Years Later, Still Not Much Meat Behind ‘FedCoin’ Fears

Every now and then, a story makes the rounds in certain corners of the financial news space, creating a big frenzy—usually a fearful one—over something that isn’t actually happening or doesn’t actually exist. These days, that is happening with a thing everyone calls Fedcoin, which is a moniker for the Fed’s mooted digital dollar. We wrote about this in 2020, noting it wasn’t a thing. To date, the Fed still does not have a digital dollar. Nor has it announced plans to create one. The New York Fed is merely studying the feasibility, as well as potential pros and cons. The effort predates the Biden administration, although the president did back the study by issuing a rather redundant executive order to that effect.^[i] This was a first step in a broader exploration that may or may not result in anything—with some early findings released last week. Some of the fear here is sociological, seemingly egged on by the Bank of England’s jawboning about how it could tie a “decentralized digital identity” to a hypothetical digital pound in the future (and with it, do things like age-restrict or allow certain kinds of spending automatically, like alcohol and tobacco).^[ii] Others worry a digital dollar means a paper dollar is dead. When you look at the actual parameters of the New York Fed’s study, however, it becomes clear that reality is quite far from this—and quite benign. The latest report, released last Thursday, shows this so-called digital dollar amounts to a modernized interbank payment system.

This may seem like a weird topic for us, considering it is rather detached from the stock market. But we have seen fear over an alleged Fedcoin and its ilk can make people question the overall soundness of US capital markets, the dollar itself—and the wisdom of stock investing. And, well, maybe we are biased, but we think the stock market is a great way to build long-term wealth, and we want as many people to participate in it as possible so that all can reap the benefits. Hence, we journey down this particular rabbit hole. 

We do so via a short but rather technical publication from the New York Fed’s New York Innovation Center (NYIC) with the thrilling title, “Facilitating Wholesale Digital Asset Settlement.” Working with several commercial banks, the NYIC wanted to determine whether adopting some of the technology underlying digital currencies could speed money transfers between two institutions, both within the US and across international borders. While the current wire transfer systems work just fine, the NYIC notes that “certain frictions remain, particularly around speed, cost, accessibility, and the settlement process.”^[iii] Could forming a new payment system around the distributed ledger technology (aka blockchain) that underpins cryptocurrencies address these issues? This is what the researchers sought to discover.

So they designed a new network based on a distributed ledger “to settle payments between tokenized regulated commercial bank and central bank liabilities.” For domestic interbank payments, “transactions were conducted in commercial bank deposit tokens and settled using a theoretical wholesale central bank digital currency, a tokenized record of a central bank liability.” So, basically, the theoretical central bank digital currency (CBDC) was an airport layover. The money started at one bank as normal dollar deposits, took a trip on the blockchain, spent a brief spell as a CBDC so the transaction could get verified, then took another trip on the blockchain to the receiving bank—where it reappeared as normal dollar deposits. For cross-border payments, the same technology “explored the potential of the concept to enhance the experience of global users of U.S. dollars as an international trade and settlement currency.” So basically, making international trade payments faster and even more secure.

The NYIC says the experiment was a success, with the benefits most obvious in cross-border payments: “The proposed architecture was able to deliver the benefits of settlement finality, a common source of truth, standard transaction data, and privacy for all participants on the network.” It could also “facilitate settlement on a near-real time, 24 hours a day, 7 days a week basis.” Frictions reduced!

There are a few things to glean here. One, again, a Fed CBDC doesn’t exist. This was all hypothetical. Two, it is all about infrastructure, and the Fed’s involvement in bank payment infrastructure is nothing new. The Fedwire Funds Service already exists. When you send a wire transfer, your funds clear through your bank’s account at the Fed and credit the receiving bank’s account, for credit to the ultimate recipient. The blockchain-based system would simply be a more modern, faster alternative than this. And, in theory, third-party systems like the Automated Clearing House (ACH) network that process direct deposits.

If these terms are unfamiliar to you, there is a reason: They are portals that banks use to execute transfers and payments on customers’ behalf. Jim and Jane Client don’t interact with those interfaces directly. They just put in the transfer or payment request and move on. We suspect that if the Fed had used another term for this besides CBDC—maybe “newfangled superfast awesome payment system, or NSAPS”—no one would be batting an eye. It would be too boring to get any attention, much less conjure bigtime fear. But alas, that is the term they used, and there aren’t any do-overs.

Anyway, hopefully it should be obvious from all of this boring back-end infrastructure talk that the paper dollar isn’t going away. Nor is the money in your bank account about to turn from normal dollars to “digital dollars” any more than they already are.^[iv] And this is not about having a FedNow app on your phone where you store digital dollars to buy goods and services. If the Fed were to adopt a system similar to what the NYIC researched, consumers would never even see the digital currency, never mind use it on a daily basis.

Whenever something new emerges like this, it is easy to get carried away. But if you take a deep breath and take the time to dig into the details, you will usually find the hype goes poof, leaving an innocuous reality in its wake.