The Fed released its long-awaited paper on Central Bank Digital Currencies last week. After reading it, I don’t get the feeling that even the authors themselves are convinced that a CBDC is the right course of action for the U.S. central bank to take — at least, not as they describe it today.
Read more: Fed White Paper Examines Creating Digital Dollar
The report comes at a time when there are many other separate but related conversations about digital payments innovations, cryptocurrencies, the innovators bringing them to market and the ecosystems they are creating and powering. There are a host of issues being discussed with respect to digital currencies specifically: the taxonomy of crypto, what problems it solves, the business models that support cryptocurrencies and whether existing regulation is enough, too much or too little.
See also: Fed’s Digital Dollar Report Finally Drops, With More Questions Than Answers
The call for comments in the report identified twenty-two questions ranging from the tactical — whether a CBDC should pay interest — to the theoretical — ways a CBDC could impact the Fed’s ability to control the monetary supply. These questions point to the sensitive interdependencies among all stakeholders that must be reconciled if the U.S. or any central bank would introduce a new digital payment tender.
Here are three that I’d like to move to the top of that list.
The U.S. economy is largely cashless today. So, what problem does a digital central bank currency solve?
Probably like many of you, I’ve had the same couple of bucks collecting dust in my physical wallet for the last two years. I just don’t use cash anymore, even in the places I once did.
Neither, apparently, do many other people living in the U.S.
The Fed paper reports that consumers used cash for only 6 percent of the value of transactions (19 percent by number, which means they used cash for small-value payments) in 2021. People have been shifting from cash to cards for many years.
More recently, mobile phones and a variety of connected devices and apps have shifted cash payments digitally, including the low-dollar transactions that were once exclusively done using cash. Peer-to-peer transactions, tipping, parking, taxi, train and bus rides were trending digital before COVID and have only accelerated since. Cash use is small and getting smaller.
Read more: Choice and Convenience: Defining Consumer Payments Today
That’s just fine with consumers who seem to like living in a mostly cashless world — it’s faster, more secure, less prone to friction — no waiting for change and then having to deal with it, no fumbling to find the right combination of bills at checkout. Businesses like cashless, too. Contrary to popular opinion, cash isn’t free to accept — there’s the cost of storing it securely, the cost of cash handling, the friction and risk of business operators running to the bank to deposit and withdraw it.
Even the small Mom and Pop businesses on Main Street USA are becoming cashless as the consumer demand for contactless and touchless forms of payment have forced those businesses to leave cash behind for more digital forms of payment: cards, cards on file or mobile wallets.
See also: Why SMBs Are Ready For A Cashless Future
From the consumer’s perspective, their “cash” is already digital and has been for a long time.
The “cash” that’s sitting in their checking account — digital. The “cash” in those accounts they use to pay their bills — digital. The digital splitting of the dinner check — just like digital cash using Zelle or Venmo. Their paychecks — digital cash. Their tax refunds from the government — digital cash. Their unemployment checks, stimulus checks, social security checks, government assistance payments — digital cash. On demand payroll — digital cash.
All deposited into the bank account of their choice and able to move digitally between accounts — me to me, me to thee, me to any business, me to the government.
Or withdraw in cash, mainly at the ATM — but that’s something consumers increasingly don’t want to do either.
Read further: How Data Will Speed The Move To Cashless Payments
So, if almost all cash is digital, what’s the need for a CBDC?
In describing the distribution of a CBDC, the Fed paper proposes an intermediated system that would involve consumers establishing accounts at an institution to receive those CBDC payments.
In practical terms, what does that mean?
Will it require that anyone getting a benefit payment from the government now set up a new account to receive those payments via the Fed’s digital dollar?
What would motivate a consumer to do that?
Are those digital dollars accepted at the places the consumers transact digitally today? Unless the CBDC account would allow consumers to spend those Fed digital dollars or pay bills with it just as they do today, those dollars would have to be transferred immediately to an existing bank account that does.
The card networks say they will work to enable CBDCs to be accepted at the merchant point of sale just as they are doing with other digital currencies. But that sounds like a lot of make-work simply to enable a CBDC that a consumer may or may not want to use as a payment tender at a merchant that already accepts the digital payments that consumers currently have, like and use.
Then there is the financial inclusion argument, which curries political favor but seems to lack factual depth.
As the Fed Paper points out, there are only 7 million unbanked people in the U.S. who, for whatever reason, do not have a bank account. Why they don’t is not well researched. Some simply don’t have any money for a bank account — that’s a social problem to be solved, but not for a CBDC.
Others have reasons not to want to leave digital breadcrumbs of themselves—a CBDC would be a risk for them.
These 7 million consumers have also shunned the many challenger banks that offer a no-frills, no-fee bank-like alternative for storing and using their money. These are the same challenger banks that say they’ve seen an influx of new accountholders eager for a digital way to receive government stimulus payments but lack bank account information on file with the Treasury.
See also: Visa: How a Global, Digital Network Can Boost Financial Inclusion
How would a CBDC and a special CBDC account pull these 7 million in?
That’s not to say that there aren’t real use cases for a CBDC. For example, banks and central banks are testing interbank settlements using CBDCs, attempting to solve the very real cross-border settlement speed, cost and transparency issues that exist today.
But finding those real problems and determining whether a CBDC is the best solution for solving them — in the face of other digital payments innovations — is the most important first step.
The payments innovations that have transformed the digital economy over the last decade have come from private industry. Can the Fed really innovate digital payments and engage in the continual innovation that consumers and businesses have come to expect of those payments?
