Crypto markets have been preoccupied by Ethereum’s London upgrade and the rise to all-time highs by Cardano and Solana. But an important speech by Federal Reserve board member Chris Waller underscored a challenging road ahead for the adoption of U.S. central bank digital currency. It was a significant departure from the recent remarks of Fed Chair Jerome Powell, who said a CBDC could replace stablecoins, as well as the words of Fed Governor Lael Brainard, who argued the dominance of the dollar requires the Federal Reserve to speed up the launch of a U.S. digital currency. A forthcoming Fed research paper will outline the benefits and risks of a CBDC. But as Waller’s skepticism indicates, the Fed may take a longer time to decide.
A CBDC has advantages to the public. The Federal Reserve issues “excess reserves” that pay exclusively interest to banks holding those reserves. A CBDC provides ordinary folks direct access to hold excess reserves as a risk-less digital asset with an interest rate that is higher than regular deposits. In a ruling a year ago, the Office of the Comptroller of the Currency (OCC) — the regulator of commercial banks — allowed financial institutions to accept crypto as deposits. A CBDC could be the next step in that process because banks have widely adopted technology for digital banking.
Indeed, over 80% of global central banks are now exploring digital currencies. In the case of the People’s Bank of China, a pilot version of the digital yuan is currently being tested across the nation. The European Central Bank and Bank of England are also moving forward on research and development of CBDCs because of significant consumer behavioral payment changes away from cash. If the Fed falls behind, a digital euro, pound and even the yuan can be a major competitor for reserve currency status because investor capital flows will encounter lower barriers in a digital payment system than a system backed by financial assets like Treasury bonds.
For crypto markets, a digital dollar could be a true game-changer. The issuance of a U.S. CBDC changes the settlement, pricing, trading and liquidity of U.S. dollar-denominated securities. The USD in digital form could become a significant competitor to Bitcoin, Litecoin and Dogecoin. A dollar-based CBDC can affect international money supply and capital flows, which in turn can impact expectations for interest rates, commodities, and equities. As Waller notes, commercial banks and foreign institutions act as conduits for Fed policy and that can amplify the Fed’s actions. A CBDC (and privately issued USD-pegged stablecoins) can therefore broaden the reach of Fed policy on financial markets and the global economy.
A launch of a CBDC in the U.S. will receive Congressional scrutiny. The current infrastructure bill that is held up in Senate procedural vote is a good example of what political challenges may arise around digital currencies. The Republicans proposed a regulatory overhaul of the cryptocurrency industry, while Democrats require increased tax compliance for cryptocurrency brokers. The amendment of a “broker” that would keep software developers and transaction validators from new reporting to the Internal Revenue Service is blocked by Democratic and Republican senators, in a strong sign that crypto is a hot political item.
The Federal Reserve likely would not issue a CBDC without Congressional legislation providing oversight of the U.S. crypto industry, but there are also other factors at play. The Fed’s U.S. CBDC research paper — the release of which may be imminent — will get significant attention. Separately, the private sector-led Digital Dollar Foundation is preparing for five pilot tests to evaluate how a digital dollar could operate.
Central bank digital currencies are upon the horizon. In emerging market countries such as Cambodia, Venezuela and Ukraine, CBDCs are either already here or making an intro in the coming months. The launch of China’s digital yuan is around the corner, CBDC projects are proliferating elsewhere across the Asia Pacific, and Europe is moving forward as well. Other countries have fewer political hurdles to implement digital currencies for the future global payment system. Time may be running out for a U.S. CBDC.