I doubt if this blog will be beneficial for the crypto and CDBC experts. But for my friends, I’ve linked several very detailed articles and reports… which I’ve tried to summarize.
With respect to payments, let me start with the quote of the week
“Tom look at the pace of change in China as a model. 15 yrs ago they were cash. 7 yrs ago they were China Union Pay, Now they are Alipay/WeChat Pay.. 3 tremendous changes in 10 yrs. I believe change will happen much faster than anyone could imagine.”
– Top 5 US Retailer
What is a Digital Dollar?
Lets start with terminology. Digital Currencies include asset backed stablecoin (ex CBDC, Diem, tether, …) and non asset backed (ex bitcoin, XRP, dogecoin, …etc) crypto currencies. Stable Coins can be backed by one or more currencies (see Diem). A ≋USD is issued by Diem, it would be a private currency and thus does not have status as a legal tender.
Central banks, including the US Federal Reserve, are assessing the launch of a Central Bank Digital Currency (CBDC) in the form of a stablecoin assigned a fixed USD exchange rate which would have status as a legal form of tender (all must accept) – a Digital Dollar. The best resource for those that want further information is the comprehensive 110 page Brooking Institution Paper – Design Choices for the Central Bank Digital Currency.
China is in Pilot phase (see today’s WSJ), with much press surrounding grand ambitions to supplant the US Dollar’s hegemony as the currency of trade (and trust).
A successful digital Yuan may serve as an alternative to the USD-centric international financial order and would not only reshape cross border trade but would likely be leveraged to shape norms of CBDCs and global governance. The political-economic implications of a successful digital Yuan are enormous. China’s digital Yuan presents therefore unique threats to the USD’s hegemony over the international financial system. While most observers believe a USD replacement is “many decades away”, China’s drive, emergent technology, as well as blowback over USD sanctions may expedite the process.
While Diem will launch a USD stablecoin in next few weeks with the goal of serving 1.7 BILLION unbanked and low cost transactions (≋USD see Libra blog), the US Fed has not yet outlined a policy upon which to collect input (still on the drawing board). As outlined in this Feb 2021 Fed paper, the Fed must first outline objectives for a CBDC. Other countries are moving MUCH faster. Last year, the Bahamas were the first to launch a CBDC (Sand Dollar). If the Bahamian and Chinese efforts were not enough to prompt action, then perhaps Diem’s effort are. Per Chris Skinner “I guess that Facebook caused many central banks to realize that if they didn’t issue digital currencies then others would”.
Clearly US and EU Central banks are 3-5 yrs behind China (Switzerland and UK are leaders). Yet this week we hear an EU MP say “We must not let Mark Zuckerberg become a central bank”. A myopic and nationalistic sentiment that will not help anyone but China. My view is that US and EU banks should run to the support of Diem, Diem has transformed to a model of openness: open standards, open participation, KYC, asset backed coins. In the Diem model, Central banks retain control of monetary policy (and M2) as hard currency is assigned to every item Diem issues.
The Fed and How “The Ledger” Works Today
Today the Fed does NOT hold the specific balance of any individual (or business), but rather each bank has a master record with the Fed. Individual records are held by the banks responsible for servicing the account (in a federated model). Payments between entities are settled between banks in a net settlement process at a clearing house (ex TCH, NACHA, …). The net settlement records are agreed to by each bank and then posted to the Fed via the National Settlement Service (twice a day).
In a slight twist to NSS above, the Fedwire service allows any bank to move money on this ledger in near real time, with the record detail containing the beneficiary account. Fedwire is ubiquitous, but there are competitors. For example TCH RTP is a Real Time Gross Settlement Services (RTGS) available to participating members. Both Venmo and Zelle transactions settle on TCH RTP (for participating banks). The TCH RTP system integrates into TCH’s overall net settlement process (NSS).
There are multiple design options for a CDBC (see BIS Jan 2021 Presentation). Like China, most would agree in a US CBDC, the Federal Reserve would manage a ledger based on blockchain (Bahama’s Sand dollar IBM/Zynesis ). In this model the Fed would hold the detailed ledger of each digital asset token to a wallet (ie Consumer) AND allow individuals to directly submit ledger updates. This is a MAJOR change, a change that could disintermediate many banking services. CBDC banking model is NOT set in stone, but rather highly fluid. Thus Central Banks are carefully considering how to define roles and services for banks (ex, KYC, WHO controls the account).
In the case of the Digital Yuan, the Brookings Institution paper (section 11.2) states
The former head of the PBoC’s Digital Currency Research Institute
described that the DC/EP would be based on the model: “one coin, two repositories, three centers.” “One coin” is the DC/EP, the “two repositories” lie in the central bank as well as the commercial banks who will distribute the digital currency and individual wallets; “three centers” refers to the data centers which will perform authentication, registration, and big data analysis
What are the advantages of a Digital Dollar?
Over the last 20 yrs, most countries have implemented an RTGS system. A CBDC is a generational leap: Money itself becomes an immutable digital object that is assigned and can’t be destroyed or created without the specific direction of the Central Bank. A costless medium of exchange that is immune to fraud and counterfeit. A Digital Dollar would be a legal form of tender backed by the US federal reserve and enjoy all the benefits of existing instruments, plus that of blockchain ledger, stability and fed network expansion to any legal entity or person.
