Originally PublishedFebruary 17, 2022

Update: February 22, 2022

Last week, in a speech at the U.S Monetary Policy Forum in New York, FRB Governor Lael Brainard continued to tout the potential of a CBDC in the U.S. digital payment infrastructure, while also highlighting potential risks. Though the topics she discussed reiterated key issues, Governor Brainard highlighted a number of topics that we did not have a chance to discuss in detail. We will discuss these topics in greater depth in a future post.

Below, we lay out some of the most pertinent takeaways:

Driving Force for a U.S. CBDC: Competition of a Private Sector Stablecoin

  • Governor Brainard’s speech, which was supportive of the FRB’s recent efforts to develop a CBDC, framed central bank interest as a natural reaction to the burgeoning cryptocurrency and decentralized finance (“DeFi”) industry. Today’s urgency, she suggests, stems directly from the need for central banks to preempt private interest in stablecoins. Her remarks are in stark contrast to her 2018 comments and 2017 comments of FRB officials including Brainard,[1] who noted that “there is no compelling demonstrated need for a Fed-issued digital currency,” as well as more recent (2021) comments from Governor Christopher J. Waller who noted that “I am left with the conclusion that a CBDC remains a solution in search of a problem.”[2] Governor Brainard’s current support is also interesting, given her role as the chair of the FRB’s Payments System Policy Advisory Committee and advocate of FedNow, FRB’s real-time payment service (see discussion of a U.S. CBDC competing directly with FedNow below).
  • The FRB’s current response to a CBDC tracks observations of a paper published by FRB staff in February 2021, which noted that market readiness will be an important driver of U.S. CBDC development. The change in tune also aligns with a September 2021 paper noting that risks from imperfect development of private stablecoins will pressure governments to develop a CBDC.
  • Stablecoins vs. CBDC. Brainard also alluded to the value of stablecoins for use as collateral in DeFi and decentralized platforms; as discussed in a recent President’s Working Group report on stablecoins (previously discussed on our blog here), stablecoins are “central to the functioning of DeFi,” as they are used to facilitate trading, including as one asset in a pair of digital assets used in an automated market maker arrangements and are frequently “locked” in such arrangements.[3] Governor Brainard noted that a CBDC could allow for increased liquidity and may be better suited for use in payments.

Driving Force for a U.S. CBDC: Competition of International CBDCs

  • Echoing the concerns of numerous critics who believe the U.S. is falling behind China, Brainard’s speech also highlighted pressure placed by the global financial market on CBDC development: “Decisions by other major jurisdictions to issue CBDCs could bring important changes to global financial markets that may prove more or less disruptive and that could influence the potential risks and benefits of a U.S. CBDC.”
  • Again, these comments are in stark contrast to skeptical statements by others at the FRB, including Governor Christopher Waller, who in August 2021 balked at the idea that an international CBDC could contribute to a decline in the supremacy of the U.S. dollar.
  • The Discussion Paper (see below) also briefly mentions the geopolitical value of a CBDC to protect the supremacy of the U.S. dollar. The dollar currently serves as the dominant currency in the international market for payments and investments, but the Paper argues that position could erode as a result of widespread adoption of a non-U.S. or private CBDC. A U.S. CBDC could prevent decline in use of the dollar, especially if different countries’ CBDCs became interoperable.

[1] Federal Reserve Board, “Thoughts on Prudent Innovation in the Payment System,” (November 30, 2017), available here (citing numerous potential issues, and cautiously noting that “while these digital currencies may not pose major concerns at their current levels of use, more serious financial stability issues may result if they achieve wide-scale usage;” “I would urge caution;” and “the prospect of a government-sponsored digital currency might even derail private-sector plans to enhance the payment services provided to their customers, thereby significantly disrupting the financial networks that exist today in ways that could create instability.” However, officials do note that these comments “[do] not mean that [the central bank] should avoid further innovation.”).

[2] In response to arguments that “a CBDC would make the payment system bigger, broader, and more efficient,” Waller disagreed: “facilitating speedier payments is not a compelling reason to create a CBDC,” “it is implausible to me that developing a CBDC is the simplest, least costly way to reach [certain unbanked] households,” “the private sector is already developing payment alternatives to compete with the banking system. Hence, it seems unnecessary for the Federal Reserve to create a CBDC to drive down payment rents.” See Federal Reserve Board, “CBDC: A Solution in Search of a Problem?” (August 05, 2021), available here.

[3] The President’s Working Group “Report on Stablecoins” provided a useful chart noting the percentage of stablecoins locked in Ethereum Smart Contracts (see page 15).

