Central Bank Digital Currencies Are Coming
I first realized we were headed toward a cashless society nearly nine years ago.
Back then, I was in a meeting with an unknown startup in Oakland, California. The company had hired a group of data science engineers to create a machine that could “print” digital dollars.
This was a way for central banks to issue their own digital currencies without having to go through the banking system.
The device was about 1 foot tall and shaped like a little black pyramid. It was only put online for the creation of new digital dollars and then taken offline when not in use.
This wasn’t a cryptocurrency like bitcoin or Ethereum. It was a way for central banks to create and track digital currencies. Since then, it’s come to be known as a “central bank digital currency,” or CBDC.
And it could mean the end of the current banking system as we know it.
What the Federal Reserve Really Does
Before I get into why CBDCs could change the way we bank, allow me to first explain how the current banking system works.
There’s a lot of misinformation out there when it comes to the role of central banks. The most common misconception is that the central bank (e.g., the Federal Reserve) “prints” money. That’s not what the Fed does.
The Fed’s job is to make sure the nation’s banks have ample reserves. They do this by purchasing assets from banks and replacing those with cash reserves.
The printing of money is actually done when a bank chooses to extend credit. That could be in the form of a mortgage or an auto loan.
It’s the nation’s banks such as JPMorgan Chase, Bank of America and Citigroup that impact the growth of money inside the system. (As an aside, the actual printing of cash is done by the U.S. Treasury Department.)
But new technologies are massively disrupting everything right now, and finance isn’t immune.
The Next Step for Central Banks
Globally, there are now 3 billion consumers on fintech apps who use e-wallets and mobile payments. Companies such as PayPal and Square are obviating the need for a traditional bank account and making online transactions easier.
The next step could be to do away with private banks that have monopolized the creation of money. This would be possible with CBDCs.
When I first met with this secretive startup in 2012, only a handful of central banks were piloting the program. Now, over 50 of them are exploring digital currencies.
China has already rolled out an e-yuan pilot to 500,000 citizens. America is creating an e-dollar. And the EU wants a virtual euro by 2025.
Instead of keeping an account with a retail bank such as JPMorgan or your local savings banks, depositors would just keep their cash at the central bank and use an app like Venmo or Square Cash to manage their balances.
Instead of writing checks or paying online with a card, payments can be made directly via the central bank’s infrastructure.
Depositors would never have to worry if the bank goes insolvent, as the money is guaranteed by the Fed.
CBDCs could cut the fees charged by the existing financial system. These amount to over $350 a year for each individual on Earth.
And it would allow for instant payments to citizens, like the ones that went out as part of the pandemic relief.
Most importantly, it would allow a central bank to break below 0% interest rates.
A New Option for the Fed
Right now, when short-term rates reach 0%, the only option in the Fed’s toolkit is to add more reserves to the system by purchasing assets off bank balance sheets. This process is known as quantitative easing.
In the current banking system, if banks started charging an interest rate on depositors (i.e., negative interest rates), there would be a run on banks to remove cash and store it somewhere else.
However, if all deposits were held at the Fed in digital cash, it could theoretically start charging a negative interest rate on paper cash.
This would encourage people to either save or invest their money and help reverse an economic downturn.
It would also give the central bank more control over the economy.
This might unintentionally lead citizens to reach for cryptocurrencies like bitcoin and Ethereum.
Editor, Strategic Fortunes
My career on Wall Street started while I was in college. I spent a summer interning for Merrill Lynch in the middle of the ‘90s bull market. I was fascinated with trading, and as a result, after college, I joined Salomon Brothers in the famed mortgage bond trading department. Later, I spent time at Citigroup working with credit derivatives. Eventually, I needed to walk away from the excess of Wall Street. That’s when I joined Banyan Hill in 2017. Now I help readers get ahead of the market and build their retirements.