Mostly Economics

Jess Cheng and Joseph Torregrossa in this Federal Reserve research note gives a lawyer’s perspective on money in digital age:

This Note analyzes current frictions and opportunities for evolution in the U.S. payment system, by viewing the legal underpinnings of money through the lens of “network effects” and “interoperability.” First, it begins with a discussion of the current structure of the U.S. payment system, with a focus on network effects. The concept of network effects for a given system generally means that a user’s benefit increases as the number of other users on the system grows.² A sound legal framework is an important foundation for network effects within the payment system. It can bring certainty and clarity to a payment arrangement, resulting in greater consistency and predictability to the parties’ payments activity; this, in turn, removes inefficiencies and provides an incentive for more parties to join the system. The ability of different arrangements to interoperate, including from a legal standpoint — that is, for users to smoothly and efficiently choose between arrangements subject to different legal frameworks, while being confident the arrangement will, like money, serve as a way to make a payment — could bring further efficiencies to users.

Second, this Note also gives a lawyer’s perspective on the role of the Federal Reserve in the U.S. payment system. Specifically, this note analyzes the Federal Reserve’s role in promoting the system’s safety and efficiency, currently by serving as a “network hub” that connects some, but not all, of the system’s forms of money. More recently, there have been calls to expand the Federal Reserve “network” further — for the Federal Reserve to go beyond merely providing to financial institutions the foundations for safe and efficient payments as it does today, and to offer new services such as a general-purpose central bank digital currency (CBDC), directly to the public or indirectly through existing banking channels.³

Finally, this Note discusses the evolving structure of the U.S. payment system. The U.S. payment system is composed of a multiplicity of issuers of money and payment arrangements. It continues to change today, particularly with the growth of payment services offered by nonbank companies. These changes are further fueled by the increased use of electronic payments, the convergence of payments and data, and a turning point in the nature of market competition with the entrance of big technology companies into payment services. Yet this diversity and innovation in money would not serve the public well if new services and products are poorly understood and poorly constructed, and do not “interoperate” well with other forms of money, including from a legal standpoint. In a fast-changing and increasingly complex world with regulatory and commercial structures built around traditional business models, how should policymakers and, more broadly, the industry respond? To provide a starting point, this Note analyzes the core tenets of efficiency and safety inherent in the U.S. payment system’s current design — in particular, the legal foundations for the critical tenet that “one dollar” has a singular meaning of “one dollar” in whatever form it takes.