Is the digital dollar dead?
It’s summer 2020. The world is under a series of lockdowns as the pandemic continues to run its course. And in academic and foreign policy circles, digital currencies are one of the hottest topics in town.
China is well on its way to launching its own central bank digital currency, or CBDC, and many other countries have launched CBDC research projects. Even Facebook has proposed a global digital currency, called Libra.
So when the Boston branch of the US Federal Reserve announces Project Hamilton, a collaboration with MIT’s Digital Currency Initiative, to research how a CBDC might be technically designed—it doesn’t raise many eyebrows. A hypothetical US central bank digital currency is hardly controversial, after all. And the US cannot afford to be left behind.
How things change. Three years later, the digital dollar—even though it doesn’t exist and the Fed says it has no plans to issue one—has become political red meat. Tapping into voters’ widespread opposition to government surveillance, a group of anti-CBDC politicians has emerged with the message that the digital dollar is something to fear.
It’s difficult to pinpoint when the dynamic changed, but a distinct brand of CBDC alarmism seemed to pick up after President Joe Biden signed an executive order in March 2022 stating that his administration would “[place] the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC.”
Now legislators in both houses of Congress have introduced bills aimed at making sure a CBDC doesn’t see the light of day. Presidential candidates are even campaigning against it.
“Anyone with their eyes open could see the danger this type of arrangement would mean for Americans who … would like to be able to conduct business without having the government know every single transaction they’re making in real time,” Florida governor Ron DeSantis, who is running for the Republican nomination for president, said in May. In campaign speeches, DeSantis has described a dystopian future in which the government uses its CBDC network to block people from buying guns or fossil fuel.
Not only does the Fed have no plans to issue a digital currency, but it has repeatedly said it wouldn’t do so without authorization from Congress. How one might work—including how closely it might imitate physical cash—is still a wide-open question that can only be answered through research and testing.
Project Hamilton’s goal was to build and test a prototype of just one component of a potential system: a way to securely and resiliently handle the same quantity of transactions that the major payment card networks process.
Hamilton’s first phase demonstrated a feasible technical approach, and the researchers promised a “Phase 2” that would explore sophisticated approaches to privacy and offline payments. But late last year, shortly after the project came under scrutiny from anti-CBDC legislators, the Boston Fed ended Hamilton. Now the sort of technical design research that Project Hamilton exemplified may have to come from outside the central bank, which prefers to remain politically neutral.
And a digital dollar looks less and less likely by the day.
The case for cash
Opponents of a hypothetical US CBDC cast it as a solution in search of a problem. Dollars are already digital, after all. If you paid with a debit card recently, did you not pay with digital dollars? China’s move to pilot a consumer central bank digital currency is not reason by itself to pursue one, they argue. Libra failed to launch; a global digital currency run by a tech company is no longer an issue. What purpose would a government-issued digital currency serve other than to give the government a tool for financial surveillance and control?
But there is a problem—probably one that you’ve noticed yourself. Physical cash is going away. Fewer and fewer vendors are accepting bills and coins. On top of that, consumers are simply choosing to use less cash. That’s in part out of convenience, but there’s another big reason: you can’t use cash to buy things on the internet.
In the US, cash payments represented just 18% of all payments in 2022—down from 31% in 2016, according to research by the San Francisco Fed. Outside the US, things are even further along the road to a cashless society. The decline of cash is a primary reason more than 100 countries are researching the idea of creating their own digital currencies.
The solution is a digital currency with all the features of physical cash, according to Willamette University law professor Rohan Grey.
That we can’t use cash on Amazon is only one argument for government-issued digital cash, says Grey. In the US, plenty of people rely on bills and coins because they don’t have bank accounts and can’t get credit or debit cards. The Federal Deposit Insurance Corporation estimates that in 2021, 5.9 million US households were “unbanked.” Besides that, Grey argues, cash has unique “social features” that we should be careful to preserve, including its privacy and anonymity. No one can trace how you spend your coins and bills. “I think anonymity is a social good,” he says.
Last year, Grey helped author a US House bill called the Electronic Currency and Secure Hardware Act (ECASH). The legislation, which was introduced by Representative Stephen Lynch of Massachusetts, would have directed the Department of Treasury to create a digital dollar that could be used both online and offline and have cash-like features, “including anonymity, privacy, and minimal generation of data from transaction.” It didn’t make it out of the Financial Services Committee, but Grey says there are plans to reintroduce it this year.
DeSantis and other CBDC opponents most likely agree with Grey that we should replicate the privacy of cash in digital form—after all, they claim to be defending Americans against a financial surveillance state. But whereas Grey is advocating for a government-controlled system, they seem to prefer something more like decentralized cryptocurrency networks, which are not controlled by any central authority.
DeSantis recently signed a bill explicitly banning a “centralized” digital dollar in Florida, apparently leaving the door open for one that is decentralized. Representative Tom Emmer of Minnesota, who introduced a bill this year that would prohibit the Fed from issuing a digital currency, has said multiple times that a CBDC must be “open, permissionless, and private.” “Permissionless” is a term enthusiasts use for crypto networks like Bitcoin and Ethereum, which are open to anyone with an internet connection. Emmer, a Republican, is one of Congress’s most outspoken crypto enthusiasts.
A spectrum of possible designs
It is not clear how currency issued by a central bank could ever be controlled by a permissionless crypto network. And Bitcoin and similar cryptocurrencies have privacy issues of their own. Though users are pseudonymous, information about the sender, the recipient, and the amount of every transaction is published on the blockchain. Investigators are skilled at using clues, like personal information that users share with crypto exchanges, to discover users’ real identities.