For much of the past century, consumers and commercial end-users could access the Federal Reserve’s balance sheet directly in only one way—by holding physical currency or coin issued or distributed by a Federal Reserve Bank.  A major drawback, however, is that Federal Reserve Bank notes and coins are bearer instruments that must be physically held and transferred in order to effect transactions.  Although the U.S. also offers digital money in the form of deposit balances at Federal Reserve Banks, only commercial banks are directly eligible to access this money through Federal Reserve Bank master accounts.

Due to a variety of factors, including declining cash use, competitive pressure from outside the regulatory perimeter, technological innovation and increasing consumer demand for innovative payment methods following the COVID-19 pandemic, central banks, including the Federal Reserve System, are exploring a digital central bank money that could be made widely available to the general public (a “CBDC”).

As of early February, around 100 of the world’s 195 countries were exploring a CBDC at various stages.  While the vast majority of jurisdictions are still in early stages of research or in the process of developing proofs-of-concept, some jurisdictions have launched high-profile pilot programs.[1]  In April 2020, China became the first major economy to pilot a digital currency, which it hoped would be widely adopted by the 2022 Beijing Winter Olympics.  As of February, the digital renminbi (called e-CNY) had over a hundred million individual users and billions of yuan in transactions.

The Federal Reserve has been investigating a U.S. CBDC for years, though development is still exploratory, with no immediate plans for a pilot program.  In a long-awaited discussion paper published in January 2022 (the “Discussion Paper”), the Federal Reserve Board (“FRB”) examines the pros and cons of a potential U.S. CBDC.  Although the FRB is careful to disclaim that the paper “is not intended to advance any specific policy outcome” and is not “intended to signal that the Federal Reserve will make any imminent decisions about the appropriateness of issuing a U.S. CBDC,” it offers insight into what the FRB sees as potential benefits and risks of a U.S. CBDC, as well as must-have features that may inform its eventual design.

Shortly after, the Federal Reserve Bank of Boston issued a paper on Feb. 3, 2022 (the “Project Hamilton White Paper”) in partnership with the MIT Digital Currency Initiative that provided results of initial design and technical research for a potential U.S. CBDC.  Congress has also held numerous hearings on the values and opportunities of a CBDC for the United States.

Below, we summarize key features of the U.S. CBDC policy debate and the current state-of-progress, focusing on the Discussion Paper.  We also review the factors that may impact the potential design of a U.S. CBDC and preview upcoming developments.

The FRB has requested comments on its paper by May 20, 2022 (120 days from date of publication). We’ll be updating this post with additional details. Check back for more updates.

Discussion Paper

As mentioned above, although the FRB does not purport to advocate for a particular policy outcome or CBDC design, the Discussion Paper asserts that any U.S. CBDC must be “privacy-protected, intermediated, widely transferable and identify-verified.”

  • Privacy-protected refers to the need for the U.S. CBDC to strike a balance between privacy rights of consumers and the transparency needed to deter criminal activity.
  • Due to FRB concerns regarding its authority under the Federal Reserve Act to authorize Federal Reserve accounts for individuals, any U.S. CBDC may need to be intermediated, i.e., offered through accounts or digital wallets provided by private sector entities (including, potentially, “commercial banks and regulated nonbank financial service providers”) with Federal Reserve accounts.
  • In order for a potential U.S. CBDC to be useful as a means of payment, the paper recommends that it be readily transferable (as distinct from the broader concept of interoperability) between customers of different intermediaries.
  • Any U.S. CBDC would need to be designed to comply with anti-money laundering and terrorist financing laws, which would require the CBDC to be identity-verified, i.e., CBDC intermediaries must be able to verify the identity of holders.

The Discussion Paper also states that the FRB does not intend to proceed with issuing CBDC without “clear support” from the executive branch and from Congress, “ideally in the form of a specific authorizing law.”

Advantages of a U.S. CBDC

The Discussion Paper contends that a U.S. CBDC could:

  1. Offer the general public access to digital money that is free from credit and liquidity risk;
  2. Offer a safer deposit substitute to other products being developed by banks and others actors, including stablecoins;
  3. Level the playing field in payment innovation for private-sector firms of all size;
  4. Generate new capabilities to meet the evolving demands of the digital economy;
  5. Improve cross-border payments;
  6. Preserve the dominant international role of the U.S. dollar;
  7. Promote financial inclusion by facilitating access to digital payments, enabling rapid and cost-effective payment of taxes and delivery of federal payments (including wages and tax refunds), providing a secure way for people to save and promoting access to credit; and
  8. Extend public access to central bank money (currently only available directly to the public via Federal Reserve Notes, i.e., paper money).

