The Breakdown - Why a CBDC Would Make the Fed’s Job Miserable

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Sunday, September 19th, and that means it's time for Long Reads Sunday. Today, I am super excited and frankly kind of surprised that it's the first time that I'm reading a piece by J.P. Coning. J.P. Koenig is a monetary economist. He's a monetary historian. He's got a great Twitter feed. He's one of those people who is often skeptical, but never just partisan and out there trying to win silly Twitter points. In other words, when he writes something, you have to at least take it as thoughtful, as considered, as serious, and not really with some hidden agenda. JP has been writing for CoinDesk for a while now, and he recently wrote a piece called Are Central Bankers Ready for Payments Theater? The TLDR on the piece is this.

Starting point is 00:01:08 If the Fed and other banks adopt a CBDC, they will inevitably become involved in disputes about what is and isn't acceptable economic activity. So let's again read, Are Central Bankers Ready for Payments Theater by J.P. Coning? It's 2026 and Federal Reserve Chair Jerome Powell has just sat down in front of the U.S. Senate Banking Committee. Powell has spent the last few days preparing to be grilled by lawmakers

Starting point is 00:01:33 about why the Fed recently raised interest rates. But the questioning quickly takes a different tack. Why is FedSend being used by dangerous white supremacists for funding? asked Senator Elizabeth Warren of Massachusetts. She's referring to the Fed's central bank digital currency FedSend unveiled in 2024. What sort of controls do you have in place to prevent this? The next question comes from Senator Mike Crapo of Idaho, who wants to know why FedSend is being used as a payment method on porn websites hosting BDSM and underage porn.

Starting point is 00:02:02 Another senator asks, FedSend has become the most popular means of payment for frauds running tech support and IRS scams. How do you plan to protect seniors? Powell's size. It's going to be a long day. Central bankers seem keener than ever to try their hand at issuing a retail central bank digital currency or CBDC. Retail CBDC is a digital version of central bank money, one that everyone can use. Retail CBDC mostly exists as a concept in central bank research papers and speeches, as well as the odd pilot program. Much of the CBDC research enterprise has centered on esoteric details, such as should CBDC pay? interest or not? How should it be distributed? Should it be hosted on a blockchain or a regular database?

Starting point is 00:02:41 But something has been missing from the discussion. After a CBDC has been built, it will have to be governed. The central bank will have to write out its Terms of Service or TOS, a payments constitution that describes who can use it and how. This TOS will become ground zero for all sorts of political disputes. Are central bankers like Jerome Powell ready to enter the messy politics of governing a retail payment system, they may discover that controversies over CBDC's permissible use and accessibility end up hogging a much larger chunk of their time than they bargained for. OnlyFans' recent ban of explicit porn, which was rescinded after a few days, illustrates how divisive payments governance can be. We still don't know why OnlyFans decided to hack off one of its own legs, but it may

Starting point is 00:03:24 have had something to do with the rules of the underlying payment systems on which the site relies. The media fallout was a huge PR disaster for all involved, including MasterC. If Fed Send was part of the picture, it too would have been dragged into the controversy. Say that a central bank like the Fed builds a CBDC. It decides to go with a very simple TOS, something like Fed Sen cannot be used for illegal activities, and that's it. Even this bare-bones payments constitution will open the Fed to attack. Fed officials will now have to arbitrate the line between legal and illegal, and that's much

Starting point is 00:03:55 trickier than it sounds. For instance, a major porn clip site quickly adopts Fed send for payments. Not long after, critics demonstrate that this clip site is selling illegal content like porn involving children along with the legal stuff. Confronted with a clear violation of its TOS, the Fed will now be forced to police its network. Before disciplining the clip site, Fed officials will have to investigate whether it acted knowingly in hosting the material. Henceforth, they may have to devise rules that all clip sites must now follow to stop illegal content. A Fed porn expert will be appointed to quickly check up on clip sites for compliance. But that sort of surveillance will be expensive. The Fed may be tempted to summarily cut off all porn clips sites from using FedSend, even non-offending clips sites. But that opens it up to charges of censorship and lawsuits. As you can see, retail payments governance quickly gets complicated, controversial, and expensive. Satoshi Nakamoto famously described another governance puzzle that central bankers will run into.

Starting point is 00:04:49 Financial institutions cannot avoid mediating disputes. People often make mistaken payments. We send money to scammers. accounts may be emptied after being taken over by fraudsters, or maybe we buy a defective product and want our money back, but the merchant isn't responding to our emails. The pressure to protect retail customers from these dangers means that central banks will probably have to devise ways to arbitrate disputed CBDC payments and subsequently reverse or undo them. But it won't be cheap to arbitrate payments disputes. Central banks will have to set up tribunals, hire and trained

