Central banks are headed toward digital currencies
The U.S. is starting a national conversation arounda central bank digital currency (CBDC).
Why it matters: Several other countries have already experimented with or released early versions of CBDCs. Such a pivot could aid underbanked populations, and help make banking and monetary policy more efficient.
Driving the news: The Senate Banking Committee held a hearing on CBDC Wednesday, led by Sen. Elizabeth Warren (D-Mass.).
- The Federal Reserve is set to release a discussion paper next month on how it’s thinking about a digital dollar.
How it would work: First, a CBDC is a digital version of the dollar, so its value wouldn’t fluctuate versus the dollar… since it is the dollar.
- Put simply, a CBDC is just a digital version of an existing currency that is issued, governed and backed by a central bank.
- CBDCs would be recognized as legal money, unlike bitcoin.
The pros: It would enable more people to become part of the banking system, reduce the cost to bank and increase the rate of payments innovation.
- The Federal Reserve could also gain more precision over money supply, and lawmakers could distribute government assistance programs such as social security and food stamps to a wider underserved group of the country.
- A U.S. CBDC could also help maintain the global predominance of the dollar.
The cons: Potential drawbacks include the traceability of digital payments. The anonymity of cash offers privacy.
- Security of financial data on hundreds of millions of people will not come easy.
- Financial institutions are also fearful banks could lose a large proportion of their deposit base.
What they’re saying: “CBDCs are ultimately quite likely for many countries,” Darrell Duffie, of Stanford’s Graduate School of Business, tells Axios. Duffie was a witness at the Senate hearing.
- “I’m not confident that they are actually necessary — that needs to be judged based on the best CBDC designs that will emerge,” Duffie adds.
State of play: More than 60 central banks have been looking into CBDCs since 2014, according to a PwC report from April.
- The Bahamas and Mainland China have active trials dubbed, the “Sand Dollar” and the “Digital Yuan,” respectively, that individuals can use as a form of digital cash.
- The Federal Reserve has been researching digital currencies since at least 2018, but at a less consistent pace compared to other central banks reviewed by PwC.
Be smart: While there is general agreement about what a CBDC is, countries are faced with hundreds of choices and decisions with respect to how they build their systems — and, in turn, what the long-term implications will be.
- So far, most observers have assumed that CBDCs will be account-based, rather than being token-based like most existing cryptocurrencies.
What to watch: Lev Menand of Columbia Law School, who also testified, tells Axios he believes the pandemic highlighted the inequities and inefficiencies of current payments system.
- “It took far too long to distribute critical economic aid in April and May of last year,” says Menand.
- Some experts also say that criminals may have stolen as much as $400 billion of unemployment benefits, Axios’ chief financial correspondent Felix Salmon reported.
Felix’s thought bubble: “Digital currencies are still in their infancy, despite bitcoin being 10 years old. I wouldn’t expect to see a U.S. CBDC this decade.”
The existential threat facing stablecoins
Stablecoins — digital currencies linked in a fixed 1-to-1 exchange rate to real currencies like the dollar or the euro — face an existential threat from the world’s central banks.
Why it matters: If the future of currency is digital, then stablecoins offer version 1.0 of what a digital dollar might look like. But they are also under-regulated, systemically risky, and uniquely vulnerable to the rise of official central bank-backed digital currencies, or CBDCs.