In January 2022, the Fed issued their CBDC report titled: “Money and Payments: The U.S. Dollar in the Age of Digital Transformation”. This report provides a transparent public dialogue about issuance of a USD retail Central Bank Digital Currency (CBDC) and some potential benefits and risks.
Central banks all over the world continue researching CBDCs, including the Bank of England, Bank of Italy, Banque de France, the Bank of Japan, People’s Bank of China, as well as a group of central banks through the Bank for International Settlements. They have all published similar discussion papers seeking to broaden the consideration around new forms of private digital currency and responding with the development of wholesale and retail CBDCs.
In the United States, discussions of a dollar-based retail CBDC have been underway for some time. The Federal Reserve Bank of San Francisco released a report in 2019 “Diary of Consumer Choice” and in 2020, the Federal Reserve Bank of Boston announced its collaboration with MIT to explore the CBDC design space and gain a hands-on understanding of the technical challenges of building a CBDC. After the Federal Reserve’s April 2021 policy meeting, Federal Reserve Chairman Jerome Powell cautioned that it is “far more important to get it (CBDC) right than it is to do it fast or feel that we need to rush to reach conclusions because other countries are moving ahead.”
What is a Retail CBDC?
A retail CBDC is defined as a central bank liability that is widely available to the general banked public. While a retail CBDC issued and backed by the Federal Reserve would be considered a form of legal tender, it would require legislative action to make that a reality. The Report notes that Congress would need update of the Coinage Act of 1965 in order for such retail CBDC to be considered an official form of legal tender of the United States. For reference, the last time the Coinage Act was updated by Congress going back to the first Coinage Act enacted by Congress in 1792.
Benefits and Risks of Issuing a Retail CBDC
There are a large and diverse number of motivations driving central banks’ interest in CBDCs, which also may vary significantly between advanced and emerging markets economies. Central banks believe that a retail CBDC has the potential to increase the safety and efficiency of retail payment systems, may be used as a complement to physical cash for retail transactions, may lead to cheaper and faster cross-border remittances and allow quick execution of government-to-person payments i.e. Covid-19 associated fiscal stimulus, as an alternative to slow credit transfers and costly cheques.
The popularization of retail CBDCs in part has been in response to the growing interest in privately-issued stablecoins (cryptographic tokens pegged to the value of a fiat currency), which have been increasing in use over the past few years since their introduction in 2014.
Federal Reserve Chair Jerome H. Powell outlines the Fed’s response to technological advances driving rapid change in the global payments landscape. As the Federal Reserve explores the potential benefits and risks of CBDCs, the key focus is on whether and how a CBDC could improve on an already safe, effective, dynamic, and efficient U.S. domestic payments system in its ability to serve the needs of households and businesses.
Federal Reserve Board Lael Brainard regarding the focus on CBDCs stated “It is essential that policymakers, including the Federal Reserve, plan for the future of the payment system and consider the full range of possible options to bring forward the potential benefits of new technologies, while safeguarding stability,” Brainard said in remarks prepared for delivery to the U.S. Monetary Policy Forum in New York “A U.S. CBDC may be one potential way to ensure that people around the world who use the dollar can continue to rely on the strength and safety of U.S. currency to transact and conduct business in the digital financial system.”
However, retail CBDCs may also pose risks and certainly would raise a variety of important policy questions, including how it might affect the financial-sector market structure (e.g., commercial bank runs), the cost and availability of credit, the safety and stability of the financial system, and the efficacy of monetary policy.
Retail CBDC Design Options and Challenges
There are several architectural design options that exist for retail CBDCs:
- Direct CBDC (dCBDC) Architecture
- Indirect CBDC (iCBDC) Architecture
- Hybrid CBDC (hCBDC) Architecture
- Synthetic CBDC (sCBDC) Architecture
In addition, there are several retail CBDC delivery methods:
- Account-based Model
- Tokenized-based Model (non-distributed ledger cryptography as used in chip cards)
- Value-based Model
There are many challenges that come with introducing a retail CBDC which include, but not limited to:
- Interoperability between countries with different CBDC architectural designs.
- Privacy concerns of retail CBDC accounts held by the central bank.
- Security concerns of building infrastructure for a retail CBDC.
- How cybercriminals might be able to take advantage of a retail CBDC through user attacks.
- How credentials will be restored for users who lose their credentials or have them stolen.
Different Approaches Towards Implementing a Retail CBDC
Each central bank is approaching the design of a retail CBDC differently, particularly as they contemplate how such CBDC could be structured to achieve certain national policy objectives; however, key questions will remain around the interoperability among varying national CBDC architectures, particularly when it comes to effecting cross border transactions.
The landscape of retail CBDCs announcements from countries around the globe providing hints of testing or research seems to be occurring on a weekly basis. But to date, no country has introduced what any other country considers to be the “ultimate solution.” The Bank of International Settlement in an April 2022 publication, surveyed central banks from 26 Emerging Markets Economies. Only some have progressed to the pilot or proof-of-concept stage (e.g. Hong Kong SAR, Saudi Arabia, Thailand, the UAE), few are close to launching (e.g. China’s eCNY), while some do not see a pressing need for a CBDC in the near future (eg Poland, Singapore).
The Federal Reserve could consider using a token-based CBDC for interbank settlement along with Fedwire, CHIPS of other RTGS systems currently used by the Federal Reserve for central bank and interbank account-based settlement. So, based on the urging of Congress and the broad public interest in a retail USD CBDC, the U.S. Federal Reserve is asking for public comments, which will be accepted for 120 days and can be submitted here.