Could Digital Wallets and a CBDC Get the US Back on Track?

Could the US be contemplating the idea of a digital currency?  With the recent coronavirus pandemic and its impact on the US economy, the idea of a digital currency that would be issued by the central bank was raised by some US politicians. 

The term “digital dollar” and “digital wallets” appeared in two draft bills dated March 22, 2020.  The two bills, “Take Responsibility for Workers and Families Act”, and the “Financial Protections and Assistance for America’s Consumers, States, Businesses, and Vulnerable Populations Act” introduced the idea of digital currency as a way to deliver stimulus payments to US citizens.

The bills define the digital dollar as “a balance expressed as a dollar value consisting of digital ledger entries that are recorded as liabilities in the account of any Federal Reserve Bank.”  Additionally, the digital dollar is also stated as “an electronic unit of value, redeemable by an eligible financial institution (as determined by the Board of Governors of the Federal Reserve System).”

A Digital Form of Cash

It sounds like a lot of words to absorb, but it is actually an interesting concept.  We usually think about digital currencies in the context of bitcoin and other cryptocurrencies. These are all decentralized forms of currency.  But the proposal is that the central bank should consider issuing its own form of digital currency.   This digital currency would essentially be an electronic version of physical notes and coins.  But unlike bitcoin, this currency would be centralized.  The Federal Reserve’s central bank or another central authority can administer it.

This means that the Federal Reserve would issue stimulus payments in a digital form.  In order to access this digital currency, you would need a digital wallet.  The bill describes this as, “a digital wallet or account, maintained by a Federal Reserve bank on behalf of any person, that represents holdings in an electronic device or service that is used to store digital dollars that may be tied to a digital or physical identity.”

The latest versions of the draft bills have removed the terms “digital dollar” and “digital wallet”. However, it appears that the central bank may be exploring the idea of a cashless society by creating a central bank digital currency or CBDC.

CBDC ensures financial inclusion

There are a number of reasons to consider using a CBDC.  A CBDC would make it easier to extend aid to vulnerable members of the population. This would include those without access to the current banking system.  

In issuing its first round of stimulus payments, the government noted in a memo that a significant proportion of the population, estimated at roughly 32 million were “unbanked” or “underbanked”. In other words, they either had no bank accounts or used financial products outside of the banking system. Another 550,000 were homeless with no mailing address.  

Vulnerable populations like this one are at risk of not getting the assistance they need.  By using a digital currency, these ones would be able to receive payments without the need for access to a physical bank.  The cost would be less than sending a physical cheque and would require the services of a financial institution. This means those in need will receive a greater percentage of the aid money. Currently, some of these donated fees are going towards service fees. This could be eliminated with blockchain technology.

Benefits of a CBDC

Using digital currency to administer relief payments is just one of the reasons a CBDC is being considered. Other reasons to implement a central bank controlled digital currency include:

1. Revolutionizing the Role of the Bank

Cryptocurrencies are challenging the traditional role that central banks play in monetary policy.  With it, individuals are able to store, spend, and move value without relying on a fiat currency.  Against this backdrop, central banks are looking at analyzing and understanding the potential effects of introducing a CBDC.  It may be a necessary step in order to remain relevant and provide a credible alternative to cryptocurrencies.

2. Less Government Control

Governments control fiat currencies and use central banks to determine monetary policy and influence the economy.  Non-governmental bodies that create their own control, take back some of this control. This has implications on fiscal policy and financial intermediation.

3. More Options

CBDCs will allow central banks more options when it comes to setting the monetary policy.  For instance, central banks would be able to implement a negative interest rate policy.  Or as an alternative to quantitative easing, it could be used to make “helicopter drops” of newly created cash to all citizens to increase aggregate demand. 

4. Increased Access

Are we becoming a cashless society? Society in general is finding that It is more convenient to use cashless payment systems. We see this in the use of credit/debit cards, apps, and contactless payment systems.  Creating a digital currency will ensure that the public will still have access to legal tender. This is especially important if cash becomes phased out.

5. Eliminate Crime

Switching to digital currency would help governments in their efforts to eliminate crime.  Since cash is difficult to trace, it is attractive for money laundering, tax evasion, and illegal transactions.  As well, there are security risks in transporting funds, and when payments are made, there are no records of exchange.  Governments can use digital currencies to eliminate crime and increase tax receipts.  

6. Safer System

It will make the financial system safer.  With CBDC, individuals, companies, and non-bank financial institutions will be able to settle with the central bank directly instead of through large banks.  This significantly reduces credit risk and concentration of liquidity in payment systems.  It will also eliminate the need for government guarantees on deposits, and provide a risk-free liquid alternative to bank accounts.

7. Saving Money

It may be more cost-effective.  With physical currency, we must pay to store and transport the money between ATMs and banks. With digital currency, all operations will be electronic and data will be stored on computers.  The money will be easier to track with greater precision and accuracy as accounting will be computerized.

