To evaluate a potential central bank digital currency, the Board of Governors of the Federal Reserve System published a document in January 2022 titled . The paper purports to summarize the current state of domestic payments systems, and further discuss the different types of digital payment methods and assets that have emerged in recent years, including stablecoins and other cryptocurrencies. The authors have requested feedback via an online form that poses more than twenty-two questions due by May 20th, 2022. Since meaningful responses require more than the five-thousand characters allowed by the twenty field - and some sections actually contain more than one question, we are publishing thoughts and observations on it here instead, while further addressing some of the shortfalls in the framing and positioning of the paper, and a consequent request for comment. Money and Payments: The U.S. Dollar in the Age of Digital Transformation response form This is a working draft for peer review and discussion . You can leave your comments below, or message me directly and I will share a Google Doc version with you for deeper engagement. We conducted an open forum on this topic online on March 29th, 2022. You can find the recording of that discussion . here General Observations As outlined in greater detail in a , CBDC discussions frequently side-step the most obvious negative externalities of government-issued fiat currency. The paper produced by the Fed is no exception, making it - yet again - somewhat of a strawman discussion. A fact that is already suggested by its title, which indicates a restriction of the evaluation to payments. This limitation seems particularly curious since the primary use case of fiat currency is observably , and digital fiat in particular currently exists only in that state. Furthermore, the title - and to a large extent the discussion itself - ignores money's function. As tendential - some may say misguided - as this use case may be in respect to government-issued fiat currency, the Fed's own shows that the amount of digital fiat currently locked in money market accounts, and certificates of deposit has never been higher than today. Simultaneously, the velocity of the US Dollar-denominated currency - presumed by the Fed to be a leading indicator for its use case for - has reached an all-time low, as shown in the graph below. previous article lending store of value reporting payments Research Standard While published under the banner "Research and Analysis", the thirty-one-page discussion lacks many criteria that would qualify it as such. In keeping with a largely unscientific approach, the paper provides no glossary that could shed light on the publisher's discernment of key terms, and readers are forced to extract definitions from the text itself. As such, the only illustration of the papers key term can be found in its executive summary on page five. The authors define a CBDC as a digital liability of a central bank that is widely available to the general public, and analogous to a digital form of paper money. In as much as the chosen wording indeed introduces several terms - including the metaphors "digital liability" and "digital form of paper money", the manuscript fails to offer further clarifications. To the contrary the authors further compromise their own chosen metaphor in the later parts of the discussion through the introduction of design demands absent from paper money - i.e. a CBDC would need to "afford transparency to deter criminal activity" (page 13). new To provide constructive input, we will prioritize the deconstruction of the suggested framing through the listed questions, rather than listing all methodological deficiencies of the paper. However, we will first address systemic shortcomings which inherently affect the entire paper and associated inquiry. Money vs. Currency Under the headline "The Existing Forms of Money", the Fed's paper offers up a variation of Jevons’ 1875 description of money as a medium of exchange, unit of account, and store of value, replacing the term 'medium of exchange' with 'form of payment'. Since we addressed that this definition only applies to certain forms of commodity money in great detail in a , we will limit the following explanation to the observable implementations of currency, as distinguished from the legal concept that is money. previous article . While individuals may default to a specific unit of account and medium of exchange, anything can be money between transacting parties. Exceptions from these contractual freedoms, can take on the form of legal tender laws, or other interventions by authorities, forcing individuals to use a specific unit of account and/or medium of exchange - i.e. citizens may be compelled to pay State and Federal taxes in government-issued fiat currencies, while it might simultaneously be considered contraband within the prison system of the same jurisdiction. MONEY Money is an agreement between two or more people, most frequently entered into to solve a coincidence of wants problem. . . These systems of money may take on various forms, including physical instantiations quantifiable by objective measures - i.e. one ounce of gold, or paper bills with standardized units of accounts. The most widely deployed examples of the latter are Federal Reserve Notes which currently provide seven standards of IOUs: $1, $2, $5, $10, $20, $50, $100. CURRENCY Currencies are standardizations of agreements over money The Fed paper’s conflation of