The Federal Reserve is investigating the potential of a central bank digital currency (CBDC) as the backbone for a new, secure real-time payments and settlements system.
The move toward a form of government-backed digital currency is being driven by Fintech firms and a banking industry already piloting or planning to pilot cash-backed digital tokens, according to Lael Brainard, a member of the U.S. Federal Reserve's Board of Governors.
“Today, it can take a few days to get access to your funds. A real-time retail payments infrastructure would ensure the funds are available immediately – to pay utility bills or split the rent with roommates, or for small business owners to pay their suppliers,” said Brainard, who serves as chair of the committees overseeing Financial Stability and Payments, Clearing and Settlements.
Immediate access to funds could be especially important for households on fixed incomes or living paycheck-to-paycheck, when waiting for funds to be available to pay a bill can mean overdraft fees or late fees that compound. Similarly, for small businesses, immediate access to funds from a sale to pay for supplies can be a game-changer, Brainard added.
Along with benefits, however, a CBDC would also bring potential risk, said Brainard, who spoke last week at the Symposium on the Future of Payments conference in Stanford, Calif.
“The prospect for rapid adoption of global stablecoin payment systems has intensified calls for central banks to issue digital currencies in order to maintain the sovereign currency as the anchor of the nation's payment systems,” Brainard said.
Last week’s speech is a marked shift from one given in 2018. At the time, Brainard said digital tokens for wholesale payments and some aspects of distributed ledger technology could strengthen traditional financial systems and markets, but warned there are “serious technical and operational challenges that would need to be overcome.”
For one, a CBDC might create “a global target for cyberattacks or a ready means of money laundering,” Brainard said during her 2018 speech at the “Decoding Digital Currency Conference” in San Francisco. “Even though central bank digital currencies may at first glance appear to address a number of challenges associated with the current crop of cryptocurrencies, this appeal may not withstand closer scrutiny.”
One reason for the change of heart from two years ago may be that since that time private efforts to create stablecoins have accelerated, including Facebook’s Libra and JP Morgan’s JPM Coin.
Brainard expressed concern that while payments have traditionally been a service provided by “trusted intermediaries such as banks,” fintech firms creating cryotpcurrencies are not under the Fed’s jurisdiction – or its regulatory oversight. “Banks offer important consumer protections,” she said.
“Because Facebook has an active user network of one-third of the global population, the company's Libra global stablecoin project has imparted urgency to the debate over what form money can take, who or what can issue it, and how payments can be recorded and settled,” Brainard said in her latest remarks. “Any stablecoin project with global scale and scope faces a core set of legal and regulatory challenges.”
In China, Brainard noted, the majority of consumers and businesses participate in two mobile payment networks, Alipay and WeChat Pay, which by some accounts handled more than $37 trillion in mobile payments in 2018.
“Building on the tremendous reach of its mobile payments platforms, China is reported to be moving ahead rapidly on plans to issue a digital currency,” Brainard said.
Mike Poutre, CEO of venture firm Terraform Capital, said, “Zuckerberg’s Libra offering was a shot across the bow, and an olive branch, to governments and big businesses around the world.
“The message is you will never again have the same level of control over your currencies as you did prior to 2009, but if you act quickly and intelligently, you can maintain a level of control and visibility,” Poutre said via email.
Todd Kornfeld, attorney in the law firm of Pepper Hamilton LLP and part of its Blockchain Practice, said the Fed may indeed be looking at private-side token development and concluding there are advantages to creating a standardized CBDC with the right framework around.
For one, a CBDC would allow banks to tie funds to an owner in a way stored currency value today cannot, Kornfeld said.
By creating a digital coin tied to the U.S. dollar and its owner through cryptographic hash keys, consumers and businesses alike would be able to track a token they own on an immutable electronic ledger, and possibly even retrieve it if an error is made after a transfer. In turn, government agencies could trace tokens, and ensure banks are complying with know-your-customer and anti-money laundering laws.
“In the US…, you have a bank account and so much money according to bank's ledger. [You] can’t say that’s my dollar,” Kornfeld said. “I think maybe they’re looking now and saying that we’ve thought about it more and there are things we could do that may make sense and maybe we should formally tokenize U.S. currency. I think this is in the early stages.”
More than 80% of central banks say they're engaged in some type of central bank digital currency (CBDC) effort, according to Bank for International Settlements survey of 66 central banks.
“The latest survey suggests there is greater openness to issuing a CBDC than a year ago, and a few central banks report that they are moving forward with issuing a CBDC,” Brainard said.
In January, the former chair of the Commodity Futures Trading Commission (CFTC) partnered with Accenture to create the non-profit Digital Dollar Project, which plans to explore the creation of a U.S. Central Bank Digital Currency (CBDC).
To be certain, there are already fast digitized money transaction services. Any person-to-person payment service such as Venmo or Zelle allows consumers to store value in an account and make a nearly instantaneous transfer to another account holder. Federal reserve banks are developing FedNow, a real-time gross settlement service to allow consumers and businesses to send payments in real time.
“In some sense, you can look at the FedNow and the clearing houses with similar products and…they’re using similar techniques and apps to try to move the U.S. dollars around faster. The banks have been constrained because the existing bank-to-bank transfer system has been slow,” Kornfeld said.
In her speech, Brainard admitted that, unlike many foreign central banks, the U.S. Federal Reserve doesn’t have complete authority over payment systems, particularly in retail banking. Given the increase in the number of nonbank payment industry players, Brainard said it may be time to review the nation’s oversight framework and consider giving the Fed explicit authority for general retail payments oversight, as other nations do.
“So let's turn to our retail payments infrastructure, which touches every American. It is critical that consumers and businesses can achieve the same speed and efficiency using their trusted deposit account providers with the safety and security they have come to expect,” Brainard said. “To make this possible, it is vital to invest in real-time retail payments infrastructure with national reach.”
Heinrich Zetlmayer, founder and general partner of Switzerland-based Blockchain Valley Ventures, said a CBDC would bring a range of benefits – especially cost savings and efficiency gains, “which are inherent to the blockchain technology innovation for the financial sector and consumers.”
A blockchain-based CBDC would essentially removed charges and bottlenecks created through intermediaries who process payments and settle them.
“It could also stimulate significantly the trading of other digital currencies and digital assets,” Zetlmayer said via email.
“In my view that does not diminish the prospects for Facebook's Libra, but certainly smaller projects need to take the new CBDCs into account in the assessment of market potential of private stablecoins,” Zetlmayer said.
Poutre agreed, saying while Libra may never get off the ground, “it set forth wheels in motion in countries around the world that will lead to Central Bank Digital Currencies.
“These ‘next generation of fiat currencies’ will eventually replace paper money around the world,” Poutre said.
“The reality is that crypto currencies have highlighted a global systemic problem in banking: in a world that now operates on a 24/7/365 mindset, how can business stay current when they are forced to use an 8-hour banking day?” Poutre said. “The advent of Bitcoin as a de facto currency is forcing the global banking community to realize that they are still working on an infrastructure that is hundreds of years old - and outdated.”