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Digital dollar

Digital dollar

The digital dollar is a proposed digital US dollar that is expected to serve as a stable alternative to other digital currencies, such as cryptocurrencies.

Overview

The digital dollar is a proposed digital US dollar that is expected to serve as a stable alternative to other digital currencies, such as cryptocurrencies. Often called Central Bank Digital Currencies (CBDCs), these digital currencies would be equivalent to paper money issued in the United States and would be different than the digital money already in use (with Harvard Business Review estimating over 97 percent of money in circulation is from online transactions).

However, most of this digital money is stored in a commercial bank ledger, or in a public ledger for cryptocurrency. Whereas a CBDC would be a liability of the central bank, which would mean it would be backed by and owned by the Federal Reserve, similar to paper money. The US Central bank released a paper looking into the possibility of adopting a CBDC on January 24, 2022, which looked to analyze the possibilities and concerns with a CBDC, with enthusiasts seeing the paper as a key milestone in the adoption of a digital dollar policy.

Advantages

A proposed benefit of a CBDC would be the ability to back the currency with the Federal Reserve, giving the currency more security. Another main benefit would be the reduction or elimination of fees, allowing users to eliminate the middlemen from transactions, allowing users to transfer money from their digital wallet directly to a cashier. Having a CBDC is expected to further pressure credit card companies and payment processors to lower fees to be competitive.

Another argument for a CBDC has been that it can open up digital transactions to those who do not have bank accounts, with more than 5 percent of US households being unbanked, according to the Federal Reserve. It would also make it easier for the federal government to distribute benefits, such as distributing relief payments directly into a digital wallet, which would be required for this system to work.

The move towards a digital dollar, or even a mirroring of the paper dollar with a digital dollar, would further allow the United States dollar to remain dominant as a reserve currency. Whereas failing to develop such a currency is considered a possible international problem, as the popularity of another digital currency, such as China's digital yuan, could be seen as more attractive for the faster transfer and settlement times for cross-border trades. The use of a digital currency could also ease monetary policy by removing intermediaries between the Fed and citizens.

Disadvantages

Perhaps the most mentioned disadvantage with a CBDC is the privacy concern, as the same relationship discussed above of bringing citizens closer to the Fed, to ease monetary policy and help the unbanked take part in the digital economy, could enable the governing authorities to monitor and manipulate transactions as they occur in the network. Further, as the federal government could use such a system to distribute relief payments, there is no reason that it could not flip that and sanction individual users financially without warning.

Many of these privacy concerns have been realized in China with the digital yuan, which has been a way for the Chinese currency to divorce itself from the reach of the US financial system and has been a way for the state to expand its surveillance reach into citizens homes. Advocates for CBDCs suggest the constitutional rights enjoyed by Americans would protect them from financial surveillance without due process, but as other surveillance issues have shown that these rights are not always respected, and in other cases ignored.

Cryptocurrency advocates have also warned that the development of a digital dollar could stifle the emerging stablecoin ecosystem, which has been proposed as a chance to potentially displace fiat currency as a transaction medium. However, some individuals, depending on their views of cryptocurrencies and stablecoins, could see that as an advantage.

Security is another major issue with the CBDC. A digital system can be hacked, and there is no physical barrier to lifting copious amounts of digital currency. This would make this currency an obvious target for hackers, especially if such a currency is centralized and closely tied with individuals, and would put users' data and finances at risk.

Federal Reserve Bank of Boston research

In collaboration with the Massachusetts Institute of Technology, the Federal Reserve Bank of Boston released research on the technological viability of a Federal Reserve-backed CBDC. The results of the research proved promising, with the research producing two separate architectures for a potential CBDC, with one code base capable of handling 1.7 million transactions per second, more than 2.5 times the number of transactions capable of being handled by Visa's network, reportedly. And the majority of these transactions were settled in less than two seconds.

This research was released a month after the report issued by the Board of Governors of the Federal Reserve. In the report, the above mentioned concerns of security and privacy were stressed, especially in regards to balancing the goal of safeguarding Americans' privacy rights and also balancing the goal with the transparency necessary to deter criminal activity. In the research conducted by the Federal Reserve Bank of Boston, this is a difficult problem to resolve, as they experimented with the CBDC technology.

Timeline

February 7, 2022
Fed designs a digital dollar that handles 1.7 million transactions per second.
February 3, 2022
The move toward the digital dollar gains steam as Boston Fed says its prototype can handle 1.7 million transactions per second.
January 20, 2022
The Fed releases a long-awaited study on a digital dollar but doesn't take a position yet on creating one.
October 4, 2021
The Fed to release a paper exploring the launch of the digital dollar.

Further Resources

Title
Author
Link
Type
Date

Analysis: A digital dollar is years away as U.S. Fed kicks issue to Congress

Web

January 24, 2022

Fed Designs Digital Dollar That Handles 1.7 Million Transactions Per Second

Jason Brett

Web

February 7, 2022

Money and Payments: The U.S. Dollar in the Age of Digital Transformation

Board of Governors of the Federal Reserve System

Web

January 2022

The U.S. Could Ban Imports of Russian Oil. What Exactly Does That Mean?

Sabrina Escobar

Web

March 7, 2022

References

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