U.S. Central Bank Digital Currency Development Posture

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Author: Zhong Hong Peng Yazhe “Bank of China Research Institute, Zhong Hong, Vice President; School of Finance and Economics, Renmin University of China

Since 2020, against the background of the impact of the new crown pneumonia epidemic, the challenge to the international status of the US dollar, and the competing layout of central banks and private digital currencies in many countries, the US government has changed its negative attitude toward the digital dollar and actively conducted exploration and research in an effort to maintain and consolidate the US dollar’s position in the new track of global digital currency competition. The new trend of the development of the U.S. central bank digital currency is worthy of attention.

U.S. Attitude Towards Central Bank Digital Currency Turns Positive

In June 2019, the U.S. Facebook Inc (Facebook) released the first version of the Libra coin (Libra) white paper, claiming to launch Libra, a synthetic digital currency based on a basket of currencies, and to create a financial infrastructure that empowers billions of people. The project was quickly called off by the U.S. Congress and opposed by several governments and central banks because of the potential risks of Libra weakening cross-border fund regulation, threatening financial stability, reducing the effectiveness of monetary policy, disrupting economic adjustment cycles, and potentially impacting the monetary sovereignty of non-reserve currency countries. In fact, since the birth of Bitcoin in 2009, digital currency has been a hot topic of discussion in all walks of life, and several countries around the world are already conducting research on central bank digital currency (CBDC). CBDC is an electronic form of central bank currency, which can be issued and circulated more efficiently through the encryption technology of digital currency. The emergence of Libra, a private digital currency, has prompted countries to accelerate the process of research and testing of central bank digital currency, and has triggered thoughts on the trend of globalization of digital currency.

In July 2019, Princeton University proposed the theory of Digital Currency Area (DCA), defining it as a network for making payments and transactions in a specific digital currency. Characteristics of a Digital Currency Area include: this digital currency is restricted to use within that network; the network provides a means of transaction for users that can only be used between participants; and the network uses its own unit of account, which is different from the current official currency. The theory suggests that the creation of digital currency zones creates strong monetary ties, reduces barriers to transactions between participants, changes the financial market landscape, and drives the reshaping of the international monetary system. However, while digital currencies and digital networks break down barriers for intra-regional users, they lead to greater fragmentation between different regions of the world, and it ultimately leads to a more segmented international financial system. in November 2019, Harvard University professor Rogoff noted that a new monetary competition has arrived, this time in the form of a war for central bank digital currencies. Digital currency competition poses a greater threat to the United States – once central bank digital currencies are introduced first by countries other than the United States, the ability of the U.S. government to use the dollar to advance its international policy goals will be greatly diminished.

Despite extensive research describing how digital currencies have emerged as a new track for global monetary competition, as of late 2019, U.S. government officials have maintained a less-than-positive attitude toward central bank digital currencies.In November 2019, in response to inquiries from members of Congress about the Fed’s development of a central bank digital currency, Federal Reserve Chairman Jerome Powell stated that the Fed is closely following the development of digital currencies, but due to a range of legal, regulatory and operational issues, it did not consider actively participating in it. in December 2019, at a House Financial Services Committee hearing, then-U.S. Treasury Secretary Mnuchin also said that he and Powell agreed that the Fed would not need to issue a digital currency for the next five years.

However, the Fed’s approach to central bank digital currencies has quietly changed as we enter 2020. in February 2020, Fed Executive Director Brainard said in a speech at Stanford University’s Graduate School of Business that the Fed has begun an investigative study on a range of issues including the regulation, protection, and feasibility of digital payments and digital currencies issuance. in May 2020, the Federal Reserve, led by former U.S. Commodity In August 2020, the Federal Reserve Bank of Boston announced a partnership with the Massachusetts Institute of Technology (MIT) to build In October 2020, the Digital Dollar Project released the report “Proposal for a Pilot Program to Explore a U.S. Central Bank Digital Currency,” which outlined nine “pilot” scenarios to illustrate how a U.S. central bank digital currency could address the common challenges faced by different stakeholders.

There are a number of reasons why the U.S. has shifted its approach to central bank digital currencies.

One is the need for digital currency in the wake of the Newcastle pneumonia epidemic, which hit the U.S. economy hard in early 2020 and led to a series of economic stimulus bills that provided economic relief for low-income people. However, when relief payments were distributed, many Americans did not receive the relief funds in a timely manner. Unable to apply for direct deposit, they had to spend more time waiting for paper checks to be mailed and were further faced with the problem of how to withdraw their paper checks once they received them. In contrast, if a more efficient and convenient digital currency is implemented, it can significantly improve government efficiency and better provide assistance to the people. In addition, in order to reduce the risk of virus transmission during the epidemic, merchants and consumers are trying to reduce the use of cash bills, and people are gradually developing new habits such as contactless shopping and keeping social distance, which also greatly promote the transformation of payment methods and payment systems to digital.

