A recent speech given by Federal Reserve Vice Chair, Lael Brainard, about the FedNow Service, gives rise to a few interesting questions relating to the implementation of a central bank digital currency. Which leads to the interesting question, is this the beginning of the end of financial privacy? Especially if FedNow is a trojan horse for a CBDC.
The FedNow Service is a pilot program that the Fed will roll out, to enable individuals and businesses to send instant payments. This they can do through their depository institution’s “master” account.
The service is in a testing phase which is intended to assess the flexibility of a neutral platform that supports a broad array of instant payments. The nuts and bolts of the system were discussed at an early adopter workshop where it was revealed that they’ve been working on this for quite some time now.
The FedNow Service Is Similar To CBDCs
However, the major selling points for the FedNow service are very similar to those of implementing a Central Bank Digital Currency.
This gives rise to the question, “Could FedNow be a trojan horse for a CBDC?”.
So, FedNow is a service that innovates the payment structure for financial institutions, allowing instant payments in a way. While one needs to look in-depth into how exactly the system works, on the surface it appears to call into question a central bank digital currency implementation in certain respects. Possibly even setting the structure for a CBDC to be implemented. The Fed is even allowing the participant financial institutions to innovate and create other services from it, just as was discussed in the series of papers about CBDCs written by a group of central banks, including the Fed’s Board of Governors.
If you believe that a central bank digital currency is being implemented with good intentions, and only consider the positive side of things, then FedNow seems to negate the use of CBDCs.
However, if you don’t believe that good intentions are behind a CBDC implementation, then there are more negative aspects of CBDCs in general, that could be used that would still merit its implementation. For more on the detrimental effects of CBDCs, click HERE.
FedNow Due For Launch In The Middle of 2023
Regardless of the nuances of the system, they should be ready to launch the FedNow service between May and July of 2023. The Fed sees this as bringing an innovative core instant payment infrastructure to all financial institutions of every size across America. All financial institutions are their target, but for now, there are a select few early adopters who’ll roll it out.
In a similar fashion to CBDCs, the Fed sees this as an opportunity for American households and businesses who want and deserve, payment transactions that work seamlessly, reliably, and efficiently. When diving into the usability of CBDCs and how they work, the cost-benefit analysis analyses and pretty much all the characteristics you could think of, apply to any form or mode of transaction.
FedNow Will Transform Everyday Payments
In the final analysis, they see FedNow as transforming the way everyday payments are made throughout the economy. Brainard went on to explain the substantial gains to households and businesses through their ability to send instant payments, at any time, on any day, with the funds being immediately available to the recipients.
This has significant cash flow advantages as it would allow recipients to make other payments immediately or manage their cash flow more efficiently.
In essence, we’ll get an instant settlement.
This is one of the arguments for a CBDC, as its aim is to introduce an instant payment structure or instant settlement. The technology obviates the need for holding periods. There’ll no longer be three-day waits on an ACH transaction, for instance.
While this is one of the major arguments for a CBDC, this is also what FedNow will do. It is designed for the backend of financial institutions. But, unlike the peer-to-peer basis of CBDCs, it is the slow implementation of the CBDC concept in that respect.
It could be a kind of trojan horse, so to speak, for implementing a central bank digital currency or a low-key way of “testing the waters”.
The Fed goes on to explain that “immediate availability of funds could be especially important for households managing their finances from pay-check to pay-check, or for small businesses with cash flow constraints”.
So, paying your bills immediately is one of the major arguments used to support CBDC adoption. This would mean paying something like your electricity bill on an hourly basis based on how much you use.
A Major Policy Change For The Fed
The explanation for doing this through cloud-based design indicates a policy change, as it is unique amongst central bank instant payment services. It allows for scalability or future-proofing, as the high volume of retail transactions and broad geographic points of resiliency will ensure continuity of service.
The takeaway point here is that this system would not just be used for settlement between institutions but also large-scale regular retail payments. What also comes to mind, is why could they not use reserve accounts at the Fed for institutional settlements. But not all financial institutions necessarily have reserve accounts at the Fed.
This also means that financial institutions can deal with instant settlements without becoming involved with repo transactions. This then tries to encompass as many financial institutions as possible rather than just the ones that are eligible to hold reserves within the federal reserve system.
Heavy Stakeholder Investment
As a way of getting institutions ready for the adoption of a system like this, the Fed has invested heavily in stakeholder engagement. They’ve done this through the pilot FedNow program, their Explorer Resource, the FedNow Community, the Service Provider Showcase, and the Early Adopter Workshop where the Federal Reserve Vice Chair’s pilot program speech was given.
The Fed is also working closely on a national level, with private sector Real-time Transport Protocol (RTP) service providers to advance their goal of instant payment availability. Message specifications must align with and support routing interoperability for the system to work within the private sector and federal reserve system. By blurring the lines between the Federal Reserve System and private entity systems, they are creating an alternate RTP instant payment system that is interoperable with the FedNow system.
This is again a similar characteristic to a CBDC, where the digital currency must be interoperable with the current financial system. It must at least be able to mesh with the current financial system initially so that transfers happen seamlessly between the systems.
The challenge is that this must happen in countries with different jurisdictional requirements and needs as well as different implementations. A focused effort is required to shift to the inevitable real-time payments process.
In this regard, the Fed expects all stakeholders, i.e. financial institutions, core service providers, software companies, and application developers, to devote the resources necessary to support instant payments. With the imminent start of the pilot program in mid-September, the Fed is pushing hard for all parties to get involved now.
It will be interesting to follow this pilot program and see how it plays out. The Fed may try to push the timeline out or it may just come in on time.
Only time will tell.
For More on Central Bank Digital Currencies in general:
https://jamesdforsythe.com/category/cbdcs/
Vice Chair Brainard’s speech can be found here:
https://www.federalreserve.gov/newsevents/speech/brainard20220829a.htm
