The latest survey from BIS (Bank of International Settlement) shows that 80% of the central banks in the study are working on Central Bank Digital Currencies (CBDCs). “Working on” is a broad term that includes late stage work as in China with multiple pilots with real money, already deployed solutions such as the Sand Dollar from the Bahamas, SOV from the Marshall Islands and Bakong from Cambodia and others that are just in the whitepaper and questioning stage. Many of the deployed solutions do not meet the strict criteria for a CBDC. The primary marker of a Central Bank Digital Currency, a liability of the central bank, is met to varying degrees by these solutions. Other considerations such as who does the issuance as well as whether it is fully backed by excess and segregated reserves also differs. The main idea is to have a friction-less digital payment rail that is separate and independent from private payment systems, to provide an alternative in times of stress which seems to hit globally every ten years, predicted to be even more frequent in years to come.
There is a general perception that central bankers are a notoriously conservative lot. This conservatism is selective, they have shown no reticence in implementing radical policies in the last couple of decades, especially in America and Europe. Quantitative Easing (QE) was taken to unprecedented levels to combat the financial crisis during Ben Bernanke’s tenure as the chairman, back in 2008. The Fed is now buying junk corporate debt at very low yields (meaning high prices), mortgages, and of course treasuries as part of QE. All of this QE is a backdoor bailout for many firms, including zombie companies. It is also a bailout of the fiscal side of the government. In addition, QE and operation twist happen to juice equity prices and now even indirectly fuel prices of crypto-currencies. The Fed has a healthy repo operation, some may say unhealthy, putting a floor under money market operations. The Fed engages in many such operations to stabilize the financial system, many of these have unforeseen effects and can be seen as extremely risky in normal times. The Fed is no stranger to risk, that is the cost to pay for stabilizing the economy.
This article is a response to the Fed note published on February 24th., which goes through a list of preconditions to be met for a general purpose central bank digital currency. The list of conditions is comprehensive and makes sense in isolation, it is also marked by an unworthy timidity and lack of concrete solutions. The following preconditions are discussed in the note: clear policy objectives, broad stakeholder support, strong legal framework, robust technology, and market readiness. The authors argue that a CBDC designed to support monetary policy transmission or economic stimulus payments, would be quite different than a CBDC that is designed to be an alternative to cash. Existing CBDC deployments and pilots prove them wrong, such seemingly contradictory policies have been handled through cash like behavior in smaller amounts in offline settings using smart cards or tiered wallets supporting different sorts of behavior.
Opposing forces acting on General Purpose CBDC adoptionFed note
Legislators and policy leaders want a digital equivalent of central bank money, because it would be unwise to leave such important infrastructure solely in the hands of the private sector. There is also the cost factor, a 2-3% tax is being levied on every transaction conducted with credit and debit cards. This tax does not come directly from the customer, it is indirectly levied through higher overall prices as merchants pass on their costs.
Other drivers for a digital dollar, are out of the control of the Fed and our legislators. Chief among them is the strategic threat to the dollar from other national CBDC projects like China’s Digital Currency Electronic Payments and vast stable-coin projects such as Facebook Diem. For the United States, an implementation of CBDC is thus transformed into a national imperative. It is no longer a project that can be endlessly analyzed and delayed. The luxury of deciding against a digital dollar may not even be available.
The operational and technical aspects of CBDCs bring with it asymmetric risk in many dimensions. Some of these include rapid contagion through digital channels and the possibility of rapid collapse of the system due to bugs or successful cyber-attacks. Any national project that is sufficiently transformative is inherently risky. Methods from other disciplines dealing with such risk should be adopted.
While it is useful to look at these preconditions in isolation, it is evident that most of the operational and adoption elements are connected in feedback loops. A systems view is called for, especially to deal with emergent effects, where a responsive legal, technical and operational framework should be yoked to an ambient observation and monitoring system with circuit breakers controlling runaway behaviors. There can be no short term plan for such a system, it has to built in stages with iterative field testing and improvement. Such a venture has to be backed by long term results driven funding, not funding dependent on short term commercial goals.
A healthy dose of behavioral design is needed to spur adoption, simpler user interfaces and the incentives for the various participants have to be clear, adoption has to be effortless. A nudge unit has to be part of any CBDC implementation team. Lower cost, ease of use and widespread acceptance of CBDC payments, coupled with legislative clarity about CBDC as legal tender will also encourage adoption.
The New York Fed is running a lab with global participation, the Fed has a new chief innovation officer, the Boston Fed is running experiments with the MIT DCI on blockchain based payment systems. So even though there are more questions than answers in the Fed note under discussion, these questions may be answered by others at the Fed itself. There is no time to waste.