On Aug. 13, a top official confirmed that the U.S. Federal Reserve is preparing for a digital currency.
Lael Brainard, a member of the Federal Reserve Board of Governors since 2014, told an audience last week that the Federal Reserve was experimenting with “a hypothetical digital dollar for research purposes,” according to Bloomberg.
Brainard also said the Federal Reserve was partnered with research teams from the Boston Federal Reserve and the Massachusetts Institute of Technology (MIT) in a “multi-year effort to build and test a hypothetical digital currency oriented to central bank uses.”
The challenges for a “digital dollar” include security and privacy concerns for a technology that would reach hundreds of millions of people and could easily see billions of transactions per day.
This Fed-enabled digital dollar will also be designed with an ability to bypass the banking system.
Imagine a network of consumer digital wallets — perhaps associated with a government ID, like a social security number — with an ability to receive digital dollar deposits directly from the central bank, or conversely to have digital dollars taken out.
Bypassing the banks would be game-changing on multiple fronts.
In terms of distributing stimulus or emergency funds, the U.S. government and Federal Reserve would have a level of fine-tuned control like never before. Payments could be sorted out by income level, employment status, geographical location, or any number of other things.
Digital dollars would likely also be programmable in and of themselves, allowing for instant tax payments at the point of sale. Tax refunds and rebates could be instant, too.
And attempts to purchase a restricted item — like, say, a firearm without proper background clearance — could be automatically denied.
In many ways, programmable digital money would be a fantasy come true for economists. This is because economists believe economies are driven by human behavior, and human behavior is driven by incentives, and all kinds of incentives could be built into digital money.
Imagine, for example, a maximum limit on the loan-to-value (LTV) ratio of home mortgages, designed to prevent future housing bubbles.
If such limits were programmed into the digital currency, as a form of “smart contract,” the transaction would not go through for a loan amount deemed too large.
Economists, political leaders, and central bank officials could then use the “smart contract” feature of digital dollars to tweak or massage incentives in all sorts of ways.
For example, fossil fuel use might be embedded with a higher VAT (value-added tax) surcharge than green energy use. Buying sugary cereal might create a small debit, whereas buying broccoli creates a small credit. And so on.
In addition to the above, all transactions would be instantly available for review, or easily aggregated into “big data” analysis patterns. This would give the Federal Reserve unprecedented new levels of visibility into the current state of the economy.
With programmable digital currency, and the ability to adjust lending parameters and other incentives via smart contracts, it could even become possible for the Fed to enact different versions of monetary policy for one part of the country versus another. In the Western states where inflation is running hot, the Fed could have tighter policy; in the Southeast where the economy is more stagnant, the Fed could have looser policy instead. And all conditions could be monitored, and modeled, in real time.
Programmable digital currency would also be a kind of monetary panopticon, spying on everything you do by way of transaction data. The use of digital wallets, and accounts linked to a government ID, would thus further tighten any government’s grip on its citizens.
All of this explains why digital currency is absolutely coming, not just for the United States, but for all industrialized countries. The hypothetical power, visibility, and control inherent in such a tool will prove impossible to resist.
This is why central banks everywhere are either running in-depth experiments, launching full-fledged digital currency initiatives, or even preparing to fine-tune and scale a prototype digital currency as rapidly as possible. China is well ahead of the game in this regard.
The rise of central bank digital currencies, or CBDCs for short, will not be a stumbling block for Bitcoin. In fact, it will likely be the opposite. The prevalence of CBDCs will make Bitcoin all the more desirable as a non-state-controlled alternative.
The coming digital dollar, call it the “smart dollar,” will be far more versatile and powerful than the old dumb dollar. The smart dollar will have encoded instructions as to where it can go and what it can do — and those instructions will be upgraded by policymakers in real time.
But a smart dollar will still be a fiat dollar, meaning, the Federal Reserve will maintain the ability to create trillions of new ones any time it chooses. That means the same old supply and demand issues — and the trouble of too much supply — will be as big a problem as ever.
Bitcoin, meanwhile, will remain “outside the system” to the extent no central bank, or any other form of centralized authority, will be able to control it. And Bitcoin will remain permanently limited in supply, due to built-in mathematical rules.
In many ways, the dawning of CBDCs — like the coming digital dollar — will be a good thing. In various other ways, however, a central-bank-issued digital currency will range from nuisance to nightmare.
Bitcoin is likely to be a welcome alternative, and a natural vehicle for saving and storing wealth — via the routine sweeping of assets into BTC — whereas a local CBDC used in day-to-day transactions might be kept on hand in smaller amounts, as a form of petty cash.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.