In defense of a digital dollar
“No CBDC in Florida.” That’s what Governor Ron DeSantis of Florida proclaimed Monday morning as he unveiled new legislation blocking the introduction of central bank digital currency (CBDC) in his state.
DeSantis is not alone. Last month, Rep. Tom Emmer (R-Minn.), the Majority Whip of the US House of Representatives, proposed the CBDC Anti-Surveillance State Act, aimed at blocking a US CBDC. These critics have expressed deep suspicion about the development of a CBDC. Meanwhile, 114 countries around the world are exploring CBDCs. Just last month, the Bank of England and the Bank of Japan announced the next stages of their CBDC development, joining the European Central Bank in working towards a proof-of-concept to be used in pilot programs. This leaves the Federal Reserve, the world’s largest central bank and issuer of the world’s reserve currency, several steps behind its peers when it comes to planning and deploying its own CBDC – the digital dollar.
Ananya Kumar is Associate Director of the GeoEconomics Center at the Atlantic Council. She leads the centre’s work with the money of the future.
Indeed, while some in the US Congress worry that the Fed is moving too quickly, most other countries worry that the issuer of the world’s reserve currency is moving too slowly. Exactly one year ago, the Biden administration issued an order on the responsible development of digital assets, and there have been some positive steps since then. Up to 15 agencies were asked to issue reports on market status, research priorities and risk reduction. These were mostly positive when it came to promoting research into the design of a CBDC. The New York Fed also decided to experiment with a wholesale, bank-to-bank CBDC prototype – “Project Cedar.” The volatility of the crypto markets starting last year, and its conflation with the CBDC, along with the silence of the Fed and other agencies since then has led to a loss of momentum on the issue.
Both Democrats and Republicans have their say: DeSantis, Emmer, Rep. Jake Auchincloss (D-Mass.) and other critics make a number of arguments against CBDCs: The first argument concerns the role of the private sector. They argue that CBDCs can disintermediate the private sector, especially commercial banks, and compete unfavorably against private sector offerings such as bank deposits or stablecoins.
Second, they argue that CBDCs provide no additional benefit to existing technologies such as Instant Payments Systems, including the yet-to-be-launched FedNow. Finally, critics rightly raise the issue of financial privacy and surveillance concerns. The risk of a poorly designed CBDC is that it could give a central bank unauthorized access to our bank accounts and transaction details.
Some of these questions can be easily answered, based on our research on global CBDCs over the past two years. In the over 100 models we have examined, commercial banks – not central banks – distribute CBDCs to the general public. Interestingly, such a system encourages new commercial activity as fintech companies and commercial banks build new wallets and tools to keep users’ money safe. Cryptocurrency and stablecoin providers should welcome healthy competition from CBDCs, especially since the mantra for the industry has been “optional” – that is, creating more alternatives to traditional holdings that speak to users. Creating reliable public money that citizens can hold alongside their regular bank deposits and crypto-assets should be the ultimate goal of both the private and public sectors.
On the issue of instant payment networks, the US is already behind many of its G-20 counterparts, and hopes to catch up with FedNow this year. However, FedNow does not connect individuals with CBDCs. The audience is financial institutions, which will be able to complete transactions faster with each other, if the program is ever completed. Nor will it offer other benefits such as interoperability with other assets and technological advantages of transaction speed, cost and, most of all, transparency of cash flows. Experimentation with the digital dollar should be done in tandem with the rollout of FedNow, and all options to improve payments should be on the table.
Finally, the question of how to build privacy in a centralized digital currency ecosystem is real. Authoritarian authorities can improve surveillance capabilities and gain access to protected information if the necessary guardrails are not built. This is an important design issue, and one that receives a lot of attention in political circles and Congress. The good news is that new technological options can not only meet minimum privacy standards, they can also improve the privacy protections offered by existing infrastructure.
Our research at the Atlantic Council has shown that privacy-preserving design can have another benefit. They can also address critical cybersecurity needs for CBDC systems. Privacy concerns rank high on the list for the European Central Bank, the Bank of England, Sweden’s Riksbank, the Reserve Bank of Australia and the Bank of Japan, all of which are working on proofs of concept that address the right balance between privacy and know-your-customer/anti -money laundering requirements (KYC/AML). The whole purpose of a pilot would be to see if these ideas work in practice. Oddly enough, opponents of CBDC won’t even figure it out.
There are good arguments for the risk of such centralization in digital payments, and privacy is the right concern to have. So is financial stability, monetary sovereignty and the lack of regulatory alignment with a range of consumer protection and KYC/AML standards. But these challenges can be solved, and the best way to do it is with more experimentation and less hesitation. There is a noticeable absence in US experimentation with CBDC design, which has created a vacuum when it comes to international technical and regulatory standards. We see a serious risk of greater fragmentation in international payments due to the proliferation of CBDC models that cannot talk to each other. And this vacuum in a global model for CBDC has the potential for replication of China’s model around the world, which has been in the pilot phase since 2020.
There is a political battle going on over the issue of the digital dollar – and given the importance of financial infrastructure, it could seriously threaten the dollar’s role as the world’s currency of choice. We must not deny the reality that most of the world, including US allies and competitors, is already in the game – creating their CBDC products, experimenting with each other and consequently creating technical and regulatory standards the US will have little say over.
Ultimately, the United States will have to cross the hurdle of public opinion—and for that, it may be incumbent on the executive and legislative branches to remember that trust is built with transparency. The Fed may want to take the path of the ECB, which has opened a dialogue between itself, the private sector and civil society as it works towards piloting the digital euro later this year. Research, experimentation, and regulatory clarity toward a proof of concept that can answer our questions about the real risks and opportunities of the digital dollar are key to American leadership in the future of money. Congress must ensure that any path forward allows for real experimentation and refinement, while balancing real security and privacy concerns.
