Cash transactions are increasingly rare. More than half of transactions in the US involved cash in 2010. The number had dropped to 28% in 2020, even before the Covid-19 pandemic, which led to wider adoption of cashless and contactless payment among businesses.
But going cashless means a heavier reliance on private companies—banks, credit card companies, payment processors—all of which have delays and fees that hit poor people hardest. At the moment, a cash-free economy would exclude the 7.1 million Americans, or 5.4% of US households, that are unbanked, meaning they do not have a checking or savings account at a bank or credit union, according to the FDIC’s most recent study in 2019.
That has the US Federal Reserve thinking about backing its own digital version of cash. A Fed-backed digital dollar would in theory function like cash—without delays, processing fees, or onboarding requirements—and could usher unbanked or underbanked Americans into the digital economy. Citizens could send cash digitally to one another or swipe a government debit card to pay, and that money would live in a Fed-backed wallet outside of the private banking system.
Building a central bank digital currency (CBDC) carries risk for failure, hacking, or breaches of personal privacy, but if the Fed can bring a digital dollar online, it could make the digital economy much quicker, more efficient, and more accessible to those who need it most.
The digital divide is growing
Right now, the US digital payment system relies heavily on the private sector. That has its downsides. Interest rates can hit hard if balances are not paid off (The average US credit card balance was about $5,900 at the end of 2020). Banks charge overdraft fees if a person takes out more money from a checking account than they have. And while some apps like Venmo and Zelle allow people to easily transfer money between one another digitally, they are still largely linked to bank accounts with multi-day processing delays—or fees for instant deposits.
What’s missing, say digital currency advocates, is a public option free of fees, delays, and hassles.
The Fed revealed last summer that after years of in-house research it had partnered with the Massachusetts Institute of Technology to “understand the opportunities and limitations” of a CBDC. The project is set to release its findings later this summer, the next step before the Fed decides if and how to implement a new currency.
“It’s very expensive to be unbanked and participate in the digital economy”
Neha Narula, who is leading Project Hamilton, the name of the Fed-MIT collaboration, told lawmakers on June 9 that a digital dollar offered a “ground up redesign of our payment systems” in the US. Skeptics like Republican Sen. Pat Toomey pushed back on the idea that a CBDC is necessary, arguing a CBDC would turn the Fed into a retail bank and claiming that the private sector does the job well enough.
But Narula sees the opportunity as revolutionary. “If we were able to create a well-designed interface to a central bank digital currency, we could do for the transfer of value what the internet did for the transfer of information, which is create a platform for innovation,” she said at the recent hearing.
Access to the US financial system should be a public good, said Hanna Halaburda, a professor at NYU’s Stern School of Business and a former senior economist at the Bank of Canada. “A lot of central banks have a mandate to provide a means of transaction that would be free and accessible to everyone,” she told Quartz. That’s a reality for cash but there is no digital equivalent at the moment.
The Digital Dollar Project, a research group pushing for a CBDC in the US, said that inclusion is the number one priority. The project is a partnership between the consultancy Accenture and the Digital Dollar Foundation, a nonprofit co-founded by Christopher Giancarlo, the former chair of the Commodity Futures Trading Commission (CFTC).
“It’s very expensive to be unbanked and participate in the digital economy,” said David Treat, a director of the Digital Dollar Project and a senior managing director at Accenture. “As we make more and more advancements in the digital economy, that divide is just growing.”
The US isn’t leading the way
The US is not the first country to consider a digital currency. In fact, it’s a bit behind the pack. More than 60 countries and jurisdictions are currently researching or deploying their own digital tender, according to the website CBDC Tracker, run by Boston Consulting Group.
The Bahamas already introduced its Sand Dollar, China is testing its digital yuan, and Sweden is testing an e-krona, among others.
The motivations are different for each country. In developing countries where populations have less access to reliable and affordable banking, CBDCs could be transformative. For those sending money across borders, digital currencies could rapidly speed up the process, which is notoriously tricky and intermediated by different banks and dynamic exchange rates.
In many nations, central bankers see digital currencies as a way to keep their currency dominant. “On both digital currency and payments, we in Europe must be ready to move as quickly as needed or risk an erosion of our monetary sovereignty — something we cannot tolerate,” Bank of France Governor Francois Villeroy de Galhau Villeroy said at a recent conference.
Digital dollars versus cryptocurrency
One of the biggest questions is whether an official digital currency should be set up in the same way as cryptocurrency. Private cryptocurrencies like bitcoin and ether rely on blockchains, decentralized ledgers that record real-time transactions across many computers. A digital US dollar would not necessarily need to.
That poses fundamental questions for America’s Federal Reserve. Will a digital dollar be run by the commercial banks or the Fed itself? Will there be a physical card associated with it so it can be inclusive of users who do not have access to broadband or a smartphone?
Halaburda said most central bank proposals right now don’t rely on a blockchain, in part because there are limitations and costs associated with many different computers replicating the same transactions. Narula told lawmakers that she, too, doesn’t believe the system would necessarily need to be based on blockchain but said it must be encrypted in some way. The Digital Dollar Project, meanwhile, is considering various architectures but believes that a distributed ledger system would offer the most robust security. It is testing a series of pilot programs for a US-based CBDC and is building Sweden’s e-krona on distributed ledger technology.
At the moment, this leaves more questions than answers.
A more secure system
The downsides of a digital dollar revolve almost entirely around two issues: privacy and security.
Unlike cash, a digital system can be hacked. There’s no physical barrier to lifting copious amounts of digital currency. A digital currency system would be an obvious target for hackers, which could put Americans’ data and finances at risk. But Narula says there are ways to secure the system, for example, by making it open source with an open API. “I’m a firm believer that open-source software is critical for security,” she said. “The more people who are looking, the more likely you are to find bugs and to find problems.”
And a digital currency also presents a new way for the state to monitor its citizens. In China, the digital yuan is a technological advancement, a way to divorce Chinese currency from the wide reach of the US financial system, and another way for the state to expand its reach. That’s less of a concern in the US, says Treat of the Digital Dollar Project, since Americans’ constitutional rights shield them from financial surveillance without due process.
But it will not be easy to convince some members of the Fed that these barriers can be overcome. Fed vice chair Randal Quarles, for example, said on June 28 that CBDCs could be a “deluded craze” informed by America’s “centuries-long enthusiasm for novelty… susceptibility to boosterism and the fear of missing out.” He jokingly likened a digital currency to the parachute pants fad of the 1980s warning of the real risks of such a system like hacking. “The potential benefits of a Federal Reserve CBDC are unclear,” he said. “Conversely, a Federal Reserve CBDC could pose significant and concrete risks.”
But other Fed members are more enthusiastic about it. Fed board member Lael Brainard offered a much rosier view for embracing innovation, while Fed chair Jerome Powell said he remained open to the idea of a digital dollar.
When CBS News asked him in April if the Fed is likely to implement a digital dollar, Powell simply said “it’s possible” but he has acknowledged “it’s more important to get it right than to be first.”