Fed keeping strictly neutral on CBDC as others plough ahead

Fed identifies problems others are already solving

The US Federal Reserve published a long-awaited discussion paper last week in which it laid out the conditions a digital dollar would have to satisfy. Elsewhere though, the Monetary Authority of Singapore is redefining these conditions as technical features within a central bank digital currency architecture.

The US report outlines that a CBDC must ‘provide benefits to households, businesses and the overall economy that exceed any costs and risks’. While this sounds like a simple prerequisite for any government project, it is a taller order for countries like the US than for emerging markets.

The US already makes widespread use of digital payments, so the low-hanging fruit of shifting away from physical cash has already been plucked. For developing markets, the immediate improvements are more obvious. But that isn’t stopping others — Singapore, China and Europe — from pressing on for their own reasons.

The Fed report does acknowledge some of these reasons, admitting that providing a CBDC could help neutralise the threat posed by the proliferation of private digital money and open up new capacities and functions for the digital economy that traditional payment systems struggle with, particularly micropayments.

The report also acknowledges the value of a CBDC in addressing the inadequacies of the cross-border payments network and in protecting the dollar’s international role. While its status as the world’s reserve currency is typically treated as unassailable, the development of cross-border CBDC payment facilities in other regions is likely to lead to the development of trading networks completely independent of the US and its currency.

Although the Fed acknowledges these benefits, the US remains politically and culturally reluctant to throw itself down the path of state digital currency solutions. This reluctance could prove damaging to its standing internationally.

It’s not that the concerns the US has are not valid, but in other, more forward-thinking jurisdictions, these questions are being broken down into their component parts and resolved. It is important to ensure CBDC users’ privacy while preventing financial crime, but with two tier systems know your customer responsibilities can still be kept with private financial institutions. Indeed, modern data architecture should mean that CBDC creates an opportunity to improve the rather inadequate privacy situation in payments.

The Monetary Authority of Singapore issued a global CBDC challenge, outlining 12 tensions: security versus accessibility, decentralisation versus accountability, personal data protection versus system integrity and more. 300 competitors from 50 countries answered the challenge, submitting proposals for CBDC architecture that addressed the problems. In November, MAS announced three winners: ConsensSys, Criteo and G+D.

There are other concerns that do not necessarily have a technical solution. Does CBDC risk blowing a hole in bank balance sheets by creating a risk-free alternative to commercial bank deposits? It is not a technical question, but a policy matter. Nevertheless, policy-makers around the world are studying the possibilities of introducing frictions to address this vulnerability, perhaps by making CBDC holdings non-remunerated or even capping them.

What the US must wake up to is that the problems it identifies have two components. First, there is the technical feasibility of constructing an architecture that meets the standards they desire. Second, there is the matter of policy, to determine appropriate levels of privacy, accessibility and accountability. Here, the technologists and MAS remain agnostic. For them, the challenge is to create an architecture that is flexible enough to allow central banks and governments to uphold the standards they require, whatever those standards are.

Introducing CBDCs does pose new challenges and bring new risks, but so does inaction. The rest of the world will make its own decisions about how to process payments. The US risks being left out. It’s time to catch up. Embrace the technical solutions and get to work on the political questions or somebody else will tell you the answers.

Lewis McLellan is Editor of the Digital Monetary Institute, OMFIF.

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