One of the biggest concerns our clients have is that the government will forcibly convert all their assets into a central bank digital currency (CBDC) over which the government has total control. Almost every central bank in the world, including the Federal Reserve, has expressed interest in developing a CBDC.
Moreover, critics of CBDCs seem to believe they’ll be foisted upon an unsuspecting public virtually overnight, perhaps as a substitute for cash or even for banks themselves.
We don’t think that’s how it will happen. We think their deployment will occur via incentives to use them, rather than having them forced upon anyone. The carrot, not the stick. That’s especially true in wealthy industrialized democracies like the United States.
But perhaps we’re getting a bit ahead of ourselves. So, let’s first define a CBDC. The Federal Reserve, in a research paper it published in early 2022, gives us this working definition:
…a digital liability of a central bank that is widely available to the general public. In this respect, it is analogous to a digital form of paper money.
Neither digital money nor central bank liabilities are anything new. Indeed, the vast majority of money circulating today exists only in digital form and can be created by any commercial bank in the form of a loan.
And as the Fed’s definition implies, paper money is a liability of a central bank. For instance, every denomination of cash circulating today in the United States displays the legend, “Federal Reserve Note.”
The Fed’s research paper goes on to analyze deficiencies in payment settlement systems which force millions of Americans to rely on costly financial services such as check-cashing services and payday loans. It also introduces a Fed service called FedNow, which will begin operations in July 2023. FedNow is designed to settle payments in seconds and can support transactions between consumers, merchants, and banks.
While the Fed is not representing FedNow as a CBDC, insiders believe that FedNow could “stand in place of a central-bank-issued digital currency” and that it constitutes the technological underpinning for one. This is due to how funds will flow within the system, with money being sent from a commercial bank through a Fed account to its ultimate recipient.
And here’s where things begin to get, shall we say, “interesting.”
It turns out that commercial banks have already developed products similar to FedNow. But they’ve now largely been shut down by the Fed and other regulatory agencies.
For instance, Silvergate Bank, which voluntarily shut down in early March, had a payment app called the Silvergate Exchange Network (SEN). That app permitted instant payment settlements between investors and cryptocurrency exchanges. Meanwhile, Signature Bank, another financial institution that shut down in March, offered an innovative payments system called SigNet. It relied on a “tokenized” representation of US dollars to again facilitate instant settlements anytime, day or night.
The near simultaneous shuttering of these banks in March led venture capitalist Nic Carter to conclude that the Uncle Sam deliberately orchestrated their collapse.
The evidence that Carter lays out, and the sequence of events we summarized in this article a few weeks ago, is persuasive. But it’s also possible to interpret the actions of the Fed and other regulatory agencies as simply attempting to prevent the collapse of dozens of cryptocurrencies, crypto exchanges, and associated crypto businesses, from spreading into the mainstream economy.
It’s also hard to visualize a situation in which the Fed would deliberately introduce a CBDC that is “widely available to the general public.” This is because there’s an inherent tension between the widespread adoption of CBDCs and the health of the US banking system.
The Fed came into existence in 1913, shortly after a severe recession. It was modeled on the New York Clearinghouse; a facility that banks used to settle debts with one another. But the Clearinghouse was clearly inadequate to deal with what came to be known as the “Panic of 1907.” At its heart, the Fed is a national payments system, and its primary responsibility is to ensure the stability of that system.
However, as the Fed’s research paper observes:
A CBDC would not require mechanisms like deposit insurance to maintain public confidence, nor would a CBDC depend on backing by an underlying asset pool to maintain its value. A CBDC would be the safest digital asset available to the general public, with no associated credit or liquidity risk.
The Fed doesn’t come out and say it, but a CBDC that’s widely held by the general public would be the death knell for banks. In a severe enough financial crisis, no bank could possibly compete with the Fed. And the Fed clearly knows it.
And while we don’t discount the concerns that CBDCs could be abused by Uncle Sam and other governments, it’s also possible to imagine a world where CBDCs actually enhance financial privacy.
As the Fed observes:
Private enterprises typically seek to profit from the personal data they can collect when people make digital payments, which can discourage their use in the first place – an inefficient outcome. A CBDC could be designed to provide users with more control over their data, for example, over whether they choose to share personal data with third parties to receive more personalized services.
And this is one more reason why we believe we’ll see more carrots and fewer sticks as the Fed explores the possibility of introducing a true CBDC.
At least at the outset, a Fed-sponsored CBDC will be introduced on a relatively small scale to avoid depleting American banks of capital. And it could be “marketed” as being more private than other types of digital payments.
For instance, we might see a proposal for the Fed to set up CBDC accounts for every American the next time an economic crisis occurs that’s comparable –or worse – than what we experienced in 2020, in reaction to the COVID pandemic-related shutdowns.
Remember, in 2020 and 2021, Congress authorized the IRS to send payments to almost every US citizen as a COVID relief measure. In the next economic crisis, payments could be made to Fed e-dollar accounts established for every American, with the amount we each receive tied to our income, as the COVID-related payments were. And perhaps those payments could be pseudo-anonymized by the Fed, to avoid financial surveillance by private companies.
And that is where the transition could begin in earnest.
The digital dollars deposited into our Fed accounts could be programmed to expire or decrease in value unless they were used by a deadline. That would offer the Fed a way to instantly prop up consumer spending during an economic downturn. The effort would be sold as a legitimate exercise of governmental authority in a crisis. In that way, people would begin to get accustomed to using a programmable CBDC. Citizens would be less inclined to be concerned that a CBDC is programmable if they were offered financial incentives to use them.
Still, so long as privately owned banks continue to exist, we don’t see how a full transition to an American CBDC could ever occur. But if a severe enough financial crisis causes most banks to collapse, citizens would be clamoring for safer alternatives, such as digital dollars deposited in their personal account at the Fed. And to the extent permitted by law, people would voluntarily move their savings from bank accounts into their own CBDC accounts.
So, the next time you hear a politician railing against how Uncle Sam will “force” us into using a CBDC, don’t believe it. The transition will begin not with the barrel of a gun, but with a cry for help.