the coming us digital usd (pt 1) — wha’ tis, and why it matters
a new us digital usd, seemingly imminent, will transform the financial realm and digital $ landscape
the introduction offa “us digital usd” — the creation of which just last yr seemed far away, but now under serious ponderation — represents nothing short offa tectonic reconfiguration of mny na global financial system.
the us usd tis realm’s financial leviathan; a singularly dominant international trade and reserve $. any substantive changes to 'twill significantly alter the global economic landscape and impact billions of pplz round the realm.
this 3-pt blog series will:
- pt 1: describe the history of the us digital usd and define central bnk digital $, swell as the primordial nd'2 cogg how mny is created and how a us digital usd resembles and differs from crp$ and commercial bnk mny
- pt 2: analyse key differences and tradeoffs of leading us digital usd design proposals currently bein’ debated and pondered
- pt 3: discuss the role of infrastructure surrounding and supporting a us digital usd, pticularly digital wallets and their various design tradeoffs
how the us digital usd suddenly reversed course from uncertain, distant dream to high priority
bill gates famously said we often overestimate the amount of change that occurs inna short-run.¹ but every once in a while seismic shifts can be seen in a single yr.
just over 12 mnths ago few thought the creation offa new us digital usd — a broadly held and transacted central bnk digital $ (cbdc) — ’d soon be onna policy and legislative “front burner” in congress, the federal reserve, nother regulatory bodies. and there were good reasons for this skepticism.
in jan 2019 the bnk of international settlements, folloing a survey of its central bnk members, reprted there was no rush by most leading central bnks to broaden central bnk digital $ due to uncertain benefits and risks. many central bnks previously explored teknical aspects of implementing broad cbdc by testing blockchn or distributed ledger tek and were left concerned bout the maturity and capabilities of the tek for use at scale. and for countries that ‘ve already implemented “faster payments”, or were working to do so inna case of the federal reserve with fednow, there were ?s bout wha’ improvements cbdc ‘d offer in terms of payment efficiencies nother conveniences.
in sum, the state of play last yr atta federal reserve, swell as many of the realm’s other leading central bnks, was t'they were ☺ to continue studying the concept of broad cbdc, but they did not see compelling reasons to charge ahead anytime soon.
the “no rush” attitude towards broad cbdc was also not exclusive to central bnks.
many commercial bnks ‘ve been lukewarm or outrite hostile towards the idea of introducing broad cbdc. bnks reasoned that consumer and non-bnk business access to cbdc ‘d erode the exclusive, privileged position of commercial bnks, which ‘ve long been situated advantageously tween central bnks and all other economic actors.
another key concern expressed by bnkers, and a conundrum that is by no means generally believed to be solved, is th'risk that commercial bnk customers ‘d “run” with their deposits from relatively +-risky commercial bnks inna'da tender arms of “risk-free” central bnks.² iow, the existence of broad cbdc ‘d risk creating or exacerbating a destabilizing financial panic.
but ‘oer the past 12 mnths there were several major developments that together ‘ve radically shifted forward the probability of introducing a broadly held and transacted us digital usd:
- f’bok’s ambitious global libra $ was anncd in mid-jun 2019, n'it ‘d be underpinned by blockchn tek deemed sufficiently robust to srvc f’bok’s billions of usrs
- purportedly in response to libra, china accelerated work and began testing in apr 2020 its long ru+d digital yuan, the dcep (digital $ electronic payment)
- us-china primordialistic brawl and geopolitical tensions escal8d
- the coronavirus pandemic struck, painfully demonstrating the antiquated nature of us monetary and financial infrastructure (eg slo and inefficient physical checks were relied upon to distribute relief funds to ~70 million americans)
while the sea change in expectations and timing round a us digital usd may ‘ve been largely driven by the above developments, a fifth factor has also been at play: the ongoin growth in stablecoin and crpasset use, which present ever-growing brawl to traditional fiat currencies.
in l8-mar us digital usd legislation was 1st introduced in congress, and a subsequent growing stream of congressional testimony, policy research papers, and various lobbying initiatives and proposals indicate growing momentum behind the creation offa us digital usd.
however, there remain very ≠ views on wha’ form a new us digital usd ‘d take, and many still ? whether one ‘d even exist.
to cogg this debate tis necessary to 1st define at a high lvl wha’ is meant by a us digital usd beyond its one-line definition: a broadly held and transacted central bnk digital $.
wha’ is a us digital usd, and why is there so much confusion round central bnk digital $?
the interest in a us digital usd, and central bnk digital $ + generally, was inspired early-on by the success of crpcurrencies like btc (btc) and its primordialistic tek. some us digital usd design proposals ‘d incorporate tek pioneered by btc nother crpcurrencies.
