In Defense of a Digital Dollar

“No CBDC in Florida.” That’s what Gov. Ron DeSantis of Florida proclaimed on Monday morning as he unveiled new legislation blocking the adoption of central bank digital currency (CBDC) in his state.

DeSantis isn’t alone. Last month, Rep. Tom Emmer (R-Minn.), the Majority Whip in the U.S. House of Representatives, proposed the CBDC Anti-Surveillance State Act, aimed at blocking a U.S. CBDC. These critics have expressed a deep suspicion about the development of a CBDC. Meanwhile, 114 countries around the world are exploring CBDCs. Just last month, the Bank of England and Bank of Japan announced next stages of their CBDC development, and in doing so joined the European Central Bank in working towards a proof-of-concept to be used in pilot programs. This leaves the Federal Reserve, the world's largest central bank and the issuer of the world’s reserve currency, several steps behind its peers when it comes to the planning and deployment of its own CBDC – the digital dollar.

Ananya Kumar is the associate director at the GeoEconomics Center at the Atlantic Council. She manages the center’s work on future-of-money issues.

In fact, while some in the U.S. Congress are worried the Fed is moving too fast, most other countries are concerned the issuer of the world's reserve currency is moving too slow. Exactly a year ago, the Biden administration issued an executive order on responsible development of digital assets, and there have been some positive steps since then. Up to 15 agencies were directed to release reports on the state of play of the market, research priorities and risk mitigation. These were largely positive when it came to furthering research into the design of a CBDC. The New York Fed also decided to experiment with a wholesale, bank-to-bank CBDC prototype – “Project Cedar.” The volatility of crypto markets beginning last year, and its conflation with CBDC, along with the silence from the Fed and other agencies since has led to a loss in momentum on the issue.

Both Democrats and Republicans are having their say: DeSantis, Emmer, Rep. Jake Auchincloss (D-Mass.) and others detractors make a series of arguments against CBDCs: The first argument is on the role of the private sector. They argue CBDCs could disintermediate the private sector, especially commercial banks, and unfavorably compete against private-sector offerings such as bank deposits or stablecoins.

Second, they argue CBDCs offer no added benefit to existing technology such as Instant Payments Systems, including the yet-to-be-launched FedNow. Finally, critics rightfully bring up the issue of financial privacy and surveillance concerns. The risk of a poorly designed CBDC is that it might give a central bank unauthorized access to our bank accounts and transaction details.

Read more: JP Schnapper-Casteras - Gov. Ron DeSantis, Privacy and the Politicization of the Digital Dollar

Some of these issues can be easily answered, on the basis of our research on global CBDCs across the last two years. In the over 100 models we've examined, commercial banks – not central banks – distribute CBDCs to the general public. Interestingly, such a system encourages new commercial activity as fintech companies and commercial banks build new wallets and tools to keep users' money safe. Cryptocurrency and stablecoin providers should welcome healthy competition from CBDCs, especially since the mantra for the industry has been “optionality” – that is, creating more alternatives to traditional holdings that speak to users. Creating trusted public money that citizens can hold along with their regular bank deposits and crypto-assets should be the ultimate goal for both the private and public sector.

On the issue of instant payments networks, the U.S. is already behind many of its G-20 counterparts, and is hoping to catch up with FedNow this year. FedNow, however, does not connect individuals with CBDCs. Its audience is financial institutions, which will be able to finalize transactions faster with each other, if the program is ever fully rolled out. It will also not offer other benefits such as interoperability with other assets and technological benefits of transaction speed, cost and, most of all, transparency in money flows. Experimentation on the digital dollar should be done in tandem with the FedNow rollout and all options to improve payments should be on the table.

Finally, the issue of how to build privacy in a centralized digital currency ecosystem is a real one. Authoritarian governments can enhance surveillance capabilities and get access to protected information if the necessary guardrails are not built. This is an important design concern, and one that gets a lot of attention in policy circles and Congress. The good news is that new technological options can not only meet minimum privacy benchmarks, they can also enhance the privacy protections provided by existing infrastructure.

Read more: John Kiff, Jonas Gross – Are There Tech Solutions to the Privacy and Compliance Trade-Offs for CBDCs?

Our research at the Atlantic Council has shown that privacy-preserving designs can have another advantage. They can address critical cybersecurity needs for CBDC systems as well. Privacy concerns rank high on the list for the European Central Bank, the Bank of England, the Sveriges Riksbank, the Reserve Bank of Australia and the Bank of Japan, all of which are working on proofs of concept that address the right balance between privacy and know-your-customer/anti-money laundering (KYC/AML) requirements. The whole purpose of a pilot would be to see if these ideas work in practice. Oddly, opponents of CBDCs don't even want to find out.

There are good arguments about the risks of such centralization in digital payments, and privacy is the right concern to have. So is financial stability, monetary sovereignty and the lack of regulatory alignment on a host of consumer protection and KYC/AML standards. But these challenges can be addressed, and the best way of doing so is more experimentation and less hesitation. There is a noticeable absence in American experimentation with CBDC design, which has created a vacuum when it comes to international technical and regulatory standards. We are looking at a serious risk of greater fragmentation in international payments due to proliferation of CBDC models that cannot talk to each other. And, this vacuum in a global model for CBDC has the potential for the replication of China’s model around the world, which has been in pilot stage since 2020.

There is a political battle brewing on the issue of the digital dollar – and given the importance of financial infrastructure, it could seriously threaten the role of the dollar as the world’s currency of choice. We must not deny the reality that most of the world, including U.S. allies and competitors, is already in the game – creating their CBDC products, experimenting with each other and, consequently, creating technical and regulatory standards the U.S. will have little voice on.

Eventually, the U.S. will have to cross the hurdle of public opinion – and for that, it might behoove the executive and legislative branch to remember that trust is built with transparency. The Fed might want to take the route of the ECB, which has opened up a dialogue among itself, the private sector and civil society as it works toward piloting the digital euro later this year. Research, experimentation and regulatory clarity building towards a proof of concept that can answer our questions on the real risks and opportunities of the digital dollar is the key to U.S leadership in the future of money. Congress must ensure that any way forward allows for real experimentation and refinement while balancing the very real security and privacy concerns.