The Fed has opted for a digital dollar. It could get the ball rolling.

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The Federal Reserve has requested public comment on a digital currency.

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The Federal Reserve issued one highly anticipated paper on a digital dollar to take a step in a process that could lead to congressional action.

The paper, which lays out the pros and cons of a central bank digital currency, does not appear to take sides in the debate about launching one. It discusses the benefits of a CBDC, but also notes that it could pose a threat to banks and new forms of money like stablecoins (tokens designed to hold a fixed value of $1).

However, by setting the stage for a debate, including a request for public comment, the Fed could get the ball rolling in Washington. The Fed said it needs congressional authority to act, which could help spur legislation that would authorize the Fed to begin drafting.

The Biden administration also wants at least a debate to get going. “The Treasury Department welcomes the Federal Reserve paper, which represents an important step forward in the public debate on central bank digital currencies,” a spokesman said Barrons.

From the Fed’s perspective, a CBDC would be a significant digital upgrade of existing formats of the currency. “The introduction of a CBDC would represent an extremely significant innovation in American money,” the Fed said in the paper, adding that it is now “considering how a CBDC might fit into the US money and payments landscape.”

A CBDC would be a liability of the central bank, not a commercial bank, like a deposit in a savings or checking account. It would be widely available to the general public, although it would not displace cash.

People could use it for digital payments, for example, or as a check replacement. And as a central bank liability, a CBDC would be “the most secure digital asset available… with no associated credit or liquidity risk.”

Among the benefits, the Fed says, a CBDC could reduce transaction settlement times. It could lower transaction fees, especially for international money transfers or wire transfers, which now cost more than 5% of the amount sent.

It could also open up banking services to millions of unbanked Americans who now depend on costly check cashing services or payday loans.

Another benefit, the Fed says, is that a CBDC could help keep the US dollar competitive in international trade. This is especially critical now that other countries are digitizing their currencies. China has pushed a digital yuan, and many other countries have CBDC programs in development.

The Fed also sees commercial banks and non-bank financial firms acting as intermediaries. They would issue and manage the digital wallets that people would use for payments and deposits.

“An intermediary model would facilitate the use of the private sector’s existing privacy and identity management frameworks; harnessing the innovative capacity of the private sector; and reduce the prospects of destabilizing disruptions to the well-functioning US financial system,” the Fed said.

Still, there is no denying the competition that a CBDC could pose for both banks and new financial networks built around stablecoins. Banks could lose deposits to the central bank if it paid competitive deposit rates; The Fed says its CBDC could be interest-free to address these concerns. The Fed could also cap the amount of CBDC an end-user can hold so banks wouldn’t see a big impact on their deposit base.

Keeping banks informed could also address privacy and cybersecurity concerns. Users’ financial transactions and data may be held by banks or other financial firms “to address privacy concerns through the use of existing tools,” the Fed said.

Also controversial is how a CBDC would affect monetary policy. One implication is that it could change the supply of reserves in the banking system, which could affect the interest rate on federal funds, for example. It could also increase the Fed’s balance sheet. Foreign demand for a CBDC would also need to be addressed – and likely limited. The potential for bank deposits to flee to the Fed in a financial panic scenario is an additional concern.

Complexity is a key reason why the US has fallen behind other countries in the new digital currency race. A CBDC also has both supporters and enemies in Congress, although it doesn’t exactly fall within the party line. It will surely be the center of heavy lobbying by the banking industry and crypto advocates on the one hand and consumer advocates on the other.

“The Fed has finally stepped off the sidelines in an important debate that virtually every major central bank is now facing to some extent,” said Eswar Prasad, an economist at Cornell University and author of the book The future of money: How the digital revolution is changing currencies and finance.

The paper, he added, “strikes an agnostic tone” and does a good job of defining the contours of the debate. The Fed is also addressing the fact that other countries are advancing faster with digital currencies, increasing the pressure on the US to adapt to the new era.

Write to Daren Fonda at [email protected]