An official digital US dollar would need to be privacy-protected, intermediated by third parties, widely transferable between holders and have robust identity verification mechanisms, the US Federal Reserve has noted in launching a discussion paper contemplating the creation of a central bank digital currency (CBDC).

A CBDC – a regulated cryptocurrency offering the flexibility of Bitcoin but pegged to existing fiat currency to avoid its destabilising unpredictability – “would represent a highly significant innovation in American money,” the report, entitled Money and Payments: The US Dollar in the Age of Digital Transformation, notes.

Such a currency would “offer the general public broad access to digital money that is free from credit risk and liquidity risk,” the report notes, which would make it suitable for private-sector investment as well as supporting new payment models like ‘micropayments’ – online transactions in extremely small amounts that aren’t well-suited to existing systems.

A CBDC “might also help to level the playing field in payment innovation for private-sector firms,” the Fed said, noting that issuing “safe and robust” private money can be “prohibitive” for smaller firms.

Because it would be issued by the Federal Reserve rather than individual banks, the report notes, “a widely accessible CBDC would be particularly attractive to risk-averse users, especially during times of stress in the financial system”.

The “riskless” nature of this investment could potentially create problems if a financial panic caused large investors to move their assets from conventional currency investments into CBDCs – driving a huge sell-off of the US dollar that would have ripple effects domestically and internationally.

“While a CBDC could provide a safe, digital payment option for households and businesses as the payments system continues to evolve and may result in faster payment options,” the Federal Reserve Board of Governors said, there may also be downsides” such as clarifying stability mechanisms and how the CBDC would “complement existing means of payment.”

Australian regulators have previously expressed concerns that the fact CBDCs would be issued by central banks could see investors bypassing existing retail banks altogether – a risk that, the Fed notes, be managed by limiting how much CBDC any person could accumulate, and how quickly.

Cashing in on digital currencies

The report is “a welcome and critical addition to the ongoing exploration of a US CBDC,” said Jennifer Lassiter, executive director of advocacy group The Digital Dollar Project, which released a discussion paper about a US CBDC in May 2020.

“The Fed’s prioritisation of public outreach through a request for public comment, followed by targeted outreach and public forums, is reflective of the intentional approach required to reimagine the US’s complex money and payment systems.”

Acceleration of digital currency discussions in the US follow a sharp ramp-up in international interest in CBDCs.

To date, nine countries have already launched CBDCs, according to the Atlantic Council’s CBDC Tracker, which notes the launch of Nigeria’s e-Naira currency in October as the first CBDC outside of the Caribbean.

Fully 87 countries are exploring options for a CBDC, with 14 countries – including China and South Korea – currently running pilot programs and preparing for launches.

Several countries are running interoperability tests evaluating the exchange of digital currencies across borders – including the Project Dunbar effort involving Australia, South Africa, Singapore, and Malaysia – which will be essential in using the currencies for international trade.

The Australian government will increase its scrutiny of a CBDC as part of a package of payment-system reforms, announced in December by treasurer Josh Frydenberg, that includes tighter controls over cryptocurrency exchanges – and consideration of the “feasibility” of an Australian CBDC.

The enquiry, he said, will “seek to address the complex issue of de-banking” – the concern that CBDCs could diminish the financial foundations of the banking system – and to ensure Australia maintains a leading role in the creation of CBDC policy that is, by its very nature, a global issue.

“Without reform,” he said, “Australian consumers and businesses [will] increasingly transact in largely unregulated environments, with any rules determined by foreign governments and large multinationals.”