Potential risks of a U.S. CBDC

The Discussion Paper also identifies several potential risks, but notes these could be addressed by design choices, e.g., by ensuring that a U.S. CBDC is not interest-bearing, or limiting the amount of CBDC an end user could hold or the rate at which they could accumulate tokens. In particular, a U.S. CBDC:

  1. Could fundamentally change the structure of the U.S. financial system, e.g., an interest-bearing CBDC that functions as a substitute for commercial bank (or other private) money could reduce the aggregate amount of deposits in the banking system, increase bank funding costs and reduce credit availability;
  2. Could impact the safety and stability of the financial system, e.g., the ability to freely convert assets into CBDC would make runs on financial firms more severe;
  3. Could affect how the FRB effects monetary policy, e.g., demand for a U.S. CBDC could place downward pressure on reserves, which in turn would make it difficult for the FRB to implement its “ample reserves” monetary policy regime in which it exercises control over short-term interest rates through the setting of administered rates (interests on reserves and overnight repurchase agreement facility offering rates), rather than actively managing the supply of bank reserves;
  4. Would need to strike an appropriate balance privacy and transparency; and
  5. Would need to be resilient to operational disruptions and cybersecurity risks, which may be difficult because a CBDC network could potentially have more entry points than existing payment services.


Token-Based and Account-Based Systems

  • A U.S. CBDC could be account-based, token-based or a hybrid.[2] A token-based system is one that is focused primarily on ensuring the integrity of the object used as money, whereas an account-based system is focused on characteristics of the owner.  The canonical token-based system is physical currency—if you pay for goods or services with Federal Reserve notes, the merchant cares primarily about whether the bills are real or fake, and not about the identity of the payer.  An example of an account-based system is a bank deposit, where there is some external record of ownership attributable to a specific owner.  Some countries are exploring an account-based system (e.g., e-CNY) whereas others are exploring a token-based system (e.g., Nigeria’s e-Naira).
  • Although the Discussion Paper does not advocate for a particular system, both the alternatives that the Project Hamilton White Paper explored were token-based systems. In order to implement an account-based system, the Federal Reserve could extend existing or planned real-time gross settlement systems (e.g., FedNow) to include nonbank participants.
  • One of the advantages of a token-based system over a more traditional account-based system raised by the Discussion Paper and the Project Hamilton White Paper is that a token-based CBDC could be designed to allow for programmability, such as smart contracts, enable automated execution of operations, e.g., automatic payment of interest, routing of tax payments or electricity fees, etc.
  • Interestingly, the Project Hamilton paper notes that a token-based system need not be based on blockchain or distributed ledger technology. Although aspects of cryptography, distributed systems, and blockchain technology can be leveraged, the paper concluded that adopting a blockchain-based system in its entirety was not a “good match” for its requirements due to issues with performance and the lack of a need to distribute trust among a set of distrusting participants.

Monetary and Financial Stability Policy by Design

  • Among the policy concerns that the Discussion Paper raises are the potential impacts that design choices might have on deposit and lending markets, and on the transmission of monetary policy.
  • The Discussion Paper warns that a widely available CBDC that serves as a close or near-perfect substitute for commercial bank money, e.g., an interest-bearing CBDC, could reduce the aggregate amount of deposits in the banking system, which could increase bank funding costs and reduce credit availability (or raise credit costs). Academic research also suggests that a sufficiently high CBDC interest rate could reduce the market share of small banks in both deposit and lending markets (although such effects might be less pronounced the more convenient the CBDC is for consumers, as the CBDC chips away at the purported “convenience advantage” of larger banks).
  • The Discussion Paper also notes that “a CBDC’s design would influence how it might affect monetary policy.” Specifically, the paper comments on the potential for an interest-bearing CBDC to impact the efficacy of Federal Reserve monetary policy transmission, particularly in our current “ample reserves” regime. (A non-interesting bearing CBDC would not apply pressure on reserves because consumers would view the CBDC as a vehicle for sending and receiving money, and not a replacement for interest-bearing assets like deposits).  As the Discussion Paper notes, however, this issue is complex.  Some researchers have noted that actual causal relationships—especially in an era of ample reserves—may vary depending on liquidity properties, interest rates, and reserve requirements of the CBDC, and convenience value and market power of intermediary banks, among other factors.  For example, a recent academic model found that while a higher level of CBDC convenience would weaken the transmission of monetary policy, a sufficiently high level of convenience could enhance monetary policy transmission.
  • Other design choices, like access rights for existing commercial banks, or levels of buildout by the Federal Reserve, availability of a mobile app, etc. may also have significant policy implications.

