The Fed is working on a crypto-style ‘digital dollar’
America can develop its own digital currency. Read on to learn more about the Federal Reserve’s announcement of a digital dollar.
Federal Reserve Chairman Jerome Powell announced yesterday that the Fed is considering the creation of a digital US dollar. It would essentially be a cryptocurrency controlled by the central bank.
Several countries are now planning to develop their own digital currencies. These are called central bank digital currencies (CBDCs) and function as a digital version of the traditional currency (fiat) of that country. For example, in the United States, it would be a digital version of the dollar.
Broadly speaking, we can group the types of digital currencies into three categories:
- Bitcoin and altcoins: Bitcoin was the first cryptocurrency, but many more followed in its wake. These are called altcoins. They often aim to use Bitcoin’s blockchain ledger technology in new and more efficient ways. Some want to make transactions faster and cheaper. Others have added new layers, such as self-executing contracts or smart contracts.
- Stable parts: Stablecoins are altcoins indexed to a stable asset, such as the US dollar or the price of gold. The idea is to reduce the risk of volatility that we see with other cryptocurrencies, while still retaining benefits like fast processing and security. Currently, you can buy both stablecoins and altcoins from the top cryptocurrency exchanges.
- CBDC: These are government issued coins that use the blockchain ledger. Unlike other decentralized cryptocurrencies – they don’t depend on a bank or government as an intermediary – CBDCs would be centralized. The central bank or the national government would still control the coin.
When will we see a digital dollar?
It will be a while before the United States introduces a digital currency, if at all. Powell said careful thought and analysis would be needed, and he laid out a roadmap for how to move forward.
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In a video post, Powell explained that the Fed has been exploring the potential benefits of a CBDC for several years. He said: “Our main focus is on whether and how a CBDC could improve an already secure, effective, dynamic and efficient US domestic payments system.”
He clarified, however, that “any potential CBDCs could serve as a complement, not a replacement, for current private sector cash and digital forms of the dollar, such as deposits in commercial banks.”
The Fed will release a discussion paper this summer, and Powell said she is committed to hearing a wide range of voices before making decisions.
Which countries already have CBDCs?
Several countries are in the process of developing CBDCs, but none have started yet.
The Chinese government was one of the first to consider a digital currency and has been working on the project since 2014. It is currently piloting a digital yuan in 10 cities. Some believe that China’s plan to launch its own CBDC is the reason for China’s recent crackdown on cryptocurrencies.
According to Gemini, Sweden has also launched a pilot CBDC called e-krona, which it started testing last year. Likewise:
- The European Union is exploring a digital euro.
- The UK has announced the creation of a working group to explore the risks and benefits of a digital book.
- The Bahamas pilot a Sand Dollar.
What does this mean for crypto?
It’s unclear how CBDCs could affect regular cryptocurrencies. The biggest problem is the question of centralization. By design, cryptocurrencies eliminate the need to have a government or central entity in the middle of transactions. This is not suitable for governments who want to keep control of the money in their country.
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Powell’s speech touched on other aspects of cryptocurrency, including the need for increased regulation. He warned that stablecoins can improve efficiency and lower costs, but they also come with potential risks. For example, these coins may not have the same protections as the money you deposit in your bank account.
He said: “Therefore, as the use of stablecoins increases, our attention must also be paid to the appropriate regulatory and supervisory framework.”
Some have issued a warning, fearing that increased regulation of cryptocurrencies will hamper the development of the industry. Others see it as a way to reduce the negative aspects of digital currencies, such as fraud and money laundering. The challenge for governments is how to protect consumers without stifling the development of blockchain technology. Powell’s discussion-based approach appears to be a step in the right direction.
Emma Newbery owns Bitcoin. The Motley Fool owns stocks and recommends Bitcoin. The Motley Fool has a disclosure policy.