money and currency clouds all further analysis and prevents the authors from correctly identifying technological innovation in general, and network technologies in particular. A shortcoming exemplified by the manuscript’s brief excursion into 'digital assets' (a rather problematic term itself) on page eleven, which starts out by proclaiming that cryptocurrencies may have "money-like characteristics", while further repeating a number of long-debunked myths surrounding the space of cryptographic primitives and decentralized software solutions - aka "blockchains". In the latter context, all tokens - including all blockchain-based stablecoins - are merely standardized smart contracts. The characteristics of any "cryptocurrency" (a rather unfortunate moniker, leading to much confusion) being "money-like" - to use the Fed's phrasing, is situational and entirely dependent on the transacting parties. Just as a tribesman in Sub-Saharan Africa may see the utility of a stack of $100 Federal Reserve Note in its ability to fuel his fire, internet users may use Ethereum's mining reward (ether) as fuel to operate an application, store of value, or means of payment. The fact that ether, bitcoin, or tether can (somewhat) readily be exchanged against fiat currencies and thus are priced in USD, EURO, or JPY is of no more relevance than the fact a banana carries a price sticker of $0.50 (more ). here For purposes of this response, we will assume that the authors indeed refer to 'paper money' referenced in the discussed paper, but apply the above-referenced first principles to the response which identifies notes issued by the Federal Reserve System as a currency. Guiding Principles The authors claim to have studied CBDC closely for several years and mention the following guiding principles for their implementation: ● provide benefits to households, businesses, and the overall economy that exceed any costs and risks ● yield such benefits more effectively than alternative methods; ● complement, rather than replace, current forms of money and methods for providing financial services; ● protect consumer privacy; ● protect against criminal activity; ● have broad support from key stakeholders. Notably, the list introduces a new crime-fighting objective, absent from current paper money offered as the analog to the discussed CBDC implementation. The new requirement on digital cash is especially curious, given the general acceptance that $100 Federal Reserve Notes are one of the most common media of exchange for criminal activities to date. And, printing dollars is a very profitable business. By value, Federal Reserve notes rank second on the list of America’s , only outperformed by refined petroleum. But selling IOUs is if course much more profitable. It costs the federal government , and a few more cents to send it overseas. In exchange for each of those bills, the United States gets a permanent interest-free loan of $100. most valuable export products around 14 cents to produce a $100 bill At the end of 2021, foreign holdings of American currency totaled almost one trillion US Dollars. Any thoughtful observer will further pause at the framing of the proposed discourse, as a juxtaposition between the public and stakeholders of the matter at hand. While the paper never clearly defines who these 'stakeholders' are, it is a curious distinction, considering the wide implications of changes to a system permeating not only every citizen holding US currency but further affecting users around the world. However, since the paper's publishers represent an agency of the federal government, reporting to and directly accountable to Congress, we will defer to that body as the primary stakeholder, with the expectation that the legislative body will serve as the voice of the people. The public may find it easier to comment on the following musings in the comments below, which will be considered before committing the response to the Board of Governors of the Federal Reserve System. Questions The quality of an answer depends significantly on the standard of a proposed question. The questions posed by the Fed listed below largely require calibration to meet a minimum viable level for a worthwhile discourse. As such many sections require the identification of hidden assumptions, the conflation of technological and policy considerations, as well as a need to pose implementation scenarios, necessary for a meaningful response. 1. What additional potential benefits, policy considerations, or risks of a CBDC may exist that have not been raised in this paper? These are indeed three very different questions, and the answers to all depend largely on the design of the CBDC. The meaning of the latter term remains somewhat vacuous - quote "CBDC is defined as a digital liability of a central bank that is widely available to the general public". Setting the lack of a clear definition aside, the principal questions when entertaining a central bank digital currency supersede those of potential benefits (for whom?), or policy considerations, as a deliberation of the latter, must be tied to the public good's character of any system serving citizens who may be required to engage with it under the threat of violence - i.e., "legal tender laws", as well as non-citizens who are subject to the externalities of such systems. Furthermore, the question of “inaction” must be addressed in the context of other nation-states issuing efficient systems of money (currencies), while extending powers to non-democratic