March 20 2020 Financial Innovation Central Bank Digital Currencies Certain observers assert that private digital currencies— such as Bitcoin Ethereum and the Facebook-proposed Libra—could become widely accepted forms of payment In response some analysts suggest central banks should issue central bank digital currencies CBDCs to maintain government-issued money’s central economic role Although no major central bank has issued a CBDC to date this In Focus describes how foreign central banks and the Federal Reserve Fed are approaching the issue It also examines policy issues raised by a CBDC Background Traditional electronic payment systems enable the transfer of fiat currency i e money backed by government decree and are operated by banks and central banks that record transfers between accounts on private ledgers Although these systems generally offer fast convenient and safe payment options they involve significant costs physical infrastructure and sometimes delays In recent years privately issued digital currencies—that is money that has no physical form and is not supported by any government authority—have been developed but have not become widely adopted for payments These systems generally record transfers on public or distributed decentralized ledgers protected by blockchain technology Often individuals’ accounts are identified with a pseudonym not directly linked to users’ real identities For more information see CRS In Focus IF10824 Financial Innovation “Cryptocurrencies” by David W Perkins Proponents of private digital currencies assert they could provide more efficient payments with greater financial privacy than when payments are made with banks Skeptics however doubt that these currencies can effectively serve as money because they are not legal tender i e no legal requirements to accept them exist and their value has been very volatile among other reasons Observers also warn that these digital currencies could facilitate money laundering and other crimes expose consumers to poorly understood risks and losses and hinder the ability of central banks to implement and transmit monetary policy unresolved Design choices include whether the digital currency would be used for wholesale or retail transactions the degree of anonymity granted to users whether it would pay interest and whether the digital currency would be a digital version of the existing legal tender or a separate parallel legal tender It is also unclear whether private digital currencies’ features such as decentralized ledgers and blockchain are needed to make a CBDC succeed Instead a CBDC might be built upon existing systems though presumably that would require several years of significant IT investment Proposals vary on these design features and as a result CBDCs could range from modestly to fundamentally different from the current financial system wherein banks store value and make payments digitally from accounts held at the Fed Proposals that vary fundamentally from the current system are those that allow nonbank firms or individuals to have digital access to money directly from the Fed and in some cases open digital accounts at the Fed International CBDC Initiatives Many governments around the world are researching testing preparing to launch or have launched CBDCs In late 2019 a Bank of International Settlements BIS survey found 80% of responding central banks are engaged in research experiments or work related to the development and use of CBDCs Around 40% have progressed from conceptual research to experiments and another 10% have developed pilot projects Some have committed to introducing a CBDC—20% of central banks mostly in emerging markets indicate they are likely to launch one within the next six years Figure 1 Figure 1 Likelihood of Central Banks Issuing a CBDC Private digital currencies’ lack of centralized authority— their main appeal to many of the proponents—is often a cause of their challenges and risks Some observers suggest that central banks should issue CBDCs to realize the touted benefits of digital currencies in a way that would reduce the obstacles and risks Design Considerations A CBDC would allow holders to store value and make payments digitally and would be backed by central banks as is the case for physical currency but other features are Source BIS survey Note Likelihood of a general purpose CBDC With international variations in central bank legal structures economic fundamentals and CBDC motivations https crsreports congress gov Financial Innovation Central Bank Digital Currencies central banks are designing and experimenting with CBDCs in a number of different ways For example the People’s Bank of China has filed more than 80 patents related to its CBDC project Uruguay has successfully piloted its digital currency the e-peso Venezuela’s central bank issued a cryptocurrency backed by oil the petro and Saudi Arabia and the United Arab Emirates are planning a joint digital currency Aber Central banks of several advanced economies the UK Canada Japan the EU Sweden and Switzerland and the BIS have formed a group to share their assessments of potential CBDCs To date central banks are not following a single CBDC model Central banks are interested in CBDCs for a number of reasons including greater control of the economy stronger surveillance of financial transactions and reduced reliance on the U S dollar e g China new revenue streams e g the Marshall Islands and consumer preferences for digital payments e g Sweden According to the BIS survey financial stability and payments safety are the strongest drivers for CBDCs among advanced economies while emerging markets are also driven by the potential for greater financial inclusion and payments efficiency However some countries may have more nefarious motivations Venezuela’s