The Fed drafts MIT to bring U.S. up to speed in the digital currency race

The global digital currency race has heightened the threat to traditional monetary policy and the dollar’s dominance, enough for the Federal Reserve of Boston to make a concerted effort to keep pace.

The Boston Fed and the Massachusetts Institute of Technology will build and test a digital currency “oriented to central bank uses.” The project's digital currency is hypothetical, given the U.S. has not formally announced a central bank digital currency. But it’s likely the U.S. will have no choice but to pursue this path, given the scale of the global parties that are pursuing the technology.

China and the Libra stablecoin project (which originated from Facebook) are both drawing a lot of attention, and play prominently in the MIT/Fed project’s materials, which states “Digital currency is direct central bank money (like cash) that exists only in digital form. No G20 country has fully launched a central bank digital currency, or CBDC, but China and Sweden are among those working on it. Private firms are also perfecting digital money, with Facebook’s Libra project among the best known.” The project’s representatives were not available for an interview before deadline.

Bloomberg/Photographer: Bloomberg/Bloomber

The Fed and MIT envision several use cases for a U.S. digital currency, such as cutting costs from international transfers and faster government transfers to individuals. The lack of such a rail has already caused problems, given the government's lackluster performance in disbursing stimulus payments during the pandemic. It’s a near certainty the U.S. won’t have a digital currency before the next round of stimulus payments.

And the biggest hurdles may not be technological.

“I’m not sure that bringing in MIT will help advance a CBDC initiative in the U.S. more quickly,” said Talie Baker, a senior analyst at Aite. “There are many concerns other than technology that need to be addressed, the biggest hurdles are political in addition to philosophical decisions around the creation of money and the impacts CBDC would have to competition amongst banks in the US.”

The Fed/MIT project contends a CBDC could prevent private sector monopolies on digital currencies, suggesting private currencies may base revenue models on mining user data, causing privacy issues. There’s a risk to resilience in the monetary system if the private digital currency market becomes too top-heavy.

These concerns indirectly reference Libra, though the Libra project has changed its structure to peg its stablecoins to individual government currencies in an effort to address claims Libra could undermine traditional monetary policy. Libra, which is slated to launch later this year, has been the subject of almost constant controversy, mostly over Facebook’s affiliation and broader privacy issues tied to the social network.

Governments around the world are working on CBDCs, and this work has accelerated given Libra’s plans and the need to speed money transfers during the pandemic. There's also growing interest from the private sector, with Visa filing a patent application for technology that would allow a fast deployment of government-supported digital currencies.

China has advanced its digital yuan project, which has progressed far enough to interest McDonald’s and Starbucks as test merchants. The People’s Bank of China is leading the project, which would allow consumers and businesses to load digital cash from commercial banks onto an electronic wallet. These wallets could then be used to support transactions between banks, merchants, consumers or the government.

China’s faster pace poses potential challenges to the U.S. dollar’s global dominance, especially if it allows China to use the digital yuan to ally with countries that are suffering because of U.S. sanctions, argues Foreign Policy magazine. Countries such as North Korea and Venezuela already use cryptocurrency to circumvent American sanctions. A Chinese-backed digital currency could potentially have more power to do so.

“Libra is simply another kick in the pants. All of the noise coming out of China is likely more disturbing,” said Tim Sloane, vice president of payments innovation at Mercator.

The U.S. lags not just China, but other nations such as Sweden, and the work to build a digital currency is complex. China, which is a less democratic country than the U.S., has faced privacy challenges as the PBOC tries to balance the anonymity of cash with the task of managing terrorism finace risk.

The U.S. monetary structure has to be changed to support a CBDC.

“A platform can’t be designed without that detail being well understood,” Sloane said, saying the easiest approach is a digital token that replaces existing cash, yet remains tightly linked by denomination and serial number under a private key that can be used online. “This leaves the U.S. monetary system relatively unchanged,” Sloane said, adding that model is similar to the Visa patent application.