America’s Much-Vaunted, Mythological CBDC

Since the start of the year, much ballyhoo has been made about central bank digital currencies, also known as CBDCs (an acronym that’s as clunky and vexatious as the discussions surrounding CBDCs themselves).

A CBDC is, according to the U.S. Federal Reserve, a digital form of fiat currency ­— effectively, electronic cash — fully backed by the central bank and “widely available to the general public.”

A minor detail that the Fed does not mention: American CBDCs are not widely available to the general public, because they don’t exist.

Not that there hasn’t been a lot of what one might call throat-clearing about launching them — one day.

For central bankers, there’s been no small amount of dreaming of the possibilities, especially in the face of Bitcoin’s recent price shocks (it topped $68,000 in November, only to crater below $20,000 in June and July), crashing stablecoin valuations (U.S. Treasury Secretary Janet Yellen renewed her call for better regulation by year-end), and an impressive array of shenanigans by crypto executives, from insider trading to literally cutting and running after a $10 billion hedge fund blowup.

According to the Fed, a CBDC would offer refuge from this shambolic state of affairs by providing a form of digital money that’s a direct liability of the Fed, firmly bootstrapped to the U.S. dollar and government, as opposed to an offshore, flash-in-the-pan startup that might lie, cheat, steal, implode, or pull a midnight runner.

As early as 2014, dozens of central banks around the world began to quietly explore the possibility of creating and issuing CBDCs — a move largely considered to be a clapback to the rising popularity of Bitcoin and other blockchain-based technologies. But unlike Bitcoin, CBDCs would be centralized and issued by the state, and they would not require a blockchain.

CBDCs would not be just like cash in your bank, transferred electronically. This would be pure digital fiat, issued and tracked by the central bank itself, which would mint CBDCs as digital coins, money, or accounts, backed by the full faith and credit of the government. It would be its own animal, let loose in an increasingly crypto world.

Yet, with few exceptions, the CBDC primarily exists as a mythical creature of the future, encompassing many competing visions, philosophies, and fantasies, utopian and dystopian alike. Notably, debates over CBDCs have galvanized both ends of the financial spectrum, from Wall Street banks to crypto advocates, with many voicing concerns over where all this could be headed.

The result is glacially slow progress on the CBDC front — despite competitive pressures from other nations lining up CBDCs of their own — with Fed Chairman Jerome Powell stating: “We do think it’s more important to get it right than to be first, and getting it right means that we not only look at the potential benefits of a CBDC, but also the potential risks, and also recognize the important trade-offs that have to be thought through carefully.”

Powell’s concerns about CBDCs are wide-ranging, from “the need to protect a CBDC from cyberattacks, counterfeiting, and fraud,” to assessing how a CBDC would affect monetary policy, financial stability, and national security, to walking the fine line between preventing illicit financial activities and “preserving user privacy and security.” No big deal.

If you’re thinking this is all very geeky and deep in the plumbing of the global financial system, you are not wrong. But this is anything but boring — and the stakes could not be higher. After all, tinkering with the inner workings of the world’s reserve currency could lead to some of the biggest changes in our financial architecture since the end of World War II.

For the past few years, the Fed has been conducting what Powell calls “experiments” in CBDCs that have involved its Board of Governors in Washington and the Federal Reserve Bank of Boston, which began collaborating with researchers at the Massachusetts Institute of Technology’s Digital Currency Initiative in 2020 to develop “a hypothetical central bank digital currency.” The Fed also released its first major paper on CBDCs in January, assuring that it would not issue a CBDC without “clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.”

In February, MIT and the Boston Fed released the findings of their work, dubbed Project Hamilton, reporting they had created a “theoretical high-performance and resilient transaction processor for a CBDC” using open-source research software capable of securely handling 1.7 million transactions per second and settling most of those transactions in under two seconds. The project, they said, is separate from the Fed’s CBDC review and seeks primarily to explore how emerging technologies might support a CBDC, drawing from concepts in cryptography and distributed systems.

In March, President Joe Biden signed an executive order encouraging the Fed to continue with its CBDC efforts without delay, placing “the highest urgency on research and development” for the design and deployment an American CBDC. Among the potential benefits: A CBDC could help expand financial services to the roughly 14 million Americans who don’t use banks (also known as the “unbanked”), reduce extortionate cross-border transaction fees, and safeguard the U.S. dollar as the world’s most-traded currency.

At this time, only ten nations have fully launched a CBDC — although 105 countries, representing more than 95 percent of global gross domestic product, are seeking to do the same, according to the CBDC tracker run by the Atlantic Council, a Washington-based think tank for international affairs and global economics.

The first CBDC to launch was the Bahamas’ Sand Dollar in October 2020, with Jamaica the latest to follow suit in May. Nigeria, Africa’s largest economy, launched a CBDC in 2021, with India, South Korea, Japan, and Russia working on CBDCs in the development or pilot stages.

The European Central Bank hopes to launch a digital euro by mid-decade, but China may be the first major economy to deliver a CBDC, as it is already deep into its testing, inviting foreign visitors to try its digital yuan at this year’s Winter Olympics, with plans to expand trial runs in 2023.