On August 23, 2019, then Governor of the Bank of England Carney delivered a speech entitled “The growing challenges to monetary policy in the current international monetary and financial system”, pointing out that the world economy is being reordered and the U.S. share of global GDP is rapidly declining, so the U.S. dollar should not continue to be the world’s reserve currency. In January 2020, the Bank for International Settlements (BIS), together with the European Central Bank, the British Central Bank, the Swiss Central Bank and others, established the Central Bank Digital Currency Working Group to study the technical options for a central bank digital currency, and the development of a digital currency. the technical options, potential benefits and risks of central bank digital currencies, and the Federal Reserve joined the working group at a later stage. In order to maintain and consolidate the status of the U.S. dollar as the main reserve currency and international payment currency, the U.S. must actively promote the digital dollar to ensure that it can continue to hold the international discourse.

Third, private digital currencies present opportunities and challenges. in April 2020, the Libra Association released the second version of its white paper, deciding to abandon the public chain, launch a new stablecoin anchored to a single fiat currency based on the original peg to a basket of currencies, and fully embrace regulation. Once Libra gains market access, it will likely rapidly develop into a super-sovereign digital currency, which This may seem to have a certain impact on the international status of the U.S. dollar, but at its core, the Libra system is still essentially based on the U.S. dollar, which not only ensures that the U.S. has more insight in terms of regulation, but also the U.S. dollar accounts for 50% of the basket of currencies pegged to Libra, which is much higher than the share of the U.S. dollar in the global payment market (40.33% of the U.S. dollar in June 2020), but makes Libra potentially a powerful tool to continue advancing U.S. dollar hegemony in the digital economy.In December 2020, Libra was rebranded under a new name, Diem. As can be seen, how to deal with the possible impact of private digital currencies on fiat currencies and actively exploit the opportunities they may bring is an important reason for the Federal Reserve to strengthen the development of central bank digital currencies.

The new layout of the U.S. central bank digital currency

Although the U.S. central bank digital currency is still in the exploration and research stage, the U.S. government’s vision and plan for the digital dollar has already taken shape. For how to develop, establish and implement the digital dollar, the U.S. has already started to layout and made a series of attempts.

First, to promote digital currency under the banner of financial inclusion, and to develop the market through “de-cash”. In the U.S., the figure of digital currency has appeared more than once in congressional proposals. in June 2020, the U.S. Senate Banking Committee held an online hearing on the theme of “digitalization of money and payments” to discuss how to solve the problems of financial inclusion through digital dollars. The lag in the Federal Reserve’s relief payments in this epidemic has exposed the shortcomings of the U.S. financial infrastructure, and members of the U.S. Congress are concerned about whether digital currency can fill the gaps in traditional financial services and help users obtain relief more effectively. In addition, the U.S. is developing markets under the banner of “financial inclusion,” and some large U.S. companies are gaining commercial benefits through the War on Cash under the guise of the Financial Inclusion Coalition. By promoting digital payment applications in non-dollar countries, U.S. companies can not only cultivate local residents’ habits of using the U.S. dollar and expand the use of the U.S. dollar, but also lay the foundation for the future implementation of the digital dollar globally and enhance the competitiveness of the digital dollar as an alternative to local fiat currencies. It can be seen that, on the one hand, the U.S. central bank digital currency has certain advantages in providing financial inclusion, which can facilitate the poor and the financially excluded groups; on the other hand, financial inclusion has become an excellent reason for the U.S. strategic layout of digital currency, which also makes the digital dollar more easily accepted by non-dollar countries.

Second, it is led by the government sector while focusing on private sector value creation. At the June 2020 hearing, Digital Dollar Project sponsor Giancarlo said that major government-sponsored technology projects often require private sector participation because the government lags behind the private sector in terms of pay levels, professionalism, project management capabilities, creativity and awareness of the degree of urgency in the industry. When conducting research related to the digital dollar, it should be led by the Federal Reserve and the Treasury Department, using a public-private partnership approach. From the current attitude of the U.S. government towards the central bank’s digital currency turning positive, it cannot be ruled out that the Fed will integrate more into the power of private companies in the future, and promote the development of digital dollar in the form of implicit endorsement by the central bank, government supervision, and cooperation between the government and private companies, which can also be glimpsed from the U.S. government’s attitude towards the Libra 2.0 white paper. For the U.S. Facebook, digital currency competition is also a competition of platforms, and if the central bank digital currency of each country can rely on the Libra platform, the enterprise will gain a huge competitive advantage. For the U.S. government, letting Libra take the lead in the digital currency space can dilute the national color and make other countries let down their guard, while also being able to maintain a counterweight to other countries until the central bank digital currency is officially issued. The U.S. government and private companies will likely achieve mutual benefits in the digital currency field in the future.

Third, the creation of a digital dollar framework that specifies digital dollar tokenization, a two-tiered system architecture, and a wholesale and retail model for both. The Digital Dollar Project White Paper proposes a model design for the digital dollar that includes: the digital dollar is a tokenized form of the U.S. dollar, operating alongside U.S. dollar cash; the digital dollar will be issued primarily through a two-tier architecture of commercial banks and regulated money senders; the digital dollar will be recorded on a new transactional infrastructure that may take the form of distributed ledger technology (DLT) to provide information and other technical support; and The digital dollar will have both a wholesale and retail model.

