussion and analysis
Market participants should note that the document does not itself enact policy or promote particular policy outcomes. The document stresses that unless there is broad public support as well as legislative and executive branches, the Federal Reserve has no intention of moving forward with a CBDC proposal. In addition to requiring broad support, the Federal Reserve clarifies that the development of a CBDC will only go ahead if research indicates that the benefits to households, businesses and the economy as a whole will exceed the risks and that a CBDC is superior to alternative methods.
While the document does not favor any specific design for a CBDC, observers should note that the Federal Reserve’s initial conclusion is based on the Federal Reserve’s acknowledgment that it does not have the power, 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 operating independently. In this scenario, private sector financial institutions would issue wallets to individuals, rather than having individuals own accounts with the Federal Reserve. Additionally, the document highlighted the transferability of a CDBC between different intermediaries as a policy consideration. If passed, it could require financial institutions to coordinate to ensure convenient access for consumers to transfer currency between financial institutions or adhere to uniform requirements for wallets and transfers. In any case, the document makes it clear that the implementation of any CBDC is something that should not be expected in the short term. Stakeholders should monitor legislative positions as Congress begins to consider the issue, as several members of Congress have raised political considerations for possibly opposing an interim CBDC in favor of a non-mediated version.3
The authors would like to thank Cindy Wu and Paul Leonardo Capuano for their contributions to this article.
1) Report on Stablecoins, President’s Task Force on Financial Markets, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency (November 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, Federal Reserve Board of Governors (January 2022), available at https://www.federalreserve.gov/publications/files/money-and-payments- 20220120.pdf.
3) The Fed kicks off the debate on issuing its own digital currency with a new white paper, Reuters (January 20, 2022).