Role of Intermediaries

  • The Discussion Paper concludes that because the Federal Reserve Act does not authorize direct accounts at the FRB for individuals, a U.S. CBDC would have to be offered through intermediaries. This form of access architecture in which end users have direct claims on a central bank, but responsibility for payments and transactions are delegated to financial intermediaries has been referred to as a “hybrid model.”
  • Other forms of CBDC architecture include a “direct model,” in which end users have direct claims against a central bank, which maintains a record of all balances (e.g., Central Bank of Iceland), and a “hybrid” or “synthetic” model in which end users have claims on an intermediaries that are fully backed by wholesale accounts that the intermediaries maintain with the central bank.
  • CBDC architecture is an important operational design choice that impacts the legal nature of customers’ claims on the central bank. For example, in a hybrid model, if the intermediary fails, holdings of the CBDC would have to be excluded from the intermediary’s estate available to creditors.
  • From the Discussion Paper, the FRB seems focused on designing a hybrid CBDC that encourages greater engagement of private sector intermediaries, grants the FRB access to convenient and already-developed systems, and relieves the FRB of know-your-customer, dispute resolution, due diligence and other compliance-related responsibilities. On the other hand, the FRB surrenders any record of individual claims and accounts and is impacted by the financial stress and information-sharing capabilities of intermediaries.

Partnerships with Academia

  • The Project Hamilton White Paper, which details a partnership with MIT’s Digital Currency Initiative, seems to indicate that the Federal Reserve is open to active collaboration with academia.
  • This type of collaboration is not new. In fact, both the Federal Reserve and industry participants have often partnered with academia on fintech-related projects.  The Stanford Research Institute partnered with Bank of America in the early 1950s to develop the first computerized check-clearing machines and the magnetic ink character recognition (MICR) technology.  The Atlanta Federal Reserve Bank and Georgia Tech partnered in the 1960s to develop a predecessor to the Automatic Clearing House (ACH) system.

Other Use Cases for a U.S. CBDC

  • Although the Discussion Paper defines a CBDC as central bank money that is “widely available to the general public,” and in multiple places mentions the possibility of capping balances available to end-users, a CBDC could be designed to accommodate more limited use cases (e.g., in wholesale payments and inter-bank settlements).
  • Central banks could develop a CBDC solely for retail (e.g., Nigeria’s e-Naira) or wholesale payments (e.g., Bank Negara Malaysia).

Critics of the Payment System

  • Critics of current payment infrastructure have long-noted that upgrading the U.S. banking and payment system to enhance for interoperability and open banking standards would require major upgrades to the existing technology stack.  Legacy payment systems including ACH, electronic fund transfer, and other interbank transfer networks have not been updated in decades.
  • Insufficiencies were highlighted by COVID-19; the existing legacy payment system prevented banks from delivering welfare aid efficiently, especially to under- and unbanked Americans.  Delays in payments caused consumers to draw down on empty accounts, triggering overdraft fees.  An efficient, real-time, blockchain-based CBDC could be an alternative solution that resolves time delays and prevents fees.
  • While the FRB has been developing its own real-time interbank clearing and settlement rail called FedNow, a CBDC may render the innovation obsolete as a CBDC could allow users to access tokens without a bank account, and also take advantage of certain innovations like smart contract programming. The target release date for FedNow is 2023. However the potential for a CBDC to overshadow or replace FedNow depends on regulator-appetite for a CBDC, availability of a CBDC for retail vs. wholesale payments, and the risks of a CBDC product.

[1] A paper published by the International Monetary Fund in early February summarized insights, emerging trends, and policy lessons from six countries that have deployed CBDCs at various stages of development.

[2] Although the Project Hamilton White Paper asserts that this crude characterization is “lacking and insufficient to surface the complexity of choices in access, intermediation, institutional roles, and data retention in CBDC design,” these distinctions have been adopted elsewhere and serve as a useful pedagogical framework.


Chen Xu is a counsel of the Banking Group and is resident in the New York office. His practice focuses on advising banking clients on a wide range of bank regulatory, policy and transactional matters and cryptocurrency-related issues, including in the areas of regulatory capital, liquidity and stress testing. Mr. Xu is recognized as an “associate to watch” by Chambers USA (2021), where clients say that he is “a tremendous resource” who is “just exceptional at working through the real technical nuances of capital rules and the other quantitative aspects of technical regulations.” Mr. Xu received his J.D. from Columbia Law School in 2013 and his B.A. from University of California, Berkeley in 2010. He can be reached at cxu@debevoise.com


Amy Aixi Zhang is a corporate associate and a member of Debevoise's Banking and Financial Institutions Groups. She graduated from Harvard Law School in 2020. During her time in law school, Ms. Zhang was President and Co-Founder of the Harvard Law School Blockchain and FinTech Initiative. She authored “Regulating Crypto Assets: Securities and Commodities,” a case study published in FinTech Law: The Case Studies by Harvard University Press in July 2020 and was a fellow at a mortgage servicing fintech company before joining Debevoise in 2020. She can be reached at aazhang@debevoise.com.