Is the American Market Ready for Its Own Central Bank Digital Currency (CBDC)?

16.04.2022

Fintech and crypto experts show support for a U.S. central bank digital currency, but the Fed’s has not taken an explicit stand yet, but instead provided a detailed illustration of  how establishing one in the U.S. could impact American banking.

Central Bank Digital Currencies or CBDCs are electronic or digital tokens like cryptocurrencies, being regulated and issued by a certain central bank. In more basic terms, CBDCs are just digital versions of your regular money or the so-called fiat currency, such as US dollars, Chinese CNY, and Philippine pesos .

Many countries have previously reported that their own CBDCs are under development, and some have even implemented them.

Recently, the U.S. Federal Reserve Board have issued a much-anticipated announcement, discussing the possibility of the U.S. implementing its central bank digital currency.

In this paper, the Board lays out a clear illustration of the direction a federal electronic currency could take, and how it could remarkably impact the future of the current traditional financial systems.

Is the American Market Ready for Its Own Central Bank Digital CurrencyThe report did not provide an explicit stance on whether the United States of America is ready to have its own digital currency and made it clear that the paper is not intended to show support for either side or provide any decision.

Rather, they mentioned that proceeding with an American CBDC is a resolution that should not be handled by the Board, but rather by Congress and the Executives.

The paper focuses on the meaning of “money”, specifically virtual currency, and how its different directions and variations could essentially modify banking. The Board outlined that electronic money that is dollar-oriented might be a simple and basic concept, but is more complicated in terms of usage, application, and future developments.

For example, there could be a CBDC dollar version that would be developed to perform scheduled transactions, which could be executed inside a blockchain without any human touchpoint. This suggests the possibility of micropayments in CBDC.

The Board’s report also detailed some alternatives in terms of policies and provided questions open to the public’s comments and suggestions.

U.S. CBDC Fundamentals

Many experts in the banking and crypto market have previously pointed out that the U.S. is at the back of many other countries in terms of building its own CBDC. For example, China was the first of the nations that had taken action for its own CBDC, named e-CNY.

The Board stated that this undeniably impacts the international image of the U.S. dollar on the global financial market. They believe that the non-existence of a U.S digital currency makes other nations more captivating to the public and that creating one might help protect the huge identity the dollar has in the market.

The Board also explicitly mentioned that a CBDC is a cautious and most protected asset in the digital market, “with no associated credit or liquidity risks.”

In the same report, the Board detailed four factors fundamental to establishing a U.S. CBDC:

  1. Middleman Distribution Model: The paper lays out the clear stance of the Board that it doesn’t envision being involved in between the business of the consumers and banking transactions. Non-government institutions and other private financial businesses would be the ones to provide digital accounts to handle CBDC-related payments and transactions.

The Board stated that a system intermediated by private organizations would provide opportunities to leverage the currently existing processes and privacy protection rules that the private ventures have . This could also pose advantages from the private businesses’ capabilities in terms of innovations and reduce major disrupting impacts to the current U.S. banking.

  1. User Identity Verification: The current U.S. financial system provides substantial anti-money-laundering policies, which is similar to what the Board envisions for a U.S CBDC. This would pose a CBDC with systems that would provide innovation capacities to the private businesses and has requirements built to reduce potential credit risks.

Federal Reserve Board mentions in their report:
“As such, it could provide a safe foundation for private-sector innovations to meet current and future demands for payment services. All options for private digital money, including stablecoins and other cryptocurrencies, require mechanisms to reduce liquidity risk and credit risk. But all these mechanisms are imperfect.”

  1. Protection and Privacy: A balance in providing transparency and user protection is essential to avoid potential criminal abuses. This would create a much more engaging services.
  1. Transferability: A CBDC should be transferable between customers and businesses, providing seamless transactions, and providing the actual liabilities to the Board.

Impacts of CBDC on  U.S. Banking

Although a CBDC might look just like a digital form of a nation’s fiat currency, the impact it’s establishment could have is much more complicated, contingent on its form.

Is the American Market Ready for Its Own Central Bank Digital CurrencyThe Board described CBDC as the best replacement for commercial currencies, and this substitution poses benefits in the banking market. Creating a CBDC could help expand banking financial reserves by bringing down aggregate banking deposits, and consequently reduce liability risks for consumers. The Board also pointed out in its paper that a form of CBDC with interest payments could raise demand from the public.

The paper made it clear that the Board do believe that CBDCs are most probably the safest digital asset and could potentially be a safety net during financial crises.

According to the paper:
“The ability to quickly convert other forms of money — including deposits at commercial banks — into CBDC could make runs on financial firms more likely or more severe.”

Currently, the usual public alternative to insurances and other traditional services in times of financial stress are stablecoins. The Board believes that in its existence, a CBDC would be a more attractive refuge.

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