U.S. CBDC – Good or Bad for Consumers and Business?
The Fed “is conducting research and experimentation related to distributed ledger technologies and their potential use case for digital currencies, including the potential for a CBDC [central bank digital currency]” – Federal Reserve Governor Lael Brainard, 2/25/2020.
After many years of dithering the Fed is seriously investigating creating digital currency – a “digital dollar”. Not bitcoin, but digital dollars backed by the United States government. Why? When will this happen? What does this mean to me?
- Consumers will financially benefit from a US digital currency
- Most businesses should embrace a digital dollar
- The Fed and US Treasury will benefit from a US digital currency perhaps more than anyone
- Financial services: dis-intermediated?
What Does Digital Currency Mean To Me?
Consumers can financially benefit from a US digital currency. A digital dollar, credit cards, and debit cards are all digital currency but a digital dollar can have significant advantages. Most importantly, a US digital dollar is backed by the US government. As a result there will be no need to pay banks to store money. US and international settlements will be faster and interest updates can be close to instantaneous. For consumers, a digital currency can be not just a currency but a digital identity.
Businesses should embrace a digital dollar. At the least, a digital dollar will be an asset leading to lower international trade and settlement fees. Most interestingly, a digital dollar could lower some bank services and their fees and/or encourage financial intermediaries to offer lower-cost differentiated services.
The Fed and US Treasury will benefit from a US digital currency perhaps more than anyone. A digital dollar will allow the Fed to perform almost instantaneous money adjustments – interest rates, banking system reserves, etc. – based on seeing cash flows in real-time. Consequently, among other benefits a central bank will immediately be able to understand and adjust monetary policy. As well, there will be significantly better AML and KYC capabilities.
Some financial services will be dis-intermediated. Some but not all financial services capabilities may be usurped by a digital dollar. Possibilities – demand deposits, CDs, international settlement. Probably not – credit, lending, insurance, brokerage, etc. Purchases and payments?
Why US Digital Currency and When?
US digital currency is an electronic representation of paper currency1. You may say “Don’t we have already digital currency – called credit and debit cards?” Well yes, our bank accounts, credit (and other types of) cards represent the value of US currency. However, this currency is a debt of the credit issuer such as a bank. The Fed’s digital currency is a central bank digital currency that is a debt of the US government not banks.
When will this happen? Well, is a a confluence of immediate factors:
- Consumers: The use of cash is declining. In the US cash use was only 26% in 2018. In comparison other countries use less cash. For example cash use in Sweden is 13%.
- Technology: Blockchain, DLT, and/or associated technologies are capable of supporting digital currency.
- Competition: China has stated it is close to testing a yuan-based digital currency. “China’s central bank has introduced a homegrown digital currency across four cities as part of a pilot program “China’s central bank has introduced a homegrown digital currency across four cities as part of a pilot program…”
- Over time, will first-mover advantage make the yuan a more powerful currency at the expense of the US dollar?
The first implementation steps testing the concept are now happening. The first steps generally involve financial institutions, not consumers, and are mostly outside the US.
Major Digital Currency Issues and Risks
US digital currency benefits are balanced by significant issues and risks. Some questions:
- What a US digital currency will be: Interest-bearing or non-interest-bearing? Attributes that change over time?
- Technology: What technology will be used? Will it be bullet-proof? What if it is hacked? “But if [the Fed] ever did [offer a CBDC], nine out of the top 10 requirements would pertain to security, said Bob Bench, director of Applied Fintech Research at the Boston Fed. “Because the second that thing goes live,” he said, “it’s the most attacked program in the world”
- Privacy: In addition to a cash being bearer IOU to the US government, a key value is the cash is anonymous. Will consumers and business care if the government can track their spending? In real-time? (Hint: Many people will answer: YES!)
- Consumer behavior: In times of crisis, will consumers run to a digital currency, causing banks to fail?
- Usability: Software and/or hardware? Will the product be easy to use? Is the account recoverable if the password is lost?
- Security: How will security, spam, and fraud be handled?
- Inclusion/access: In 2018 22% of US consumers were unbanked or underbanked. 23% of seniors do not have a mobile phone. What about these users?
It is my opinion that non-US consumer CBDCs will appear within the next year. In the US – within the next three years?
Central banks will take a measured approach but the advantages of CBDCs are hard to ignore. Consequently, many countries are investigating central bank digital currencies. For example, Peru tried it (and failed). Venezuela is trying and failing. More experiments are coming such as China, the Marshall Islands, the Bank of Korea, and Singapore.
What is the Impact on the Finance Industry?
There are many questions. Will a digital dollar dis-intermediate financial services firms or make them more efficient and profitable? Key factors – will the Fed offer services directly to consumers or via the existing banking system / financial institutions? Will customers want banks to be the intermediary for Fed digital dollar deposits? Or will customers want to deal with the Fed directly? For what services will digital dollars be used? Enough for a future post 😉
What Should I Do?
Corporations and local governments need to consider the benefits and risks of a digital-based on their specific situation. Therefore over time these entities should consider separating their financial processes from specific financial services providers to take advantage of the potentially lower costs of digital currency.
Financial services businesses need to completely be on top of the Fed and US Treasury moves in this area – a US digital dollar is a business-model buster for some financial services lines of business.
There is nothing for consumers to do right now. However, this is different for consumer advocacy and privacy groups. There are tremendous issues regarding privacy, government data, and inclusion.
The above is an OVERVIEW of the current state of US digital currency. Stay tuned for more in-depth discussions.