There are many people out there espousing that 2023 is when we will see a central bank digital currency (CBDC) for the USD. This is something that is gaining traction as many believe government tyranny is spreading. While that is certainly the case, we are not seeing a CBDC related to the US dollar anytime soon.
In short, the Federal Reserve has no incentive to create one. After all, as stated previously, the idea of a CBDC is really a joke. Other than control, the use cases for them are rather limited. Governor Waller summed it up best when he stated that CBDC are a solution looking for a problem.
Do not worry, the Fed is on top of things, at least in this regard. For all its shortcomings, which is a growing list, this is something the Fed is getting right. Yet, common for our era, it is completely misunderstood and poorly research.
Therefore, we will explain what FedNow is, how it will operate, and why it is not a CBDC.
FedNow - True Innovation
FedNow is technology at its finest. This is the Fed moving their system into the 21st century. From this perspective, it should be applauded.
What is FedNow? It is nothing more than a payment system. Essentially, it is a network similar to Visa. The main difference is it is run by the Fed and caters to its member institutions. In other words, it does not deal with the general public.
FedNow is going to make things radically different. Settlement times will be near instantaneous. Account balances will be updated 24/7 (presumably 365). It will be similar to cryptocurrency. With this, when a transaction occurs, after settlement, the ledger is updated and wallets have the new balances. FedNow will do things with people's bank accounts.
This is bringing banking out of the "stone age", at least within the United States. Remember, this is a domestic system since the Fed, in theory, is only allowed to oversee the US based financial institutions.
We can see how the Fed is using technology to update the services it provides. The latter part of this sentence is vital.
How It Works
This system is targeted to roll out in 2023. It will come in phases so we are not going to get the full impact immediately. Nevertheless, understanding how it will work is imperative keeping things in perspective. Those who are claiming it is a CBDC clearing did not read the material relating to it.
So what happens once the system goes live?
Here is how it looks graphically.
We will take the step-by-step process from the Fed's website.
1, In step 1, a sender (i.e., an individual or business) initiates a payment by sending a payment message to its financial institution through an end-user interface outside the FedNow Service. The sender’s financial institution is responsible for screening the payment according to its internal processes and requirements.
- In step 2, the sender’s financial institution submits a payment message to the FedNow Service.
- In step 3, the FedNow Service validates the payment message, for example, by verifying that the message meets message format specifications.
- In step 4, the FedNow Service sends the contents of the payment message to the receiver’s financial institution to seek confirmation that the receiver’s financial institution intends to accept the payment message. At this point, the receiver’s financial institution will have the opportunity to confirm or deny that it maintains the specified account.
- In step 5, the receiver’s financial institution sends a positive response to the FedNow Service, confirming that it intends to accept the payment message. Steps 4 and 5 are intended to reduce the number of misdirected payments and resulting exception cases that can occur in high-volume systems.
- In step 6, the FedNow Service debits and credits the designated master accounts of the sender’s and receiver’s financial institutions (or their correspondent financial institutions), respectively.
- In step 7, the FedNow Service sends a payment message forward to the receiver’s financial institution with an advice of credit and in parallel sends an acknowledgement to the sender’s financial institution, notifying it that settlement is complete.
- In step 8, the receiver’s financial institution credits the receiver’s account. As a term of the FedNow Service, the Federal Reserve Banks anticipate requiring the receiver’s financial institution to make funds available to the receiver almost immediately after step 7. This crediting to the receiver’s account as well as the debiting of the sender’s account by their respective financial institutions happens outside the FedNow Service.
In short, this system is changing nothing in terms of the relationship between depositors, banks, and the Fed. We see an advancement in the communication and settlement system but that is it.
The key point here is #6. Here it is again:
In step 6, the FedNow Service debits and credits the designated master accounts of the sender’s and receiver’s financial institutions (or their correspondent financial institutions), respectively.
By highlighting Master Account, we instantly understand what is taking place. The Fed is NOT dealing with the general public. Instead, the Fed, like now, can only engage with member institutions who have an account with the Fed. Those are called Master Accounts.
The average person does not bank at the Fed. He or she interacts with commercial banks. This is not only the modus operandi for the US banking system, it is part of the Federal Reserve Act of 1913. Basically, a CBDC for the USD would require a change by Congress. That is not to say it couldn't happen but, for now, the Fed cannot create "Fedcoin" even if it wanted to.
Getting back to the system, we see how the Fed is providing a service to its member institutions. Banks can utilize this service for near instant settlements. Of course, by extension, the commercial banks are providing this to their customers.
Notice What Is Missing
Sometimes the most glaring evidence is what is missing. When we look at the process, or even glancing at the diagram, we notice a couple start differences between cryptocurrency.
The first is that FedNow does not include the sender or receiver. They are not a part of the system. It is only accessed by the member banks who are the actual users. All payments are done through one's bank account, via the bank.
Here is where we see the first missing piece. There is no wallet. The system is still structured whereby customers have accounts with the commercial bank. CBDCs are a threat to commercial banks because they could provide a wallet which provides the ability to send, store, and receive money. We do not see this here.
The second glaring absence is the lack of tokenization. Where is the CBDC? How does it fit into the equation?
We see this is using the USD as the currency for transacting. Since it is already in digital form, there is nothing to tokenize. The payment system is being created to transfer dollars from one account to another, through the intermediary system that is already in operation. Again, this is nothing more than a technological upgrade. "Fedcoin" is not present. The US Dollar is still the main currency utilized.
Finally, the Fed still has no control over the money supply. Any digital dollars that are sent on this payment system first have to be generated by the commercial banking system via loans. Without that, there is no extra USD.
The debit and credits applied in step 6 are still done using reserves, not USD. That is the medium the Fed uses to interact with the commercial banks. The instant settlement of reserves still provides the Fed no ability to expand or contract the supply of USD.
If this were a CBDC, the control would be in the hands of the creator. We can clearly see it is not.
In Conclusion
The Fed might end up implementing a CBDC. This is not something that was totally eliminated. According to their statements, the Fed is looking into it. However, the sense is Jay Powell is not for this. In fact, the likelihood of one coming under his watch decreased after the Bank of Japan abandoned its CBDC project.
A CBDC would be a catastrophic failure. The FedNow system actually looks like a decent technological upgrade. While it is still the existing banking system, the infrastructure is about to get a major overhaul.
This is not a CBDC.
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