US Digital Dollar Will Be Kind to Banks

US Crypto Digital Dollar

The president of the United States, Joe Biden, put in place the machinery to urgently develop a cryptodollar, the digital currency of the United States.

The objective of the Biden administration is to evaluate the technical requirements and infrastructure necessary to provide the country with its own digital currency, which will be backed by the Federal Reserve.

The executive order signed this Wednesday by Biden covers different aspects related to cryptocurrencies, in addition to the digital dollar, and was very well received by the market, which expected much stricter literature.

The cryptocurrency that the Biden administration has in mind is actually a central bank digital currency, known in jargon as CBDC.

The peculiarity of this currency is that it is issued directly by the central bank so that citizens can buy them directly without depending on a financial institution.

For this reason, and to the extent that the launch of the crypto-dollar could accelerate the development of other CBDCs, commercial banks are suspiciously watching an initiative that potentially reduces deposit holdings.

Digital Dollar United States

Hybrid crypto-dollar model to iron out rough edges with commercial banks

The reaction model with customers from commercial banks changes profoundly if they have a CBDC.

For example, if the ECB launched a mobile application that allowed its users to have digital euros, they would no longer have a relationship with commercial banks, which is of great concern to financial institutions.

However, “the model that is accepted by commercial banks, because it is the least uncomfortable, is the hybrid CBDC,” they explained to the Market Times in financial sources.

In this case, the central bank puts its digital currency into circulation through the applications of commercial banks and they are the ones that distribute it among their clients, with which they do not lose their commercial relations either.

Incentives to Curb CBDC Holdings

The problem is important because citizens could be incentivized to pass their money to CBDCs and bypass financial intermediaries.

So that this does not happen, elements such as negative interest rates are introduced from certain amounts of digital currencies, specifically, above 3,000 dollars.

Thus, banks would be incentivized for their clients to have funds in CBDC, because they remain linked to them, especially if they have the bank’s own application, but limiting the risk of a deposit leak.

In addition, financial entities do not have to provide provisions for the money in CBDC, which currently happens with deposits.

The ECB is also working on the digital euro

In Europe, the European Central Bank is also working on its proposal for a digital euro, the bases of which are set out in the document ‘On a digital euro’.

Among the various problems posed by central bank digital currencies, according to this report, is the possibility that the digital euro could have a negative impact on the stability of the financial system.

Greater demand for the digital euro would put upward pressure on the financing costs of commercial banks, which would have to deleverage and reduce their credit supply.

Furthermore, if their traditional business model is compromised, banks may decide to take on greater risks in an attempt to be more profitable.

Similarly, if commercial banks take fewer deposits and are less involved in payment routes, they may have less information about their customers, which in turn will impair their ability to assess risk.

Given these risks, “it is not desirable for the digital euro” to attract large investment flows, the document argues. For this reason, the digital euro should be an attractive means of payment but designed to avoid its use as a form of investment. Hence the negative rates that will apply.