The Federal Reserve isn’t in a rush to join the crypto bandwagon. That's the takeaway from a draft paper the Fed released Thursday laying out the pros and cons of a central bank digital currency (CBDC).

The 40-page report makes no policy recommendations and is designed to solicit comments from the public.

"We look forward to engaging with the public, elected representatives, and a broad range of stakeholders as we examine the positives and negatives of a central bank digital currency in the United States," Federal Reserve Chair Jerome Powell said in a press release Thursday.

The report offered this caveat: "The paper is not intended to advance any specific policy outcome, nor is it intended to signal that the Federal Reserve will make any imminent decisions about the appropriateness of issuing a U.S. CBDC."

Powell tempered expectations surrounding the paper during his renomination hearing on Capitol Hill last week, saying “it’s more going to be an exercise in asking questions and seeking input from the public, rather than taking a lot of positions on various issues … although we do take some positions.”

Powell initially promised in May to deliver the report last summer, but the publication timeline saw several delays.

Fed wants buy-in

Studying the potential creation of a CBDC is crucial to maintaining the dollar's standing as the world's reserve currency, advocates have said. Powell and other Fed representatives, during many congressional hearings, have fielded concerns from lawmakers that the U.S., by not yet having an operational CBDC, risks falling behind other nations in the technology of finance.

Central banks in Nigeria and several Caribbean nations have already launched CBDCs. Other countries — notably China and South Korea — are using them in pilot projects. Another 87 countries are exploring a CBDC, according to the Atlantic Council.

In Thursday's paper, the Fed emphasized the importance of security in a pilot product.

"The Federal Reserve’s initial analysis suggests that a potential U.S. CBDC, if one were created, would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable, and identity-verified," the central bank said. "Designing appropriate defenses for CBDC could be particularly difficult because a CBDC network could potentially have more entry points than existing payment services."

The Fed added that the government would need to "ensure a CBDC would preserve monetary and financial stability as well as complement existing means of payment," noting it would need to be certain to "preserve the privacy of citizens and maintain the ability to combat illicit finance."

Despite the challenges, the Fed said, "a CBDC could enhance the operational resilience of the payment system if it were designed with offline capability (that is, if it allowed some payments to be made without internet access)."

The Fed reiterated it won’t issue a CBDC without clear support from both the executive and legislative branches "ideally in the form of a specific authorizing law."

Fed vs. commercial banks

If adopted en masse, a CBDC, in theory, could muscle in on commercial banks' business model. Although a healthy proportion of consumer transactions are already digital, the money transferred through card swipes is backed by commercial banks, whereas a U.S. CBDC would be backed by the Federal Reserve.

That means a CBDC "would not require mechanisms like deposit insurance to maintain public confidence, nor would a CBDC depend on backing by an underlying asset pool to maintain its value," the paper noted.

"A CBDC would be the safest digital asset available to the general public, with no associated credit or liquidity risk," the Fed wrote.

The lack of risk may push some depositors to keep their money with the Fed — another point the central bank raises in Thursday's paper.

“This substitution effect ... could reduce the aggregate amount of deposits in the banking system, which could in turn increase bank funding expenses, and reduce credit availability or raise credit costs for households and businesses,” the Fed wrote.

CBDC and other projects

A Fed official did not give a timeline for potential implementation of a digital dollar, according to Bloomberg. Rather, the official said the central bank would assess next steps after a May deadline for comments.

Thursday's paper is separate from the Boston Fed's research project with the Massachusetts Institute of Technology on the technological aspects of a CBDC. That research could be released as early as next month. 

While the paper characterized the existing U.S. payment system as "generally effective and efficient," it acknowledging "certain challenges remain." In particular, the Fed calls out the "slow and costly" nature of cross-border payments, and spotlights the "significant number of Americans [who] currently lack access to digital banking and payment services."

The Fed also touted the prospect of getting more people banked as a benefit of its FedNow real-time payments system, slated to launch in 2023. There's no mention of a potential CBDC shifting that priority.

The paper, however, did dim the prospects of consumer bank accounts through the Fed. Current law “does not authorize direct Federal Reserve accounts for individuals, and such accounts would represent a significant expansion” of the central bank’s role, the Fed wrote in the paper — meaning banks or other service providers would need to operate those accounts.

Reaction

The Fed is accepting comments on the paper for 120 days. And a feedback form the Federal Reserve posted on its website contains more than 20 questions on CBDCs.

The American Bankers Association (ABA) signaled Thursday that it — and its members — would take the Fed up on that prospect.

The "implications" of launching a CBDC "require a careful weighing of the real-world costs and benefits before any decision to move forward," Rob Nichols, CEO of the banking trade group, said in a statement.

"Policymakers would need to show that a U.S. CBDC would somehow improve upon this reliable, tested retail banking system that serves our communities and our economy so well, and we believe it will be very difficult to make that case," Nichols said, adding that the ABA "recognize[s] the importance and complexity of this discussion."