What Would Be the Benefits and Drawbacks of a Digital Dollar?

Key Insights

• Biden government has stepped up the pace of digital USD progress.
• Some are reluctant to let China win a tech race.
• Others are unsure if a digital dollar is desirable – or necessary.

Central bank digital currencies (CBDCs) have become the talk of the town this year: First came the Winter Olympics in Beijing – when China took the opportunity to showcase its digital yuan to the world for the first time. Next came the Ukraine crisis, with sanctions forcing Russia to ramp up its own efforts to create a digital version of the RUB.

And in the meantime, crypto adoption and bitcoin (BTC) advocacy just keeps gaining pace – forcing central and commercial banks to create solutions that can compete with crypto in the remittance, digitization, and cross-border transactions arenas.

But while the digital yuan is likely to make a nationwide rollout in the coming months and the likes of the European Central Bank, the Bank of England and the Bank of Japan have begun exploring their own CBDC options, the dollar has become the (analog) elephant in the room.

The greenback is the world’s reserve currency, and a digital version would change the way that the world’s biggest economy does business. A digital USD could also become a heavy-hitting international trade tool for the digital age.

But until recently, progress on a digital USD was positively glacial.

All that has changed in the past few weeks, however. In February, the Boston Fed and the Massachusetts Institute of Technology (MIT) revealed results from what they are calling “Project Hamilton” – a design for a high-performance, resilient transaction processor for a CBDC that, in two tests, handled 1.7 million transactions per second.

President Joe Biden’s recent Executive Order on “Ensuring Responsible Development of Digital Assets” also instructed agencies to produce reports on a digital USD – a sign that Washington is finally getting serious about possible CBDC issuance. But what positives – and negatives – could a digital greenback bring?

Why Issuing A Digital Dollar Would Be a Good Idea

The US needs to keep pace with China

China’s digital RMB is almost ready to come out of the oven. Some 8 million users of digital e-commerce platforms are already buying everything from takeout noodles to dumbbells using the CBDC in 11 major cities, with a glut of extra cities about to be added to the pilot.

For those who are a little slower to put things together, China is the world’s new super power. The digital yuan will pass the dollar as one of the world’s top reserve currency and American citizens are no longer going to be able to opt-out of the true consequences of war.

— Alchemical Daddy (@AlchemicalDaddy) March 19, 2022

Some American Senators are none too pleased that the US is nowhere near this kind of progress. Sherrod Brown last year urged the Fed to “lead the way” on CBDCs and noted that “some of our international counterparts are moving quickly to determine whether to implement a central bank digital currency.” Brown wrote:

“The United States must do the same. We cannot be left behind.”

The USD needs to compete with crypto

The fiercest opponents of crypto are often the most vocal advocates for CBDC adoption. They realize that conventional finance has a long way to go if it wants to compete with fintech and crypto.

Stablecoins and crypto markets aren’t actually an alternative to our banking system.

They’re a mirror of the same broken system––with even less accountability, and no rules at all. pic.twitter.com/EvWwuFh886

— Sherrod Brown (@SenSherrodBrown) December 14, 2021

Even in Russia, the Central Bank has repeatedly called for a blanket crypto ban and the urgent rollout of a digital RUB.

The Fed has long ago realized that it cannot really work with crypto and that decentralization essentially wrests power away from any kind of central financial hub. As such, all it can really do – some would say – is to regulate crypto to the point where it can do no harm to the USD, and then copy all of its “good” parts for use in a digital dollar.

The Fed should create a digital reserve currency for the Web 3.0 era

The greenback is still the currency the world goes to when it is spooked about local inflation or when international companies want to make trade deals. But CBDCs and – maybe one day – stablecoins could threaten that.

Joke in China tech circles:

The only thing China and the US agree on … the Web 3.0 revolution has to happen in the US

😂😂😂

— Rui Ma 马睿 (@ruima) March 17, 2022

Meta/Facebook and its Libra/Diem plans may be dead in the water, but the idea of a tech giant releasing a fiat–backed global token petrifies regulators. As would a digital yuan if it proved a hit on the global stage.

Some, like the Twitter founder Jack Dorsey, speak about BTC’s potential to become the internet’s native currency. But if a digital USD that did away with the need for bank transfers, Swift and the rest were to appear tomorrow, trade firms would likely be all over it.

And Why it Might Not Be So Great After All…

A Digital USD Is Not Needed (Yet)

Not only does this CBDC model raise “single point of failure” issues, leaving Americans’ financial information vulnerable to attack, but it could be used as a surveillance tool that Americans should never be forced to tolerate from their own government.

— Tom Emmer (@RepTomEmmer) January 12, 2022

Some lawmakers are concerned that an American CBDC runs contrary to the tried and true US values of encouraging competition in the private sector. Senator Tom Emmer, one of the biggest critics of CBDC issuance has claimed that a CBDC could “put the Fed on an insidious path akin to China’s digital authoritarianism.”

Some Fed officials have stated that they don’t see an obvious need for a CBDC, while others have urged a wait-and-see approach. A Washington Post opinion columnist recently suggested:

“The United States does not need to be first to issue a digital currency; it needs to be the best.”

The non-digital USD is still dominant, so why risk a digital dollar launch now?

Even if CBDCs launch elsewhere, there is scant evidence to show that this could lead to widespread de-dollarization. Sure, some economies such as Russia have been purging their currency reserves of the greenback and the likes of El Salvador and Honduras have been trying to chip away at their dollar dependence.

But when most people talk of hard currencies, they are talking about the USD and perhaps a select few others. Per a Fed report last year, the dollar “comprised 60% of globally disclosed official foreign reserves in 2021.”

Banks *in China itself* still use the greenback for more than two-thirds of their cross-border claims. Just 14% are denominated in yuan. pic.twitter.com/HgxuW5rKdf

— David Fickling (@davidfickling) March 17, 2022

The Fed added that “this share has declined from 71% of reserves in 2000. The chasing pack is miles behind: 21% of holdings are in the euro, with just 2% in RMB. Will a digital yuan – or ruble – really change this picture?

Can the US afford to sit and wait as the CBDC race gathers pace?

The UK banking giant Barclays recently claimed that its analysts had concluded that the Fed “should have few problems in achieving widespread use of a CBDC, at least domestically if it determined that there was a need for one.”

The bank claimed that this was due to the fact that “when it comes to legality, stability, and trust – the three main advantages of public-sector systems – the Fed and the dollar score highly.”

CBDCs are still unproven on the global stage, and while it may be galling for some to let China win a tech race, others will insist that it would be more prudent for Washington to keep its digital currency powder dry for the moment – and let others test the waters first.