On the technology side, there has been little innovation in U.S. central bank money as legal tender, despite a long history of electronic transfers of cash. The tokenized digital dollar, as a new and more dynamic form of central bank currency, will be able to provide a higher level of portability, programmability and accessibility, which in turn will significantly improve the efficiency and modernization of the U.S. payments system. In a token-based model, distributed ledger technology enables data to be shared, replicated and synchronized among network members, and any changes in the ledger are reflected in a timely manner in copies owned by all members, ensuring the uniqueness of the system and preventing duplication. The technology enables the automation of transactions, increases efficiency and enables a move from centralization under the control of one entity to a high degree of decentralization. Future central bank digital currencies issued by the Federal Reserve will be fully trusted by the U.S. government and therefore fully convertible with Federal Reserve notes (bank notes or cash) and reserves.

In terms of mechanism, central banks have chosen very different R&D paths, which can be broadly divided into two categories: most developed economies choose to prioritize the development of wholesale central bank digital currencies, such as Japan and Europe, where digital currencies are mainly used in large-value clearing scenarios between financial institutions, including the interbank market and cross-border transaction settlement; more emerging market economies choose to prioritize the development of retail central bank digital currencies for More emerging market economies choose to develop retail-type central bank digital currencies for public use. The digital dollar project white paper shows that the digital dollar, like the dollar cash, is issued by the Federal Reserve and distributed to the U.S. public through commercial banks, a two-tier structure that will not subvert the current U.S. monetary system. At the same time, the digital dollar will be applied to both wholesale and retail payments. The U.S. hopes to enhance the efficiency of the financial system through wholesale transactions and improve the experience of cross-border payments and securities transaction settlement; and to promote the development of financial inclusion through retail transactions to achieve cash-like security and the convenience of peer-to-peer payments. Of course, we also see that the effectiveness of monetary policy and the intermediary function of banks may be affected by a certain degree of competition between this retail-type central bank digital currency and bank deposits. Coupled with the high proportion of cash in the U.S. money supply, retail-type digital dollars will face certain systemic financial risks.

Prospects

According to the latest findings from the Bank for International Settlements in January 2021, 86% of central banks worldwide are actively researching the potential of central bank digital currencies, 60% are experimenting with the technology, and 14% are deploying pilot projects. With such intense competition for central bank digital currencies, it is expected that the U.S. will inevitably continue to increase its research and development efforts to compete for leadership and market advantage in digital financial innovation.

Since entering 2021, the Biden administration has shown a more positive and open attitude toward U.S. central bank digital currencies. In an interview with the New York Times, U.S. Treasury Secretary Yellen made it clear that it makes sense for the Federal Reserve to study digital dollars, and that the digital dollars issued by the Federal Reserve could lead to “faster, safer and cheaper ways to pay. However, the U.S. government also has concerns about digital dollars, such as how regulators will manage money laundering and illegal financing, and how digital dollars will affect the operations of the Federal Reserve and banks. In March 2021, Powell appeared at a BIS video conference titled “Global Central Banking Innovation in the Digital Age” and reiterated the Fed’s position that it is “slow” to move forward with digital currencies, stating that the Fed has an obligation to The Fed is obliged to be at the forefront of understanding the technical challenges, to figure out the costs and benefits of advancing the digital dollar, and that the Fed is “not in a hurry to move forward with this project”. It is clear that Powell has maintained his view that a central bank digital currency is “more important” to the United States than the first.

Currently, the development and testing of central bank digital currencies has become an important area of international monetary competition, especially for large countries, and many countries around the world hope to improve their competitiveness in the international monetary system by issuing central bank digital currencies as early as possible. Historically, technological progress played an important role in the process of replacing the British pound with the U.S. dollar, and the U.S. dollar gained a competitive advantage in currency with technological progress to achieve currency substitution. In the face of the new wave of global central bank digital currency competition, the U.S. will more actively promote the research and development of digital dollar in the future to ensure the leading position of the U.S. dollar in the international monetary system. In terms of the specific realization path, the focus should be on the possible progress of the U.S. government’s realization of the central bank digital currency function with the help of private enterprise stablecoins. Stablecoin has a super large-scale user base and strong funding sources, a broad application scenario and rich payment channels, and has the technical foundation to transform to a central bank digital currency. Of course, judging from the statements of U.S. government officials, the U.S. will not be in a hurry to officially land the digital dollar. Overall, given the importance of the U.S. dollar and its dominant position in the existing international monetary system, it is expected that the U.S. will take a positive but cautious approach to the development of a central bank digital currency, balancing the potential benefits and potential risks of a central bank digital currency, and both actively promoting and focusing on improving digital currency regulation and legislation. We should pay close attention to the new trends and features of global central bank digital currencies, including the U.S., and track and study and actively respond to the possible spillover effects.

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