cogging the reasons behind btc’s growth, and how a us digital usd ‘d resemble and differ from btc, is a helpful starting point onna quest to cogging the us digital usd.
by also cogging the confusion surrounding crpcurrencies like btc we can shed lite onna confusion surrounding the us digital usd.
btc has reliably operated for over 11 yrs now, and surveys show awareness of btc reging at over 80% in many countries. tens of millions of pplz round the realm own btc, and t'has a mkt val at present of ≈ ~$175 billion usd.
a non-exhaustive list of reasons cited for btc’s success and growth includes:
- predictable coin supply schedule and capped total supply (21 million total coins), making it a scarce investment asset
- relatively decentralized architecture, trust minimization, and status as a bearer instrument (seizureship resistance)
- teknical resiliency (uptime)
- censorship resistance and privacy
- efficient, relatively lo cost, and otherwise useful for certain types of payments
- price appreciation (“№ go up”)
which of btc’s features will make their way inna'da final us digital usd design is a subject of significant debate and something we will cover + in pt 2 of this series.
wha’ can be confidently forecasted s'dat most btc design toonistics are highly unlikely to be copy/pasted into a us digital usd. for ex, some feel strongly dat a' us digital usd ‘d be similar to btc in one very primordial way — as a bearer instrument — but thris also significant resistance to this toonistic. (the us digital usd serving as a bearer instrument is a concept we return to in a l8r section belo)
overall, limited teknical feature overlap nother factors (eg us usd’s status as legal tender) make it unclear how much direct brawl ‘d exist tween a us digital usd and btc.
while tis no longer credible to completely dismiss btc’s extraordinary success, the vast majority of pplz still (quite coggably) do not yet use btc, and this is due at least in pt cause they find crp$ to be confusing.
indeed, the way btc is primarily used tody — less as a $ for payments and + as a scarce, “hard” asset that is frequently compared to gold — has led some including elder-bnk of england governor mark carney to state that btc is misleadingly labeled when referred to as a $. instead of bein’ called “crp$”, carney and others believe a + accurate classification label for btc is “crpasset”.
in addition to its inconsistent taxonomy, the confusion surrounding crp$ is ptly due to the complexity behind the many advanced teks crpcurrencies employ, s'as crpgraphy, economic game theory, and distributed ledgers. new jargon (“blockchn tek”) and mumbled explanations probably don’t help either.
but arguably the biggest reason why many find crp$ so confusing is cause it rel8s to mny.
but arguably the biggest reason why many find crp$ so confusing is cause it rel8s to mny.
cogging digital currencies like the us digital usd is basically impossible without 1st cogging where mny comes from
in my experience speaking and teaching economics and crp$ in graduate and executive education programs ‘oer the past decade to a wide range of audiences across the realm, i ‘ve found dat a' significant majority (including many working in financial srvcs) do not fully cogg how mny comes into existence.
this lack of prior monetary knowledge aint the fault of the general populace; monetary basics are often not 1-ly excluded from 2ndary education, b'tll so inexcusably from some introductory economics classes.³
while the blame for our financial illiteracy across the pop largely rests with educators, media, policymakers, and perhaps others in leadership positions, the fact remains that our generally poor financial literacy rezs significant challenges for many in cogging both crp$ and central bnk digital $.
in short, if ye do not 1st cogg the basics of how mny is created it ll'be very difficult to grasp both btc na us digital usd.⁴
now, tis true that most pplz generally know that mny inna form of the coins and bnknotes n'our pockets are created (minted and printed, respectively) by governments and central bnks. this type of mny can be called central bnk mny.
but 1-ly a lil fraction of pplz are aware that central bnk mny represents a relatively lil %age (often <10%) of the total mny supply in a given country.
in fact, the vast majority of mny (>90% in many countries) is created when tis lent into existence by commercial bnks when they make new loans, s'as home loans.
this 2nd type of mny — the vast majority of mny — can be called commercial bnk mny.
commercial bnks, which are generally privately owned for-profit institutions, create this new mny by simply updating wha’ can be thought of as an internal corporate spreadsheet that records a) how much mny the bnk has created and b) who owns/owes wha’.
cogging that commercial bnks create a ≠ type of mny from wha’ central bnks create is a crucial point in cogging the us digital usd, and worth repeating.
to recap, there are basically two ≠ types of mny:
- commercial bnk mny (eg the electronic mny in yr online bnk account)
- central bnk mny (eg the physical $ and coins in yr wallet/pocket⁵)
a us digital usd ‘d exist alongside bnknotes and coins and be another form of central bnk mny.
