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Should the Federal Reserve Issue a Central Bank Digital Currency? By Paul H. Kupiec August 2021 During Federal Reserve Chairman Jerome Powell’s July 2021 congressional testimony, several elected members encouraged Powell to fast-track the issuance of a Federal Reserve digital cur- rency. Chairman Powell indicated he is not convinced there is a need for a Fed digital currency. But he also indicated that Fed staff are actively studying the issue and that his opinion could change based on their findings and recommendations. In this report, I explain how a new Fed- eral Reserve digital currency would interface with the existing payment system and review the policy issues associated with introducing a Fed digital currency. The Bank for International Settlements defines Governors of the Federal Reserve System 2021b). “central bank digital currency” as “a digital payment Digital deposits are money recorded in (electronic) instrument, denominated in the national unit of ledger entries with no physical form. Digital Fed- account, that is a direct liability of the central eral Reserve deposits can only be held by financial bank” (BIS 2020). In his semiannual appearance institutions (primarily banks) eligible for master before Congress, Federal Reserve Chairman Jerome accounts at a Federal Reserve bank. Powell indicated that the Fed was studying the idea Most businesses and consumers are not eligible of creating a new dollar-based central bank digital to own Federal Reserve master accounts, so they currency (USCBDC) (Lee 2021). The design of cannot own Federal Reserve digital deposits under USCBDC has important implications for the US finan- current arrangements. They can own central bank cial system. To facilitate the policy discussion, I money in the form of paper Federal Reserve notes discuss how a US digital currency relates to existing or hold “bank money”—US dollar-denominated forms of dollar-based money, the payments sys- digital currency in the form of bank deposits that tem, competing privately issued stablecoins, and are exchangeable at par into paper Federal Reserve the policy issues associated with USCBDC design. notes. Unlike central bank digital money, bank- issued digital deposits can be subject to default Central Bank Money, Digital Money, losses if the bank issuing deposits fails. However, and Efficiency of Payments Systems bank deposits up to $250,000 per depositor are fully insured by the Federal Deposit Insurance At present, the Federal Reserve issues two types of Corporation (FDIC), and the maximum effective central bank money—paper Federal Reserve notes and digital Federal Reserve deposits (Board of AMERICAN ENTERPRISE INSTITUTE 1 Terminology A short description of some industry-specific terminology is below. Stablecoins. Stablecoins are a class of cryptocurrencies that attempts to maintain a fixed exchange rate with a designated fiat currency or basket of fiat currencies by holding reserve assets that can be used to buy and sell coins on cryptocurrency exchanges to maintain the target exchange rate peg. Federal Reserve Master Account. Eligible institutions may have one master account at a designated Federal Reserve bank that is both a record of financial transactions that reflects the financial rights and obligations of an account holder and of the Federal Reserve bank with respect to each other and the place where opening and closing balances are deter- mined (Board of Governors of the Federal Reserve System 2021c). Automated Clearing House (ACH). The ACH is an electronic funds transfer system run by NACHA, formerly called the National Automated Clearing House Association, since 1974. This payment system provides ACH transactions for use with payroll, direct deposit, tax refunds, consumer bills, tax payments, and many more payment services in the US. Blockchain. Blockchain is a decentralized, distributed, public digital ledger consisting of historical transactions processed and recorded in uniform sequential groups of transac- tions called blocks. Each block of transactions is processed across many computers using cryptographic methods that make it difficult to falsify a record or alter records retroactively. Permissioned Blockchain. This blockchain network has limited access to a shared dis- tributed ledger. Controlling access to ledger transaction processing and record verifica- tion allows ledger security to be maintained with more efficient cryptographic methods. insurance coverage on bank deposits can be increased The transfer of digital bank money is the primary simply by keeping deposit accounts in multiple banks. mechanism used to settle retail transactions in the The infrastructure for settling domestic trans- US. Transfers of bank retail digital deposits are actions between financial institutions using cen- inexpensive but historically have taken longer to tral bank digital deposits is well-developed, fast, settle than central bank digital deposit transfers. reliable, and inexpensive. 