Could a U.S. CBDC undermine the existing financial infrastructure?

The Federal Reserve is preparing to launch a U.S. CBDC system that could bring major changes to America's financial ecosystem. Some say Terra's UST crash was what led to this move, while others point to Facebook’s Libra proposal in 2017 as the catalyst.

FIs are concerned that CBDCs will undermine the existing financial infrastructure, while the crypto community claims the government is gunning for totalitarianism. In short, there is a lot of chatter, so Tearsheet spoke to a few experts to get some clarity on the matter.

“For the U.S. dollar to remain the global reserve currency, it's important that we take the steps necessary to make sure that we're a leader in this space,” said Jonathan McCollum, the Chair of Federal Government Relations for Davidoff Hutcher & Citron.

McCollum says the United States has different values than totalitarian governments, and it needs to show the rest of the world that it is possible to uphold those values if a CBDC is designed correctly and the right laws are put in place to protect the individual consumer.

In essence, a U.S. CBDC is a digital version of the U.S. dollar, and is a liability of the Federal Reserve in the same way that cash is today. What sets it apart from cryptocurrencies and stablecoins is that it is issued by the central bank of a country rather than a private company. And yes, it uses multiple cryptographies, but that doesn’t mean the government is launching a cryptocurrency.

“The nature of any currency has to do with security. Paper currency, for example, carries multiple layers of complex security to keep it from getting counterfeited and free to ensure that people who use it know that it came from the central bank,” said Jonathan Dharmapalan, CEO of eCurrency.

Dharmapalan explains that the multiple cryptographies in digital currency are no different than those applied to a dollar bill. For example, a dollar bill is intricately woven to a precise thread count and weight. Each dollar bill issued by the central bank has a unique serial number and plate number. It has Federal Reserve indicators that consist of a letter and number designation corresponding to one of the 12 Federal Reserve Banks. In addition, it bears the green treasury seal and signature of the current Secretary of the Treasury.

Over the years, central banks have issued this paper technology – each note is a blend of 25% linen and 75% cotton, with tiny red-and-blue synthetic fibers evenly distributed throughout the paper. A CBDC simply transforms all of those details into computer code.

How it began

In January 2022, the Biden administration published a paper examining the pros and cons of a potential U.S. CBDC and invited comments from the public. Perhaps out of natural resistance to change, or a distrust in banks and government in general, the public’s comments were not enthusiastic about the initiative.

Some scathing comments from the financial and technology sector emerged as well. "The Federal Reserve rightly recognizes that a CBDC could present serious risks to financial stability and…could undermine the commercial banking system in the United States,” wrote the Banking Policy Institute.  

“Many of the benefits of a CBDC are already being met by private-sector innovations, like USDC, through blockchain-based payment systems,” responded Circle, the issuer of the USDC stablecoin. “CBDCs and centralized payment system innovations…pose serious potential breaches of public trust.” 

How it's going

In September 2022, the Biden administration released a comprehensive framework for the responsible development of digital assets, and developed policy objectives for the U.S. CBDC system. 

The policy objectives address the public and private sector’s concerns in broad brush strokes. However, the government seems resolved to pursue the creation of a U.S. CBDC — and if implemented, promises to respect human rights and promote economic growth, but admits that more research is needed before the implementation.

McCollum maintains that the U.S. government is at least 3 to 5 years away from full implementation of CBDCs on a large scale. He points to the time-consuming process of passing legislation – given the evenly divided Congress – and adds that nothing is guaranteed. 

“I think first Congress needs to pass legislation that gives authority to the Federal Reserve and the Department of Treasury to start the process. And as we know, passing legislation can often take quite some time in the U.S., and it has to go through both chambers,” he said. 

Maybe when contemplating the imminence of CBDCs, a helpful perspective is to reflect on how the U.S. Postal Service manages to coexist alongside emails and instant messaging apps.