- Powell states that CBDC development is a high-priority initiative for the Federal Reserve as they consider frameworks that will not undermine banks
- The Fed is likely to consolidate control over the U.S. monetary system via end-to-end oversight made possible by a CBDC rollout
- The digital U.S. dollar will have to compete with other private dollar-pegged digital currencies when it is finally launched
The U.S. Federal Reserve is approaching the topic of Central Bank Digital Currency (CBDC) and its native digital U.S. dollar with absolute vigilance, according to a statement made by Fed chairman Jerome Powell to Congress last week. The intricate, labyrinthine network of technical infrastructure involved in the development of a digital U.S. dollar has been at the forefront of researchers’ and stakeholders’ minds in this colossal undertaking.
A thorough examination of the digital U.S. dollar project is well underway; the Fed has bumped it to the top of its priority list, but as “significant technical and policy questions” remain unanswered, an extended waiting period lies ahead before the rest of the world will hear about any confirmation on a launch.
Powell’s recent statement is positioned similarly to previous updates; no consequential addition as to where the Fed currently stands in the development phase was revealed with his testimony. This raises the question — what is the Fed’s perspective on a CBDC and how will the agency chart its course towards the release of the digital U.S. dollar?
The Digital U.S. Dollar — In The Eyes of the Fed
The variegated benefits and objectives of developing CBDCs have been effused about since the second half of 2019, ranging from improving inefficiencies in existing financial systems to growing or retaining the strength of a country’s national currency.
To date, specifics on the uses and architecture of the digital U.S. dollar have been scarce. According to the Bank of International Settlements (BIS), the U.S. has been noted simply as exploring “possible future capabilities” with its CBDC. However, based on a brief framework provided by the Fed and through the comparison of a hypothetical digital U.S. dollar with the internationally-acclaimed digital yuan, here is how the Fed may utilize it.
Beginning with a deeper look into FEDS Notes released Feb. 24 regarding CBDC development objectives following Powell’s statement, the digital U.S. dollar will adhere to existing relevant regulations put in place by the Fed:
“For the United States, whatever specific objectives may arise for a CBDC, they should be consistent with the Federal Reserve’s longstanding objectives of the safety and efficiency of the nation’s payments system, as well as monetary and financial stability. A CBDC arrangement must be in keeping with these objectives, which have guided the central bank since its establishment in 1913.”
There are talks about the digital U.S. dollar being positioned to substitute the U.S. M0 money supply, which includes all physical currency in circulation in the economy at present. In short, it will be uniquely created, issued and distributed to the public as physical banknotes or coins typically in accordance with current laws governing cash. Data from Trading Economics reveal the following numbers for different money supply categories in the U.S. for January 2021:
|United States Money||Last||Previous||Highest||Lowest||Unit|
|Money Supply M0||5247900.00||5206600.00||5247900.00||48362.00||USD Million|
|Money Supply M1||6750.90||6619.40||6750.90||138.90||USD Billion|
|Money Supply M2||19395.30||19186.90||19395.30||286.60||USD Billion|
The M0 money supply has been on a steady upward trend since July 2020 as the Fed practiced unlimited quantitative easing, continuing to flood the market with more greenbacks. Zooming out to highlight the growth of M2 money supply, year-on-year growth rates hit new highs above 25% in January 2021, a feat never before seen according to the Fed’s records. Comparing the M0/M2 ratio, the percentage amount of circulating cash is at 27.06%, which constitutes more than a quarter of the total U.S. money supply.
Digitalizing the U.S. dollar could allow the Fed to exercise end-to-end control over the monetary system aside from the printing and destroying of money, which may lead to greater financial stability for the economy. This indicates full Fed oversight over the digital U.S. dollar that is distributed to the public from commercial banks and other institutions, especially as the Fed is considering utilizing a mix of current and new technologies to facilitate this financial machinery.
At this level, the digital U.S. dollar bears similarities to China’s digital yuan, which has been touted as a replacement for China’s M0 money supply by the People’s Bank of China (PBoC). It is also faced with the challenge of a ballooning M2 money supply where it has seen 156.79% growth from 2011 to 2020 at over $33.79 trillion (218 trillion Chinese yuan), mainly attributed to a veritable surge in commercial bank loans. The digital yuan is expected to help with managing China’s debt market and in time to come, facilitating the sale of more U.S. treasuries.
In response to China’s potential attempt to undermine and overtake the U.S. dollar in the future, it stands to reason that the U.S. may adopt a similar approach with its own CBDC in retaliation.
Still, there will be speed bumps along the way, including scalability, privacy and interoperability tied to full-blown CBDC substitute. Technical issues aside, a lack of infrastructure and global acceptance is key to supplanting the greenback as the preeminent global reserve currency.
Same Same But Different
On the spectrum of digital currencies, how does the upcoming digital U.S. dollar compare to the plethora of dollar-pegged stablecoins available in the existing market?
Leaving factors such as technological design, use cases, ease of adoption and accessibility out of the picture, the statutory digital U.S. dollar certainly can be regarded as a notch above other unregulated alternatives. This includes the Tether USDT stablecoin and even Facebook’s to-be-released Diem stablecoin, which has seen stuttering progress due to regulatory opposition for more than a year.
The digital U.S. dollar has no such issues as a legitimate currency issued by the country’s central monetary authority. Comparing USDT and the digital U.S. dollar, a beleaguered Tether spent 22 months in a drawn-out legal battle with the New York Attorney General’s office. The probe concluded in February 2021 with the firm being ordered to pay $18.5 million in penalties and a ban from conducting business in New York.
It is intriguing to note that Powell’s comments on revisiting a CBDC coincidentally followed the news of USDT’s successful settlement. On one hand, with a market capitalization of more than $34.9 billion, USDT is the world’s benchmark stablecoin and possibly the digital U.S. dollar’s largest competitor when it is finally released. On the other, if there is one thing that USDT’s settlement has proven, it is that there is room for compromise on the regulatory front to ensure co-existence between stablecoins and a CBDC.
The lines are blurred, however, when we bring regulated digital currencies such as Circle’s USDC stablecoin into the picture. How would the Fed then make a case for the adoption of CBDC? At this point, it all boils down to:
Reputation and supply
Individuals may trust the Fed and banks more than they do stablecoins, even if they are regulated, as a result of familiarity and convenience. Critics of stablecoins often highlight the supply issue, where private companies are unable to guarantee that their dollar-pegged stablecoin is backed up by actual U.S. dollars in reserves. On this note, statements by Circle made in October 2020 show that the number of USDC issued has not eclipsed that of U.S. dollars the company has in custody, erasing doubt over the actual value of a USDC stablecoin. Regulated stablecoins are therefore placed on equal footing with a Fed-issued CBDC.
Preference and function
Stablecoins form an indispensable bridge between the pure crypto and pure fiat worlds, and are paramount for sophisticated and aspiring traders alike who wish to dabble in the crypto market. For this reason, it may be more valuable to hold USDC, which can be easily converted into cryptocurrency, rather than digital U.S. dollars.
It is too early to forecast the fate of crypto in the hands of the Fed and a released digital U.S. dollar, but one thing is for certain: The battle between CBDCs and other private currencies is not an all-or-nothing gamble. Adoption will happen at various points between both and until then, we can only await a decisive move on the Fed’s part.