Digital currency race between US and China is on, who is winning?

The United States Congress and Board of Governors of the Federal Reserve System are examining whether the US should issue a Central Bank Digital Currency (CBDC) in cross-border payments. The research and public engagement on CBDCs are due to a number of developments, including the growth of stablecoins, advancement of foreign CBDCs, and competition between the US and the People's Republic of China in a race to determine which CBDC will be the primary digital form of currency as an alternative to the US dollar as a global reserve currency.

On June 15, 2021, the House Financial Services Committee Task Force on Financial Technology held a hearing titled "Digitizing the Dollar: Investigating the Technological Infrastructure, Privacy, and Financial Inclusion Implications of Central Bank Digital Currencies." This hearing was focused on the overall feasibility and future role of a digital currency issued by the US Government. The main topics discussed included financial inclusion, consumers' right to privacy, and what agencies would carry out the implementation of a digital dollar. While there is no legislation tied to this hearing, yet the bipartisan enthusiasm surrounding the topic suggests this idea will be acted upon in the future.

The chair of the task force, Rep Stephen Lynch (D-MA), began the session by pointing to the fact that while payment systems evolve as technology advances, "cash still plays a vital role in the financial ecosystem." He outlined how cash is permissionless, meaning no outside entity can regulate how it is used, and it is untraceable. While the concept of a CBDC may sound similar to cryptocurrencies, such as Bitcoin, Rep Lynch pushed back against this claim with the example of the Sand Dollar, a digital currency issued by the Central Bank of the Bahamas which has enjoyed success in bringing currency to unbanked citizens.

Digital currency systems resulted in increased financial inclusion in the Bahamas, and this specific point was discussed at many points throughout the hearing. When governments create and distribute digital currency that citizens can access via a mobile app or prepaid card, people who live in rural areas or are otherwise unable to go to a consumer bank can have access to non-cash currency and, more broadly, to the financial markets.

As Cadet explained in her testimony, "the reality is the banking business model still leaves millions of citizens under banked, many with no access to basic bank accounts and relatively no access to cost effective digital payments and online economy." This disparity has only become more apparent during the Covid-19 pandemic, when many people were unable to travel to a bank to open an account or receive assistance in setting up mobile banking services. Cadet also explained how "low-income households are forced to pay extra for financial services when they find themselves in an illiquid financial position. They are either faced with costly overdraft fees or must resort to the services of illegal or informal money lenders facing predatory costs and conditions." Witnesses explained how these, obstacles to financial inclusion clear solutions in a financial ecosystem have that includes digital currency.

As with most debates regarding an expansion of the federal government, several lawmakers and witnesses expressed concerns about consumer privacy. The main debate surrounding the digital dollar is whether it should remain an untraceable form of currency like cash, or whether limited information should be collected to prevent money laundering and illicit payments. There seems to be bipartisan consensus that giving the US Treasury or Federal Reserve unchecked surveillance powers over a digital dollar would infringe on individual liberties, but there is disagreement over the extent to which a digital dollar should be private and permissionless.

Rohan Greyspoke about peer-to-peer payments, which were not discussed in depth by other witnesses or lawmakers at the hearing. Peer-to-peer payments describe transfers between users, which would in this case consist of one user sending another user digital dollars. Grey took the position that peer-to- peer payments should be allowed with no third-party approval, meaning that any person would be able to send digital dollars to anyone they choose. Grey remarked that while this opinion may sound "radical," it is, in essence, preserving the "permissionless" feature of cash.

He supports this position by stating, "Preserving the right to hold currency and make peer-to-peer payments directly without third-party involvement or approval is a small-c conservative response to the socially disruptive effects of digitization and the internet." While others did not express disagreement with this position, it can be inferred that those who support government surveillance for crime prevention would not agree, such as Chairman Lynch, who emphasized in his opening statement the need for a balance between privacy and preventing misuse.

Another point of debate throughout the hearing was the discussion of specific duties of federal agencies in a digital dollar system. While some participants were quick to place the onus on the Federal Reserve and Treasury to carry out a digital dollar system, others suggested the involvement of a slew of other federal agencies. Jonathan Dharmapalan gave a decisive opinion in his testimony, stating "The responsibility to securely produce notes and coins is placed on the Treasury of the United States. Extending that responsibility to the production of CBDC would be a natural extension of the role of the Treasury. The Federal Reserve can then fulfill its subsequent role as the issuer and distributor of the CBDC." Similarly, to Dharmapalan, several of the other witnesses, such as Dr. Jenny Gesley and Ms. Cadet, established the Central Bank as the main distributor of currency in a CBDC program. In the United States' case, it can be assumed that "Central Bank" refers to the Federal Reserve. Grey, on the other hand, pushed back against this assertion and calls for a "polycentric digital Dollar architecture," stating, "other public agencies, such as the Treasury and the Postal Service, have unique needs, priorities, and expertise that should also be considered when evaluating the appropriate division of executive branch responsibilities for digital fiat currency infrastructure."

After his testimony, several Republican members of the subcommittee expressed their disagreement with the suggestion that the United States Postal Service should be involved in consumer banking due to perceived fiscal inefficiencies within the department. There was not a clear consensus among the hearing participants about what agencies would be responsible for issuing and distributing digital dollars, but it seemed to be agreed upon that the Federal Reserve and Treasury would have primary roles in the system.

In this hearing, there was widespread enthusiasm for the creation of a government-issued digital currency. This topic is exceedingly relevant as China develops its own digital Yuan and attempts to challenge the US dollar as the default global reserve currency. Possibly the most important point agreed upon by both parties was the fact that the United States should strive to be the most thorough when creating digital currency, rather than being the first. Financial services firms should stay updated for developments within the digital currency space to adjust their strategies; accordingly, banks will be valuable partners to the government when digital currency eventually needs to be distributed to consumers.

(The author is Executive Director, RISC Services, Ethan Parker, Center of Regulatory Intelligence)