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A digital dollar — why, how, and why now

Image Credit: Jason Reed/Getty Images

Since Facebook’s announcement of its proposed Libra project last summer, monetary authorities worldwide have redoubled their efforts to develop central bank digital currencies (CBDCs). These efforts were underway even before Libra, for very good reasons — Facebook’s announcement simply sped up developments that were inevitable.

The sudden slowdown in productive activity worldwide brought on by the present coronavirus outbreak makes the matter more urgent. Social distancing measures are antithetical to many kinds of productive activity. “Knowledge workers” might be able to continue their work remotely, but most others can’t. Economies worldwide are accordingly confronted by simultaneous supply-side and demand-side shocks.

In order to mitigate, minimize, and reverse these shocks, we need to act as quickly as humanly possible, and this means that our capacity to store and to transfer value — to make and receive payments and disburse monies — must be sped up as well. The millions of Americans who are now struggling hardest cannot afford to wait weeks for their checks to come “in the mail.” Whatever we’re able to do to optimize our payments architecture, we must do.

Digital currencies are an optimal means to achieve payment efficiency. The reasons are straightforward. A currency is simply “that which pays” in a payments system and “that which counts” in a system of value accounting. To design a digital currency is accordingly to design a digital payment platform. It is to design a literal speed-of-light mechanism of value transfer and storage. It is to supply a banking and financial infrastructure by supplying a commercial architecture, as is always the case in any commercial society or “exchange economy” such as our own.

The sooner the United States can adopt such an architecture, the better. That is true for reasons not only related to this time of crisis response but also for long-term commercial and financial inclusion and efficient transacting.

In a commercial society and exchange economy such as our own, a commercial architecture must be accounted for as an essential public utility — as freely available to citizens, legal residents, and businesses as are sidewalks, highways, and parks. Status quo payment services that extract fees or financial data from customers, or that require the unbanked to have bank accounts, will not cut it. Nor, of course, will check cashing firms that skim from the checks that they cash.

In any economy whose size and growth are measured by gross domestic product (GDP) as ours is, moreover, to streamline the payments system is in effect to facilitate growth. Faster transacting means more transacting within any given time interval, which in turn means more growth as measured by GDP. The same phenomenon occurred with the proliferation of credit cards and will only accelerate when we move all digital payments to real time. A publicly provided digital payment platform is accordingly a justice gain and a growth gain alike.

It is also a crisis-mitigation gain. Congress has debated multiple mechanisms, this past month, by which to get badly needed relief money to individuals and businesses across the country. These debates have highlighted the Byzantine complexities of our presently sprawling and often-incommensurable national payments system — assuming the word “system” can even be used here with a straight face.

There is no reason to keep going on like this — any more than there was when Congress and President Lincoln instituted the Greenback to replace the hundreds of wildly fluctuating “wildcat” notes as the nation’s first uniform paper currency. We are now in a “wildcat” payments era, and there is as much reason to go national in the digital space during the present crisis as there was to go national in the paper banknote space during the Civil War crisis.

Option 1: Treasury Wallets and Treasury Dollars

There are a few ways to do this. One especially easy way to do it would be simply to add two functionalities to the Treasury’s already existing network of Treasury Direct accounts. Any citizen or legal resident of the U.S. with a bank account and a Social Security or Taxpayer I.D. number can now open a digital account with the Treasury through which to transact with the Treasury any time of the night or day in Treasury securities. It takes literally no more than 10 minutes to open an account and begin transacting.

The Treasury would only have to add three things to this existing platform to convert it into a universal digital payment platform:

1) give Treasury Direct Accounts digital wallet functionality;

2) add “horizontal” peer-to-peer (P2P) connectivity between the resultant Treasury Direct digital wallets to the current “vertical” connectivity between Treasury itself and Treasury Direct Accounts; and

3) ensure that (a) existing bank accounts have that same connectivity to these wallets or (b) issue a new Treasury Dollar that is equivalent to one Federal Reserve Note (i.e., current dollar bill) both in value and in legal tender status.

Because upwards of 25% of Americans are unbanked or underbanked, we think (3)(b) — that is, a Treasury Dollar — preferable to (3)(a). Treasury Direct wallets then would amount to a form of digital banking open to literally all citizens, legal residents, and businesses in the country. This is a good in its own right, and is more than that now. In this hour of crisis, it is an urgent necessity.

A second option, either instead of the Treasury Option or to replace it after there’s time to build an entirely new infrastructure, is to assign the Fed the task of issuing and administering a new digital dollar.

Option 2: Fed Wallets and Digital Federal Reserve Notes

It might be preferable, in time if not immediately, to charge the Fed rather than Treasury with the task of developing, issuing, and administering a new digital dollar. The advantages of going this route are several. The Fed already administers the national payments system and the FedNow system now nearing completeness. It also already administers a system of dollar-denominated accounts — namely, bank Reserve Accounts — through which it conducts its monetary policy operations, and in time it could seamlessly integrate its wallet operations into those. The disadvantage is that it could well take the Fed longer than the Treasury to make this change.

