According to an announcement by the Federal Reserve Bank of New York, several global banking giants have signed up to take part in a 12-week digital dollar or central bank digital currency (CBDC) pilot. Unsurprisingly, this has ruffled a few feathers, not just because of the potential implementation of “programmable digital dollars”, but more so that it’s come following months of denial from Federal Reserve chairman Jerome Powell.
According to the announcement, Citigroup, HSBC, Mastercard and Wells Fargo are among the financial companies participating in the experiment alongside the New York Fed’s innovation centre. The pilot will test how banks using digital dollar tokens in a common database can help speed up payments.
Before going into the implications and why this matters, here’s a short primer on the US Federal Reserve System.
Quick word on the how the Federal Reserve works
In financial markets, it’s fairly well known that the US central bank is the Federal Reserve, currently headed by Jerome Powell. However, what is less understood is the fact that there are 12 distinct federal reserve banks within the US, of which New York is the largest by net asset value. Each individual reserve bank is in turn represented in the 12-member Federal Open Market Committee, the entity that sets monetary policy (i.e. interest rates) in the US.
With that out of the way, here’s the important bit to take note of: the pilot is being trialled by the New York reserve bank and not the Federal Reserve itself. But of course, the Federal Reserve itself is intrinsically involved in the process as it works closely with all of its 12-member banks.
US Federal Reserve chairman Jerome Powell said as recently as September that it would take some time for the US to make a decision on a digital dollar, most commonly referred to as a CBDC. However with the news coming out of the New York reserve bank, it seems that something was likely brewing for some time.
What is the New York reserve bank up to?
According to the announcement, it is exploring the feasibility of an “interoperable network of digital central bank liabilities and commercial bank digital money using distributed ledger technology”. In simple terms, they are working with financial companies and trialling the use of blockchain technology to facilitate inter-bank transfers.
In among the jargon and use of three-letter acronyms, a key paragraph stands out:
“This theoretical FMI [financial market infrastructure] provides a multi-asset, always-on, programmable infrastructure containing digital representations of central bank, commercial bank, and regulated non-bank issuer liabilities, denominated in U.S. dollars.”
Put simply, the trial here appears to be for the foundations of a wholesale CBDC, distinct from a retail CBDC. The former relates to inter-bank digital dollar transactions between financial institutions, whereas the latter is between a central bank and ordinary citizens and businesses.
Okay, there’s a CBDC trial underway, so what?
To many, the news is a sign that a retail CBDC is on the horizon signalling that central banks could soon program conditions into how one’s money is capable of being spent. A quick scan of Twitter and the comments of the news reveal that very few feel comfortable with the notion of a retail CBDC. As one user put it, ”There are no benefits to a CBDC other than total financial control. It is not alarmist to call it an existential threat to liberty”.
However proponents would be quick to point out the purported benefits of retail CBDCs to include:
- Instant transfer and settlement, compared to the slow and tedious legacy system;
- Facilitates global trade and financial innovation; and
- Enables direct individual-level monetary and fiscal policy
- Monetary – you can program higher interest rates for savings for young and reduced or even negative rates for the elderly as they reach retirement age (and government wants to incentivise consumption).
- Fiscal – welfare payments or ‘stimulus cheques’ directly into your digital wallet, rather than through the banking system which is slow and inefficient.
Benefits notwithstanding, it’s not entirely surprising that the crypto community isn’t convinced, as Bitcoin was specifically created to extract central planners from money.
In addition to concerns of privacy and financial freedom, some found the timing to be somewhat suspicious.
With recent news of an imminent digital Euro and north of 105 countries at some stage of the CBDC experimentation process, there may well be grounds for the concerns that have been raised. The US pivoted quickly from thinking about CBDCs to trialling one in the matter of a month. That in itself speaks volumes, but the true motivation remains to be seen.