Inspecting Central Bank Digital Currency
How digital currencies are reshaping how we think about money.
James Camron’s Terminator came out in October 1984 but our fascination with dystopian Sci-Fi future settings predates this movie a long way. My introduction to the film was a baptism of shock and horror that I will never forget. I was young, but old enough to know that I had to watch the movie covertly outside of my mother’s jurisdiction. The joke was on me though, as I could hardly get any sleep that night. I was too busy watching the sliding glass door of my cousin’s living room scanning for the red eyes of the T-800 coming to end my existence. The premise of the movie, and others like it, effectively taps into our fear response because of their perceived plausibility. The future is uncertain, and the outcomes of technological advances can be fraught with unintended consequences. Therefore, our default mode is to look at most innovation as a threat at first.
Now, all grown up and completely prepared for T-800s arrival, my fearful gaze shifts to the next technological horror: the Central Bank Digital Currency, or the CBDC. Much has been said about this topic, but facts get obfuscated by conjecture and what we end up with is a useless fear response. A prudent reaction to the subject requires a cursory understanding of what a CBDC is and what problems it is attempting to resolve. Narrowing our scope of focus is helpful to better understand the topic so I will double-click on what the Fed has dubbed the ‘Digital Dollar’. First, what it is: simply put, the digital dollar would be a direct obligation of the Federal Reserve held in an account directly with the Fed. It is not much different than cash which literally states, “This Note Is Legal Tender For All Debts, Public And Private”. In other words, it would be cash held with the Fed through a digital ownership structure, thus bypassing traditional banks. The Fed would likely use a consensus mechanism (i.e. blockchain) managed by its various branches to maintain the ledger, or it could use existing financial institutions to this end. The specifics of how it would work are still unclear.
It is not much different than cash which literally states, “This Note Is Legal Tender For All Debts, Public And Private”.
On its face, the whole thing sounds rather pointless and comes across as a nationalization of the financial services industry. That is, unless you’ve used some of the more popular digital asset networks, such as Bitcoin, to transact and understand their upside potential. These include nearly instantaneous final settlement, low transaction fees, global reach, and auditability of the transaction. Additionally, a benefit unique to the Digital Dollar would be riskless custody because your digital asset would be held by the same entity with authority to create more of the same currency. This would negate the need for depository insurance. Anyone remember my article on SVB? The system could streamline peer to peer payments but it would also massively improve the efficiency of direct payments to and from government entities. Think of the CARES Act in 2020 and the millions of transactions that generated, many to fraudulent recipients. There are more benefits than described here, for sure, but these should be enough to dispel fears that the CBDC initiative is simply a pure power grab.
It wouldn’t be a thorough analysis if we did not review the negatives. The doomsayers suggest that this will usher in a government surveillance panopticon that could be abused by authoritarians. This would be true except for the fact that the Fed is on record that the Digital Dollar, if adopted, would complement the existing financial system, not replace it. Also, this reality is subverted by the mere existence of nascent decentralized digital assets (i.e. Bitcoin) that offer reasonable alternatives if faced with such authoritarian abuse. Next, this “panopticon” is largely already a reality. According to the Fed, nearly 94% of transaction throughput done today is executed digitally via commercial bank ledgers and non-bank networks such as Visa. These transactions are all monitored as required by law, specifically the Patriot Act. Next on the list of potential cons is the concept of programable money, which is the notion that your digital dollar could be given an expiration date or could be redeemable only at certain retailers or even for certain products or services. This, I believe, would eventually be implemented if a CBDC is adopted and presents the area of greatest concern given it harbors the most potential for unintended consequences. Governments are comprised of humans and humans are prone to error. The more complex we humans make things, the more opportunities for error there are. Unless a Digital Dollar program is built specifically to prevent programable manipulation, I do not see it as a positive development.
So, how close are we to a Digital Dollar? My answer is not very close. At least not while Jerome Powell is Chairman of the Federal Reserve, which is until 2026. The adoption of a Digital Dollar would cripple the business structures of many major financial institutions and they would need to be given the opportunity to pivot their business models to support the program and not drag the economy into recession. Next, it represents a major risk for politically exposed figures. Toying around with something as fundamental as the base currency is not for the faint of heart and I don’t know of many policy makers that would welcome the slings and arrows that would come along with this. The Fed is on record stating that a CBDC would not happen without congressional and presidential support. In other words, it would need to be ratified by law before the program sees the light of day. I believe that this day will come, it just isn’t imminent. For those of you looking for a deeper dive, here’s a link to the Fed’s publication from January 2022. It’s a long read but worth it for the curious.
Happy Easter!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
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