Is the idea of a digital dollar just a fad — like the 1980s craze with parachute pants that became synonymous with Michael Jackson and MC Hammer?
Randal Quarles, the Federal Reserve’s vice chair for supervision, recently used that very imagery to express his scepticism. He wasn’t trying to prejudge the monetary authority’s thinking, which will soon be outlined in an eagerly awaited discussion paper on a so-called FedCoin. But speaking for himself, Quarles isn’t convinced that the Fed should have to issue its own electronic money to the public even if other central banks do so. My interpretation of what he’s suggesting is this: Instead of one, there could be many digital dollars. All private.
By 2023, the US will put in place FedNow, its first new payment system in 40 years. It will allow two people to instantly exchange funds from their bank accounts at any time of the day, any day of the year, without needing an intermediary like PayPal Holdings Inc’s Venmo. After that, there’ll be little extra gain to users from cutting out the banks’ balance sheets in the middle and making payments directly as customers of the Fed. Without limits on the FedCoin held in smartphone wallets, however, an exodus of bank deposits could threaten financial and price stability.
Volatile cryptocurrencies like Bitcoin may never pose a serious challenge to the dollar’s hegemony. Nor is China’s impending e-CNY much of a justification for why the Fed must follow suit to keep America in the race. Even if there’s no FedCoin, there will still be other digital-dollar stablecoins — synthetic online currencies offered by private issuers like Diem that can be freely converted 1:1 into dollars. “A global US dollar stablecoin network could encourage use of the dollar by making cross-border payments faster and cheaper, and it potentially could be deployed much faster and with fewer downsides” than a central bank’s own digital currency, Quarles said at a bankers’ convention in Sun Valley, Idaho.
Although it appears to be little more than a fashion statement for now, a FedCoin may still come in handy in the not-so-distant future. In an internet-of-things world, our devices will also make and receive payments. We’ll set the rules, but not authorise each transaction. A conventional payment system that offers 24×7 settlement may be able to build a technological bridge to self-executing software code — smart contracts — powering machine-to-machine claims. But it may be easier to settle a very large number of transactions with tokenised money. And if central banks recognise one another’s digital IDs, cross-border remittances could become a lot cheaper with digital currencies issued by them.
Ditto for offline person-to-person payments, which are most reliably settled using the liability of a central bank. Similarly, when businesses clear one another’s claims, they also want to update their accounts automatically. The traditional bank-to-bank payment system, which imposes a character limit on the information that can be shared along with a payment, struggles with “incomplete reference data for the clearing process and often requires manual correction”, according to Bundesbank’s research. Vendor payments get messy when invoice values are adjusted for defects and credit notes. This inefficiency, too, is best eliminated using some type of programmable cash.
Then again, a FedCoin is not an absolute necessity. Many of the benefits of future innovation should be equally attainable with private blockchain-based tokens like JPMorgan Chase & Co’s JPM Coin. As for warding off the threat to King Dollar from e-CNY, given China’s stalled efforts to internationalise its currency via Hong Kong, it’s unclear if a digital yuan will dramatically alter the balance.
The Fed discussion paper will give a clearer hint of whether the US intends to issue a paperless version of the world’s most popular currency. (The dollar has a 41 per cent share of international payments outside the euro zone.) It’s entirely possible that the central bank will pause in 2023 with FedNow. The route it takes will be crucial to banks and intermediaries like PayPal. It will also be watched closely in Beijing, where the monetary equivalent of parachute pants is already a rage.