1 Domestic transfers of Table 1 provides the fees and settlement times central bank digital deposits can settle in real time associated with Automated Clearing House (ACH) or end of day depending on the settlement system domestic deposit transfers for a sample of US used.2 Settlement systems for international trans- banks. New real-time processing systems are now fers of central bank deposits are reliable if more available (Clearing House 2021) for settling bank expensive than domestic transfers. However, efforts retail digital transactions (Zelle 2021). In addition, are underway to reduce international transactions popular online money transfer services3 linked to costs (FSB 2020b). bank accounts offer, for a fee, a faster settlement 1 For example, Fedwire, the Federal Reserve System for transferring bank master account balances, charges institutions a monthly fee for access and transactions fees that depend on the volume of transactions. The FRB (2021) details the current Fedwire ACH fee schedule. 2 Board of Governors of the Federal Reserve System (2021a) explains the Federal Reserve’s Fedwire Fund Services. 3 Venmo is an example of a state-licensed money transfer service that offers settlement times faster than standard ACH transactions do. AMERICAN ENTERPRISE INSTITUTE 2 Table 1. Electronic Bank Deposit Transfer Fees and Settlement Times at Selected Banks Financial Institution Cost (Both Directions Unless Specified) Approximate Delivery Times* Transfer Fee Alliant Credit Union $0 One business day Ally Bank $0 Three business days American Express National One to three business days; three or more $0 business days for transfers initiated at the Bank bank where the funds should arrive Axos Bank $0 Three to five business days To Bank of America account: $0 From Bank of America account (three busi- Three business days; option for next-day Bank of America ness days): $3 delivery From Bank of America account (next day): $10 To Bank5 Connect account: $0 From Bank5 Connect account (standard de- Up to three business days; option for next- Bank5 Connect livery): $0 day delivery From Bank5 Connect account (next day): $3 Barclays $0 Two to three business days Boeing Employees Credit $0 Two to three business days; option for free Union next-day delivery Capital One 360 Bank $0 Two business days Chase $0 One to two business days Three business days; option for free next- Citibank $0 day delivery Discover Bank $0 Up to four business days Navy Federal Credit Union $0 Two to three business days PNC Bank $0 Three business days Synchrony Bank $0 Up to three business days TD Bank $0 One to three business days To US Bank account: $0 Three business days; option for free next- US Bank From US Bank account: Up to $3 day delivery (incoming transfers only) To Wells Fargo account: Three business days Wells Fargo $0 From Wells Fargo account: Two business days Note: * These are typical outgoing and incoming transfer times when initiated through online banking, according to each financial institution’s disclosures and general policies. Delays can occur due to holding periods, sending after daily cutoff times, initial service setup, and other reasons. This list includes only personal accounts, not business accounts. Source: Burnette and Tierney (2021). time than standard ACH transfers (Venmo 2021). electricity consumption (McDonald 2021), and trans- The volume of transactions settled in real time will actions fees and settlement timing vary according undoubtedly increase over time. to the volume of transactions and the public In contrast, the processing of cryptocurrency computing resources processing the distributed transactions is costly in computing resources and ledger. Figure 1 shows the average daily cost of pro- AMERICAN ENTERPRISE INSTITUTE 3 Figure 1. Average Daily Cost to Process a Stablecoin Transaction on the Ethereum-Distributed Blockchain Ledger Source: YCharts (2021). cessing a stablecoin transaction on the Ethereum- USCBDC transactions processing. This presumes distributed blockchain ledger over the past year. of course that international ownership of USCBDC These costs, while much higher on average than would be legal and widely used. the costs of domestically transferring bank deposit Proponents of private stablecoin cryptocurren- balances, are mostly lower than the cost of trans- cies and USCBDC argue that both would provide ferring bank deposits internationally. the unbanked with a new, more affordable way to access to the banking and payment system. As dis- USCBDC, Stablecoins, and Competing cussed below, unless USCBDC pays

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