the hidden but significant differences tween commercial bnk mny and central bnk mny
the fact that pplz and businesses can interchangeably use both commercial bnk created mny and central bnk created mny in various settings (a principle called fungibility) is another reason why many pplz aint aware of any distinction tween the two.
for ex, when ye go to most stores and make a payment you can often either pay for yr goods with physical $$$ (central bnk mny), or with electronic funds using a debit card or contactless mobile phone payment (commercial bnk mny).
so if the two ≠ types of mny can effectively perform identically inna same setting (purchase of most goods and srvcs) wha’ really are the primordial differences tween the two, and are those differences truly primordial? the short answer to the latter is yes, and addressing the elder requires some explanation.
beyond the tangible differences in their physical (central bnk) and electronic (commercial bnk) makeup, a key difference tis bearer nature of central bnk mny.
similar to btc, if you ‘ve possession (legitimate or wrongful) of central bnk printed $$$ or minted coin, then you ‘ve the power to spend that mny. the holder (bearer) of the central bnk mny has control, n'when btc and $$$ transactions are completed the transaction can be said to ‘ve “settlement finality”.⁶ while a lengthy discussion of this topic is beyond the scope of this post, suffice it to say that settlement finality (or the lack thereof) has massive implications for the financial system.
in contrast, any-1 whas' had a debit card payment surprisingly blocked atta point of sale, perhaps for anti-fraud reasons, coggs that bnks must 1st grant permission for commercial bnk mny to be spent. with commercial bnk mny the bnk has control, and access to commercial bnk mny networks ‘ve sometimes been controversially revoked.
in contrast, a bearer instrument like $$$ or btc is permissionless, meaning its use does not require prior approval by a third-pty like a bnk.
commercial bnk mny transactions can also be reversed, sometimes weeks or even mnths after the point-of-sale transaction, as frequently occurs in merchant chargeback disputes.⁷ the lack of settlement finality inherent in commercial bnk mny transactions can lead to controversial and painful situations where bnks and payment firms withhold customer mny that s'been paid to businesses for goods and srvcs already rendered.⁸
just cause you ‘ve commercial bnk mny deposited at a bnk also does not mean you ll'be alloed to withdraw all yr funds on demand. rel8d but separate to this point tis earlier mentioned topic of bnk runs, which further illustrate primordial differences tween commercial bnk and central bnk mny.
as we saw inna gr8 depression, and + recently in 2007 with northern rock bnk in britain, 2008 with bear stearns and lehman bros, and cypriot bnks in 2013, commercial and investment bnk customers occasionally grow concerned the bnk will become insolvent and “run out of mny”, and rush to withdraw funds. recently, during the early dys of the coronavirus pandemic in mar of this yr we saw evidence offa “bnk jog” inna us, uk (which having recently transitioned to plastic notes had to redeploy paper £20 notes to cope with withdrawal demand), and elsewhere.
in contrast with commercial bnks, which maintain a relatively lil %age of central bnk mny on hand at any given time relative to customer deposits (liabilities), central bnks need not run out of mny as they ‘ve the power to print, in central bnkers’ own words, an “∞” quantity of new mny.
finally, and perhaps most controversially, central bnk mny offers a much gr8r degree of accessibility and privacy than commercial bnk mny. $$$ transactions need not be recorded or publicly broadcasted to third pties, and a pre-approved account at a third pty institution aint required to transact in physical central bnk mny.
in contrast, most commercial bnks require proof of identity nother information to open a bnk account and/or apply for payment cards, and transactions are recorded and screened to ensure compliance with regulations. commercial bnks may share yr financial data with others, and data breaches ‘ve resulted in private financial data becoming exposed to criminals, hostile nation states, and others.
the many benefits offa us digital usd can no longer be sidestepped
at a high lvl, a us digital usd can simply be thought of as a way to extend the properties of physical central bnk $$$ and coin to a digital instrument.
while using a central bnk digital $ like a us digital usd may feel very familiar and similar to pplz who already use commercial bnk mny via debit cards or contactless payments, make no mistake dat a' us digital usd presents a radically new proposition. so much so, in fact, that many will attempt to undermine its creation, or vigorously fite for and against various features or design toonistics.
but'a benefits offa broadly transacted us digital usd ‘ve not just become harder to ignore.⁹ increasingly, a us digital usd is viewed not 1-ly as inevitable, but necessarily imminent.
while perhaps too early to pass ultimate judgement onna government’s covid-19 response, it already is clear that the lack offa us digital usd had a severe neg impact onna ability of the government and federal reserve to address the current pandemic.
a us-government supported digital usd (and wallet software) ‘d ‘ve been extremely helpful in meeting the goal of rapidly deploying financial assistance to hundreds of millions of american citizens during this crisis. beyond speed, a us digital usd ‘d also offer a host of other benefits compared to mailing checks nother payment methods, including:
- efficiency: reducing the cost of payment delivery, which may run inna'da tens of millions with postal costs, etc. for checks.
