With technology platforms introducing digital private money into the US payments system, and foreign authorities exploring the potential for central bank digital currencies (CBDCs) in cross-border payments, the Federal Reserve is stepping up its research and public engagement on CBDCs. An important early step on public engagement is a plan to publish a discussion paper this summer to lay out the Federal Reserve Board’s current thinking on digital payments, with a particular focus on the benefits and risks associated with CBDC in the US context.
Four developments are sharpening the focus on CBDCs: the growing role of digital private money, the migration to digital payments, plans for the use of foreign CBDCs in cross-border payments, and concerns about financial exclusion.
Some technology platforms are developing stablecoins for use in payments networks. A stablecoin is a type of digital asset whose value is tied in some way to traditional stores of value, such as government-issued, or fiat, currencies or gold. Stablecoins vary widely in the assets they are linked to, the ability of users to redeem the stablecoin claims for the reference assets, whether they allow unhosted wallets, and the extent to which a central issuer is liable for making good on redemption rights.
Unlike central bank fiat currencies, stablecoins do not have legal tender status. Depending on underlying arrangements, some may expose consumers and businesses to risk. If widely adopted, stablecoins could serve as the basis of an alternative payments system oriented around new private forms of money. Given the network externalities associated with achieving scale in payments, there is a risk that the widespread use of private monies for consumer payments could fragment parts of the US payment system in ways that impose burdens and raise costs for households and businesses.
A predominance of private monies may introduce consumer protection and financial stability risks because of their potential volatility and the risk of run-like behavior. Indeed, the period in the nineteenth century when there was active competition among issuers of private paper banknotes in the United States is now notorious for inefficiency, fraud, and instability in the payments system. It led to the need for a uniform form of money backed by the national government.
Multidisciplinary teams at the Federal Reserve are investigating the technological and policy issues associated with digital innovations in payments, clearing, and settlement, including the benefits and risks associated with a potential U.S. CBDC. For example, the TechLab group at the Federal Reserve Board is performing hands-on research and experimentation on potential future states of money, payments, and digital currencies.
A second group, the Digital Innovations Policy program, is considering a broad range of policy issues associated with the rise of digital payments, including the potential benefits and risks associated with CBDC. To deepen the research on the technological design of a CBDC, the Federal Reserve Bank of Boston is partnering with Massachusetts Institute of Technology’s (MIT) Digital Currency Initiative on Project Hamilton to build and test a hypothetical digital currency platform using leading edge technology design options.
This work aims to research the feasibility of the core processing of a CBDC, while remaining agnostic about a range of policy decisions. MIT and the Boston Fed plan to release a white paper next quarter that will document the ability to meet goals on throughput of geographically dispersed transactions with core processing and create an open source license for the code. Subsequent work will explore how addressing additional requirements, including resiliency, privacy, and anti-money-laundering features, will impact core processing performance and design.
Research and experimentation are also occurring at supervised banking institutions to explore new technology to enhance their own operations and in response to demands from their clients for services such as custody of digital assets. While distributed ledger technology may have the potential to improve efficiencies, increase competition, and lower costs, digital assets pose heightened risks such as those related to Bank Secrecy Act/anti-money laundering, cybersecurity, price volatility, privacy, and consumer compliance.
The Federal Reserve isactively monitoring developments in this area, engaging with the industry and other regulators, and working to identify any regulatory, supervisory, and oversight framework gaps. Given that decisions at one banking agency can have implications for the other agencies, it is important that regulators work together to develop common approaches to ensure that banks are appropriately identifying, monitoring, and managing risks associated with digital assets.