Should the U.S. Government Create a Token-Based Digital Dollar?

Should the U.S. government create a digital dollar?

Proposals for “central bank digital currency” (CBDC) come in two basic types: account-based and token-based. I have been critical of proposals for an account-based system. Until recently, there didn’t seem to be much active interest in a token-based system. But now comes a significant token-based proposal in a new white paper by the Digital Dollar Project. Would a token-based system be any better than an account-based system? It might, but it all depends on the design details. Let me explain.

An account-based CBDC would mean that households and businesses have retail checking accounts directly on the Federal Reserve System’s balance sheet. A detailed proposal for such a “FedAccounts” system by three legal scholars (Morgan Ricks, John Crawford, and Lev Menand) is available here. (I recently exchanged views with Ricks in an online event hosted by the Cato Center for Monetary and Financial Alternatives.) It is implausible that a FedAccounts system, run by a bureaucracy with no experience in retail payments, unguided by profit and loss, will provide better or more efficient service than systems offered by banks and other competitive private firms. But it isn’t implausible that threats to privacy would arise from a system that gives a government agency real-time access to all deposit transfers.

A token-based CBDC would mean that households and businesses hold circulating digital Fed liabilities in digital wallets (think mobile phone apps), the way they hold Bitcoin or Tether[1], or the way they hold Federal Reserve Notes in analog wallets. This model has been labeled “FedCoin.” The Federal Reserve System would know the dollar quantity of FedCoin in circulation, but in principle, as with physical notes and coins, it needn’t know which users hold how many of these digital dollars. One prominent supporter of the FedCoin concept since 2015 has been Federal Reserve economist David Andolfatto. An early sketch of the concept was provided in 2014 by blogger J. P. Koning.

In May 2020 a group calling itself “The Digital Dollar Project” released a report entitled “Exploring a US CBDC.” Although it deliberately leaves many important details to be determined later, the report deserves our scrutiny as an updated and prominent proposal for a token-based system. The report expands on an earlier WSJ op-ed by two of the Project’s principals, J. Christopher Giancarlo and Daniel Gorfine. Giancarlo once headed the Commodity Futures Trading Commission while Gorfine was the CFTC’s chief innovation officer. The named authors of the report include Giancarlo and Gorfine, plus Charles H. Giancarlo (CEO, Pure Storage) and David B. Treat (Accenture) as additional Project directors, together with eight more contributors from Accenture.

From the user’s point of view, the Digital Dollar Project’s “champion model” is akin to a well-backed dollar stablecoin, that is, a transferable digital token pegged to $1.00 per unit by its issuing entity. (Tether is by far the leading US-dollar-linked stablecoin with more than $9 billion currently in circulation. Here is a list of the many other available stablecoins.) But there are some differences between the Project’s model and the typical stablecoin: the model’s coin issuer is not a private entity, the fix to the dollar is free of default risk, and the exchange-rate variation around the $1.00 peg is zero. The issuer is to be the same US government agency currently responsible for supplying fiat US dollars in paper and ledger-entry form: the Federal Reserve System.

Rather than buy FedCoins on an exchange, a user would get them from banks the way she gets fresh Federal Reserve Notes, redeeming her deposit dollars for them. She would hold FedCoin balances in a digital wallet, perhaps an app on her cell phone, and spend them online or in person, or transfer them to her friend, using the phone app.

The Fed would stand ready to interchange FedCoins (which the report calls “Digital Dollars,” but FedCoins is less ambiguous) 1:1 with existing types of base money, Federal Reserve Notes (which are not to be abolished), and commercial banks’ reserve balances on the books of the Fed. In this way FedCoins are to be a form of fiat money, part of the US dollar monetary base. They are to have “the same legal status as physical bank notes,” which I interpret to mean that they are to be legal tender like Federal Reserve Notes. That is, they cannot be refused in the discharge of any dollar-denominated debts. Commercial banks will be as happy to accept them on deposit, and to pay them back out, as they are to accept and pay out Federal Reserve Notes.

