My Comments on the U.S. Fed's CBDC Paper

The United States Federal Reserve published a white paper detailing its investigation of developing a Central Bank Digital Currency on January 20, 2022, and the window for public comment is open until May 20, 2022.

As the writer of the Digital Universal Drachma whitepaper, I thought I might share my thoughts on the paper’s content and the answers I will be submitting to some of the questions asked.

Overall Reception

In the grand context, I’m rather pleased with the content of the Money and Payments: The U.S. Dollar in the Age of Digital Transformation paper. In a refreshing change of pace, a new entrant to the cryptocurrency economy is approaching its development with sincere respect for the consequences of its actions.

That said, I hope this thoughtfulness does not become an obsessiveness with initial perfection that prevents concrete development and releases from actually occurring.

I was pleased to read that the Federal Reserve expresses no interest in producing a CBDC that enables Orwellian dominance, nor will it allow the development of private cryptocurrencies to form a future relegated to economic anarchy.

Responses to Prompts for Comments

But you didn’t really come for me to pat the Fed on the back. You want some real meat to chew on, so here it is; my answers to a selection of the questions asked in the Request for Comments.

Could some or all of the potential benefits of a CBDC be better achieved in a different way?

Yes, rather than issuing an entirely centralized digital currency, the US Federal Reserve ought to consider taking an approach to digital currency similar to the one it currently uses for its fiat money—that is, one that is collaborative with the private sector.

The Federal Reserve currently allows banks to effectively issue legal tender. By being so focused on the idea of a Central Bank Digital Currency, the US Fed is ultimately limiting the scope and resilience of America’s future digital currency.

The full nature of the alternative proposal is not able to fit in this comment, so I refer you to the full white paper of the Digital Universal Drachma (as published on the Internet Archive and Hackernoon).

Could a CBDC adversely affect the financial sector? How might a CBDC affect the financial sector differently from stablecoins or other nonbank money?

As previously mentioned, if the digital currency the US Federal Reserve decides on is strictly in control of the central bank, the financial sector would be left in a place of limbo. If banks create legal digital money, and the central bank does the same, this will result in effectively recreating the economic disunity that existed before the Coinage Act of 1792.

Banks currently use digital currency through account balances of broad money, backed by a ratio of narrow fiat money—that is, M0 and M1/M2 money have distinct forms and functions. The introduction of a CBDC would make M0 currency have the same form and enable the same functional advantages of current M1/M2 money.

Thus, the currency created by the financial sector would be at risk of being perceived as far less valuable since its guarantee of value is less strict, its ease of use for everyday transactions the same, and its convertibility less than that of a CBDC.

This can be avoided, however, by including the financial sector in issuing digital currency to ensure a unified and stable method of transacting. I once again refer to the Digital Universal Drachma white paper for further discussion.

If cash usage declines, is it important to preserve the general public’s access to a form of central bank money that can be used widely for payments?

Yes, the public must always have easy access to a form of central bank money. As the 2008 financial crisis demonstrated, it is unnervingly likely for the financial sector—and thus the currency they issue—to completely collapse upon itself without government intervention.

Thus, it is the responsibility of the central bank to ensure that the common person has access to money it guarantees itself to prevent the complete decimation of the lower and middle classes in the event of an economic crisis.

How might domestic and cross-border digital payments evolve in the absence of a U.S. CBDC?

The most likely scenario is that another global economic power’s currency will eventually be phased in to become the new international reserve currency. That means the Bank of International Settlements, foreign debt, and even the backing of a nation’s fiat currency will all be reliant upon a digital currency from the likes of China to conduct business.

International economics is a game of hedging bets on trust in a currency’s stability and enabling efficient and cost-effective transferring of assets. Without a digital currency sponsored by the US government, the USD would first lose to other currencies in terms of ease and efficiency, and then in trust, as it becomes apparent that the American economy refuses to modernize.

How should decisions by other large economy nations to issue CBDCs influence the decision on whether the United States should do so?

Ideally, the decisions of other large economies regarding CBDCs should not at all influence the decision of the United States. We should be the leader in this economic frontier.

That being said, decisions by other economies should be engaged with diplomacy to seek a unified digital currency among the nations—with each nation’s economic authority able to continue to make economic policies—with the goal of creating a more inclusive and resilient global economy.

How could a CBDC provide privacy to consumers without providing complete anonymity and facilitating illicit financial activity?

Digital currencies should have the trait of auditability, not anonymity. That is, through cryptographic protocols such as hashing, the true identity of a user is made entirely opaque in normal circumstances.

However, since transactions are not private, end-to-end encrypted, nor obfuscated through Tor or Monero-like methods, the government would be able to use its extensive computing resources to uncover the identities behind suspicious transactions. A more detailed account of the specifics of this can be found in the Digital Universal Drachma white paper.

Should CBDC be legal tender?

Yes. If a CBDC isn’t legal tender, it is just a symbolic gesture of engaging in the crypto economy without actually endorsing the benefits it can bring to society.

Should CBDC pay interest? If so, why and how? If not, why not?

No, a CBDC should be a functional form of transactional currency, not an investment. Investments can already be made in private digital assets; what the economy needs is a government-guaranteed transactional digital currency.

If the idea is just to offer a flashy new form of bonds, the general public is left out of the digital economy, and the U.S. Fed risks becoming obsolete in daily cryptocurrency usage.

Should the amount of CBDC held by a single end-user be subject to quantity limits?

In a sense, but not a direct quantity cap. Instead, as further explained in the Digital Universal Drachma white paper, the ratio of assets backing the digital currency should be a function of the Herfindahl–Hirschman Index of a given sector that the end-user belongs to.

Thus, while not punishing competition, it discourages stagnation and inequitable consolidation of wealth.

Should CBDC have “offline” capabilities? If so, how might that be achieved?

Yes, offline capability is essential to ensuring economic inclusion. As digital currencies are dependent upon verification online to prevent double-spending, the question becomes: how does one prevent double-spending when offline?

My suggestion is to borrow the concept of endorsement from Directed Acyclic Graphs. In short, a unit of currency’s most recent transaction must be verified by a specified number of trusted financial institutions before being spent.

That way, a user can store the public key of said institutions offline to verify their endorsements of its ownership, but that unit cannot be further spent until it syncs with the online network and is verified.

Are there additional design principles that should be considered? Are there tradeoffs around any of the identified design principles, especially in trying to achieve the potential benefits of a CBDC?

For a full discussion of other design principles, please see the Digital Universal Drachma white paper. The following, though, are two key concepts to consider:

• Interpolation-based ownership history, rather than traditional blockchain, provides substantial benefits when it comes to the size of the ledger.

  
  

• Panmetallism (a further development of bimetallism) would provide trust and stability in the currency’s value, just as Hamilton argued when laying the foundations for the American economy.

Conclusion

While I am encouraged by the disposition the US Federal Reserve demonstrated in their request for comments, my hope is that such serious consideration for the future of cryptocurrencies expands to all sectors that stand to be affected.

Credit unions, businesses, lawmakers, academics, and voters must all become involved in designing a digital currency that capitalizes upon this historically unique opportunity to re-imagine the nature of money.