Obviously a CBDC would improve the efficiency of the payment system. It would likely allow for the voluntary retirement of paper money by replacing it with a value store that can never be lost, stolen. From a policy perspective it would accelerate the mechanics of stimulus and intervention. At a commerce level is would allow direct merchant to consumer interaction, and provide improved access for specialists. (See Central Bank Digital Currency and Future of Monetary Policy – Sept 2017)
At the Fed level, the urgency is not because of the need for retail innovation or V/MA costs. The US in the midst of a global race to protect the dollar as a monetary standard.
Chinese officials have made no secret that their greatly accelerated efforts at introducing and distributing the digital yuan are an opening move in their long-term strategy to undermine the dollar’s global supremacy and expand their influence.
For investors, this is an important point. A drive to protect the dollar has unique momentum. This is NOT a tech innovation, but rather CBDC whole sale change to the nature of money. It encompasses a policy impacting: financial markets, trade, treasury and national competitiveness. While it is possible that the US Fed will pursue a wholesale only CBDC (like the Swiss) China’s focus on retail should lead us to the same model. Fortunately either way Diem will be retain focus on retail and is best place to serve as a platform for experience and growth. My view is that Facebook Libra, provided the base model CDBC.
Normally I would discount any threat to V/MA. Why? Because any “new” network would need to create a set of SHARED INCENTIVES that are greater than the current network. A fed CBDC initiative (encompassing retail) would not only overcome V/MA’s ubiquity (to create a new network), it could end run the banks AND gain support for its larger national objectives.
For the Diem association (now free from Facebook). The motivations are at the opposite end of the scale. They are working to solve a global problem that is unsolved today: How to move low value transactions globally across any person (banked and unbanked)? At no cost? I see them running best within the umbrella of multiple Central Banks. Most central bank concerns would go away if Diem would quickly take a position on transaction limits (ex individual can’t hold more than $500 or transact more than $200/mo).
While CBDC digital dollar and Diem’s ≋USD are solutions which differ in: governance, legal tender acceptance, issuance and some technology. BOTH can coexist.
Who is impacted?
I’m going to take a narrow focus on this one. Lets start with retail payments and banking. Per my blog yesterday, an open frictionless ability to move money enables retailers, service providers and direct billers to engage with consumers DIRECTLY. This would further accelerate the unbundling of traditional bank services. CBDC would achieve what “Open Banking” cannot: ubiquitous access to the value every consumer holds (directly).
There are NO CLEARING AND SETTLEMENT systems in a digital dollar. It is a ledger transaction assigning ownership of a digital asset to a wallet.
Every money moving service provider within traditional settlement will be impacted in a model where money is an immutable digital object assigned by the Central Bank. This frictionless ability to move money would SUBSTANTIALLY impact most debit, credit and ACH transactions. While many banks are considering how to play in “Open Banking”, CDBC may turn the nature of banking and payment networks upside down. A future where Retail Banks are removed from payments and left with: core lending, risk management and the exchange of digital currency.
Think about the NeoBanks that developed around Visa’s GPR and White Label Banks (ex TBBK, Meta). In a Digital Dollar world money is stored centrally and exchange is instant. The need for a banking “relationship” will change for many people. If my Payroll could be deposited into a digital dollar, what role does a bank play?
Merchants and Merchant focused service providers (like Stripe, Shopify and Paypal) will bring traditional bank services into their mix. Internationally, India presents the most advanced model of what this would look like, albeit with a common payments access (UPI/IMPS vs a CBDC). Amazon India pictures below.
For banks, the Fed would likely design limits and roles (see Forbes on Bahama’s Sand Dollar) to protect the overall stability of bank DDA/Liabilities.
- Funds that can be held in digital dollars
- Tiers of transactions and KYC (ie address AML issues)
- Bank issuance of proprietary digital dollars (AFI)
If the Fed sets a low limit on consumer funds held in a CBDC, V/MA will have little impact. However if there is a higher limit (think payroll deposit) the DDA will be remade, and with it debit card, bill payment and money movement.
Traditionally bank product change in 20 yr cycles. China has proven that this cycle is gone: in last 10 yrs China has moved from Cash, to China Union Pay to Alipay/WeChat Pay.. and will likely move again. See today’s WSJ on Digital Yuan Use.
I see a US Fed CBDC pilot in next 2 yrs, and release in 3-4. Yes this timeline is much faster than most would agree with. In my view acceleration is based not only on Fed’s desire to preserve the dollar, but also a political environment that is generally antagonistic to banking.
In a conservative model, the CBDC has $500 limit and pilot is complete in 3 yrs. US V/MA debit volumes will be impacted in Year 5 (2026) by 2-4%.
In aggressive model, CBDC has a $5000 limit and pilot is complete in 24 months. US V/MA debit volumes will be impacted by 10%-30%.
- Walmart, Amazon, Shopify, Google, Paypal and others are well placed to execute immediately (given India experience).
- B2B “growth” GDV (including invoice/bill payments) see substantial impact as billers seek immediate relief from interchange
- CBDC will accelerate use of BNPL
With respect to PayPal, I see them as a net beneficiary of CDBC both in reduction of take rate and merchant services for use of digital dollar (wallet and acceptance).
Key Investor Indicators to watch
- CBDC Pilot Timeline
- Diem Progress (launch in next few weeks)
- CBDC Transaction Limits
- China’s Digital Yuan and Alipay Use
- US Fed Policy Support (and Legislative Advocacy)
- Switzerland – Completed Trial Dec 2020 (Wholesale focused)
- CBDC in UK and Australia (2 yrs ahead of US)
Get ready for a new payment roller coaster in 2 years.. The future will be closer than we think.