The US Federal Reserve created FedNow to make USD settlement faster and cheaper between financial institutions. The system will offer 24/7 operating hours plus a full-featured back-office suite.
Scheduled to launch by July 2023, FedNow vastly improves upon traditional interbank settlement systems like FedWire or ACH systems. It offers superior costs, scale, features, and intraday finality.
Put simply, FedNow almost completely obviates the need for a US central bank digital currency (CBDC).
Here’s how FedNow will accomplish almost everything a digital dollar could accomplish — and how it will outcompete most digital assets, including stablecoins. What’s more, it will accomplish all of this without any blockchain.
Instant peer-to-peer payments with irreversible finality
When it’s integrated into the vast majority of US financial institutions, FedNow will allow instant USD settlement between US residents on a peer-to-peer (P2P), business-to-business (B2B), and business-to-consumer (B2C) basis — even if bank offices are closed.
For the first time, it will allow almost any financial institution to settle payments with other institutions instantly. This feature will eliminate the usual ‘three to five business days’ timing of legacy payment settlements. As a result, it will give payees who rely on cash flows reliable, intraday access to cleared funds.
Admittedly, it will not serve everybody. Its functions are limited to customers in good standing with qualified US financial institutions. However, FedNow will still connect the majority of US residents, as well as many wealthy USD users abroad. This will soon encompass hundreds of millions of people.
As the clearinghouse for the world’s reserve currency and reference rate for the vast majority of global trade, the Federal Reserve is the world’s preeminent central bank. Per Pareto’s principle, FedNow might only connect 20% of the world’s population on a peer-to-peer basis but it may still connect 80% of the world’s peer-to-peer electronic payments.
Since 2017, crypto promoters have derided bank branches’ inconvenient locations and operating hours. They argued that access to one’s money should not depend on teller windows nor the risk of using an ATM at night. They also argued that senders should be able to send irrevocable funds without imposing the risk of chargebacks.
Another selling point of cryptocurrencies was their promise to reduce transaction costs. Consider, however, that FedNow also promises lower costs than almost any blockchain in existence.
Specifically, the Federal Reserve will charge most financial institutions a de minimus $25 monthly access fee — a fraction of the cost of running a single node on most public blockchains. For payments up to $100,000, FedNow will charge just 4.5 cents per transaction paid by the sender plus 1 cent per transaction request paid by the requester.
Even better, this fee schedule accounts for the complete transfer in fiat, with no on/off-ramping through any crypto exchange. FedNow eliminates all fiat-crypto fees, risks, and delays.
With very few exceptions, FedNow offers cheaper payments than almost any public blockchain. It is also secured by the world’s most valuable ledger: the books of the Federal Reserve, which secure transactions worth quadrillions of dollars annually.
The Federal Reserve already settles trillions of transactions every year and has limitless data and throughput capacity via government-managed data centers. FedNow’s centrally managed database will allow for highly scalable transaction processing. This is, of course, the advantage of an entirely centralized approach to digital payments.
Contrast this centralized database to most public blockchains which constrict data to as little as a few megabytes every hour.
- By 2017, decentralization led the Bitcoin community Blocksize War, which ended in a rift.
- On one side were the so-called big blockers who wanted to increase the size of Bitcoin’s ledger to accommodate more transaction data.
- On the other side were the small blockers, who valued a small file size for Bitcoin’s blockchain in order to decentralize thousands of fully validating nodes with cheap, small hard drives.
- Ultimately, the small blockers prevailed as the Bitcoin community valued decentralization over scalability.
Scalability remains an issue for any digital asset that prioritizes decentralization. FedNow, in contrast, is 100% centralized and, therefore, scalable with nearly limitless throughput.
Unlike most stablecoins which regularly struggle to maintain their peg, FedNow will transmit an unchanging, guaranteed dollar value at all times with zero price fluctuations.
FedNow offers tools to combat fraud. Tools include a maximum limit on transaction sizes (initially proposed at $500,000 per account, per day), the ability to flag accounts involved in suspicious activity, and reporting tools that include semi-automated as well as manual reviews.
Future capabilities of FedNow
Although not slated for the initial launch, the Federal Reserve has also planned some upcoming FedNow features in development.
- Alias-based payments, which could include a ‘Fed directory.’ Alias-based payments could eliminate the need to remember an account or routing number. The Ethereum Name Service (ENS) does the same thing for Ethereum by creating domain names, or ‘aliases’ for Ethereum addresses that look like long strings of numbers and letters.
- Support for APIs
- Bulk payments applications like payroll
- Enhanced remittance services for B2B payments
- Additional safety controls
In summary, the Federal Reserve plans to release its highly anticipated FedNow system in July 2023. It threatens to outcompete most digital assets, especially stablecoins, through its centralized operation with government backing.
Although FedNow will only serve customers of financial institutions with access to the US banking network, it could soon connect hundreds of millions of people on a P2P, B2B, and B2C basis. FedNow will enable 24/7 instant, irreversible, peer-to-peer payments with low costs and high throughput.
Although purposefully slow, expensive, and decentralized cryptocurrencies like Bitcoin have chosen not to compete on most of these features, many other crypto projects might need to reevaluate their differentiated value propositions in light of the imminent launch of FedNow.