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Explained: The Fed Reserve’s plan for cryptocurrencies, and why it is significant

The US Federal Reserve is going to issue a paper shortly that will focus on the benefits and risks of a central bank digital currency, seeking public comment on whether it should go ahead with the plan and flagging the risks etc.

Written by Pranav Mukul , Anil Sasi | New Delhi |
Updated: May 27, 2021 11:13:17 am
Explained: US central bank’s digital currency plan and why it is significantAn illustration of Bitcoin (Reuters Photo/File)

The US has taken a decisive step towards issuing its own central bank digital currency, with the Federal Reserve announcing it will release a research paper later this year that explores the move further.

The timing of this announcement is significant on two counts — one, this comes at a time when the cryptocurrency market has suffered its worst crash in over 12 months, with leading cryptocurrencies sliding over 25 per cent in 24 hours that signals an end to a bull run that propelled bitcoin and ethereum to record highs.

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Two, this move by the US central bank comes in the wake of China joining multiple countries that have ended the central bank digital currency (CBDC) space, stoking concerns that this could undermine the US dollar’s position as the reserve currency of the world.

What did the US Fed say?

Though the US Fed did not set any specific plans on the currency, Fed Chairman Jerome Powell presented the progress of payments technology and said the central bank has been “carefully monitoring and adapting” to those tech innovations.

“The effective functioning of our economy requires that people have faith and confidence not only in the dollar, but also in the payment networks, banks, and other payment service providers that allow money to flow on a daily basis,” Powell said in a video message accompanying the announcement Thursday.

“Our focus is on ensuring a safe and efficient payment system that provides broad benefits to American households and businesses while also embracing innovation,” he said.

How does the Fed propose to operationalise the plan?

The US Federal Reserve is going to issue a paper shortly that will focus on the benefits and risks of a CBDC, seeking public comment on whether it should go ahead with the plan and flagging the risks etc. Powell said in the video that this “represents the beginning of a thoughtful and deliberative process’ when it comes to thinking about a CBDC.

“We are committed at the Federal Reserve to hearing a wide range of voices on this important issue. Before making any decision on whether and how to move forward with the US CBDC taking account of the broader risks and opportunities it could offer,” he said. He also said the CBDC should be designed for general public use and should be a compliment, not a replacement for cash.

How are other jurisdictions looking at cryptocurrencies and digital currencies?

Just last week, China barred financial institutions and payment companies from providing any services related to cryptocurrency transactions. This means that banks and online payments channels, must not offer clients any service involving cryptocurrency, such as registration, trading, clearing and settlement.

China had issued such a ban in 2017 as well, but compared with the previous ban, the new rules have expanded the scope of prohibited services, and surmise that “virtual currencies are not supported by any real value”. The announcement of a crackdown by Chinese authorities led to major cryptocurrencies seeing a crash in their prices by as much as 40% in a 24-hour period.

What about India?

In India, the government has floated The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which will prohibit all private cryptocurrencies and lay down the regulatory framework for the launch of an “official digital currency”.

It was to be introduced in Parliament’s Budget session earlier this year, but was held up as the government continues discussions with stakeholders.

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