In Long-Awaited CBDC White Paper, Fed Flags Privacy, Financial Stability Risks

The U.S. central bank believes the current financial system might be bolstered by the creation of a central bank digital currency (CBDC), but only one that works within the current network of private banks, rather than a CBDC that the Federal Reserve issues directly to consumers.

The Fed released its long-awaited white paper on CBDCs Thursday. It did not commit to creating (or not creating) a digital dollar, but did explain its questions in approaching the issue and ask for public feedback on questions of privacy, financial stability and just how a digital dollar might be used.

Fed Chair Jerome Powell alluded to this during a recent nomination hearing before the Senate Banking Committee, telling lawmakers that the report was "ready to go" after several delays.

"And by the way, it’s more going to be an exercise in asking questions and seeking input from the public rather than taking a lot of positions on various issues, although we do take some positions," he said at the time.

Officials haven’t yet committed to issuing, or even developing a digital dollar, and the document underscored how far away such decisions remain. Still, it shed considerable light into what would make a hypothetical CBDC successful for the U.S.

“The Federal Reserve’s initial analysis suggests that a potential U.S. CBDC, if one were created, would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable and identity-verified,” the paper says.

The intermediaries could be commercial banks or other nonbank payment entities. In other words, the Fed does not want consumers setting up personal accounts at central bank locations to access these CBDCs, but rather, would prefer that existing banks and similar financial firms maintain their role.

Cybersecurity, the prevention of financial crimes and meeting future needs are also all considerations that the Fed must look at before it can begin to issue a CBDC.

"Any CBDC would need to strike an appropriate balance between safeguarding consumer privacy rights and affording the transparency necessary to deter criminal activity," the paper says.

Moreover, the Fed wants "clear support" from both the executive branch of the federal government and Congress before it will issue a CBDC, "ideally in the form of a specific authorizing law."

Maintaining dollar hegemony could be one benefit of a U.S. CBDC, the paper said, especially in a future where more countries tout their own digital cash.

The report noted that the dollar is currently the most widely used payment and investment tool in the world, as well as being the global reserve currency. This ubiquity gives the U.S. the ability to influence "standards for the global monetary system," the report said.

"It is important, however, to consider the implications of a potential future state in which many foreign countries and currency unions may have introduced CBDCs. Some have suggested that, if these new CBDCs were more attractive than existing forms of the U.S. dollar, global use of the dollar could decrease – and a U.S. CBDC might help preserve the international role of the dollar," the paper said.

Public comments are open for the next 120 days, the Federal Reserve said.

In a statement following the report's publication, Senator Sherrod Brown (D-Ohio), chairman of the Senate Banking Committee, said in a statement that he looked forward to working with the Fed and executive branch on CBDC that "ensures workers, small business, community banks and credit unions can continue to participate in our digital economy."

“The Federal Reserve’s report is a good first step toward designing a central bank digital currency that will bring more Americans into our banking system and help maintain the United States’ leadership in the global economy,” he said.

Senator Pat Toomey (R-Pa.), Brown's Banking Committee counterpart across the aisle, said he was "encouraged" by the report's noting it needs Congressional support before the Fed would issue a CBDC, as well as the Fed's note that it would not directly offer retail accounts. The lawmaker did raise concerns about the privacy aspect of the Fed's CBDC proposal however.

“While the report mentions the importance of CBDC privacy, I’m concerned the Fed does not clearly explain how it would protect consumer transaction data. There’s also a question in my mind whether the Fed’s report implies that a CBDC would not allow for direct peer-to-peer transactions. This characteristic is fundamental," Toomey said.

UPDATE (Jan. 20, 2022, 23:30 UTC): Updated with additional context, statements from lawmakers.