The Fed paper begins with an overview of the payments systems that it has introduced over the last several decades: the paper check clearing system, then the ACH network for clearing and settling electronic bank-to-bank payments in the 1970s.
Cash, the heart of the CBDC debate and the payment system that the Fed does control, remains an analog payments form factor that moves between businesses, ATMs, cash processing centers and the Fed in cloth sacks transported by armored cars with armed guards.
Aside from the 2019 announcement of its plans to introduce its own real-time payments rails, FedNow, in 2023, there’s not been much else. That announcement came four years after The Clearing House and its network of banks announced it was creating its RTP® rails. The last major innovation in ACH — Same-Day ACH — debuted in 2016. But it was created and pushed by the banks, not by the Fed.
Compare that to the raft of payments innovation from within the private sector that happened in the last 15 years as the world shifted to digital and mobile. Those innovations that have moved cash to cashless in the U.S. and around the world are the result of innovators seeing the inefficiencies of analog payments and creating new digital and digital-first alternatives.
They’ve leveraged advances from the private sector — connected devices, payments networks, security, identity and fraud solutions, AI, GPS, APIs and a slew of enabling tech powering a digital transformation that has only accelerated over the last two years.
See also: Contactless Payments Continue to Drive New Waves of Innovation
The move to cashless, and the satisfaction of consumers and businesses with those digital alternatives, rests largely at the feet of private-sector innovators. These new players are continuing to improve digital payments platforms, embed digital payments into existing apps and ecosystems and innovate the customer-facing experience and back-end payments infrastructure.
This isn’t intended as a slap at the Fed, which does so many vital things to preserve the safety, soundness and integrity of our financial system. It importantly and critically controls the country’s monetary policy. It operates the real-time gross settlement system, Fedwire, that is the foundation for how our country’s financial system operates.
The Fed just hasn’t ever been regarded as operating at the forefront of digital payments innovations. Perhaps that’s not even how it’s wired to operate.
See more: Federal Reserve Pushes Digital Payments Standards to Boost Adoption
It may also not be what the payments ecosystem wants the role of the Fed to be. Highly efficient, yes. Safe and sound, absolutely. At the forefront of digital payments innovation? Maybe not so much.
The innovation that the payments and financial services ecosystem does want from the Fed has more to do with expanding access to Fedwire and providing a choice in the rails used to move money between already-established digital accounts in real time. The Fed should continue to innovate the part of the digital payments iceberg that consumers and businesses never see, the part that preserves the resilience and efficiency of how money clears and settles between those bank accounts.
In a cashless world, being connected is critical to the conduct of commerce. What is the Fed’s role in protecting digital payments from going offline?
Growing up, I can remember Mom telling me to always to have a five- or ten-dollar bill with me, “just in case.” It was sound advice when digital methods were anything but ubiquitous, and even when available, were not always reliable. Cash was accepted anywhere and everywhere, and still is.
But today, that $10 or $20 bill is now a plastic card tucked in a pocket for transactions in a physical setting, and cards on file or mobile wallets when transacting online.
Which works just great — until it doesn’t.
The AWS outage in December of 2021 was a recent reminder of the havoc that comes when people can’t go online to access their money, when merchants can’t make online sales or process payments, when streaming services can’t stream, when websites won’t load. People and businesses freaked as their literal lifeline to the digital world and digital commerce was unavailable to them for a few hours. A software glitch and overloaded networks was to blame, AWS spokespeople later said.
Read more: AWS Outage: A Warning Shot That Underscores Breadth and Pace of Digital Economy
When New England has its big Nor’easters and power is knocked out for a few hours or a day, life literally comes to a standstill. People can put on sweaters, coats and hats to keep warm and light candles and use flashlights to see, but once the laptop and mobile phone battery runs out, it’s all over until the power snaps back. Not even a plastic card tucked into a pocket will work if stores don’t have any power to operate their POS terminals.
Being connected — to the internet and to electricity — is critical in a world where digital payments rule.
Enabling offline transactions is a risk that the Fed paper also acknowledges, but one that goes beyond enabling a face-to-face transaction in a remote area that lacks internet connectivity, as central banks are testing in emerging economies where that is a real issue.
It’s what happens when the world goes offline.
Cybersecurity experts say the biggest risk to the financial and payments systems is an attack on the electric power grid — potentially putting the biggest financial institutions and payments networks at risk of a large-scale attack by bad actors. I still remember a PYMNTS Innovation Project session in 2016 in which Admiral James Stravidis outlined this risk, citing a scenario as stark and terrifying as it was believable.
The Fed has a role to play in protecting the country’s financial systems from that risk, as do all branches of government, along with the private sector. It’s an issue that goes well beyond any one digital payments method to protecting consumers and businesses from that potentially catastrophic systemic risk.
What’s Next?
As I read it, the Fed report came across as one that had to be written — it was promised in July 2021 and, by its own timeline, was already about six months late. Over the last two years, roughly 100 countries have either piloted or announced intentions to create a CBDC pilot. The world was waiting for the U.S. to take a position on the role of central banks and CBDCs, particularly as it relates to the collective central bank concern over stablecoins and how CBDCs may or may not coexist with them.
But unlike the President’s Working Group on Financial Markets report on stablecoins released in November of 2021, the Fed’s report on CBDCs doesn’t advocate for a specific course of action. Instead, it provides an overview of the pros and cons — and invites stakeholders to share their thoughts on a series of questions the Fed says will shape its thinking, provoke public debate and ultimately inform its recommendations.
In doing so, the Fed bought more time — at least a year, probably longer.
It is the right approach at the right time.
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