Starting point is 00:05:18 personnel, and so forth. Complicating matters is that certain types of products, like virtual goods are more prone to fraud in payments reversals than others, like restaurants, and disputed payments involving these high-risk goods will demand a disproportionate share of the Fed Tribunal's time. The Fed may decide to charge higher fees to higher-risk industries, or the Fed may ask all industries to bear the same costs. Either way, it'll attract constant political flack for unfairness. And maybe that's fine. Maybe central bankers really do think that it's important to get involved in all the thorny issues surrounding retail payments governance. Maybe they want to vet website content in arbitrate disputes. They may like the challenges of getting caught up in woke social media wars over

Starting point is 00:05:56 platforming and deplatforming. Maybe they think they can do a better job of writing a TOS than Visa and MasterCard. But central banks already have responsibility for setting monetary policy, which is an incredibly important task. Many of them have financial regulation duties too. Hopefully, the demands of payment systems governance don't overwhelm them. NIDIG sponsors this podcast, and they also put out a really good newsletter, focused purely on Bitcoin. If you want to want insights into what's driving market moves, regulatory changes, and the metrics that deserve your attention, sign up at nidig.com slash nLW. That's nydig forward slash nLW. Outsourced governance? Let's zoom forward again to 2026. There's got to be a way around this,

Starting point is 00:06:49 thinks Jerome Powell, as various Democrat and Republican senators tear into him about Fed's end. Can we at the Fed provide Americans with a CBDC without any of the controversy? One possibility is to offload some of the responsibility for running Fed Send onto the private sector. That is, the Fed does the nuts and bolts of issuing and redeeming CBDC, but commercial partners, Bank of America, Chase, PayPal, take care of all the customer-facing duties. They onboard Fed Fed Send customers, check for money launderers, arbitrate disputes, and de-platform anyone who is caught doing something illegal. By taking on governance, the private sector thus absorbs the political risk. This will be expensive, though, and the banks and fintex will have to be compensated. That means

Starting point is 00:07:27 giving them a bigger say in how FedSend user fees are set. But even under this tiered model, Powell still won't be safe from the controversies that flow from CBDC governance. As long as the Fed's CBDC is offered through banks and fintech but branded as a Fed product, FedSend, the politics will always lead back to the brand owner, the Fed. If it wants to be fully firewalled from payments theater, the Fed has to give up on CBDC branding. But at this point, FedSED would be like all other Fed products that are offered wholly through banking intermediaries, like FedACH or FedWire. The banks repackaged them or white-label them as they see fit and set the price. At which point the Fed has become just another dumb pipe, one with no control over the final product.

Starting point is 00:08:06 It's not really a CBDC anymore. It's just another bank product. What's the point? I'd suggest that there's a trade-off between the effectiveness of a CBDC and the amount of sweat and tears a central bank is willing to put into ongoing governance. Going full CBDC means taking on a huge amount of work. Central bankers may choose to limit their involvement in governance and the associated sweat and tears, but that means the product will not be as transformative as it would otherwise be.

Starting point is 00:08:29 To date, central banks have tackled retail CBDC as a technological problem, but I worry they are underestimating the challenges posed by governance. Hopefully they get up to speed. The last thing they want is to build a fancy CBDC and then regret it because of all the political hassle it brings them. I think this is a great little piece on an unanticipated challenge for the Fed as it considers a digital dollar. I also think in a weird way it highlights why it makes so much sense that the CCP, China's

Starting point is 00:09:00 communist government, is the first and leader in the world trying to put out a CBDC. This sort of governance challenge is for them something that they are very comfortable with because there's not a good approximation to the American system by which the Fed would be subject to constant lawsuits and constant political pressure. The leadership behind the CBDC and China, the digital yuan, will simply set the policy and no one will complain, at least not functionally, at least not with any practical expectation of recourse or change. Now, I often find it frustrating when people rush to try to label the American left as wanting Chinese-style social controls. However, I think that it does get into a very dubious era when we start talking about policing who can and who can't use payment systems.

Starting point is 00:09:46 Perhaps it will be not surprising that I think this way, given that I'm focused on crypto and Bitcoin. but there it is nonetheless. There are many politicians who would love to use a financial system to fight against the things that they find repugnant. The particular targets of that acrimony might be different on the left versus the right, particularly in the case of the religious right. But nonetheless, it's a power that we have to ask, is that a power that we want our elected officials to have? I've said before, and I'll say again, it does feel inevitable to me that the U.S. will choose at some point to digitize its dollar system. I think, frankly, that it probably will not consider these particular governance challenges. I think that it will view them as something to be

Starting point is 00:10:26 figured out later, to be figured out in practice, to let courts help decide, despite how onerous, distracting, frustrating, problematic they may be. I think it's something for us to fight against, at least, to bring up now earlier before the CBDC is designed, and that's been my modus operandi forever when it comes to a U.S. digital dollar. The deeper it gets into the design, the less chance to shape the design there is. Decisions will be made that have ramifications that have sunk costs that simply won't be reversed, at least without far more energy to correct them than it would have taken to get them to change before they ever came to be. I'm very excited that there are people out there like J.B. Coney who are writing these interesting pieces, and I hope you enjoyed thinking

Starting point is 00:11:04 about it from this different perspective. For now, guys, I appreciate you listening, and until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Why a CBDC Would Make the Fed’s Job Miserable

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