Because Federal Reserve Notes are not to be abolished, the Digital Dollar Project proposal does not eliminate the “zero lower bound” on the Fed’s nominal interest rate target posed by the storage of zero-yielding currency, and thus does not enable negative interest rate policy. The Report describes its champion model as “monetary policy neutral.” I consider that a welcome feature and not a bug in the proposal, but NIRP enthusiasts who want to abolish cash will consider it a shortcoming. Whether FedCoins are to bear interest is left an open question.

The Report is generally fuzzy or flexible on technical details. FedCoin payments are to be “recorded on new transactional infrastructure, potentially informed by distributed ledger technology.” What, pray tell, is this “new transactional infrastructure”? How is it “informed” by distributed ledger technology?

In a confusing sentence (p. 9), the authors of the report declare that “a US CBDC would serve to upgrade the infrastructure of money (the ultimate public good) and act as a catalyst for private sector and market innovation.” Dollar bills or FedCoins are clearly not public goods: they are rival in use and readily excludable, as the authors recognize (p. 10). So presumably it is “the infrastructure of money” that is supposed to be a public good. But the infrastructure of “payment rails,” like the infrastructure of literal train rails, itself exhibits rivalness in use and excludability. Payment rails (like credit card systems, check clearing systems, or real-time payment networks) are congestible, gated, and have historically been privately provided. It’s arguable that a unit of account role of money exhibits non-rivalness and non-excludability, but the Project is not proposing to upgrade the unit of account.

It is easy to agree with one policy implication (p. 8): “We accordingly do not view a digital dollar as antithetical to the development of private sector payments and stable coin initiatives, many of which seek to tokenize commercial bank money.”

The report (p. 6) offers only very fuzzy reassurance against the surveillance of FedCoin transactions:

The digital dollar will support a balance between individual privacy rights and necessary compliance and regulatory processes, decided upon by policymakers and ultimately reflecting the jurisprudence around the Fourth Amendment.

The Fourth Amendment to the US Constitution secures “persons, houses, papers, and effects, against unreasonable searches and seizures.” Its application to financial privacy depends on whether financial data counts as “papers” or “effects,” and on the standard for what is “unreasonable.” The currently dominant 4A jurisprudence regarding the privacy of transactions involving ordinary bank deposits, unfortunately, is that there isn’t any, based on the “third party doctrine.” As Jennifer Lynch of the Electronic Frontier Foundation has explained:

This principle holds that information you voluntarily share with someone else — whether that “someone else” is your bank (such as deposit and withdrawal information) or the phone company (the numbers you dial on your phone) — isn’t protected by the Fourth Amendment because you can’t expect that third party to keep the information secret. By sharing that information with a third party, you have assumed the risk that it will be shared with others.

A very basic design choice, then, is whether FedCoin transfers will share information with a third party (like the Fed), in the manner of deposit transfers, or won’t, in the manner of purchases using paper currency. Under the third-party doctrine, however, sharing with the Fed means in effect sharing with any federal agency that wants the information—whether the Justice Department, the FBI, or any other bureaucracy. So much for privacy.

To the extent that FedCoin payments provide information to the Fed (namely, the payment’s size, sender, and recipient), there will be no barrier to government surveillance unless one is specifically enacted into law. Information would not always be provided to the Fed if some payments were allowed to be anonymous or pseudonymous as with paper currency. For example, the German GeldKarte, a stored-value card system introduced in the 1990s, initially allowed for anonymous cards to be purchased with cash. Prepaid gift card balances today can be spent anonymously, even online, but only once. If a stored-value or prepaid card could accept additional funds peer-to-peer, without recording the identity of the sender, it could preserve privacy in transactions much like paper currency.

Digital Dollar wallets could preserve privacy in a similar way. But the Project report proposes that FedCoin wallets “could be readily registered through a regulated hosting intermediary performing requisite Know Your Customer/Anti-Money Laundering (KYC/AML) checks,” which seems intended to rule out anonymous payments. A footnote (p. 13, fn. b) simply punts on whether privacy-preserving alternatives are to be permitted: “The decision to permit un-hosted wallets is a separate policy and design choice subject to separate analysis and consideration.” The authors do rightly caution (p. 20) that while “full surveillance and traceability may achieve broad goals of law enforcement,” such traceability “would reduce its attractiveness and inhibit adoption by even the most law-abiding users.”