China also has made no secret of the fact that it seeks to replace the U.S. as the world’s reserve currency owner, teaming up with central banks in the United Arab Emirates, Thailand, and Hong Kong to create a global digital currency network fit for cross-border transactions.

More broadly, the Basel-based Bank for International Settlements, in a joint report with the International Monetary Fund and the World Bank, called this month for nations around the world to work together on designing and developing CBDCs from their embryonic stages for maximum interoperability, access, efficiency, and financial inclusion.

Meanwhile, the U.S. remains tied with the U.K. in being the furthest behind when it comes to developing CBDCs among the G7 economies, according to the Atlantic Council.

Last July, during a congressional hearing entitled “The Promises and Perils of Central Bank Digital Currencies” held by the House Subcommittee on National Security, International Development and Monetary Policy, lawmakers widely acknowledged that the U.S. had fallen woefully behind on CBDCs, citing “the long-term consequences if we lose our competitive edge to countries like the People’s Republic of China.”

On the other hand, they agreed with Powell that while the U.S. must “not cede its competitive advantage, we must not rush the process for the sake of simply keeping up.”

Why all the hand-wringing? Because decisions will need to be made about exactly what comes out of the money spigot, who gets it, and who controls it.

Let’s say you want to obtain and start using CBDCs to make purchases or pay bills. How do you get a hold of this digital money? Do you go directly to the Fed and keep an account with them? Or do you go to a bank?

This question alone remains one of the biggest sticking points, because who doles out CBDCs has major implications for banks, Wall Street, and, by extension, global economies.

While it has always been a public-interest issue in the U.S. financial system that it’s the banks — not American citizens — who get the direct benefit of receiving safe, insured government money (other than cash, with tight limits on customer withdrawals), CBDCs offer the chance to rectify that by providing accounts with the Fed directly to the public.

But according to the Fed’s paper from January, this is not likely to happen, as past efforts by central banks to accept retail deposits put them in competition with private banks, disrupting the overall financial system.

Gregory Baer, chief executive of the Bank Policy Institute, a nonpartisan Washington public policy and research group that has studied CBDCs closely, noted that if this kind of capital flight were to happen in America, CBDCs could dramatically change the balance of power between banks and the Fed — with the potential for handing too much clout to the U.S. government.

This past spring, Baer wrote that if bank depositors were to begin moving their money from their banks to accounts with the Fed, their deposits would be used differently than they are now. With a bank, customer deposits are often used to make loans to other customers, while a CBDC would fund the holdings of securities issued by the U.S. Department of the Treasury, he explained. “Thus, if consumers and businesses transfer money from deposits to CBDCs,” he wrote, “they would stop funding the economy and start funding the government and government-sponsored enterprises.”

These sorts of Big Government fears are harbored not only by the banks and nonpartisan research groups, but also by leaders of the crypto community, who object to CBDCs on practical — as well as ideological — grounds.

Earlier this year, Erik Voorhees, a leading voice in the crypto community who also runs ShapeShift, an open-source crypto-trading platform, observed, “No one who’s in crypto likes CBDCs. No one who understands the value of cryptocurrency likes CBDCs at all.”

For the crypto world, which extols the virtues of decentralized commerce free from government control, CBDCs provide all the drawbacks of centralized fiat, with the added sin of being monitored by the government.

“It will have all the rules that each bank and each central government wants to impose, just like the banking system today, and yet it’s even worse because it will have greater surveillance capabilities over all the people using it,” Voorhees said. “It’s like all the worst aspects of fiat today in your bank — plus Orwellian spy surveillance nightmare.”

He questioned whether there is genuine demand for CBDCs, or if it’s just governments wanting to issue them to compete with crypto. “Who is asking, who is clamoring for CBDCs? Only people who want surveillance over their subjects, those are the only people,” he said. “Obviously, this is why China is leading the pack in terms of adoption of CBDCs.”

There’s something else to consider: Even if there is a way to preserve total privacy for U.S. citizens in their use of CBDCs, is it possible people are truly prepared for — just for starters — a Fed debit card? “No American, however trusting or patriotic, is likely ready for that,” argues Junaid Ghauri, co-founder and chief investment officer of crypto asset management, research, and technology firm Pareto Technologies.

While he considers himself neutral on CBDCs, Ghauri believes it’s a question of making the case to consumers. Do they really want or need CBDCs? Are CBDCs demonstrably missing from their lives? “The burden is on the offering itself: What is the problem we’re actually trying to solve?” he asks. “Maybe it’s just an easier way to digitally transact with the dollar. If that’s the motivation, that’s great. But what else? Are you perhaps opening the door to other things?”

CBDCs would allow the Fed to take a much more targeted approach to macro policy, for instance, by providing stimulus or subsidies directly to specific groups of people, such as by age, occupation, geography, or other demographic. This could be useful. But it would arguably give the government unprecedented access to American citizens’ financial affairs, which “goes against the basic tenets of America,” Ghauri notes.

“Where it gets Orwellian is the government’s ability to monitor a person’s financial life,” he says. “If the U.S. were to roll out a CBDC, I think it would be met with a lot of pushback. Innovation sucks for the incumbent.”