Bit-Bucks
March 2023
“Give me control of a nation’s money and I care not who makes it’s laws” Mayer Amschel Bauer Rothschild
Since the origin of bitcoin in 2009, cryptocurrency rose from obscurity to ubiquity seemingly overnight. As of last June there were over 12,000 different digital currencies, which peaked in market value at nearly $3 trillion, or about one third of the of the Federal Reserve’s balance sheet. While the crypto space has been wildly volatile, the prospect of tokenized money continues to garner attention, and not just to investors and speculators, but central bankers as well. Ironically, while the world was transfixed on the collapse of former crypto exchange FTX, a senior official from the New York Federal Reserve made a surprising announcement; the Fed has been developing its own digital currency (CBDC). And they aren’t alone. Central banks around the world are currently doing the same.
At first blush, a CBDC makes perfect sense. The evolution from a paper society to a digital one created immense efficiencies (immediate delivery, lower costs, labor savings, reduced environmental impact, etc.), so it stands to reason the same would hold true for banking. In fact, most financial transactions today are digital; credit/debit cards, ACH bank settlement, direct deposit, bill pay, digital wallet, etc. Furthermore, the Federal Reserve already incorporates a wholesale digital payment system for/between member institutions, as banks electronically transact with one another using reserve accounts held at the Fed, and have done so for decades.
But there’s a vast distinction between a wholesale CBDC, which we already have, and a retail CBDC. Advocates of a retail CBDC tout a litany of benefits such as increased payment efficiency, decreased criminal activity, heightened payment security, and cost reduction, to name a few. In a recent interview, Treasury Secretary Janet Yellen discussed the Administration’s social goals, particularly the role of a CBDC in serving the unbanked/underbanked, or those who do not currently have a banking relationship.
Not all experts are in favor of a CBDC, however. Concerns include the risk of hacking and cyber-attacks, potential government surveillance/reduced financial privacy, and the angst that might result from making Uncle Sam your banker. But one glaring issue with a retail CBDC is the potential disintermediation of the banking system. Currently, savers open an account with a bank or credit union and deposit their surplus savings. Borrowers, in turn, use banks for home, auto, personal, student, business, and commercial loans. Every day banks compete for business, which promotes financial innovation, better products, service/services, rates, fees, and the like. However, a retail CBDC is a radical departure from the current model. Savers would bypass banks and instead deposit funds directly with the Federal Reserve. The most likely scenario is that the Fed would pay a market rate of interest on deposits, competing with private institutions and potentially giving the central bank a competitive advantage due to the perceived safety of deposits held directly with the Federal Reserve.
Critics further allege that with the Fed controlling the purse strings, it could effectively ignore traditional underwriting standards and instead allocate capital based on social objectives, such as diversity, equity/equality of outcome, or climate change. Similar to the federal progressive tax system, those with higher incomes, assets, and credit scores could conceivably subsidize those whom the government deems has a greater need for credit. In other words, needs-based as opposed to merit-based.
Most CBDC proponents, like former Fed vice-chair Lael Brainard, perceive money as a public good which, by definition, is both non-excludable in its provision and non-rival in its consumption. Clean air and national security are two common examples. But a state-run banking system is incompatible with liberal western democracy and antithetical to economic and political freedom. According to Augustin Carstens of the Bank for International Settlements, “The key difference with the CBDC is the central bank will have absolute control—and the power to enforce it.”
In conclusion, the introduction of CBDCs has the potential to offer a range of benefits and risks. CBDCs could provide improved efficiency and security in the payments system. However, they could also lead to disintermediation of the banking system, increased cyber risk, loss of Fed independence, and politicization of monetary policy. As such, central bankers and lawmakers alike will need to carefully consider the potential benefits and risks. As always, the devil’s in the details.
Mark Lazar, MBA
Certified Financial Planner™
Pathway to Prosperity
34 Comments
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