The Federal Reserve currently only recognizes one form of currency: physical Federal Reserve notes. Because paper money is still the backbone of our financial system, moving money around digitally is still tricky. The Automated Clearing House (ACH) is our current method for digital payments, which has numerous drawbacks, including fees, payment limits, long transfer times, and the inability to pay internationally. Even “modern” payment platforms like PayPal are just a promise that the money is coming. It may show funds, but the money has yet to be transferred. In this article, we will discuss how Central Bank Digital Currencies (CBDCs) are proposed to solve these issues and what impacts it will have on your investments:

What CBDC Digital Dollar Could Look Like

The Federal Reserve would issue Central Bank Digital Currencies as a Digital Dollar. Funds would be held in an individual’s digital wallet, which a bank or government could provide. Wallets would be funded by depositing physical cash into an ATM or transferring funds from a bank account. The Federal Reserve would allow the easy 1:1 conversion between the Digital Dollar and its cash counterparts. Additionally, taxes could be paid with it. As with other countries where CBDCs have been rolled out, individuals can only see their transactions, whereas the government can see all transactions on their private ledger. Governments claim this is a way to reduce financial crime, but those who are skeptical note the privacy risks.

How CBDCs Would Be Used for Retail Investors

One of the main benefits of CBDCs is increased financial inclusion. No bank account would be needed to store CBDCs in a digital wallet, which could increase the involvement of the 1.4 billion individuals who are unbanked in our global financial network. Physical cash would also see a reduced reliance, which is a step toward our already digitized economy. Payments made with a CBDC would experience the same instantaneous transfer of value seen with Bitcoin but without Bitcoin price volatility. Transaction fees need to be paid in Bitcoin to incentivize miners to spend money to run the blockchain, whereas a CBDC would have no fees. The government would run these servers as part of its budget.

How CBDCs Would Be Used for Institutions

Institutions would see an increased simplicity with financial compliance and tax payments with digital currencies. Since blockchains provide records of all transactions, any audit trails would be easy to locate. In the same vein, automatic tax payments could be implemented, saving corporations money on expenditures to ensure they pay proper taxes. With the decreased reliance on cash, it would be assumed that many retail bank deposits would go directly into individual digital wallets instead of banks. Decreased deposits will limit the ability of banks to provide credit to customers. The growth of CBDCs does present a threat to the current banking system, which is why banks will likely be involved in the issuing process.

CBDCs vs. Stablecoins

As we discussed, Central Bank Digital Currencies would be on private blockchains controlled by the government, whereas crypto stablecoins operate on public blockchains like Ethereum. CBDCs are the fiat dollar in digital form. Stablecoins, on the other hand, are “pegged” to the US Dollar because of the cash reserves their issuing company keeps. A level of trust is needed with stablecoins; the issuer keeps one dollar for every token they issue. This company is also responsible for accepting conversions back to dollars, which the federal reserve would handle. CBCDs remove that layer of trust in a company to maintain that peg but have an added layer of risk with governments controlling the rules of the blockchain. We have seen brief dependencies of USDC, a stablecoin issued by Circle because Circle had a portion of their reserves in the now-saved Silicon Valley Bank.

Impact on Digital Asset Adoption

The implementation of a Digital Dollar in the form of a Central Bank Digital Currency is a validation of the crypto thesis. One of the reasons Bitcoin and other cryptocurrencies have gained popularity is the lack of easy digital payments in the modern age. Bitcoin will remain a valuable part of any portfolio because it is outside the realm of the government. A Digital Dollar still has the same potential inflation that cash has. Bitcoin and other cryptocurrencies will also benefit from increased infrastructure, funding, attention, and innovation within the digital financial world. People will be more familiar and comfortable with digital assets causing a removed dependency on physical cash that stops some people from believing in cryptocurrency as a viable asset.

Potential Drawbacks

The most talked about the concern with CBDCs is the issue of privacy. Any CBDC that could be rolled out would allow the central government to track every transaction an individual makes. Every wallet would likely be tied to your identity. This issue could inhibit the younger generation from adopting CBDCs if they already see the benefits of non-central bank currencies such as Bitcoin. The Bitcoin blockchain tracks all transactions, but there is no direct tie between your wallet and identity. An individual can have infinite wallet addresses controlled by the exact seed phrase, which keeps users anonymous on the internet.

Florida Governor Ron DeSantis mentioned these points when introducing legislation to ban CBDCs in the state. Also, they mentioned the potential for the government to programmatically limit CBDC transactions for purchases such as gas and firearms. Other drawbacks include an increased cybersecurity risk, exemplified by the numerous crypto hacks over the last year, and interoperability with the existing payment system. A CBDC could disrupt legacy industries such as international payments, credit cards, and traditional banking.