“Now is the time for Congress to begin the process of considering and passing legislation authorizing the issuance of a U.S. CBDC,” says a new report released Wednesday by Congressman Jim Himes (D- CT), the first white paper (Himes Report on CBDCs) by a congressman about a central bank digital currency for the United States. Himes, who chairs the subcommittee on national security, international development, and monetary policy, chaired a hearing in 2021 titled “The Promise and Perils of a Central Bank Digital Currency.” It could be argued that his position as chair of this particular subcommittee places the notion of issuing a CBDC squarely within his purview in Congress.
The proposal is titled “Earning the Future of Money: A Proposal for a U.S. Central Bank Digital Currency” and begins by defining a CBDC as “a digital form of central bank fiat currency.” According to the proposal, a CBDC would have advantages over privately issued stablecoins that are based on the strength of the issuer and crypto assets that are volatile in nature. The proposal argues that the Fed has a responsibility to explore and possibly issue a CBDC during this time when the crypto asset ecosystem continues to grow. “While it is possible that stablecoins and CBDCs co-exist, central banks should not delegate the development of a digital dollar entirely to the private sector,” the proposal states.
The proposal notes the work of the Federal Reserve in releasing a paper on CBDCs titled Money and Payments: The US Dollar In An Age Of Digital Transformation. The proposal reiterates the Fed’s description of the various benefits of a CBDC, such as risk-free payments, better cross-border transfers, support for the global role of the dollar, and opportunities for greater financial inclusion. The proposal also mentioned what the Fed found to be potential risks of issuing a CBDC, such as financial system disruption, security leak issues, monetary policy effects, and privacy concerns. and data protection.
The white paper is very thoughtful and one could infer that it is a pitch for the rest of Congress to start looking at legislation authorizing Congress to allow the Federal Reserve to issue a US CBDC. The proposal outlines how, “…the Fed would not proceed with issuing a CBDC ‘without clear support from the executive branch and Congress, ideally in the form of specific authorizing legislation’.”
The Beginnings of Digital Assets and Blockchain
The proposal compares the origin of the Internet to the technology of digital assets. “The current stage of digital asset and blockchain development generally resembles the development of the internet in the early 1990s. about the future and disbelief in the seeds of truly transformative technology,” the report says.
The document also sought to address the concerns of his Republican counterparts and many incumbents in the current financial system who are skeptical of the idea of a CBDC. The proposal provided three arguments to colleagues opposite as well as to skeptics. First, a U.S. CBDC, leveraging the full trust and credit of the U.S. government, could be a unique, secure, and reliable platform for innovation. Second, a digital equivalent of a physical US dollar is likely a way to preserve the dollar’s position as the world’s reserve currency of choice in the future. Third, a CBDC could have trust and cost benefits that unbanked and underbanked populations might see as an opportunity to participate in the U.S. financial system.
The risks of a CBDC
The proposal also lists some risks of issuing a CBDC. First, a CBDC would have a federal backstop as a liability of the Fed, which would create unique new risks for monetary policy. Second, the question of whether CBDCs could be considered as commercial bank deposits, which would then lead to a reduction in deposits in the banking system, was examined. Finally, in times of stress, a CBDC could be seen as a safe haven that would also lead to a countercyclical reduction in bank deposits.
The proposal attempts to consider whether CBDCs should have intermediaries that allow consumers to accumulate and spend their digital money. or whether CBDCs should be unmediated where the Fed interacts directly with the public. The proposal ultimately agrees with the Fed that a retail CBDC should be intermediated with private sector participants as intermediaries of a US CBDC.
The proposal suggests imposing limits on the amount a consumer can hold in a digital wallet. Additionally, the proposal suggests that it is not possible for the Fed to pay interest on the CBDC. The reasons for these limits are to prevent CBDCs from potentially withdrawing deposits from the legacy banking system as well as to avoid a negative interest rate imposed on digital wallets.
The CBDC Ledger: Distribute or Centralize?
By determining the architecture of the Fed CBDC’s ‘digital ledger’, the proposal explains the traditional centralized databases currently used by financial institutions today in the legacy system versus bitcoin, which has a distributed ledger/blockchain without permission that can be used by the public. The proposal’s suggestion is to split the difference into what is characterized as an “authorized semi-distributed architecture”. In this case, access to the CBDC network would require permissions from the Federal Reserve or other regulators, as opposed to allowing the general public to access the network. The whitepaper gives an example where a deposit-taking institution that offers a CBDC custodial service may have permission to modify the network, while a payment service provider may only have permission to read the network. The proposal argues that an authorized system would provide high levels of network security against unauthorized access or cyberattacks as well as privacy.
When it comes to the types of digital wallets that individuals would own to hold their CBDCs, the notion of “account-based wallet” is recommended by the Himes report on CBDCs. The rationale for this type of “regulatory custody” structure, as the report describes, would be a “robust user identification process that requires intermediaries to certify the identity of wallet holders.” The proposal notes that this choice contrasts with a token-based structure, which involves verifying the authenticity of the digital asset rather than the holder of the wallet.
According to the report, this account-based structure mirrors current digital banking structures such as Fedwire and commercial payment systems that allow for “participant validation” before finalizing transactions. Regarding the concerns many have about the privacy impacts of a CBDC, the proposal suggests that “the U.S. retail CBDC would allow the Fed to work with intermediaries and experiment with cryptographic techniques that allow officials to identify money laundering operations and track illicit funds while protecting personal information and data.
The proposal also suggests that the United States could become a leader in CBDC privacy standards that “…could encourage other platforms – domestic and international – to implement data privacy mechanisms. data that protects consumers in the digital asset ecosystem. However, one of the most difficult challenges the proposal highlights is how “an American CBDC would present new and serious privacy challenges.”
How a US CBDC could work between the Fed, a private sector intermediary and the public
An example of how a US CBDC could work between the Fed and an intermediary, as well as someone looking to make a purchase from a merchant, is shown in the article below to give an idea of the flow that this proposal has in mind.
The proposal again emphasizes that the interactions of all these different players in the CBDC ecosystem, “…will raise concerns that a CBDC payment system could evolve into a shortcut for government oversight, collection data, or worse. Additionally, a CBDC that stores consumer data would be an attractive target for cybercriminals. However, the proposal seems confident that this issue can be managed and suggests the Fed “conduct testing methods with a wide range of encryption evidence with the aim of protecting transactions and the identity of individuals from disclosure”.
The proposal also provides that access to distribution CBDCs “…should be open to non-bank entities and other businesses wishing to offer CBDC wallet services, provided that non-banks can meet the security parameters of the critical infrastructures such as user identification protection, cybersecurity resilience, network maintenance, data management and storage protocols.This encouragement to “non-bank” entities that are today technology providers for Digital Currency Systems gives the idea of how some members of the digital asset private sector today can serve as intermediaries for US CBDCs in the future.
The document concludes on the importance of national security, noting that “Security standards and best practices for a U.S. CBDC must be consistent with the objectives of the Bank Secrecy Act (BSA), particularly with respect to the documentation, record keeping, employee training, audit cooperation and internal policies. So any digital asset provider that wants to act as an intermediary as a “non-bank entity” will likely need to have excellent BSA compliance skills.
All in all, it’s not too common to see a congressman take the time to publish his own white paper on a particular topic. However, the publication of this proposal shows that Himes is not misunderstood of exactly what is at stake and the complexity of the idea of CBDCs, not to mention what implementation might look like one day. work on such an important project.