Creating a US CBDC: Understanding four fundamental truths
Editor’s note: This report was written in collaboration with the The Digital Dollar Project, a nonprofit organization created to encourage research and public discussion on the potential advantages and challenges of a U.S. Central Bank Digital Currency (CBDC)—or a “digital dollar.”
As we begin 2023, the optimism about central bank digital currency (CBDC) is bright. In 2022 we saw increased interest from central banks to forge a new path in cross-border payments, financial inclusion, and mitigating financial crimes. Globally, 114 central banks are in different stages of their CBDC exploration, and momentum is building quickly with several programs being piloted or in limited use. As the US moves forward with its exploration of a US CBDC, it's important that exploration is grounded in four fundamental truths:
What CBDC is, and isn’t;
Privacy is essential;
CBDCs are not intended to replace cash; and
The US Central Bank is not looking to disintermediate commercial banks.
It is important to articulate these truths to establish a clear and strong foundation upon which to build a US CBDC. Given the prominence of the US dollar as the world’s reserve currency and the interconnected nature of the global economy, robust exploration of a US CBDC is essential to sustaining international trade and financial stability. It’s also a unique opportunity to transform markets and human lives by enhancing financial inclusion.
What CBDC is and isn’t
CBDC is a digital currency issued by a central bank and is a legal currency/tender backed by the full faith and credit of a government. A US CBDC would be fiat money and, just like US paper currency and coins, would be backed by the United States government. It would provide an alternative to–not replacement for–cash.
CBDC is not a cryptocurrency. Cryptocurrencies are digital or virtual currencies not issued by a central authority, such as a government. Cryptocurrency is highly volatile to intraday and longer-term price swings, making it too speculative for routine transactions. CBDC is also not a stablecoin. Stablecoins are a type of cryptocurrency whose value is pegged or tied to that of another currency, commodity, or financial instrument. While a stablecoin’s value may be pegged to the US dollar, it is issued by a private company and not issued by or an obligation of the US government.
Privacy is essential
Privacy is a foundational principle in today’s financial system. As such, it would carry forward—and potentially even be enhanced—with the introduction of CBDC.
With a US CBDC, we are not looking to dilute privacy. Rather, a CBDC leveraging privacy-enhancing technology could be more private than digital payments via private companies that are not subject to the Fourth Amendment or protection from unreasonable search and seizure by the US government. The technical capabilities of a digital currency, including the ability to embed terms and requirements right onto the asset itself, could allow for greater privacy controls, including the ability for individual customization, similar to how you can adjust privacy settings for different apps on your phone.
CBDC is not intended to replace cash
A US CBDC is not intended to replace cash. Whether consumers and businesses ultimately use CBDC rather than cash on a day-to-day basis is their choice—just as whether they choose to use cash or a credit card is a matter of personal preference today.
The objective is to add another, more flexible, and trusted form of legal tender in a digital currency suitable for use in an increasingly digital world. This will allow the US to support liquidity, broaden financial inclusion, and deliver multiple benefits to businesses and consumers, including more efficient processing, accelerated access to funds, and potentially lower costs. As a digital fiat currency equivalent to the US dollar, a CBDC provides an effective safeguard against digital currency fragmentation, enhances the ability to implement monetary policy, and enables the US to maintain a global leadership position—while creating new avenues of efficiency and innovation.
The US Federal Reserve is not looking to disintermediate commercial banks
In a 2022 paper, the Federal Reserve explicitly noted the importance of an intermediated model using commercial banks and regulated non-bank financial providers. The current, two-tier banking system offers inherent benefits for both business and consumer and, with the addition of a US CBDC, its respective roles could look like this:
Federal Reserve: The issuer of US CBDC.
Commercial banks and other regulated payment companies: Conduits to and providers of financial products and services and to perform know your customer (KYC), anti-money laundering (AML), and other regulatory requirements, similar to what they do today.
Naturally, there will likely be some changes given the nature of a digital currency and how it behaves; a seismic shift isn’t expected.
With global CBDC momentum building, the US is well-positioned to establish a clear and strong foundation upon which to build a US CBDC. With testing anchored in empirical data and real-world use cases, and grounded in the four fundamental truths discussed above, we have the necessary ingredients to move forward. And everyone has a role to play. In addition to central banks, commercial banks, and regulated payment providers, the private sector must consider how a potential US CBDC—or CBDC developments worldwide—might impact their business.
As we embark on this journey, the CBDC conversation will only benefit from ongoing learning as various proofs of concept and pilots commence or conclude; these can further inform design and development. In the coming months, The Digital Dollar Project will hold a series of privacy-focused roundtables, bringing together academic and industry experts for in-depth, inter-connected discussions on enhancing individual privacy in building a potential US CBDC. This is part of an ongoing, industry-driven commitment to foster broad discussion and engagement in this critical topic.
To read more insights on this topic, please download our latest thought piece, US CBDC: Four Foundational Truths, in collaboration with the Digital Dollar Project.