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A Digital Dollar Would Have Winners and Losers. Here’s What’s at Stake.

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A number of countries are working to turn their currencies into digital assets.
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Banks and stablecoins could be on the losing end while consumers would be winners if the Federal Reserve gets approval to digitize the dollar.

The Fed outlined its thinking on a central bank digital currency, or CBDC, in a highly anticipated report on Thursday. While the report doesn’t make policy recommendations, it lays out a blueprint for transforming the dollar into a digital asset. The report also requests public comment on a CBDC and says that the Fed won’t proceed without “clear support” from the White House and Congress, ideally in the form of legislation.

The report is likely to stir up debate in Washington and could build momentum for legislation authorizing the Fed to start work. Many Democrats in Congress have signaled support for a CBDC, arguing it could help lower transaction costs for consumers, and benefit millions of “unbanked” people who lack bank accounts, paying steep fees for check-cashing and other services.

Some Republicans have also voiced support for a CBDC, saying the U.S. should digitize the dollar to compete globally against China and other countries that are turning their currencies into digital assets. More than 85% of central banks are working on digital currency projects, including the European Central Bank, which is studying a digital euro.

Congress already has some draft legislation to work with: A bipartisan bill, called the 21st Century Dollar Act, was introduced in the House last year by Rep. French Hill (R-Ark.) and Rep. Jim Himes (D-Connecticut).

Yet while a CBDC may be welcomed by consumer advocates and hold appeal for U.S. economic interests abroad, it also has its foes.

The banking industry, in particular, could face more competition if the Fed starts vying for consumer deposits and payment services. And the banking lobby is sounding alarm bells.

“A U.S. CBDC could fundamentally reshape our banking and payments system which remains the envy of the world,” the American Bankers Association said in a statement on Thursday. “Policy makers would need to show that a U.S. CBDC would somehow improve upon this reliable, tested retail banking system …and we believe it will be very difficult to make that case.”

Banks argue that they could face more competition from the Fed for consumer deposits. That could raise lending costs, they argue, and leave less capital for making loans and extending credit. The Fed could also pressure banks into raising interest rates on deposits, affecting their profitability.

“If I were the CEO of a large bank I wouldn’t be in favor of this, my shareholders could get lower profits,” said Darrell Duffie, a finance professor at the Stanford Graduate School of Business, in an interview. “The more effective a CDBC is, the more that existing bank franchises in payments and deposit areas are disintermediated and made less profitable.” 

Banks could provide most, if not all, the benefits of a CBDC, Duffie adds. “But it’s not in the interest of banks to do that, because banking isn’t a 100% competitive industry and banks aren’t interested in a manner that would provide the services and cost benefits of a CBDC.”

The Fed appears open to solutions that could mitigate the disruption to banks. It said in its report that banks could act as intermediaries for a CBDC, providing digital wallets and interacting directly with consumers. CBDCs could be non-interest-bearing, or pay less interest than banks do on deposits. And there could be limits on CBDC deposits so that banks wouldn’t lose much, if any, of their deposit base.

Consumers, on the other hand, could benefit if the risk of losing deposits to the Fed presses banks to raise the interest rates they pay, or lower transaction fees. Banks now pay nearly zero-percent interest on deposits, due to the ultra-low rates set by the Fed.

Banks could also face competition for CBDC wallets from nonbank “fintechs.” The Fed noted that “nonbank financial service providers” could be a conduit for a CBDC. That could open up to CBDCs to any company with a money-transmitter license, including some of the biggest names in tech: PayPal (ticker: PYPL), Square (SQ), Apple (AAPL), Google (GOOGL), Amazon.com (AMN), and Facebook (META).

Opening up CBDCs to fintechs could also be a win for consumers, says Duffie, since it could make a CBDC interoperable across payment platforms, expanding competition for services and potentially reducing fees for consumers.

A CBDC may also pose a dilemma for stablecoin issuers; it could be a source of competition in areas where stablecoins are already in use.  

Stablecoins are thriving as substitutes for digital dollars in crypto markets, used as a parking place for trading, borrowing, and lending activity. More than $140 billion in stablecoins are circulating, primarily in USD Coin and Tether. They are also gaining traction for international money-transfers, or remittances.

Many companies are also working on proprietary stablecoins, including JP Morgan Chase (JPM), PayPal, and Meta (through its long-delayed Diem project). A CBDC could compete against those privately issued coins for deposits and other financial services.

A CBDC could take money-transfer business away from stablecoins. And if it was interoperable across different blockchains, it could be used to buy and sell things like videogame assets and nonfungible tokens.

The Fed also indicated that a CBDC could provide superior liquidity and lower credit risk than privately issued stablecoins. And it could help alleviate some of the market-stability risks now associated with stablecoins.

“In our rapidly digitizing economy, the proliferation of private digital money could present risks to both individual users and the financial system as a whole,” the Fed said. “A U.S. CBDC could mitigate some of these risks while supporting private-sector innovation.”

We’re still a long way from a CBDC making a dent in the U.S. money system. And in some ways, a CBDC would just be an extension of the electronic money we already zap around via apps like Zelle and PayPal. But a CBDC would have more features, including the potential to be programmed, like other digital assets. And it could speed up settlement into real time for things like checks that now take days to clear.

Given the rapidly advancing technology, the Fed may have no choice but to digitize the dollar. It’s just a matter of time.

Write to Daren Fonda at daren.fonda@barrons.com

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