The long-awaited report on the US Federal Reserve’s Central Bank Digital Currency (CBDC) has been released.
With respect to a CBDC, the United States is proceeding with caution, explicitly stating that it is neutral on the subject and does not favor any particular outcome regarding the creation of a CBDC.
However, the Fed recognizes the benefits that a CBDC can bring to banking and payments settlement, as well as the hurdles that would need to be overcome before CBDC implementation becomes a reality.
Here are the key findings from the Fed’s “Money and Payments: The US Dollar in the Age of Digital Transformation” report.
The Federal Reserve recognizes that innovation in the banking and payment settlement space takes place periodically. There have been several advances in these markets that have been possible due to new technologies that have enabled innovation. The Fed believes that blockchain technology and digital currency can be one of those innovations that can improve the world of banking and payment settlement. The Fed has therefore explored the technology, its advantages and the disadvantages that come with it.
How a CBDC Can Improve America’s Banking and Payments Systems
The Fed knows that the banking and payment system can still be improved. Its report stated: “7 million, or more than 5% of American households, are still unbanked. [And] almost 20% more have bank accounts, but still rely on more expensive financial services such as money orders, check cashing services and payday loans.
The report notes that cross-border payments often come with high transaction fees as well as slow settlement times due to time zone differences.
“In the second quarter of 2021, the average cost to transfer funds from the United States to other countries was 5.41% of the notional value of the transaction. These high costs have a significant impact on households that carry out remittance transactions. The high costs of cross-border payments also affect small businesses that make infrequent global payments to suppliers. Reducing these costs could benefit economic growth, improve global trade, improve international remittances and reduce inequality,” he said.
Considering the native characteristics of most digital currencies, such as an almost instant payment settlement time, low transaction fees that are often less than a penny, the low barrier to entry given that most blockchain networks are public and the ability to program money, the Fed sees digital currency as a monetary tool that could reduce the number of unbanked or underbanked people in America while reducing the costs associated with sending money funds and cross-border payments.
“A US CBDC would provide the general public with broad access to digital currency without credit risk or liquidity risk. As such, it could provide a secure foundation for private sector innovations to meet current and future payment service needs and demands,” the Fed report said.
“A CBDC could generate new capabilities to meet the changing speed and efficiency demands of the digital economy. As noted above, for example, a CBDC could potentially be scheduled to make payments at certain times. Additionally, a CBDC could potentially be used to make micropayments — financial transactions that typically occur online and involve very small amounts of money — that traditional payment systems aren’t necessarily designed to facilitate.
Implementing a CBDC would create a whole new set of problems for both the central bank and residents of the United States. The creation of a CBDC would mean that a new form of currency would enter the economy, which would change the structure of the banking and payment settlement system. Experts at blockchain research firm nChain expect countries of all sizes and economic developments to now realize the benefits of blockchain technology and implement national digital currencies. Simit Naik, Chief Commercial and Strategic Officer of nChain, said, “Central banks have more clarity on their requirements and the benefits of using a public blockchain to deliver CBDC that is most like cash.”
For the Federal Reserve, the main concerns are that digital assets could worsen bank runs, reduce the availability of credit in financial markets, and have the potential to disrupt the current concentration of economic power.
“Because central bank money is the most secure form of money, a widely accessible CBDC would be particularly attractive to risk-averse users, especially during times of stress in the financial system. The ability to quickly convert other forms of money, including commercial bank deposits, into CBDCs could make runs on financial companies more likely or more severe. Traditional measures such as prudential supervision, government deposit insurance and access to central bank liquidity may be insufficient to prevent large outflows of deposits from commercial banks to the CBDC in the event of a financial panic,” did he declare.
“Banks currently rely (largely) on deposits to fund their loans. A widely available CBDC would serve as a close – or, in the case of an interest-bearing CBDC, almost perfect – substitute for commercial bank money. This substitution effect could reduce the overall amount of deposits in the banking system, which could in turn increase banks’ financing expenditures, and reduce the availability of credit or increase the cost of credit for households and businesses.
How to reduce the risks associated with CBDC
The Fed points to a President’s Working Group (PWG) document, which raises the same concerns about a CBDC as the Fed. The PWG report says the solution would be for Congress and lawmakers to create regulatory frameworks that would mitigate the risks associated with implementing a CBDC; however, the report acknowledges that there are currently gaps and uncertainty about who has the authority to regulate CBDCs.
The Fed seeks expert advice
Overall, the report indicates that the Federal Reserve has blockchain and digital currency on its radar and will continue to research these technologies until there is sufficient evidence that they are beneficial and ‘they should be implemented in the banking and payment system, or they are too risky and should not be implemented.
“The Federal Reserve will only take further steps to develop a CBDC if research indicates benefits to households, businesses, and the economy as a whole that outweigh the downside risks, and indicates that CBDC is superior to alternative methods. . Further, the Federal Reserve would only pursue a CBDC in the context of broad public and intergovernmental support,” the report found.
To catalyze this initiative and better understand CBDCs, the Fed is seeking expert advice. It accepts comments on their specified set of questions until May 20, 2022.
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