Central bank digital currency (CBDC) research and development has been a high priority in China, and the United States appears to be following suit. The Federal Reserve of New York and a group of private banking firms recently launched a 12-week ‘digital dollar’ pilot project. But there are still concerns about how this could affect financial independence.
On March 9, 2022, US President Joe Biden placed “the highest urgency” on research and development efforts into a potential US central bank digital currency. Was it a move to stay relevant or competitive compared to other sectors?
Many would agree. A handful of countries, including China and Russia, have already started pilot programs. The US, UK and most of the Eurozone are still under investigation and research phase. This is evident in the CBDC tracker chart below:
There are notable differences in the development of CBDCs by region. Western countries are in danger of falling behind in this regard.
America is now taking the first steps to bridge this gap.
proof-of-concept trial
On November 15, various major investment banks partnered with the US Federal Reserve to begin work on a digital dollar. BeInCrypto reports that the NY Fed’s “Innovation Center” will engage Citigroup, Mastercard, Wells Fargo, HSBC and other major financial players to run the test.
Adding to that, the official post reads:
“The Federal Reserve Bank of New York announced that its New York Innovation Center (NYIC) will participate in a proof-of-concept project to explore the feasibility of an interoperable network of central bank wholesale digital money and commercial bank digital money. -Entity Distributed Ledger.”
The proof-of-concept will run for 12 weeks and will test various features and functions of the digital dollar.
The project is specifically being carried out to test the “technical feasibility, legal feasibility and commercial applicability” of distributed ledger technology on the Regulated Liability Network (RLN).
key aspects
The 12-week trial will focus on six key areas:
- regulatory framework: The platform will align with the existing regulatory framework and preserve the existing requirements for deposit-based payment processing, notably maintaining Know Your Customer and Anti-Money Laundering requirements.
- scope: The PoC will emulate digital money issued by regulated institutions in US dollars, although the concept may extend to multi-currency operations and regulated stable coins.
- token: The PoC will emulate 100% alternative and redeemable tokens alongside other forms of money.
- industry collaboration: The POC will involve dialogue with the broader US banking community, including community and regional banks.
- Result: Following the conclusion of the PoC, the banking group will publicize the results, which they hope will be an essential contribution to the literature on digital money.
- plans: The participants of the banking group are not committed to any future phase of work once the POC is completed.
The NYIC pilot project news from Nov. 4 followed a more recent research initiative. Dubbed Project Cedar, the first phase of the CBDC trial tested forex spot trades.
It was done to determine whether blockchain solutions could improve “the speed, cost, and accessibility of cross-border wholesale payments.”
join the race
Regions such as Russia and China have already begun to consider how CBDCs will be used in the daily lives of the average person.
China recently passed a milestone of 100 billion yuan ($13.9 billion) in digital yuan transaction volume on August 31, 2022. This is a 36.3% increase in volume since June.
This reflects the rapidly growing adoption rate of China’s digital yuan (also known as e-CNY).
According to a report by the People’s Bank of China (PBoC), citizens of select cities in China will be given access to the digital yuan wallet. China aims to expand the scope of its current digital yuan trials to some of its most populous and developed provinces by the end of the year, according to Fan Yifei, deputy governor of the People’s Bank of China.
While still in the early stages, Russia has also started laying the groundwork for its digital ruble CBDC support.
mitigate risk
Both China and Russia have motives for moving quickly on CBDC implementation in order to reduce their dependence on the United States dollar. Some Chinese state researchers also floated the idea of a pan-Asian digital currency.
The digital token will be linked to a basket of 13 currencies, including the yuan, the Japanese yen, the South Korean won and 10 ASEAN countries.
The South China Morning Post wrote,
“More than 20 years of deep economic integration in East Asia have laid a good foundation for regional currency cooperation. Conditions have gradually been created for the establishment of the Asian yuan.”
It just goes to show why other countries like the US and the UK are acting with caution and calculation. That said, there are still huge concerns and doubts about the world economy running on CBDCs.
Financial freedom, isn’t it?
CBDCs have the potential to make tracking and monitoring that much easier for governments, despite potentially destroying financial freedom as they claim. It’s no coincidence that the world’s most authoritarian regions are at the head of the pack, rushing to deploy them.
For example, the International Monetary Fund (IMF) touts CBDCs as a path to financial inclusion. But this could have some serious implications that came to light after the IMF-World Bank annual meeting in October.
Deputy Managing Director Bo Lee highlighted the various use cases CBDCs are studying and how they can improve financial inclusion through programmability.
However, his comments received severe backlash as he portrayed the opposite of financial inclusion. Those comments suggest that governments want to be able to program money to control what people can and cannot buy.
In a 2021 white paper, the World Economic Forum wrote about the potential pitfalls of trying to micromanage society through CBDCs. Some concerns include limits on the size of transactions, how much currency will be allowed to be held, and the nature of goods that a person can purchase.
Nick Anthony, a policy analyst at the Cato Institute’s Center for Monetary and Financial Options, has similar concerns. BeInCrypto reached out to him for comment on the latest CBDC development.
They said that:
“Many policymakers in Congress and agencies alike are looking at CBDCs like it’s their job to keep up with the Joneses. And it looks like the Fed’s pilot is the next step in that. But the fact is that countries like China and Nigeria Moving on to the CBDC, they should have a signal to go in the opposite direction.
cbdc implications
In an overview and the latest development, the United States Federal Reserve Board released a paper on 17 November to discuss ‘Macroeconomic Implications of CBDCs’. It analyzed the potential positives and negatives and emphasized the role of CBDCs with respect to monetary policy and remuneration.
According to this paper, a digital dollar could improve welfare by ‘reducing financial friction in deposit markets, promoting financial inclusion, and improving the transmission of monetary policy’. However, it also has some restrictions:
“CBDCs involve significant risks, including the potential for bank arbitrage and associated contraction of bank credit, as well as potential adverse effects on financial stability.
A CBDC also raises important questions about the implementation of monetary policy and the footprint of central banks in the financial system. Ultimately, the impact of a CBDC depends critically on its design features, particularly remuneration.
Nonetheless, it is not a total surprise why politicians and banks support CBDCs. This is because they will allow a peer-to-peer/government/bank-peer exchange. You may recall that Prime Minister Justin Trudeau ordered banks in Canada to freeze the accounts of his political critics.
Either way, the relationship between a government and its CBDC will raise challenging questions about what financial independence really means.
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