The Federal Reserve Bank of New York last week announced a 12-week pilot program for a dollar-denominated Central Bank Digital Currency (“CBDC”). Participating financial institutions are BNY Mellon, Citibank, HSBC, Mastercard, PNC, TD Bank, Truist, U.S. Bank and Wells Fargo.

The participants’ press release characterized the effort as a “proof of concept project that will explore the feasibility of an interoperable digital money platform known as the regulated liability network (RLN). . . . [The project] will test a version of the RLN design that operates exclusively in U.S. dollars where commercial banks issue simulated digital money or ‘tokens’—representing the deposits of their own customers—and settle through simulated central bank reserves on a shared multi-entity distributed ledger. [The project] will also test the feasibility of a programmable digital money design that is potentially extensible to other digital assets, as well as the viability of the proposed system within existing laws and regulations.”[1]

Developing a functional, safe, secure and widely-accepted digital payments system for CBDCs will be the most ambitious international banking project ever undertaken. The just-announced pilot is a first step in that direction. A fully developed system is likely to emerge only after lots more work, trial and error take place, and only when a core group of economically powerful nations agree to it by treaty or convention.[2] Other nations will join later in the interest of bolstering their own economies. A particular challenge the RLN pilot intends to address is “interoperability” among a series of distributed ledgers.[3]

Even within the Federal Reserve System, not all Governors agree digital dollars are needed. Fed Governor Christopher Waller argued last month that the U.S. dollar’s role as the world’s reserve currency will not be diminished by lack of a digital form factor. Benefits of CBDC pale compared to the risks, he said, including money laundering, international financial stability concerns and financing of terrorism.[4]

Waller’s concerns are valid, but he is mistaken to think the dollar’s primacy is unassailable. On the eve of WW I, British bankers would have said the same about the pound sterling. Regardless, exploration and adoption of CBDC is a Herculean undertaking that will require users to reframe their thinking about the nature of money and how it is used as a store of value. For comparison’s sake, consider the rise of all-purpose credit cards, the nearest equivalent mass market banking innovation of our lifetime.

Amid post-WW II prosperity, about a dozen banks experimented unsuccessfully with all-purpose credit cards. Leading banks derided the innovation as "lowering banking's image by engaging in an activity more properly associated with pawnshops."[5] Yet the idea caught the attention of California’s Bank of America, which was a large bank that prided itself on serving “the little fellow” other large banks avoided having as customers.

BofA in the mid-1950s set up a six-person product innovation team led by 41-year-old Joseph Williams, a Philadelphia banker who moved to San Francisco-based BofA, attracted by its middle-brow culture. He modeled BofA’s credit card on Sears Roebuck’s and Mobil Oil’s offerings, including a 25 day grace period for payments, 18% interest rate on carried balances and an assumed credit loss ratio of 4%. For proof of concept, in 1958 the bank distributed BankAmericard-branded cards to every one of its customers in Fresno—60,000 people in a city of 240,000. No credit application needed; the card arrived in the daily mail. Fresno was chosen because the customer base was big enough to be statistically significant and because if the new product flopped, it would be easier to explain away the failure to bank regulators and the media than if it occurred in a major market.

BofA courted Fresno retail merchants to accept BankAmericard, arguing it would increase sales of merchandise and relieve them of the expense of maintaining and collecting house credit accounts for regular customers. Unspoken was the fact that BofA could also more profitably offer consumer credit because it could afford the then-expensive IBM mainframe computers on which banking business had come to rely. The computers were the processing engine for all the retail transactions paid via BankAmericard.

Thirteen months after the Fresno test, the bank had 2 million cards in circulation and 20,000 participating merchants. What worked well in Fresno faltered badly in Los Angeles. “[C]rooks were quick to decipher the symbols on a stolen credit card, so they knew what the floor limit was. That way, they could make hundreds of small purchases under the limit without having to worry about a merchant calling the bank and finding out the card was stolen. [BofA] discovered that prostitutes were adept at lifting cards from johns. It learned how easy it was for merchants to cheat them. It learned that thieves could break into its warehouse and steal unembossed BankAmericards, which they would then offer to sell back to the bank. Because credit card crime was so new, the bank had a hard time getting the police interested in pursuing these thefts; because it feared the thieves would emboss the cards and use them, it often did buy them back.”[6]

The Los Angeles debacle led BofA executives in late 1959 to weigh quitting the business. They decided not to, believing consumer credit was a growing business segment for their bank and the economy generally, and because they thought Los Angeles had already brought them every bad outcome possible. A decade later, millions of Americans, including me, had their own BankAmericard. In my case, it came with a $300 credit limit even though I had no steady job and was 16 years old. Today, the 25-day grace period and 18% interest rate remain industry standard. Industry credit losses average 5%, a point higher than BofA estimated in 1958.

Like credit cards, CBDCs are likely part of our future because global economic integration will continue despite current reconsideration of its ways and means. The needed financial and legal infrastructure, as well as customer education, are only beginning to be conceived. The unfolding calamity damaging millions of FTX crypto exchange account holders will put added pressure on the Federal Reserve System to create safe, reliable means for domestic and international electronic financial commerce. The time has come and there is much work to be done.

[1] https://www.businesswire.com/news/home/20221115005936/en/Members-of-the-U.S.-Banking-Community-Launch-Proof-of-Concept-For-A-Regulated-Digital-Asset-Settlement-Platform

[2] Letters of credit are an example of a widely used tool of international business finance that are not governed by any law, but instead are subject of two conventions contractually agreed to by users, the Uniform Customs & Practices for Documentary Credits (UCP 600) issued by the International Chamber of Commerce and the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit. The UCP was first issued in 1933 and has been revised six times, most recently in 2007. Contracts customers enter into with banks for issuance of letters of credit incorporate the UCP by reference, making it part of the contract.

[3] In its simplest expression blockchain technology works as a cross-referencing network of computers. When a transaction is entered on one computer’s blockchain registry, it automatically replicates itself in the registry on all the other computers, which also perform programed tasks to determine if the transaction is accurate, legitimate, and meets other preestablished criteria. The interoperability problem is how do you connect all of the networks so they all function as one. Imagine the box score part of a baseball stadium scoreboard that gathers and presents data from other scoreboards at games in other cities that day and vice versa. The scoreboards both report information to fans and validate it as a matter of league records and team and player standings.

[4] https://www.federalreserve.gov/newsevents/speech/waller20221014a.htm

[5] J. Nocera, “The Day the Credit Card Was Born,” The Washington Post, November 4, 1994, available at https://www.washingtonpost.com/archive/lifestyle/magazine/1994/11/04/the-day-the-credit-card-was-born/d42da27b-0437-4a67-b753-bf9b440ad6dc/

[6] Id.