The US is not alone in looking at the use of digital currencies.  In fact, other nations already have projects in the works. Sweden is piloting a project using Accenture.  The UK’s Bank of England has published a discussion paper about their plans to implement a CBDC.  In fact, according to one source, 80% of the world’s central banks are exploring the idea of digital currencies, although most are still in the pure conceptual research or experimental stage. 

CBDC is Not Cryptocurrency

It is important to note that a CBDC is not the same as a cryptocurrency.  It borrows some properties of a cryptocurrency but with some differences as well.  A CBDC is not decentralized. This is because the government issues the currency. Central banks control the CBDC and make decisions on money supply and transactions.  It is basically a digital version of a fiat currency. The main thing to note is that the value of the currency is stored on a computer system.

Unlike a cryptocurrency that is not owned or managed by anyone, a CBDC is trusted and permissioned since it is managed by an entity and requires membership. A cryptocurrency uses an open and distributed ledger which allows for transparency.  A CBDC, on the other hand, would need to comply with financial laws and regulations regarding data confidentiality. This will be done form of Distributed Ledger Technology (DLT) and is implemented as a private network.

Digital wallets

Like cryptocurrencies, you can access a CBDC through a digital wallet.  A digital wallet is a software that stores your public and private keys.  The wallet allows you to interact with the blockchain to send and receive digital currency and monitor your balance.  It does not store the actual currency itself. Rather, it would only hold the keys.  

The public key is the address that a user would use when sending and receiving funds. We can liken it to a bank account number.  The private key is what proves ownership of the public key and is similar to a PIN number.  In the proposed bill, the central bank will manage the digital wallet on behalf of its citizens.  

CBDC and Its Effect on Monetary Policy

As discussed earlier, one reason to implement a CBDC is that it would open up new instruments of monetary policy.  In the past, central banks have relied on policies such as lowering interest rates to near-zero or even negative rates.  But these have failed to produce the desired effect of stimulating bank lending, borrowing, and increased economic activity.  

Monetary policies use quantitative easing to push down interest rates across a wider range of financial markets.  However, rather than stimulating the real economy,  it has resulted in increasing the prices of bonds, shares, and other financial assets.  This has in reality created more wealth for the already wealthy since only a small percentage of the population owns these assets.  And the trickle-down effect of increasing spending in the real economy has not been realized.

With CBDC and the use of digital wallets, it would be possible to use an alternative approach called “helicopter money”.  In this approach, central banks would create new money. The money created can then be distributed equally to all citizens. This will increase their ability to spend, without increasing their debt.  

Unlike quantitative easing, it would benefit everyone equally as they would now have extra money to spend on consumer goods, paying down debt, or investing.  Digital currencies, linked with digital accounts or wallets maintained by the central bank, would create an easy channel with which to distribute this money.

CBDC as a way to “future proof” the US dollar

A whitepaper, published by Accenture and the Digital Dollar Foundation, explains the need to “future proof” the US dollar if it is to retain its status as the world’s reserve currency.  This was especially important in light of the fact that other nations were already looking to launch their own CBDCs, in particular, China.

Having a CBDC would increase competition in international payments and would help to integrate financial markets.  Experts believe that the US has the most to lose if it falls behind in the race to roll out a CBDC that would achieve international use.  

The whitepaper also points to the decline in the use of cash and the benefits of financial inclusion as other reasons for a CBDC.  It advocates a “champion model” in which a CBDC would exist as a third form of money besides fiat currency and commercial bank money.  

Finding the right balance

A CBDC administered by a Central Bank gives rise to concerns about privacy. Unlike cash which is anonymous and private, a CBDC would be easier to track and audit.  In a worst-case scenario, it may be used to monitor a citizen’s activities, and to freeze funds or prevent money from moving overseas.  

In developing a CBDC that would be acceptable to its citizens, central banks need to find the right balance between anonymity and full traceability.  And as with all things digital, they need to adopt the highest standards of cybersecurity to prevent issues with hacking.

The Future of CBDCs

The need for a central bank digital currency is being driven by advances in technology, the rise of digital currencies, and the decline of cash. Central bank digital currencies hold promise in changing the way we transact value. 

It combines the benefits of cryptocurrencies, i.e. high speed, low transaction cost, disintermediation, with the benefits of traditional currencies, i.e. price stability and status as legal tender.  The move to digital currency would allow governments to modernize and upgrade an outdated infrastructure with new technology.                            

Will the US create its own digital currency?  

In response to the request to explore this possibility, the US Federal Reserve recently stated that it has indeed “assessed and continues to carefully analyze the costs and benefits of pursuing such an initiative in the US.” 

However, it also went on to say: “To date, our observation is that many of the challenges [CBDCs] hope to address do not apply to the US context.”  So while the idea of a CBDC is on the radar of the Federal Reserve, it may yet be years away from implementation. 

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