?? Fed study discusses pros and cons of digital dollars
?? US Federal Reserve does not take a clear position
?? asked the public to participate
As early as 2021, Fed boss Jerome Powell announced according to “CNBC” that the US Federal Reserve wanted to deal with the digital dollar in a working paper. The study, which was originally expected for the summer of 2021, has now been published and is likely to have disappointed many crypto enthusiasts. Because although the Fed goes into some detail in its report on the advantages and disadvantages of digital central bank money – also called Central Bank Digital Currency (CBDC) – it still lacks a clear positioning. Instead, the study, titled “Money and Payments: The US Dollar in the Age of Digital Transformation,” is intended to be merely a “first step in a public discussion between the Federal Reserve and stakeholders about CBDCs (CBDCs)” and does not seek any specific policy outcome advance. Nonetheless, the study provides some arguments as to why a CBDC would benefit the country and be a better means of payment than the current cryptocurrencies that are gaining traction.
This is what digital central bank money could look like
“The introduction of a CBDC would represent a highly significant innovation in the area of American money” and would have the potential to fundamentally change the structure of the US financial system, the study states. It offers a range of potential benefits, but also poses certain risks. The Fed understands the CBDC to be a digital cash version that is just as available to the public as the US dollar is currently, but which represents a liability of the US central bank and not commercial banks. This means account holders would deposit or withdraw their money from the Fed instead of from commercial banks as they have done up until now. In the case of a digital dollar, they could at most act as a middleman, since the US Federal Reserve’s business model does not allow private individuals to maintain accounts there directly.
The Fed sees these advantages in the digital dollar
The study lists several points as possible advantages of CBDC. For example, financial services could be provided to people who currently do not have a bank account, thereby expanding access to the financial system and creating more financial inclusion. In addition, households and businesses would generally have easy access to an electronic form of central bank money that would also bring security and liquidity. Furthermore, the digital dollar would enable faster and cheaper transactions, even across national borders if the necessary technical prerequisites were created together. For example, transactions could be completed in real time and stimuli, such as those paid out in the corona pandemic, could reach people faster. According to the US Federal Reserve, post-dated payouts and very small money transfers, which are not necessarily supported in the traditional banking system, are also possible with a digital dollar and the associated system. According to “Insider”, many people in the USA are currently using third-party providers such as PayPal to transfer small amounts. This would then no longer be necessary.
Specifically, it is also stated that digital central bank money would offer the advantages of cryptocurrencies in payment transactions, but at the same time eliminate some of their risks. “A CBDC would be the most secure digital asset available to the general public without any associated credit or liquidity risk,” the working paper said. Both of these risks are greatest with cryptocurrencies, while money stashed at commercial banks faces little credit or liquidity risk. With money stored at the Fed, however, these risks do not exist at all. Therefore, according to the study, it is considered “the safest form of money”. The authors of the study also criticize cryptocurrencies for their sometimes high energy consumption, high volatility, sometimes severe limitations when processing transactions and the vulnerability of users in terms of fraud, theft and loss. A digital currency issued by the US Federal Reserve could do all this better.
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Risks of CBDC easily manageable?
According to the Fed, one of the biggest risks of a digital dollar is that it could “change the roles and responsibilities of the private sector and the central bank”, thereby destabilizing the financial system. Because if bank customers withdrew their money from the banks in times of crisis and shifted it into the digital dollar of the US Federal Reserve due to the higher level of security, the commercial banks could get into trouble. Because they need the account deposits of their customers in order to be able to grant loans, among other things. However, if they put their money in a digital wallet instead of in a bank account, the Fed believes it could become more difficult for consumers to get a loan in the future or the costs could increase significantly. It would also be similarly dangerous for the functioning of the financial system if consumers would rather rely on safe central bank money than safe US government bonds. As a possible solution to this problem, the study authors suggest limiting the amount of money that each user can hold in digital dollars or accumulate within a short period of time, or suggest that CBDC could generally remain interest-free – in contrast to the money that is on stored in a classic bank account or invested in government bonds.
A digital dollar could also affect the power of the Fed and influence how the Federal Reserve sets interest rates and manages inflation. “Over the long term, the Federal Reserve may be forced to expand the size of its balance sheet to accommodate CBDC growth, with a similar balance sheet impact to issuing increasing amounts of physical currency,” the study said. Therefore, the Fed must adapt the way it conducts monetary policy to the new situation.
However, the report also points out that some of the risks to the financial system are inherent in the very existence of stablecoins. Because at least the stablecoins, which are linked to the development of the US dollar, are already very close to a digital currency issued by the US Federal Reserve. Should there be a run on this privately organized cryptocurrency in the future and it be used more widely, this could destabilize the financial system in the same way as a run on a CBDC – with the important difference that, according to the study, the stablecoins would have gaps in supervision by authorities . Without digital central bank money, the Fed would, so to speak, let the reins be taken out of its hands.
These are the Fed’s next steps towards a digital dollar
“The introduction of a CBDC would represent a highly significant innovation in the area of American money. Therefore, broad consultation with the general public and key stakeholders is essential,” says the Fed study. To kickstart this discussion, the report also includes 22 questions that anyone can comment on through May 20, either digitally directly to the Fed or in scheduled public forums.
In this context, the US Federal Reserve makes it clear once again that it will only push ahead with the development of a digital dollar if research sees clear advantages for private households, companies and the economy as a whole and both the public and politicians clearly agree would signal support.
Editorial office finanzen.net
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