How is FedNow, set to launch in July, different from stablecoins and CBDCs?

The U.S. Federal Reserve Bank will officially launch the real-time payment system FedNow in July, providing a 24/7 service 365 days a year to meet the needs of businesses and individuals for instant fund transfers. What is FedNow? How does it differ from stablecoins and central bank digital currencies (CBDC)?

FedNow to Address Existing ACH Drawbacks

The development of FedNow is primarily aimed at improving the shortcomings of the largest retail payment system in the United States—Automated Clearinghouse (ACH). ACH is an electronic transaction method that allows the transfer of funds between banks and other depository institutions. Typical ACH payments include salaries, consumer and business bills, interest, dividends, and social security benefits. It is the system most commonly used by American consumers, but regular ACH transfers may take up to three business days to settle and be made available to the end-users, even longer during holidays.

FedNow, a project led by the Federal Reserve Bank of the United States, aims to address the delay in the settlement of financial transactions between institutions by providing 24/7 service 365 days a year to meet the needs of businesses and individuals for real-time fund transfers, thereby creating more economic benefits.

FedNow integrates the financial industry, payment processors, fintech companies, etc., to bring instant and convenient payments to individuals and businesses, reducing costs related to overdrafts, error refunds, and more. According to the "President's Economic Report" submitted to Congress by the White House Economic Advisory Committee, FedNow is estimated to save American households over $7 billion annually.

If FedNow is widely adopted, low-income groups may have more opportunities to benefit from this innovative and responsible use of financial services, making banking services more inclusive. However, the commitment and active participation of the private sector are required to make FedNow more widely available and convenient for more people to use.

How Does FedNow Differ from Stablecoins?

Stablecoins are decentralized digital assets designed to provide stability and fast transactions by pegging their value to specific assets or currencies, existing on the blockchain. The commonality between stablecoins and FedNow is their ability to process transactions instantly, unlike traditional banking systems.

However, FedNow was designed initially for the domestic payment system in the United States, which is far from the borderless inclusive finance and cross-border remittances that stablecoins aim for. Currently, regulatory compliance and reserve transparency are key points of observation. The decreasing issuance by compliant stablecoin issuer Circle in the U.S., contrasted with the soaring market value of Tether, which focuses on offshore business, indicates a higher demand for stablecoins in developing countries than in the U.S.

Can FedNow Replace CBDCs?

As mentioned in the 2023 President's Economic Report, money can exist in physical forms like cash and digital forms like electronic bank accounts. Central Bank Digital Currency (CBDC) is akin to cash liabilities of central banks but exists in digital platforms enabling real-time exchange and settlement. CBDC systems can be established in various ways, such as wholesale CBDC limited to financial institutions like banks, and retail CBDC for individual use. The creation of CBDC does not necessarily rely on DLT distributed ledger technology but could be operated by a trusted central authority—the central bank of a country.

The report also mentions the benefits of implementing CBDC in the U.S., including enabling payment systems as a foundation for further technological innovation, facilitating faster cross-border transactions, and promoting financial inclusion and fairness by providing broader access to financial services through CBDC.

However, CBDC must ensure that such payment systems adhere to human rights, democratic values, and privacy principles. There are risks associated with having CBDC in the financial system. Widely used CBDC, being the safest form of currency issued by central banks, may be particularly attractive to risk-averse users compared to stablecoins, especially during times of stress in the financial system. The ability to swiftly convert bank deposits into CBDC may increase the likelihood and severity of systemic bank runs. In the event of operational failures or cyberattacks on the CBDC platform, investor confidence could be undermined.

FedNow is essentially a domestic payment system in the U.S., distinct from CBDCs that may involve cross-border transactions. While the FedNow, set to launch in July, seems imminent, various research and testing projects for CBDCs are ongoing vigorously. However, there are legislative and privacy controversies to be resolved before formal implementation, indicating many variables still need to be addressed.