The digital dollar pilot project begins
The digital dollar pilot project begins
Fintech

The digital dollar pilot project begins

By Marco Cavicchioli - 16 Nov 2022

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The US central bank has initiated a pilot project to test the digital dollar. 

The digital dollar is nothing more than a natively digital version of the traditional dollar, in other words, the same currency in a slightly different form. 

It consists of digital tokens that are exchanged on a common database on which all transactions are recorded. 

The digital dollar pilot project

As Reuters reports, a number of banking giants, including Citigroup, HSBC, Wells Fargo, and especially Mastercard, will participate in the New York Federal Reserve’s pilot project on the use of the digital dollar. 

The pilot project will last 12 weeks and will be run by the New York Fed‘s Innovation Center. 

It has been titled “the regulated liability network,” and will be conducted in a test environment with simulated data. 

It is therefore not a field test, but just a simulation to see if payments can be accelerated using digital tokens on a common database. 

The key point is precisely the centralization of all transactions on a single database

To date, dollars are not exchanged on centralized transactions on a single database, even when they are exchanged digitally. Instead, natively digital dollars only ever stay within the Fed’s centralized database, making it much easier and faster to trade them. 

This digital architecture is inspired by that of the blockchain, although the digital dollar is not a cryptocurrency and is not blockchain-based. No disclosure has been made as to what other technologies it is based on. 

According to the head of the New York Fed’s market’s group, Michelle Neal, the central bank’s digital dollar could actually speed up settlement times in the currency markets.

CBDCs: the United States working on its own digital dollar

CBDCs (Central Bank Digital Currencies) are digital currencies issued by central banks. 

These are not cryptocurrencies, because they are for all intents and purposes fiat currencies only issued in a slightly different form than traditional digital currencies.

The main difference with traditional digitally traded fiat currencies is precisely that they have a single central database managed by the central bank itself. This solution makes transactions extremely fast. 

But the main advantage is probably another, which is that it enables smart contracts. 

Indeed, people started talking about CBDCs after real cryptocurrencies began to spread. 

Blockchain-based cryptocurrencies are transparent and trustworthy, and in some cases even allow for the transparent, predictable, and unredeemable execution of smart contracts. 

With traditional fiat currencies, smart contracts are simply not possible, except in specific cases and on specific networks. With CBDCs, on the other hand, it becomes possible to use smart contracts on fiat currencies as well, in a general, across-the-board way. 

The lack of privacy

However, CBDCs have an underlying problem: the total lack of privacy

Indeed, there is no intention that they can be used anonymously, and since the central bank has access to all transactions recorded on its centralized database, it could in fact know the senders and recipients of all transactions, including amounts and dates

While such a database will not be public, so as not to reveal all transaction details to the world at large, the central bank, however, will have full access to it, and this probably makes CBDCs the least anonymous currencies that have ever existed. 

Competition with stablecoins

CBDCs are not cryptocurrencies and therefore will not compete with real crypto. 

However, they could compete with stablecoins, although the lack of privacy could convince many stablecoin users to continue using them. 

In addition, there is another element in favor of stablecoins: censorship resistance. 

Indeed, the central bank operating a CBDC will have the power to block, cancel, limit, or modify any transaction. For example, the problems that currently exist in transferring fiat currencies to or from crypto exchanges will remain even if CBDCs are used instead of traditional fiat currencies.  

Given that by far one of the main reasons for using stablecoin tokens is precisely to have no problems in transfers to or from crypto exchanges, or from one exchange to another, it is hard to imagine that stablecoins could realistically be replaced by CBDCs for this type of use. 

The speeding up of digital dollar transactions

It is no coincidence that the Fed’s pilot project is specifically about the speed with which interbank transactions can take place. 

With traditional fiat currencies, which are now mostly exchanged digitally, interbank transactions are slightly complex because they take place between different systems. 

For example, Mastercard has its own database on which it stores all its transactions, and Citigroup has another. When transactions have to take place from Mastercard’s database to Citigroup’s, a so-called “settlement” (settlement or liquidation) has to take place, which is by no means an immediate and trivial operation. 

However, in the event that Mastercard and Citigroup use the digital dollar, and thus the Fed’s common database, transactions between them (called “interbank”) would also be trivial and immediate. 

Overall, bank settlements have significant costs and timeframes, so using the digital dollar for interbank transactions has the potential to reduce both costs and timeframes. 

Add to this the possibility of creating self-executing smart contracts, and the digital dollar reveals the potential that often escapes common sense. 

Competition with cryptocurrencies

Yet there are no reasonable reasons why cryptocurrency users should prefer to use CBDCs. 

CBDCs in crypto markets will be used, but only as an alternative to traditional fiat currencies, or at most in some cases to stablecoins. However, they have no potential to replace cryptocurrencies, except for some smart contract uses. 

It is worth mentioning that since they are neither decentralized nor censorship-resistant, the smart contracts of CBDCs will never be able to replace those of DeFi

Marco Cavicchioli

Born in 1975, Marco has been the first to talk about Bitcoin on YouTube in Italy. He founded ilBitcoin.news and the Facebook group" Bitcoin Italia (open and without scam) ".

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