Either way, the steps the Fed would have to go through would be reminiscent of, but not identical to, those the Treasury would have to go through:

1) give existing Reserve Accounts P2P digital wallet functionality;

2) convey such P2P digital wallets to all citizens, businesses, and legal residents in addition to banks;

3) ensure that existing private sector bank accounts have the same “horizontal” P2P connectivity to these wallets.

Technical Requirements

The technology involved in laying out an infrastructure for the digital dollar is not trivial to build, but neither is it daunting or especially challenging. It has been done before, by multiple FinTech firms and networks for multiple purposes over the years. Through a partnership between academia, Silicon Valley, and policymakers, this is definitely possible. All that differs now is that we are doing this for a public purpose — that of installing a universally accessible, fee-free, and frictionless state-of-the-art national value-storage and payments architecture. This is obviously desirable at all times, but especially so in times of distress.

What, more specifically, does the technology look like for supporting digital dollar wallets for citizens, legal residents, and businesses, without requiring them also to maintain separate private sector bank accounts? It is, believe it or not, not at all complicated. There are several key layers of any such system, and only one has yet to be built.

1) The accounts layer: There must be safe, secure accounts that have reliable “know your client” (KYC) identity-authentication protocols. These accounts function as users’ virtual wallets, from which they can send, and into which they can receive, digital dollars. They are essentially bank accounts with smart device keypads instead of storefronts. Critically, wallet holders have instant access to their funds, which is not the case with Venmo, Paypal, or other private sector payment platforms that depend upon multi-day automated clearing house (ACH) operations to finalize payments. Treasury Direct Accounts already possess most of these features and can be readily upgraded to complete the replication. Fed Wallets could be given these features from the get-go. Regardless, collaboration with the private sector and academia will be crucial in crafting state-of-the-art identity, authentication, and authorization controls in order to minimize any chance of fraudulent activity.

2) The payments layer: There must be real-time capacity for simultaneous debiting of payor accounts and crediting of payee accounts. The Federal Reserve is developing such a system — FedNow — for clearing between banks. Treasury can readily supply the same among all Treasury Direct wallets — the technology, again, has long been familiar in the financial technology industry.

3) The application programming interface (API) layer: This enables interoperability between the system being developed on the one hand, and other verified third-party services, including PayPal, Venmo, merchant POS systems, and cross-border payment services on the other hand. These integrations will be desirable insofar as there continue to be other ways to send money to friends, family, and businesses. But it is worth also bearing in mind that the upgraded digital dollar wallet is meant to enable costless payments among all parties who pay or are paid in legally permissible transactions.

4) The ledger: The Treasury Direct or Fed Wallet accounting system as a whole is the final layer. This layer enables aggregation of transactions while also constituting a node through which to inject Treasury Dollars or Fed digital dollars for macroeconomic purposes. The ledger can be distributed (a DLT) and thus grounded in blockchain technology, or can be centralized as Treasury Direct and the Federal Reserve system is now. If we ultimately decide to go the DLT route, then we might see some increased complexity in implementation as we make architectural decisions concerning encoding keys, hashing, and hot/cold storage. But the underlying concepts and requirements don’t change, and in any event we can enable Treasury Direct as currently constituted or Fed Wallets from the get-go for P2P use without having to wait. Any subsequent move to a blockchain can be planned and executed at our leisure.

As we noted above, central banks worldwide are already developing and rolling out digital currencies in the name of greater commercial inclusion, smoother payment systems, and less leaky monetary policy. Sweden began its first public trial of the e-Krona project, long in development, only this February. Most importantly, China in the last week has launched a government-led Blockchain Services Network that will rapidly enable the use of digital yuan in payments as soon as next month. Is there really any reason — especially now, amidst the crisis — to cede China the advantage, or even global monopoly status, in this space as well?

If the COVID-19 crisis ends within the next few months, the digital currency infrastructure might not be robust enough for immediate launch. However, recent inefficacies in stimulus payments have only made it more obvious that we need a faster and more inclusive financial system. Sending and receiving money should take no longer than sending and receiving email. Adding fuel to the fire, China is capitalizing on American paralysis to become the worldwide leader in payments. The time to act was yesterday. But there is still time — and hope.

Robert Hockett is Edward Cornell Professor of Law and Finance at Cornell University, and serves on the boards of the Digital Fiat Currency Institute and the Public Banking Institute. 

Anshul Gupta is completing his M.S in Computer Science at Stanford University and has experience building technologies for the Federal Reserve and Microsoft. 

Lawrence Rufrano is Executive Director of the Advanced Financial Technologies Lab at Stanford University and Managing Director of EvoNexus.

The opinions expressed here are not necessarily those of the authors’ institutions.

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