The United States is considering issuing a digital dollar, which would be backed by the nation’s central bank and could help reinforce the U.S. role as a leader in the world financial system. Several financial institutions, including Citibank and Mastercard, announced this week that they’re testing the idea in a 12-week pilot with the Federal Reserve Bank of New York.
The interest in launching a digital currency is motivated by many factors, such as enabling faster, safer, and cheaper payments. But mostly it is an effort to keep up, as China and other countries have already issued—at least in pilot form—digital currencies backed by their central banks, and cryptocurrencies have become increasingly popular, says Bhaskar Chakravorti, dean of global business at The Fletcher School and executive director of the Institute for Business in the Global Context. For now, the interest in such currencies has persisted even after the spectacular meltdown of the cryptocurrency exchange FTX earlier this month.
“The recent implosion of [cryptocurrency exchange] FTX should be a warning to everyone about how little even so-called experts understand about this emerging phenomenon of decentralized finance,” says Bhaskar Chakravorti, dean of global business at The Fletcher School.
Photo: Alonso Nichols
“If we don’t have a digital dollar and other central bank currencies take off—particularly if the yuan, the Chinese currency, takes off—the dollar will definitely lose its supremacy in international settlements,” says Chakravorti, who chairs the Digital Planet program at Fletcher. International settlements are the way that banks in different countries facilitate payments across borders.
Consumers won’t be using digital dollars right away. Although President Biden issued an executive order on the responsible development of digital assets in March and the White House in September released a comprehensive framework for the development of a central bank digital currency, the government is still studying the issue.
If the U.S. does move ahead, this new form of currency probably won’t be put into wider use for several years, Chakravorti says. The very limited 12-week pilot involving the Federal Reserve Bank of New York will be rolled out soon using simulated digital tokens and data.
Tufts Now spoke with Chakravorti to learn more about the digital dollar. He details how it could help consumers and businesses, and addresses concerns about privacy, security, and inclusion—and what comes next.
Tufts Now: Many people rarely use paper money these days. What is the difference between digital dollars and the electronic payments we now use?
Bhaskar Chakravorti: A digital dollar is a digital form of the physical currency—in paper or metal form—that we used to keep in our pockets or in our wallets. Because it is meant to mimic traditional currency, the dollar, it is also a claim on the central bank. So the basic difference is, instead of actually printing physical money, the central bank will be issuing a cryptographic representation of money issued in electronic form, and it will be backed by the full faith and credit of the U.S. government.
That’s very different from electronic payments that we make today. Whether it is using credit cards or Venmo or even cryptocurrencies, each one of them is a somewhat different mechanism by which we pay people without pulling out physical cash.
None of these latter kinds of payments are backed by the U.S. government. Essentially, they are payments enabled between commercial banks or by a payment transactions provider.
What are the potential advantages of a digital dollar?
One of the most basic advantages is that you get rid of the inconvenience of physical cash. Of course, we have alternatives to physical cash already, here in the United States, through all these other electronic forms, such as credit cards or digital payments systems, such as Venmo.
But there are many people—roughly 4.5% of households—even here in the United States who don’t have a bank account, so they don’t have the luxury of being able to connect a digital wallet like an Apple Pay or a Venmo to a bank account. A digital currency could enable people in that category to also have the convenience of being able to make and receive electronic payments. Someone without a bank account could get paid in digital dollars, for example, and avoid the high fees of a check-cashing facility to convert a paycheck into cash.
For merchants, too, there are advantages. They could receive payments instantly and they could avoid the fees they normally pay credit card or payment transactions companies or the money they have to spend to safely transport physical cash from cash registers to their banks.
Another advantage is in terms of international settlements. This is the primary driver of governments like the United States looking at digital currency.
Thinking about establishing a digital dollar is really a defensive move, because China is issuing a digital currency and a lot of other countries around the world are considering digital currencies. If the U.S. government does not consider its own version of a digital dollar, it will be left behind.
How would digital currencies affect international transactions?
Almost 50 percent of international bank loans are dollar-denominated and it may be a little less prevalent in other areas such as trade invoicing and payments, but 90 percent of foreign currency trading involves the dollar on one side of the transaction.
Today, if I have to send money from my bank account to somebody who is in a different part of the world, I can use a financial transaction system such as the SWIFT system, where essentially the payment is made from one currency to another. International financial transactions rely on “reserve currencies,” which are widely held by governments, central banks, and private institutions to conduct such transactions. Countries like to hold reserves for many reasons, as economic buffers, making payments and moderating the value of their own currencies. There are a couple of issues with this status quo: the dominant international reserve currency is the dollar, and there are delays in making those international payments.
A number of other countries are wondering: Why do we rely on the dollar being the dominant international reserve currency? Instead, if we were to just have electronic currency backed by our respective central banks, then we can make these international transactions a lot faster, almost instantaneous.
Which other countries are moving toward digital currencies backed by their central banks?
Among the major economies, China is the first country out of the gate with its own digital currency. It’s moving to displace the dollar as the central currency being used for international transactions.
Currently there are about 11 countries that have launched digital currencies. There are 15 that are piloting them. There are 26 countries that have them in development, 45 countries that are studying the issue. And 19 out of the 20 G20 countries are exploring a central bank digital currency.
So basically, the United States has no option but to consider a digital dollar. If we don’t have a digital dollar and other central bank currencies take off—particularly if the yuan, the Chinese currency, takes off—the dollar will definitely lose its supremacy in international settlements.
The dollar’s status as the dominant reserve currency offers many advantages to the U.S., apart from global prestige and an acknowledgment of its political and economic stability. It allows the U.S. to borrow money abroad at a lower cost and it gives it power to impose sanctions by cutting off the ability to transact in dollars. Of course, this dominance is not guaranteed to last forever. If the U.S. share of the global economy declines and other currencies rise, this dominance is vulnerable.