Newly confirmed Federal Reserve Vice Chair Lael Brainard this week said the central bank views a digital dollar as part of the global financial system's future that works in sync with the private sector.

“I see the potential of a digital dollar as being complementary to a stable system that would include stablecoins and commercial bank money,” Brainard said before the House Financial Services Committee on Thursday. “A digital currency backed by the U.S. government … could be an important support to a broader system of private sector innovation.”

“Blockchain has real inefficiencies associated with proof of work in the way it verifies a ledger. A CBDC wouldn’t have those inefficiencies on settlement,” she added.

Federal Reserve Board Governor Lael Brainard testifies before a Senate Banking Committee hearing on her nomination to be vice-chair of the Federal Reserve, on Capitol Hill in Washington, U.S., January 13, 2022. REUTERS/Elizabeth Frantz

A consortium of Republicans and Democrats — who homed in on including more unbanked Americans in the financial system — questioned Brainard for three hours on what merits a CBDC could provide.

“There is potential for significant harm to our financial system if we move forward without sorting through potential consequences,” said Patrick McHenry, the Republican ranking member of the committee. “In its report, the Fed listed a number of potential benefits of a CBDC — most of which, in my opinion, could also be realized through private sector alternatives.”

Brainard said new forms of digital money such as stablecoins that do not share these same protections could reintroduce risk into the payments system.

“As we have seen, such new forms of money can lose their promised value relative to fiat currency, harming consumers or, at large scale, creating broader financial stability risks,” said Brainard.

Brainard sees a CBDC acting as a neutral baseline upon which private financial services could innovate. “In any circumstance a CBDC would create a neutral settlement layer that would allow the private sector to innovate more rapidly and effectively,” said Brainard.

She also noted the Fed would still preserve banks as intermediaries in the payment system, emphasizing that banks would be responsible for verifying identities and maintaining consumer privacy.

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“[The] core principle of any digital dollar would need to be privacy protected,” Brainard said, noting the Fed would not retain direct individual accounts at the central bank.

cbdc or central bank digital currency on tablet for business concept 3d rendering

Brainard said it was important to think of a CBDC from the viewpoint of the future stakes of the global financial system with the U.S retaining its dominant stance as the world’s reserve currency along with the benefits that offers consumers and businesses.

“The dollar is the most widely used currency in international payments and investments, which benefits the United States by reducing transaction and borrowing costs for U.S. households, businesses, and government,” Brainard said. “In future states where other major foreign currencies are issued in CBDC form, it is prudent to consider how the potential absence or presence of a U.S. central bank digital dollar could affect the use of the dollar in global payments.”

If Congress decides to pursue a CBDC, Brainard said it could take five years to work out security and design features.

Some lawmakers voiced concern over whether the creation of a CBDC would diminish deposits at banks, taking away money banks use to make loans. Brainard said the Fed could design a CBDC in such a way that would not happen by making sure a digital dollar doesn’t pay interest much in the way cash does not – and capping the amount of digital dollars any one person could hold.

“It’s less attractive than deposits if it’s not interest bearing," she said. "Consumers are accustomed to making payments on mobile apps without interest on those balances so it’s a natural way to go to me."

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Still Brainard acknowledged that the natural evolution of the payment system and the gravitation towards mobile payment apps is already leading to diminished use of cash and deposits, and a CBDC could see some further reduction.

Members of the Fed are divided on adopting a CBDC. Brainard has been supportive of a CBDC, while other members of the Fed, including Fed Governor Chis Waller, have taken a more skeptical view. Brainard repeatedly assured lawmakers Thursday that the Fed would not pursue a CBDC without support from the executive branch and Congress.

The Fed issued a discussion paper on a CBDC in January to ask for input from the public. The paper's comment period closed on May 20, and as of that date, it had received nearly 2,000 comments from a wide range of stakeholders. Brainard said the Fed plans to publish a public summary of comments in the near future. U.S. stablecoin issuer Circle said a central bank digital currency isn’t needed and creates more risks, underscoring that private-sector stablecoins are already achieving what a CBDC would hope to offer.

“Many of the benefits of a CBDC are already being met by private-sector innovations, like USDC, through blockchain-based payment systems," Circle said in comments to the Fed’s discussion paper.

Jennifer Schonberger covers cryptocurrencies and policy for Yahoo Finance. Follow her at @Jenniferisms.

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