Federal Reserve Publishes Note Detailing Preconditions for a General-Purpose Central Bank Digital Currency (CBDC) | Practical Law

Federal Reserve Publishes Note Detailing Preconditions for a General-Purpose Central Bank Digital Currency (CBDC) | Practical Law

The Federal Reserve Board published a note entitled Preconditions for a General-Purpose Central Bank Digital Currency (CBDC), which highlights considerations necessary for creating a general-purpose CBDC that would be used by the public for daily payments.

Federal Reserve Publishes Note Detailing Preconditions for a General-Purpose Central Bank Digital Currency (CBDC)

by Practical Law Finance
Published on 22 Mar 2021 • USA (National/Federal)
The Federal Reserve Board published a note entitled Preconditions for a General-Purpose Central Bank Digital Currency (CBDC), which highlights considerations necessary for creating a general-purpose CBDC that would be used by the public for daily payments.
On February 24, 2021, the Federal Reserve Board (FRB) published a note entitled Preconditions for a General-Purpose Central Bank Digital Currency (CBDC), which highlights considerations necessary for creating a general-purpose CBDC in the US that would be used by the public for daily payments. In general, these include:
The paper lists the preconditions in an attempt to spark inquiry but does not suggest solutions.

Clear Policy Objectives

In order to develop a CBDC, its purpose must first be clearly defined. The report notes that, generally, central banks seek to address current challenges and also explore future capabilities by developing CBDC. The note quoted a recent Bank for International Settlements (BIS) report that highlighted the following protentional benefits of CBDC:
  • Enhanced payment system resiliency.
  • Increasing payment diversity.
  • Encouraging financial inclusion.
  • Improving cross-border payments.

Broad Stakeholder Support

The report provides that, in order to develop a CBDC, a variety of stakeholders need to work together in both the private and public sectors including:
  • Government bodies.
  • End users.
  • Financial institutions.
  • Technology and infrastructure providers.
  • Academia.
  • Standards development institutions.

Strong Legal Framework

As noted by the FRB, a sound legal framework is an important foundation necessary to creating a general purpose CBDC. In order to build such a framework, issues that must be considered include:
  • Whether the issuance of a general-purpose CBDC would be consistent with the Federal Reserve's mandates, functions, and powers under the Federal Reserve Act.
  • Legal tender status of the CBDC.
  • How to prevent illegal use of the CBDC such as money-laundering, terrorism financing, and evasion of sanctions.
  • How privacy is respected and how personal data is protected in a CBDC arrangement.
  • Legal responsibilities associated with the CBDC.

Robust Technology

The report states that new technologies may need to be developed in order to meet the business and operational requirements for a CBDC. The paper includes a table of key aspects of the technology that would be necessary, which includes general technology capabilities such as system integrity, operational robustness, and operational resilience, as well as further information and explanations about the importance of specific aspects of these capabilities.

Market Readiness

In order to introduce a CBDC, the FRB notes, there must be adequate demand and supply. Demand may arise from economic and/or policy interests and would require that both individuals and businesses be willing to accept a new payment instrument. In order to generate supply, ecosystem structures, hardware infrastructure, and market participants must be ready to accept a CBDC, and coordination of activities, and communication among all parties is would be essential. Although the timing of true market readiness is impossible to predict, certain activities such as surveys, interviews, focus groups, and testing could help identify progress.