Sovereign Digital Currencies: Parachute Pants or the Continuing Evolution of Money

Abstract

Facebook’s Diem proposal, the growing interest in cryptocurrencies, and the decreasing use of cash have all raised concerns regarding the government’s ability to enact monetary policy and retain monetary sovereignty. While China has already launched their own sovereign digital currency (SDC), the U.S. Federal Reserve (the Fed) appears to be more concerned with getting an SDC “right rather than quickly.” As money and payment systems keep evolving, and the divergence between money and legal tender becomes greater, there is a need to investigate not only what effect any potential SDC would have on the financial system, including the possible disintermediation of banks, but also its impact on privacy and data security.

In this article we delve into the evolution of money and why the government finds itself at a crossroads with regard to the establishment of an SDC. Although numerous reasons have been given for establishing a SDC, the one aspect that must be acknowledged is the potential for a global stablecoin to displace any potential SDC due to the network effect. We explore money alternatives, types of sovereign digital currencies, and the design decisions involved with creating an SDC. Whether direct or indirect, token-based or account-based, there are risks that must first be discovered and addressed. After discussing the global impact of SDCs, including the potential first-mover advantage and impact on reserve currency, we explore the future of money alternatives concluding policymakers in the U.S. have an unbelievably difficult series of decisions to make. This article endeavors to highlight some of the most pressing issues.

Keywords: CBDC, Central Bank Digital Currencies, SDC, Sovereign Digital Currencies, stablecoins, Federal Reserve, Diem, reserve currency, digital dollar, money

JEL Classification: E5, K2