The US dollar could go digital. Here’s what you need to know

With the Biden administration now throwing new weight behind innovating Americans’ money, here’s what to know about a potential CBDC.

What is a Central Bank Digital Currency and how would it work?

The Federal Reserve defines CBDCs as “a digital form of central bank money that is widely available to the general public.” A key difference from current forms of digital cash in a bank account or payment app is that the money would be a liability of the Fed and not commercial banks — hence the “central bank money.” This means it would be an actual US dollar in digital form, not an investment in a cryptocurrency or a holding in your PayPal.

There are differing opinions on how this would work and what it would look like, but in theory it could alleviate the need for third-party processors when transferring money.

“At a very high level, a CBDC is just digital money that would be issued by the central bank,” Sarah Hammer, the managing director of the Stevens Center for Innovation in Finance at the Wharton School of the University of Pennsylvania, told CNN Business. “It would be based on the fiat currency of that country, so it would be based on the money supply — and then it would be implemented using a government database or approved private sector entities working with the government.”

Yermack, who has been studying the rise of digital currencies for years, added that a CBDC “would actually operate an awful lot like Bitcoin or other cryptocurrencies.”

“You’d have a network of wallets, probably held by members of the public, where people could pay each other directly without going through a third party,” Yermack said.

A significant tech decision for policymakers, according to Hammer, is whether a US central bank digital currency runs on a blockchain, the technology underpinning cryptocurrencies like Bitcoin, as it would throw federal government weight behind this emerging tech.

“It can be operated through a central database, or through distributed ledger technology, the blockchain,” Hammer said.

Yermack, however, said it is “likely that whatever they’re working on is going to be what the Fed grabs onto and tries to scale up.”

China’s digital yuan, however, notably does not operate on blockchain tech. The digital yuan aims to replace cash payments and can be accessed through a government-backed mobile app as well as Tencent’s WeChat. It uses existing tech infrastructure used by approved Chinese commercial and online banks and payment platforms, and is issued by the People’s Bank of China.

What are the potential benefits and risks?

A CBDC could potentially offer consumers a more convenient, safer and cheaper alternative to the options available currently. It could also alleviate the need for cash and crackdown on fraudulent transactions, according to Hammer, as well as make it more efficient for collecting taxes or dispersing targeted government funds.

“There are some financial inclusion benefits of having a central bank digital currency,” she added, touting their ability to reach Americans that don’t have bank accounts.

There are several potential risks, including tech barriers and security concerns as well as privacy threats, Yermack noted. Its potential to take on some of the work performed by commercial banks and credit markets has also caused some to worry.

Moreover, a CBDC could potentially threaten the independence of the Fed and raise a slew of new policy questions.

“The risk of political abuse is huge,” Yermack said. “If you give the central bank this kind of power, the political safeguards would probably need to be much higher than currently in place for the Federal Reserve.”

While Yermack says a CBDC will likely call for some “thoughtful political redesign” and a transition period as nations experiment with it over the next decade, he still sees “many good reasons to do this.”

“Throw in the fact that people really don’t like using cash — the preferences of the public are pushing governments in this direction as well,” Yermack said.