Will the dollar go digital? What you need to know

The private sector has had its hands in the world of cryptocurrencies for years, but the country’s central banks have held off—until now. While far from a certainty, here’s what you need to know about the development of a central bank digital dollar.

By Colleen Morrison

You’re not alone if you’ve never heard of a central bank digital currency. Yet over the past few years, dozens of countries have looked into creating one. And this growing wave of attention around central bank digital currency, or CBDC, has finally spread to the United States.

In August, the Federal Reserve Bank of Boston announced its partnership with the Massachusetts Institute of Technology (MIT) to conduct research that will “explore the use of existing and new technologies to build and test a hypothetical digital currency platform.” That same month, the People’s Bank of China concluded its initial pilot of its digital currency/electronic payment (DC/EP) to the tune of $162 million in digital wallet transactions. By October, the Bank for International Settlements and seven central banks, including the Federal Reserve, released a report outlining “foundational principles and core features of a [CBDC].” Each announcement gave credence to a technology that previously operated on the fringes of standard payment systems.

“Our goal is to get smarter on this technology and the unique requirements of a central bank digital currency, and the trade-offs therein, particularly if a decision is made to do so in the future.”
—Jim Cunha, Federal Reserve Bank of Boston

But what exactly is a central bank digital currency?

A form of cryptocurrency, CBDC offers a digital solution backed by a central bank, making it less volatile than a market-based digital currency like bitcoin. While CBDC can leverage distributed ledger technology such as blockchain just like bitcoin does, it doesn’t require that structure to operate. Central banks have therefore started exploring the options for a fully digital solution that complements existing payment types.

In fact, that’s the basis for the collaborative work between the Federal Reserve Bank of Boston and MIT. This multiphase research effort will include building and testing an American CBDC with a focus on speed, security, privacy and resiliency. They plan to publish their findings publicly, and the first research paper and open source license for code is anticipated by the middle of this year.

“The work we’re doing, Project Hamilton, is technical research,” says Jim Cunha, senior vice president of secure payments and fintech at the Federal Reserve Bank of Boston. “We’re trying to determine the current and emerging technologies that can handle the unique requirements of a CBDC for the U.S.” Cunha adds that there has been no decision yet to move to production or to a pilot program. “Our goal is to get smarter on this technology and the unique requirements of a central bank digital currency, and the trade-offs therein,” he says, “particularly if a decision is made to do so in the future or if we are directed to via legislative action.”

Why now?

Given that the first form of digital currency, bitcoin, has operated for more than a decade, this newfound attention on CBDC seems to have emerged with a surprising urgency. Yet, a multitude of market developments have drawn the attention of central banks on a global scale, particularly the launch of Libra, Facebook’s proposed digital currency.

When the Libra Association—a group of tech, venture capital and other entities—released its white paper in June 2019, there was a flurry of activity. In the U.S., hearings were hosted by both the Senate Banking Committee and House Financial Services Committee within days of the announcement. And as Federal Reserve chairman Jerome Powell pointed out at that time, the sheer size of Facebook’s network would raise Libra to systemically important levels.

“The Libra white paper … really caught the attention of central bankers and regulators,” says Brian Laverdure, vice president of payments and technology policy at ICBA. “Given the potential of it becoming systemically important just like that, [the Federal Reserve was] concerned about what it could mean to national currencies and the ability to affect monetary policy.”

But Libra alone didn’t light the fire under central banks to explore a digital currency. Cunha believes there are three main reasons for this increased attention. The first, he says, is China’s release of its digital currency project. The second is the adoption and release of private-sector stablecoins (cryptocurrencies that peg their market value to some external reference, such as the dollar or the price of gold), such as Libra. Finally, countries are moving toward digital currencies for policy reasons, including the reduction in physical cash usage.

Initiatives like the Digital Dollar Project have added fuel to the fire. A joint collaboration between Accenture and the Digital Dollar Foundation, this program advocates for a U.S.-backed digital currency. It launched in January 2020 with a project brief that outlines the case for and principles of a digital dollar. And since that time, the project has released a white paper detailing the benefits of CBDC and a summary of proposals for nine distinct pilots to assess CBDC’s use cases and viability.

What you need to know

CBDC has certainly attracted a lot of financial industry attention, but with investigations in their nascence, what’s the takeaway for community banks today?

First and foremost, community bankers should get up to speed on this technology and all that it offers. “Like the early days of the internet, do your homework and stay abreast of developments,” Cunha says. “It was hard to predict in the early days of the internet how it would impact banks, but it did in many ways. [With CBDC], at some point, you’ll need to understand what policy decisions were made, if there is a particular role the banking community will play and how you will integrate that into your product mix.”

In addition to forward-thinking product planning, community bankers should stay on top of regulatory developments and guidance on broader digital currency and cryptocurrency topics. For example, the Office of the Comptroller of the Currency (OCC) issued an interpretation that clarifies the ability for community banks to provide services to issuers of stablecoin. And the Department of Justice (DOJ) released its report, Cryptocurrency: An Enforcement Framework, to address the increasing prevalence and criminal activity associated with cryptocurrencies. While Laverdure wouldn’t say that digital currency has risen to a central role, it has the potential to impact monetary policy, implementation and enforcement.

“Policymakers are starting to see payments as another tool to affect policy,” Laverdure says. “With topics like financial inclusion and nationwide economic growth, they’re starting to see payments as a possible means to those ends.”

While much around CBDC remains up in the air, community bankers can hold onto one certainty: Digital currency in all of its forms is here to stay.

“This is a question of what is the next step in the evolution of money,” Laverdure says. “As the industry seeks to shape the next stage of money and payments, new ideas and technologies continue to be added to the mix. Everyone wants a piece of the pie, and the pie just keeps getting bigger.”

Central bank digital currencies around the world

The U.S. is not the only country pursuing this topic. In fact, according to counts from the International Monetary Fund, about 50 countries are in various stages of exploring publicly available retail CBDC.

  • The Central Bank of the Bahamas has launched the sand dollar, the first fully executed CBDC. It is backed in a one-to-one ratio by the Bahamian dollar, which is tied to the U.S. dollar.
  • China continues to pilot its digital currency/electronic payment (DC/EP), with reports indicating that in the initial phase, digital wallets processed 3.1 million digital yuan transactions between April and August 2020. The Shenzhen government also opened a lottery to award a total of 10 million yuan (about $1.5 million) in digital currency, with 50,000 people receiving incremental amounts.
  • Both the Ukraine and Uruguay have completed pilots of retail CBDC. The Ukraine report concluded that due to its limited, low-volume size, the pilot “did not fully uncover the [currency’s] attractiveness.” However, it did point out that if a centralized model is chosen, it should be legally regulated. Uruguay began exploring its CBDC, the e-peso, in 2017, which did not rely on distributed ledger technology but instead leveraged its own proprietary platform. Though the results of the initial six-month trial indicated traction with citizens, the central bank has announced no formal next steps.
  • Other countries are soliciting input from key stakeholders. For example, in November 2020, the European Central Bank issued a public survey on the concept of CBDC.

Colleen Morrison is a writer in Maryland.