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How CBDCs Could Undermine Commercial Banks

First, let’s define some terms. A “central bank digital currency” (I’ll use the acronym CBDC from here on out) is a digital fiat currency. In most versions of proposed and in development CBDCs, the digital currency is actually a part of the money supply (versus just a claim on a physical bill).

Discussion of digital currencies has been on the rise for some time, although it has accelerated over the last year thanks to two factors:

The introduction of Facebook’s Libra

China’s acceleration of their DCEP (digital currency electronic payments) project in response to Libra

Since then, there has been a tidal wave of government interest in digital currency projects, working groups formed among nations, and increased interest from the Bank for International Settlements.

The perceived benefits for CBDCs include:

Solving information issues (in other words, being able to actually understand how big the money supply is and how quickly it’s moving at any given time)

Solving money distribution issues (in other words, being able to get people money they’re owed - or claim money the government is owed)

Greater visibility into possible financial crime.

Hanging on this second point for a minute… When discussions began in earnest about how to distribute Federal stimulus money, one draft proposal from the House included a provision to create a digital dollar in order to facilitate easy payment. This was quickly hacked out of the bill (for reasons we’ll get to below) but was remarkable for being included at all.

Now, when it comes to the third point - greater visibility into possible financial crime - this is also one of the push backs. Three key downsides or arguments against CBDCs include:

Greater surveillance capacity - upon all citizens not just criminals

Complexity to implement from the system we have today

Disruption of commercial banking sector

It is this last point that is the subject of a recent research report from the Federal Reserve Bank of Philadelphia’s research arm.

In today’s system, citizens don’t have a direct banking relationship with the Federal Reserve. Instead, they interact with commercial banks.

The Philadelphia report, however, argues that in a CBDC context, many citizens would instead opt to bank directly with the central bank, due to perceptions of greater stability. The Fed could become a “deposit monopolist,” which would threaten maturity transformation, as described here by The Block:

Maturity transformation is a practice among banks by which they secure short-term sources of financing — including deposits — which are then transformed into offerings like mortgages and other long-term forms of lending.

So why does this matter?

The conversation around digital dollars is heating up. Former CFTC Chairman Christopher Giancarlo is leading the Digital Dollar Project advocating for a US dollar CBDC.

One of the biggest sticking points is likely to be in questions of relationships with commercial banks, so understanding the argument is extremely useful in getting a sense for how this might play out.

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