leaderships' intent on replacing the US dollar as a reserve currency. It is further important to note that the Secretary of the Treasury is the chief international monetary policy official of the United States. While the Federal Reserve has separate legal authority to engage in foreign exchange operations, these operations are conducted in close and continuous consultation and cooperation with the Secretary to ensure consistency with U.S. international monetary and financial policy. Setting these entanglements aside, the largest potential benefit of a digital bearer instrument backed by the U.S. government is to provide censorship and surveillance-resistant currency to citizens around the world unable to participate in the global financial system. As history has shown, that when government-issued currencies fail, citizens have most often turned the paper version of the US Dollar. 2. Could some or all of the potential benefits of a CBDC be better achieved in a different way? To answer the question of "potential benefits of a CBDC" requires to first establish the negative externalities of current implementations of 'digital currencies', further necessitating an understanding of the terminology, as well as current technologies. Currencies are systems of money. Setting legal tender laws aside, money is an agreement between two or more individuals or entities (anything can be money). From a technological perspective, the unit of account for the latter is merely a user interface function, since the medium of exchange has de facto defaulted to bytes. Legacy technologies, such as database-maintained digital ledgers, carry an inherent principal-agent risk, and are not censorship-resistant. As such, potential benefits from a digital currency can only be achieved by a CBCD that is a true digital bearer instrument, which is optionally custodied by a central or commercial bank on behalf of the actual owner, without the ability of the institution to revoke control over these assets without due process. The implementation of a CBDC must therefore enable financial service providers (FSPs) - including commercial banks and credit unions - to offer 'CBDC Cash Accounts' (CBDCCA). In a departure from the current demand-deposit account system paradigm, CBDCCAs would take on the form of 'digital lock boxes', fulfilling the proposed requirement of a CBDC analogous to a digital form of paper money. FSPs would offer 'blind custody' solutions, curtailing the principal-agent problem inherent in traditional account-based systems. A robust ecosystem of these custody solutions has developed over the past five years, and is readily available to serve the legacy banking system with appropriate technologies. 3. Could a CBDC affect financial inclusion? Would the net effect be positive or negative for inclusion? Today people are most-often excluded from the financial system due to their socio-economic status and/or because they cannot meet the requirements imposed on the commercial banking sector. According to a conducted by the Federal Deposit Insurance Corporation an estimated 5.4% of U.S. households were unbanked” in 2019, which means that in 7.1 million US households not one person had a checking or savings account at a bank or credit union. Of these 29 percent cited that they “don’t have enough money to meet minimum balance requirements”, another 16.1 percent of unbanked households cited that they “do not trust banks”. Lastly, 20% of unbanked do not have the necessary personal identification documents to establish a bank account. 2019 survey As before, the net effect of a CBDC on financial inclusion will largely depend on the specific implementation. If the CBDC design will indeed be analogous to a digital form of paper money - and in particular not require government-issued credentials - a relevant portion of the unbanked will be able to participate in the financial system, using a digital bearer instrument, potentially providing a net positive effect to that cohort. 4. How might a U.S. CBDC affect the Federal Reserve’s ability to effectively implement monetary policy in the pursuit of its maximum-employment and price-stability goals? The main questions of monetary policy are readily answered by the fundamental organizing principle of the market: private property. In that respect each individual is a policymaker, making policy with his own property; and each individual pursues the objectives that he would choose to pursue. Monetary policy is, as such an exception from general free market principles, the violation of which has historically been the primary cause of depressions and uncertainty. CBDCs may mitigate against the latter by strengthening property rights, and visibility into (and reaction to) interferences with the free market. As Milton Friedman has pointed out, one of the most important things monetary policy can do is ‘‘prevent money itself from being a major source of economic disturbance.’’ If indeed implemented as, and analogue to, a digital form of paper money, users will readily be able to move CDBCs from one yield-earning state to another. A CDBC executed in this way, can avoid a state of debasement, aiding those otherwise limited to 'cash-based' transactions. 