On January 20, 2022, the US Board of Governors of the Federal Reserve (“Federal Reserve”) released its long-awaited report (“Report”) on the benefits and risks presented by a potential US central bank digital currency (“CBDC”).1 The Report reveals that the Federal Reserve is far from launching a CBDC.
Although the Report is officially neutral on the merits of a CBDC, the Federal Reserve recognizes in the Report how the issuance of a CBDC would fundamentally change the nature of the Federal Reserve’s role in the financial system, as well as the significant technical challenges involved in issuing a CBDC. Accordingly, the Federal Reserve states in the Report that it will move forward with a CBDC only if further research demonstrates that the benefits of a CBDC outweigh its risks and only with “broad public support” and “clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.”
The Report requests comments on a series of questions to help the Federal Reserve improve its understanding of the potential benefits and risks of a CBDC. The comments are due by May 20, 2022.
The Report consists primarily of an overview of: the existing forms of money; the current operation of the US payments system; and the uses, functions, benefits and risks of a CBDC. Even though money in the United States has predominantly been held in digital form (for example, in bank accounts recorded as computer entries on commercial bank ledgers), the Report points out that a US CBDC would differ from existing digital money available to the general public because a US CBDC would be a liability of the Federal Reserve, not of a commercial bank.
The Report notes some potential benefits of a CBDC, stating that a CBDC could provide a safe, digital payment option for households and businesses and may result in faster payment options between countries. As for the risks of a CBDC, the Report identifies potential risks to monetary and financial stability, as a CBDC would change the structure of the US financial system and how monetary policy and financial transactions are conducted. The Report also identifies risks to consumer privacy and disrupting the ability of the federal government to combat illicit finance. The Federal Reserve’s initial analysis in the Report suggests that a potential US CBDC, if one were created, would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable and identity-verified.
The intermediation point is particularly important because the Federal Reserve Act does not authorize direct Federal Reserve accounts for individuals. Therefore, an intermediated CBDC would need to rely on private institutions to offer accounts or digital wallets to facilitate the management of CBDC holdings and payments. This presumably would require existing or new private institutions to become fiduciaries, custodians or bailees of the customers whose CBDC they hold, akin to the trust department of a commercial bank or the services offered by money transmitters.
However, by removing deposits from the balance sheet of a commercial bank (fiduciary holdings, custodial assets and bailments are not liabilities of a financial institution), a CBDC could reduce bank lending in the US financial system. This is because commercial banks use deposit liabilities to fund loans but generally cannot do so with off-balance sheet items.2
The Report does not contain a specific policy recommendation regarding whether the United States should adopt a CBDC and requests public comment on 22 questions related to CBDC benefits, risks, policy considerations, and design. The Report states that responses will be used as part of a broader analysis by the Federal Reserve of the appropriateness of a US CBDC. However, it does not indicate the form or timeline for that analysis or for the eventual determination of whether the Federal Reserve will recommend the issuance of CBDC. Now that the Federal Reserve has finally released the Report, the question is whether other federal agencies will take additional actions to assert their jurisdictions over digital assets in the form of enforcement actions and/or regulatory guidance and potentially provide some additional clarity about regulatory expectations over the rapidly evolving digital asset market.
1 Federal Reserve, Money and Payments: The U.S. Dollar in the Age of Digital Transformation (Jan. 20, 2022), https://www.federalreserve.gov/publications/money-and-payments-discussion-paper.htm.
2 See, e.g., BPI, A Costly Misunderstanding About CBDC (Dec. 21, 2021). The Report does not explore the possibility of rehypothecating CBDC holdings, and in any event, such an arrangement may not fully replicate the liquidity transformation of deposit liability-based lending.