Even with registered wallets, spending could be kept private by excluding identifying information about sender and recipient from the ledger, in the manner of cryptocurrency privacy coins like Zcash and Beam with revelation only by user choice (“opt-in auditability”) or court order. Following current US reporting requirements for large currency payments, privacy could be the default for all transactions under $10,000. Matthew Green and Peter Van Valkenburgh have recently discussed the technical issues connected with designing digital dollars that are “private by design such that (as is the case with physical cash) even the issuing authority can’t engage in surveillance of transactions system-wide.” And they pose the crucial policy question: “Without privacy, do we really want a digital dollar?” The Digital Dollar Project report deliberately takes no real stand on privacy design issues. It rather announces a process: “The Project intends to convene stakeholder working groups to develop these design features and recommendations.” First embrace our effort to get a FedCoin, it suggests, and then you can help us hash out the details.

What is the proposed advantage of FedCoin over existing ways of making payments? The report (p. 11) says that “a digital dollar would offer a new choice for digital transactions, instantaneous peer-to-peer payments, and in-person transactions” with “potentially lower costs.” But such commercial services as Venmo and Cash App, and stablecoins like Tether, already offer convenient dollar payments and peer-to-peer transfers at little cost to consumers. As for speed, most US checking accounts are already in banks that are members of The Clearing House’s RTP® system, which has offered real-time payments since 2017. Meanwhile the Fed forecasts that its own FedNow system will be ready in 2024. Only a Pollyanna can expect the Fed to offer innovative payment service at lower cost, whether account-based or token-based, when it has been consistently behind the private sector to date.

The report recognizes that the US private sector has been a leader in payments tech. It nonetheless hopes for the Fed to become an innovator someday soon—after many rounds of public policy discussions involving stakeholders from many interest groups. That is hardly a recipe for getting ahead of the curve. Permissionless innovation by private cooperatives and enterprises promises better results.

Some of the Digital Dollar Project’s enthusiasm for improving the Federal Reserve’s product offerings seems nervous, derived from a fear of the US government losing power. Should the US fall technologically behind in digital payments, they fear, it will be less able to continue projecting US government power globally. They write (p. 32): “If payment systems could bypass Western banks heavily linked economically and geopolitically to US dollar reserves, the effectiveness of economic sanctions as a central and unifying tool of our foreign policy would be at serious risk.” This is a poor argument for creating a CBDC given that US economic sanctions are being overused. A Fed initiative to reinforce the use of sanctions should be regretted rather than applauded. Furthermore, without a credible commitment not to invalidate or freeze FedCoins held abroad, akin to the Fed’s commitment never to invalidate Federal Reserve Notes in circulation, the foreign demand to hold FedCoins (touted earlier in the report as a benefit) will be limited.

The US dollar will remain the world’s primary reserve currency due to strong network economies—there will be no reason to switch—so long as the Fed keeps dollar inflation rates as low as those of potential competitor currencies.


A FedCoin retail payment system is likely to be less inefficient than a FedAccount system, because it does not require an ill-equipped Federal Reserve System bureaucracy to provide as much retail customer service. Still, it requires the Fed to step outside its expertise, and into the realm of private enterprise, to launch and maintain a retail digital wallet system. FedCoin may also be less invasive of privacy, but that depends entirely on the relative designs of the two systems, yet to be specified. The Digital Dollar Project’s “champion model,” although deliberately underspecified at this point (in hopes of broadening its appeal), provides a useful framework for further discussion of the standards necessary to ensure that a CBDC system does not make the money-using public worse off. At a minimum a FedCoin system should not bring constraints on private innovation in digital payments for the sake of its own market share, nor should it reduce financial privacy. So long as its use is entirely voluntary, there is not much to object to other than the likely waste of taxpayer money to subsidize the costs of creating and operating it.



[1] Bitcoin is of course denominated in its own unit of account, BTC, and its dollar price varies freely (while its volume in circulation is predetermined).