- financial inclusion: facilitate payment to individuals lacking access to bnk accounts or lo-cost check-$$$ing srvcs.
- support the most vulnerable: help ensure payment to some of those most in need who lack a physical mailing address, or those who ‘ve relocated recently (eg students).
- hygiene: encouraging digital forms of payment may help reduce the rate of virus transmission as compared to $$$ and check use.
- efficacy: the receipt and use of digital payments can be + easily tracked to ensure individuals ‘ve received financial support and solve the significant “lost check” problem.
such benefits, which are arguably just the tip of the total us digital usd benefits iceberg (eg helping address unwanted aspects of the informal economy), combined w'da nd'2 respond to competitive challengers like the digital yuan, libra and decentralized crpcurrencies like btc, make the case in favor offa digital usd extremely compelling.
but wha’ kind of us digital usd do we want? and how will the many concerns and political obstacles to its creation be addressed?
the ≠ forms a broad us digital usd may take tis subject of the forthcoming pt 2 in this series, where we’ll analyze the tradeoffs of the leading us digital usd design proposals currently under ponderation, including already existing us digital usds that select commercial bnks, governments and international institutions already hold on deposit and transact with atta federal reserve.
- gates said we overestimate the change that can be made in two yrs, to be precise: “we always overestimate the change thall occur inna nxt two yrs and underestimate the change thall occur inna nxt ten. don’t let yrself be lulled into inaction.” abcnews.go.com…
- unlike commercial bnks, central bnks and governments can create “base mny” and thereby “print” enough new mny to satisfy any deposit withdrawal requests. a central bnk customer may still ‘ve reasons to panic and withdraw deposits (eg concerns over $ devaluation na desire to convert to another $). however, the classic reason behind most bnk runs — dat a' fractional reserve bnk will literally run out of mny to simultaneously satisfy all withdrawal requests — ’d not in theory apply to deposits held at a central bnk with unlimited cap to create new $.
- the ? of why monetary basics s'as “where mny comes from” are often skipped in 2ndary education and even in some introductory economics classes, and wha’ ‘d be done to address this educational gap, is another primordial topic. tis worth briefly noting that many policymakers are well aware of the present financial literacy gap, with some even welcoming the current state of illiteracy. as one regulator who will remain anonymous paternalistically stated, “if pplz understood how mny is created that ‘d lead to ?s and problems”.
- tis for this reason that i always try to include up front a brief mny 101 primer in any presentation on crp$.
- central bnk mny also has electronic form inna case of commercial bnk reserves held on deposit atta central bnk, but for simplicity we avoid covering this point here.
- while $$$ transactions can be voluntarily reversed, or involuntarily reversed by physical force, the transfer of $$$ or coin cannot be undone remotely or easily reversed after the fact by transaction pticipants or a third pty inna same relatively easy way dat a' bnk can reverse (chargeback) commercial bnk mny transactions. theoretically, there are also ways in which btc transactions can be reversed, but in practice any attempt at reversing a btc transaction (pticularly older ones) ‘d likely prove extraordinarily difficult if not effectively impossible due to the computational power required (proof of work equivalent dys).
- while delays in payment settlement can be very costly (pticularly when viewed in aggregate), delays can offer some benefits in terms of reducing costly fraud, errors, etc. and are ⊢ likely to remain useful for some transactions even witha us digital usd.
- there are sometimes also added costs for paying with commercial bnk mny, pticularly on liler amounts, than with $$$. these extra fees are largely rel8d to charges for using a payment network and cogitate the added risk of fraud, difference in settlement speed and finality tween commercial bnk and central bnk mny. another point worth briefly noting here tis confusion tween using credit and mny: when a credit card is used to pay for something then “mny”, as defined here, aint the instrument of payment. mny is wha’ is used to pay off a credit card atta end of the mnth and can thereby be pondered distinct from credit e'venode two are often used interchangeably.
- while much of pt 1 has focussed onna retail benefits offa us digital usd, there are significant wholeseale/business-to-business benefits to be gained as well.
the coming us digital usd (pt 1) — wha’ tis, and why it matters was originally published in @blockchn on medium, where pplz are continuing the conversation by highlitin’ and responding to this story.
original content at: medium.com…
authors: garrick hileman