government is trying to use the petro to raise money amidst U S sanctions Iran and Russia have also considered CBDCs as a way to circumvent U S sanctions Federal Reserve Views In response to congressional inquiries the Fed stated in November 2019 that it is “not currently developing a CBDC ” and has only committed to “continue to analyze the potential benefits and costs” in the future Its rationale is that “it is not yet clear what additional value a general purpose CBDC could provide in the U S ” compared to the existing payment system According to the Fed the concept “raise s important legal monetary policy payments policy financial stability supervision and operational questions” that would have to be resolved before moving forward The Fed reports that it has been actively researching the issue The Fed has highlighted legal uncertainty about whether all of the actions needed to successfully issue a CBDC could be taken under existing authority These include whether a CBDC would be legal tender whether the Fed could offer accounts or digital wallets to the public and what legal rights obligations and protections CBDC users would have Currently the Fed must charge prices that reflect its costs to provide business services and can only pay interest to banks on balances at the Fed If Congress chooses to facilitate CBDCs it might pass legislation to remove any identified legal barriers Issues for Congress In the United States unlike some other countries that are considering CBDCs the existing payment system features trusted methods for digitally delivering funds Although real-time payments i e instant settlement are not yet ubiquitous they are expected to be in a few years Whether a CBDC would achieve equivalent or better performance at less cost and thus justify the cost of developing and issuing one is uncertain A major policy consideration is the extent to which a CBDC would displace private activity If available to consumers CBDCs could partially displace private digital currencies and maintain government’s central role in issuing money—whether this is desirable depends largely on an individual’s view of those currencies In the more expansive vision for CBDCs anyone could hold CBDCs in a Fed account for at a minimum making payments or storing value This would mark a fundamental shift in the Fed’s role—the Fed does not provide retail services to the public currently—and would have the potential to displace private payment systems and banks From a typical economic perspective government provision of private goods and services is only desirable if there is a market failure or the service has the characteristics of a public good It is unclear whether the U S payment or banking systems suffer from market failures that a CBDC could address Some proponents believe a CBDC could promote financial inclusion but that would depend largely on whether the CBDC would be less expensive and easier to access than banking services under current law the Fed would have to provide the CBDC at cost However a CBDC could also harm underserved populations if it led to reduced acceptance of less costly payment options such as cash Some proponents claim that because bank runs pose systemic risk a partial shift from private bank accounts to Fed accounts would increase financial stability In contrast others assert Fed accounts could increase systemic risk by enabling bank runs by offering an alternative to bank accounts that people could switch to during times of bank distress Cyberattacks also pose systemic risk and it is unclear whether a CBDC would make the financial system more or less resilient to them A CBDC that provided complete anonymity would seemingly be incompatible with current policies designed to curb money laundering and other illicit activities Thus the Fed may be required to track and store information about CBDC users and their transactions This would reduce individuals’ privacy but might be more effective at preventing illicit activity Dealing with privacy implications and technical challenges in providing retail services would expose the Fed to reputational risk potentially bringing into question its political independence which is viewed as beneficial to monetary policy However proponents argue that a CBDC would improve the effectiveness of Fed monetary policy because it could transmit rate changes directly to consumers—including potentially negative interest rates if CBDCs displaced cash Different proposals vary on what role a CBDC would play in the financial system As different CBDCs are proposed and developed Congress may consider the various policy implications and relative costs and benefits of the Fed issuing some type of CBDC in the future Marc Labonte Specialist in Macroeconomic Policy Rebecca M Nelson Specialist in International Trade and Finance David W Perkins Specialist in Macroeconomic Policy https crsreports congress gov Financial Innovation Central Bank Digital Currencies IF11471 Disclaimer This document was prepared by the Congressional Research Service CRS CRS serves as nonpartisan shared staff to congressional committees and Members of Congress It operates solely at the behest of and under the direction of Congress Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has been provided by CRS to Members of Congress in connection with CRS’s institutional role CRS Reports as a work of the United States Government are not subject to copyright protection in the United States Any CRS Report may be reproduced and distributed in its entirety without permission from CRS However as a CRS Report may include copyrighted images or material from a third party you may need to obtain the permission of the copyright holder if you wish to copy or otherwise use copyrighted material https crsreports congress gov IF11471 · VERSION 1 · NEW