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: Move toward digital dollar gains steam as Boston Fed says its prototype can handle 1.7 million transactions per second

The creation of a government-backed cryptocurrency took a major step forward Thursday when Federal Reserve Bank of Boston released research in collaboration with the Massachusetts Institute of Technology, on the technological viability of a Fed-backed digital dollar, also known as a central bank digital currency.

The results are promising for the viability of a digital dollar, as the research produced two separate architectures for a potential U.S. CBDC, with one code base capable of handling 1.7 million transactions per second, according to a white paper released Thursday. That’s more than 2.5 times the number of transactions Visa can handle on its network, according statistics cited by Visa CFO Vasant Prabhu in a recent Barron’s interview.

Furthermore, the vast majority of these transactions were settled in less than two seconds, a tantalizing result for users of the U.S. banking system, which can force customers to wait days before a fund transfers are settled.

That performance is also far superior to popular cryptocurrencies, with the bitcoin network capable of handling just 7 transactions per second and ether just 25, according to research by Shihab Hazari, a software developer and former researcher at Ontario Tech University. Though developers are working on methods to increase throughput on these blockchains, it’s unlikely that decentralized networks like bitcoin can compete on these metrics with a centralized network like the one proposed by the Boston Fed and MIT.

The successful rollout of a central bank digital currency will likely be resisted by bitcoin purists, who see bitcoin as means to overthrow the power of central banks and governments over money. Other crypto enthusiasts who aren’t wed to the libertarian ideology that motivated the creation of bitcoin are likely to welcome a digital dollar as evidence that the government is embracing their vision of a global economy greased primarily by cryptocurrencies.

Along with the research paper, the Boston Fed and MIT plan to upload the code that powers these experimental architectures to GitHub, a service that hosts open-source code and enables developers around the world to give feedback and refine and improve the code.

“It’s critical to understand how emerging technologies could support a CBDC and what challenges remain,” Boston Fed Executive Vice President Jim Cunha said in a press release. “This collaboration with MIT and our technologists has created a scalable CBDC research model that allows us to learn more about these technologies and the choices that should be considered when designing a CBDC.”

Americans are already using digital forms of money to execute most transactions. Cash use accounted for just 19% of all payments in 2020, according to the Federal Reserve Bank of San Francisco, while digital money, including credit cards, debit cards and bank transfers accounted for 67% of all transactions.

A central-bank digital currency could work much like the mostly bank-issued digital money Americans use today, with some key differences. First, it would be backed by the full faith and credit of the United States government and therefore risk-free. Second, transactions using a CBDC could be executed nearly instantaneously at little cost, and with proper collaboration with foreign central banks, greatly reduce the cost and time it takes to execute cross border transactions.

Advocates of CBDCs also believe a digital dollar could be used to foster greater financial inclusion, enabling Americans who are skeptical of banks to use a digital form of the Federal Reserve notes they carry in their pockets, enabling them to participate in the ever-expanding online economy.

The research comes on the heels of a report issued by the Board of Governors of the Federal Reserve, which argued that if the central bank were to issue a digital dollar, it would be intermediated by the existing financial system, which would provide consumers with digital wallets or accounts for storing digital dollars. The report also stressed the need to safeguard Americans’ privacy rights, while balancing that goal with “the transparency necessary to deter criminal activity.”

Researchers at MIT and the Boston Fed identified these competing priorities as an especially thorny problem as they continue to experiment with the technology. While it’s possible to design a CBDC that would retain little data on transactions, such a design makes it more difficult to audit transactions for accuracy and to monitor for cyber intrusions, according to the white paper.

Phase Two of the project, which is now underway, will include further research into these issues as well as research into making a digital dollar interoperable with other central bank digital currencies, and potentially, private cryptocurrencies like bitcoin BTCUSD, -0.75% and ether ETHUSD, -1.65%.

“There are still many remaining challenges in determining whether or how to adopt a central bank payment system for the United States,” said Neha Narula, director of the Digital Currency Initiative at MIT, in a press release. “Open-source software provides an important way to collaborate, experiment, and implement.”

One benefit of a central bank digital currency in the eyes of financial regulators is their potential to supersede popular stablecoins like dai  DAIUSD, 0.00,  tether USDTUSD, +0.01%   and USD coin USDCUSD,  — digital assets that peg their value to the U.S. dollar. These instruments are used by cryptocurrency investors to park unused funds and protect them from the extreme volatility in crypto markets.

The Biden administration released a report on stablecoins in November that outlined a variety of risks stablecoins pose to investors and the economy more broadly, including risks related to a so-called “run” on a stablecoin because of doubts about the backing assets. Many popular stablecoins are backed by real assets, and maintain their value by promising to always exchange one token for one U.S. dollar. If investors lose confidence in the amount or quality of assets backing a stablecoin, it could trigger “a self-reinforcing cycle of redemptions and fire sales of reserve assets,” the report said.

The Biden administration recommended that Congress pass legislation requiring stablecoins be issued by a bank insured by the Federal Deposit Insurance Corporation and overseen by federal banking regulators, in order to mitigate these risks. An effective and popular digital dollar, however, could potentially reduce the need for stablecoins by giving the crypto economy a means to seamlessly transform their tokens into central bank money.

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