Will There be a Digital Dollar? Let’s Review the Pros & Cons

As cryptocurrencies seem to be the hot topic lately, countries like China and Sweden are already looking into digitalizing their own currencies. It seems that U.S. is also following the example with Federal Reserve issuing a report last Thursday explaining the pros and cons of a digital dollar.

The positives of a digital dollar

One of the positives of a digital dollar could be less credit and liquidity risk. Taking the commercial banks out of a simple money transfer could mean less risk of a default (third party defaulting). It would also mean fewer transaction fees. When it comes to liquidity, since CBDC would be encrypted, direct money transfer payments overlooked by the Central Bank could be made without a clearing party. This would make the transfers faster and more efficient.

A digital dollar could also simplify cross-border payments, moving away from clearing payments the traditional way – through a third party and using what made crypto so popular – encryption.

A CBDC could be scheduled to make batches of small payments, that traditional systems might not allow for.

Another possible positive of CBDC for the U.S. influence is that it could help maintain the dollar as the world’s primary reserve currency, especially if threatened by other currencies who already have or plan to move towards digital cash.

Over 5% of U.S. households do not have a bank account, it could be argued that introducing CBDC could bring financial services to such households with its ease of use.

The negatives of a digital dollar

Allowing the Fed to back digital payments could completely change the structure of the U.S. financial system. Commercial banks rely on deposits to dole out loans, but a CBDC could replace cash held in commercial banks with digital wallets offered by the private sector. That could mean that taking out a loan is going to be far more difficult in the future.

Another possible issue is massive outflows of cash from commercial banks in times of economic uncertainty. Traditional measures to battle that would be insufficient if people were to start converting their bank holdings into CBDC.

An even scarier scenario is the federally backed digital dollar eroding the central bank’s policy power. By changing the amount of reserves in the financial system, the traditional way of setting interest rates and managing inflation might need to change. There would need to be an influx of cash into the federal reserve just to accommodate fluctuations between outstanding cash, bank reserves and CBDC holdings.