Either way, using a blockchain network won’t suffice, says Grey, because many of the same people who rely on cash also lack internet access. He envisions cards that could be tapped together or to smartphones to transfer value anonymously, online or offline. Like physical dollars, the digital stand-ins would be so-called bearer instruments, meaning that possession gives the holder rights to ownership. There are a number of unanswered technical questions about how to pull all this off securely, however—a fact that Grey acknowledges.
Unanswered technical questions were also the motivation behind Project Hamilton. The researchers set out to investigate possible designs for a “resilient transaction processor” that could handle at minimum tens of thousands of transactions per second, the capacity they determined necessary to handle the volume of retail transactions in the US. But they also sought to develop a transaction processor that was flexible enough in its design to leave open a range of options for other parts of the system, like technologies for privacy and offline payments.
The software they came up with does not use a blockchain, but it borrows components from Bitcoin. Neha Narula, director of the Digital Currency Initiative at the MIT Media Lab, says it’s possible to break a blockchain system down into its component parts and then apply some but not all of those pieces in a different context.
For example, one piece is a blockchain’s decentralized nature, which makes it possible to run a cryptocurrency system without relying on any one person to control it. The team decided that a CBDC would not need this property, since it would be run by a central bank. Another property of blockchains is known as Byzantine fault tolerance (BFT), which allows the network to keep functioning even if malicious participants are acting dishonestly. The Hamilton team decided they could assume that since the system would be run by a single central bank, there wouldn’t be malicious participants, and so BFT wouldn’t be required.
Ditching BFT and decentralized governance has its benefits. In Bitcoin, maintaining them both makes the system expensive and slow to run, in part because data must be replicated on every computer on the network. The result is that Bitcoin can only process around seven transactions per second. In early 2022, the Hamilton team demonstrated a system capable of processing 1.7 million transactions per second—much faster than even the Visa network, which Visa claims is able to process 65,000 transactions per second.
Like Bitcoin, Hamilton’s transaction processor used cryptographic signatures to authorize payments. It also used Bitcoin’s method for recording transactions, called the unspent transaction outputs (UTXO) model, which stops people from spending the same coin twice. The details of the UTXO model are complicated, but it works because each transaction references the specific coins being spent.
Narula stresses that Project Hamilton was a “first step” toward understanding how a CBDC might be designed. The team made the software open source so that other teams could build on it. But it was not advocating for specific design decisions. There is a spectrum of possible CBDC designs, ranging from traditional bank accounts that the Fed offers directly to consumers (currently it only offers accounts to banks) to something that looks like a “digital bearer instrument,” Narula says.
Besides demonstrating the ability to handle lots of transactions, Hamilton also showed that “if designers want to, it’s possible to build a system that stores very little data about transactions, users, and even outstanding balances,” says Narula. “A big misconception about CBDCs right now is this assumption that they have to be built in a way where whoever is running it can see everything.”
So… what’s next?
Nonetheless, not even a fundamental research project like Hamilton was able to escape the ire of anti-CBDC politicians.
In December of last year, Emmer and eight other members of Congress sent a letter to the president of the Boston Fed, arguing that there had been “insufficient visibility into the interaction between Project Hamilton and the private sector.” The legislators cited an FAQ from the Project Hamilton report stating that the Fed had been working with “government, academia, and the private sector” to learn about “potential use cases, a range of design options, and other considerations” related to CBDCs.
The letter went on to ask several questions, including whether the Boston Fed intended to fund startups interested in designing CBDCs and whether any firms involved in the project might be able to “exploit a regulatory advantage over competitors.”
Emmer’s office did not respond to MIT Technology Review’s questions regarding whether it ever received answers to the questions in the letter. But the Federal Reserve does not invest in startups. And it’s not surprising that Project Hamilton would openly take input from the private sector, because many of the most innovative ideas for digital currency technology lie in the commercial arena.
The letter’s final question asked how Project Hamilton was addressing concerns about “financial privacy and financial freedom” in a CBDC system. In fact, the “Phase 2” promised in the Hamilton research report, which was published in February of 2022, was explicitly meant to entail research into the use of advanced cryptography to “greatly increase user privacy from the central bank.” But when the project shut down in December, the announcement made no mention of Phase 2.
The Fed, which aims to stay out of politics whenever possible, hasn’t stopped doing research on CBDCs, says Darrell Duffie, a professor of finance at Stanford’s graduate school of business. But it has slowed considerably, and “nobody is charging ahead openly” the way Hamilton did, he says. Duffie speculates that “maybe Project Hamilton would have had another phase” if it had not been for Emmer’s letter.
A spokesperson for the Boston Fed declined to answer questions about Phase 2. Project Hamilton “was completed at the end of 2022,” the spokesperson said in an emailed statement, adding that the Boston Fed “continues to contribute to ongoing Federal Reserve System research that aims to deepen the Federal Reserve’s understanding of the technology that could support the issuance of a CBDC.” The spokesperson also reiterated that the Fed “has made no decision on issuing a CBDC and would only proceed with the issuance of a CBDC with an authorizing law.”
According to MIT’s Narula, the collaboration with the Boston Fed “reached a natural end.” But the Digital Currency Initiative has continued working on the research project formerly known as Hamilton and still hopes to publish some of that work.
“The only way to really truly understand these types of systems is to build and test them,” she says.
