Fed Releases Long-Awaited Digital Currency Paper: Analysts Discuss Privacy Concerns

Powell-Digital Currency, Washington, United States - 01 Dec 2020
Susan Walsh / AP / Shutterstock.com

The Federal Reserve Board released its long-awaited discussion paper about the pros and cons of a potential U.S. central bank digital currency (CBDC) on Jan. 20, inviting comment from the public. A digital currency being enacted would have massive economic influence on both the domestic and international economies.

See: The Federal Reserve Explained: How This Critical Institution Operates
Find: The Federal Reserve Isn’t Raising Interest Rates — Yet

While this is the first step in a discussion as to whether — and how — a CBDC could improve the safe and effective domestic payments system, the paper does not favor any policy outcome, the Fed said in a statement.

“We look forward to engaging with the public, elected representatives, and a broad range of stakeholders as we examine the positives and negatives of a central bank digital currency in the United States,” Federal Reserve Chair Jerome Powell said in a statement.

The 33-page paper — which was expected “soon” as of July 2021, according to Powell’s comments at the time — summarizes the current state of the domestic payments system and discusses the different types of digital payment methods and assets that have emerged in recent years, including stablecoins and other cryptocurrencies.

Make Your Money Work for You

Analysts Weigh in on Digital Currency

Ari Redbord, head of legal and government affairs at blockchain intelligence company TRM Labs, told GOBankingRates that the Fed’s paper is really a first step in what could be a very long journey toward a CBDC — particularly given the assertion that the Fed would look to Capitol Hill for an authorizing law, which will take time.

“That said, the Fed, for the first time, lays out what it would expect from a CBDC — that it could be used to buy goods, pay taxes, and that it be programmable to deliver payments at certain times. The Fed also weighs pros and cons from benefits like financial inclusion and cross border payments to risks like stability and financial crime,” Redbord said.

“The bottom-line is that the U.S. is really pre-first inning when it comes to launching a digital dollar. Compared to other countries we are arguably behind, but, at the same time, it also signals a desire by the Fed to work with the White House and the Hill on getting it right when, and — big question — if, we are moving toward a digital dollar.”

The Fed notes in the paper that while a CBDC could provide a safe, digital payment option for households and businesses as the payments system continues to evolve — and may result in faster payment options between countries — there could also be downsides. The paper outlines how to ensure a CBDC would preserve monetary and financial stability as well as complement existing means of payment. Other key policy considerations include how to preserve the privacy of citizens while maintaining the ability to combat illicit finance, an issue that is paramount to several experts.

Make Your Money Work for You

Discover: 11 Best Cryptocurrency Stocks To Invest In

Michael Carter, chief compliance officer at crypto exchange Bittrex, told GOBankingRates that while CBDCs hold the promise of benefiting the banking and financial system by offering increased efficiency, a digital dollar may also hold tremendous power in terms of tracking every transaction made. This could potentially result in a serious threat to privacy, so safeguards should be put in place to protect individuals from intrusions that threaten their civil liberties, Carter added.

“Crypto assets — which are categorically different from CBDCs — could be implemented in tandem with CBDCs to ensure both efficiency and appropriate privacy. Though in theory CBDCs have the potential to completely normalize cryptocurrency by increasing the adoption and usage of digital assets, it is imperative that the benefits that make crypto so attractive today aren’t compromised as a result,” Carter concluded.

Privacy Concerns Surrounding a Digital Dollar

This sentiment is echoed by several experts, who, while underscoring the benefits of CBDCs, also warn of potential complications.

Ehab Zaghloul, chief research scientist at Tribal Credit, told GOBankingRates that under a CBDC, the Fed would have very detailed information about each individual’s spending and credit history. In turn, interest rates could be specifically tailored to any particular individual’s credit health.

“This would be far more efficient than the current system, which sets rates almost like a blanket over the entire economy and, in turn, imposes rates that are often either too high or too low when it comes to matching the individual credit profile of people and businesses. In short, with a CBDC, everything can be tailored for maximum efficiency, helping to spur national growth.”

Make Your Money Work for You

The caveat, Zaghloul added, is that there’s an enormous potential cost that accompanies such efficiency – namely, the utter lack of privacy that consumers encounter if cash dollars are replaced by digital dollars. Digital dollars could be traced and tracked with excruciating detail.

“Every purchase or donation has the potential to be recorded by the government and misused in a number of disturbing ways, which is why it’s incumbent on the government to create policies that protect the privacy of citizens. This could be done in a number of ways — for example, by enabling a CBDC to operate alongside cryptocurrencies,” he said, as cryptos can provide a tremendous amount of privacy via encryption.

Learn: Should You Keep Your Money in the Bank or Invest in Crypto?
Explore: 5 of the Most Crypto-Friendly Banks

“So perhaps a healthy balance could be struck in which a CBDC is offset by the privacy features of Bitcoin and other cryptocurrencies. This is a topic that we can expect to feature more heavily in the national debate as people work to ensure that we can access all the benefits of CBDCs without experiencing the potential breach in privacy,” he added.

The Fed said that to fully evaluate a potential CBDC, it is asking for public comment on 22 questions with a posted deadline of May 20, 2022.

More From GOBankingRates

Share this article:

Make Your Money Work for You

About the Author

Yaël Bizouati-Kennedy is a full-time financial journalist and has written for several publications, including Dow Jones, The Financial Times Group, Bloomberg and Business Insider. She also worked as a vice president/senior content writer for major NYC-based financial companies, including New York Life and MSCI. Yaël is now freelancing and most recently, she co-authored  the book “Blockchain for Medical Research: Accelerating Trust in Healthcare,” with Dr. Sean Manion. (CRC Press, April 2020) She holds two master’s degrees, including one in Journalism from New York University and one in Russian Studies from Université Toulouse-Jean Jaurès, France.
Learn More