Let’s Get Digital: Cryptocurrency and the United States Digital Dollar

In the last several months El Salvador and China have established the two poles in government stances on cryptocurrency, with El Salvador fully embracing it by adopting Bitcoin as a legal tender and China completely rejecting it by declaring all cryptocurrency transactions illegal. Regulation of cryptocurrency, which has now ballooned into a two trillion-dollar market, has become a major topic in Washington, D.C. Critics argue it needs close regulation given its volatility and prevalence in illicit activities, while advocates assert that regulation should proceed with extreme caution less it stifle innovation and the opportunity to be the global leader in blockchain technology. 

An intriguing third path forward has recently emerged, with the United States Federal Reserve announcing a study exploring the launch of a “Digital Dollar,” also known as a Central Bank Digital Currency (CBDC). While the specifics of how a U.S. CBDC would function are up in the air, many other nations are moving forward with digital currencies of their own. Given the rise of decentralized cryptocurrencies and government-backed digital currencies, the United States should release a Central Bank Digital Currency. 

Cryptocurrencies – The Good, The Bad, and The Ugly

The ascent of cryptocurrency has been called many things, from a fool’s gold rush to a revolution, but even detractors recognize that it provides utility to adopters. This utility is largely a product of cryptocurrency’s decentralized nature, which makes quick international transfers possible without paying an intermediary. Migrant workers, for example, adopted cryptocurrency as a cheap method to securely transfer remittances home instead of relying on expensive and shady brokers. More broadly, businesses, particularly in developing nations, benefit from the seamless transactions and reduced costs.

While these uses are widely considered legitimate, the decentralization is also valuable to criminal groups, terrorist organizations, and rogue states. The elimination of an intermediary reduces costs, but also means that transactions are done anonymously and without scrutiny. Illicit actors exploited this from the beginning, most prominently in the early 2010s digital black marketplace dubbed “The Silk Road.” In the present day, use of cryptocurrency has expanded to IS-linked terrorist groups and North Korean hackers, with cybercrime in particular becoming an area of major concern. 

Cryptocurrency has become the dominant form of payment in ransomware, which has experts and private businesses pressuring the Biden Administration to act. Ransomware is now a global problem that causes billions in damages. Most alarmingly, ransomware has impacted critical infrastructure, such as the UK’s National Health Service in 2017 and the more recent Colonial Pipeline hack. In response, the United States has targeted cryptocurrency payments, both through recovery efforts and proactive sanctions. More action is likely on the way, giving regulators the challenge of limiting illicit activity without stifling innovation.

Centralized Digital Currencies

Inspired by and apprehensive of the popularity of cryptocurrency, nations around the world are implementing CBDCs. Central banks want to retain control over their nation’s currency so they can enact monetary policy, and CBDCs represent a potential competitive advantage if implemented effectively. Across the globe, 81 countries are currently in the adoption process, ranging from Sweden to The Bahamas. Any nation not at least considering a CBDC risks missing out on the tremendous improvements it can offer.

The increase in data and enhanced flexibility in distribution could allow for more effective policy making and service delivery. Stimulus funds, for example, could be streamlined through easier direct payments to citizens, including those without access to traditional banking services. These funds could further be programmed in novel ways, such as slowly losing value so consumers are incentivized to spend them immediately. These and other entirely new forms of monetary policy become possible with CDBCs, which governments can use to more effectively and swiftly respond to crises.

At the same time, CBDCs raise serious privacy issues. Authoritarian regimes have a history of using new technology to monitor and control their populations. By removing the existing barrier between states and personal finance, CBDCs present a glaring opportunity for increased state surveillance. These concerns must be carefully weighed against potential improvements to the economic system. 

Global Reserve Status

While releasing a CBDC presents clear advantages, the United States must also consider what it stands to lose. Specifically, the U.S. dollar is the global reserve currency, which gives the United States an edge in the global financial system. Among other benefits, the United States borrows cheaply and can impose costly sanctions. This status, however, is not an official designation but instead a competitive position based on a currency’s trustworthiness and  usefulness in global trade. So, the U.S. dollar risks being replaced if a superior alternative emerges. 

China’s recent pilot of a CBDC, the electronic-Renminbi, should draw the attention of U.S. policymakers for precisely this reason. An unrivaled Chinese CBDC could see considerable use, particularly after China’s cryptocurrency ban, and may allow the renminbi to challenge the U.S. dollar as the dominant global currency. Particularly in the context of the openly discussed United States-China competition, the ability of China to more easily withstand sanctions and gather troves of economic data would subvert U.S. influence. While Chinese officials claim that any ability to transfer the electronic-Renminbi seamlessly across borders would require additional changes, it represents a long-term threat to the primacy of the U.S. dollar. Given everything that stands to be gained and lost, the United States must release a CBDC.

The U.S. Digital Dollar

Should the U.S. Federal Reserve release a CBDC, what characteristics might it possess? Given the importance of trustworthiness in the determination of a reserve currency, it is imperative the United States take its time and release a strong product. Any transition away from the U.S. dollar as global reserve currency will happen slowly, and a poorly implemented CBDC could be more harmful than no CBDC at all. To ensure a strong CBDC is released, the U.S. should emulate the proven useful features of cryptocurrencies, such as reducing the processing time for payments from the typical 3-5 days through a bank to the mere minutes it takes cryptocurrencies. This would ensure that a U.S. CBDC is competitive with decentralized digital currencies, as the lack of such features would likely hinder adoption.

A strong U.S. CBDC can mitigate the risk of any harmful impacts from impending cryptocurrency regulation, which proponents of cryptocurrency argue will hamper legitimate uses and suppress innovation. While regulators must take extreme care to ensure blockchain innovation is not stymied, a CBDC which allows for the same legitimate uses as cryptocurrency would alleviate the problems caused by any dampened functionality. Cryptocurrency advocates argue that decentralization is its distinguishing and attractive feature – if that is the case, then a CBDC, regardless of its characteristics, will not harm cryptocurrency. But, if the primary value of decentralization is that it can be exploited by illicit actors, then a CBDC will illuminate that and make further regulation the obvious path forward.