5. How could a CBDC affect financial stability? Would the net effect be positive or negative for stability? As before, the answer depends largely on the specific implementation of a CBDC. As with printed notes, CBDC entries will presumably be non-interest-bearing bearer bonds of no fixed maturity. As these are issued by a federal entity, they are debt obligations of the federal government. Further, these "notes" must be exchangeable, without restriction and at par, or face value, through commercial banks, for interest-bearing Treasury debt. Financial instability is largely caused by market distortions, in particular the creation of fiat currency supply for non-productive activities. As such, a CBDC must first and foremost openly report on – and surface - these structural problems and have the technical capability to provide reporting functions while protecting the privacy of transacting parties. 6. Could a CBDC adversely affect the financial sector? How might a CBDC affect the financial sector differently from stablecoins or other nonbank money? This question contains a false premise, as the “financial sector” does not exist as an end to itself but is a conduit to facilitate real economic activities. And, in as much as a CBDC introduces efficiencies to the primary use cases of currency (lending, store of value, spending/payment), it may encourage commercial banks to adopt equal or better technologies. It must be noted however that enormous sums of fiat currency are currently held with commercial banks in money market accounts, and certificates of deposits. Fiat currency locked in these contracts will not return yields above the expected rate of debasement for the foreseeable future. A CBDC must be able to unlock these funds to make them available to a competitive lending market. 7. What tools could be considered to mitigate any adverse impact of CBDC on the financial sector? Would some of these tools diminish the potential benefits of a CBDC? Commercial banks should be allowed to create hosted “branded wallets” which can hold CBDCs from any central bank, as well as any privately issued digital assets. The ability to create branded CDBC wallets should be provided as software development kits and must be available to both custodial (hosted), and non-custodial wallet providers. The latter ensures the “cash-like” quality of a CBDC, while fostering financial inclusion for individuals currently excluded from the legacy financial system. 8. 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. 9. How might domestic and cross-border digital payments evolve in the absence of a U.S. CBDC? “Payment” is too vague of a term to be discussed in a meaningful way. However, in as much as digital bearer instruments of any unit of account can settle with finality in near real-time, and provide “programmable money” optionality, these are a already technical reality which cannot be ignored without suffering the consequences of technological debt. The latter can already readily be observed in the decline of USD denominated transactions of global economic activity. 10. How should decisions by other large economy nations to issue CBDCs influence the decision whether the United States should do so? CBDC's implemented as true digital bearer instrument with ability to create "programmable money" provide an instant competitive advantage to any nation. This technology exists today, and its implementation is actively being pursued by other large economies. The United States must urgently increase its efforts to catch up to these developments, to avoid putting its own economy at a distinct disadvantage. 11. Are there additional ways to manage potential risks associated with CBDC that were not raised in this paper? From a technological perspective the medium of exchange has observably defaulted to bytes. The unit of account of any currency is a mere user interface function. Which is to say, discussing the latter amounts to arguing about the color of bytes Currencies are network technologies that exist in the wider context of the internet. Engagement with the latter is largely a matter of client technologies - i.e. digital wallets. The ability to freely use the latter, while supplementing it with nation-state enforcement mechanisms that protect human agency outweighs the importance of a discussion of 'currencies', including CBDCs. 12. How could a CBDC provide privacy to consumers without providing complete anonymity and facilitating illicit financial activity? The question entails a false choice, assuming the intellectual integrity in reference to a CBDC's analogy to physical cash. The latter medium of exchange currently provides complete anonymity, enabling a cottage industry comprised of licensed financial service providers who profit from illicit activities. However, as with previous questions, the answer is largely dependent on the technical implementation of a CBDC. Assuming the latter will indeed take on the form of a digital bearer instrument, any measures directed at curtailing 'illicit activities' are unlikely to be implemented at the level of a digital bearer instrument. 13. How could a CBDC be designed to foster operational and cyber resiliency? What operational or cyber risks might be unavoidable? Cyber resiliency is primarily achieved by the decentralization of individual data controllers. These suffer from an inherent principal-agent problem ("admin access"), exponentially increased by legacy technology, in particular database solutions. Unavoidable cyber risks are those inherent to the human condition, as most cyber security breaches are not a result of technical intrusion but hacking by the means of social engineering. 14. Should a CBDC be legal tender? Yes, however only in respect to its acceptance by government agencies. Private persons or organizations should not be legally required to accept a CDBC. 15. Should a CBDC pay interest? If so, why and how? If not, why not? No. The Fed was established to provide price stability and prevent periodic banking crises. It has accomplished neither but instead caused price instability and massive banking failures, by distorting market forces. The Fed’s near‐ zero interest policy has set the economy on an unsustainable course: With inflation at record highs and interest on various types of savings accounts at less than one percent, those who thought to have been acting financially responsible and saved are de facto being penalized for trusting the central bank, and forced to accept what is, in effect, a negative rate of interest. Credit is no longer being allocated by the market but to classes of borrowers as determined by politicians. Central Banks must be provably market neutral, 16. Should the amount of CBDC held by a single end-user be subject to quantity limits? No. Also: what qualifies as an "end-user". Would the largest corporations be "end-users"? 17. What types of firms should serve as intermediaries for CBDCs? What should be the role and regulatory structure for these intermediaries? In order to fulfill the requirements of a CBDC analogous to a digital form of paper money, the role of intermediaries should be limited to "blind custody", similar to the functions physical lock box vendors - including commercial banks - provide today. 18. Should a CBDC have "offline" capabilities? If so, how might that be achieved? Yes. Several solutions exists today that work on the principle of unspent transaction outputs (UTXOs) 19. Should a CBDC be designed to maximize ease of use and acceptance at the point of sale? If so, how? Yes. - QR codes have long been used for payment functions, and most point-of-sale systems support their implementation already. 20. How could a CBDC be designed to achieve transferability across multiple payment platforms? Would new technology or technical standards be needed? To achieve transferability across multiple payment platforms, a CBDC design should be compatible with the Ethereum Virtual Machine (EVM). While originally developed for the open-source Ethereum blockchain, EVM has emerged as the de facto standard globally. The paradigm provides standalone implementations across the most used programming languages (Python, C++, JavaScript, Go, and Haskell), and a majority of existing decentralized network systems (i.e. blockchains and directed acyclic graphs) opted for EVM compatibility. Already more than one hundred client applications (“wallets”) utilize the standard, with an estimated 2.7 billion users as of March 2022 ( ). src 21. How might future technological innovations affect design and policy choices related to CBDC? Predictions for how future technological innovations can affect design and policy choices for a central bank issued digital bearer instrument can be deduced from past technological innovations such as the introduction of the voice-over-internet protocol (VoIP). While some governments penalized their own citizens, making it "illegal" to use VoIP client software (presumably to protect state-owned telecommunications carriers), other nations embraced the technology, and allowed new industries to be build atop of the protocol. This greatly benefitted the citizens of these countries, which were heretofore metered by the Minute for every phone call. Telecommunications companies adopted the protocol for their backbones, and phased out obsolete infrastructure. Digital bearer instruments build atop decentralized software solutions such as blockchains, have been successfully tested for more than a decade, and reliably move tens of billions worth of currency daily. According to , revenue from global payments exceeded $1.9 trillion in 2020. In the light of that year's global gross-domestic product of $84.7 trillion (source: ), it could be said that each product or service incurred a tax an extra 2.2% tax. - Not enabling the US Dollar to operate as a frictionless digital bearer instruments, is not akin to keeping the rotary phone alive in the age of smartphones, it is comparable to forcing internet users to affix stamps on their emails. Less messages are being sent, fewer commercial transactions are taking place, innovation is stifled. The 2021 McKinsey Global Payments Report WorldBank 22. Are there additional design principles that should be considered? Are there trade-offs around any of the identified design principles, especially in trying to achieve the potential benefits of a CBDC? We outlined design principles as well as practical design considerations in a . previous Hackernoon article Background: Why take the time to respond? For the past five years - continuing to date - we have evaluated hundreds of solutions addressing value transfer systems in order to determine their long-term viability, which in turn is our criteria for their investability. These ideas range from entirely new concepts - such as automated market makers - to the simplest solutions, introducing new payment technologies. As a venture fund that applies the scientific method to the analysis of investment opportunities in emerging network technologies, we consider the viability of a given solution in terms of its competitiveness globally. Our views and assessment are necessarily broader than the framework provided by the Fed paper would allow for. We are currently summarizing these in an upcoming book . Streaming Money
