Board of Governors of the Federal Reserve System

Recent technological advances have ushered in a wave of new private-sector financial products and services, including digital wallets, mobile payment apps, and new digital assets such as cryptocurrencies and stablecoins. These technological advances have also led central banks around the globe to explore the potential benefits and risks of issuing a CBDC.

A CBDC is a digital liability of a central bank that is widely available to the general public. In this respect, it is analogous to a digital form of paper money.¹ Today, Federal Reserve notes (that is, physical currency) are the only type of central bank money available to the general public. As a liability of the Federal Reserve, a CBDC would be the safest digital asset available to the general public, with no associated credit or liquidity risk. It could provide households and businesses with a variety of new financial products and services, support faster and cheaper payments (including cross-border payments), and expand consumer access to the financial system.

However, a CBDC could pose a variety of risks and would raise important policy questions, including how it might affect financial-sector market structure, the cost and availability of credit, the safety and stability of the financial system, and the efficacy of monetary policy.

Like other central banks, the Federal Reserve is engaged in research into this topic. The Federal Reserve's work focuses on how a CBDC could improve on an already safe, effective, dynamic, and efficient domestic payments system, with full recognition that the implications and risks must be thought through very carefully, including implications for financial stability.

In January, the Federal Reserve published a discussion paper as a first step in fostering a broad and transparent public dialogue about the potential benefits and risks of a U.S. CBDC.² The Federal Reserve does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from the Congress, ideally in the form of a specific authorizing law.

Design of central bank digital currency

While no decisions have been made, the Federal Reserve's January discussion paper indicates that a potential CBDC would best serve the needs of the United States by being privacy protected, identity verified, intermediated, and transferable:

• Privacy protected: Protecting user privacy is critical. The Federal Reserve is researching technological and policy options for a robust privacy framework.
• Identity verified: A CBDC would need to comply with rules designed to combat money laundering and the financing of terrorism.
• Intermediated: Under an intermediated model, private-sector intermediaries would offer accounts or digital wallets to facilitate the management of CBDC holdings and payments.
• Transferable: A CBDC must be seamlessly transferable between customers of different intermediaries.

Potential benefits and use cases

The Federal Reserve is considering how a CBDC might fit into the U.S. money and payments landscape. A crucial test for a potential CBDC is whether it would provide benefits to households, businesses, and the overall economy that exceed any costs and risks and whether it would yield such benefits more effectively than other methods.

A CBDC has the potential to support financial stability. In a rapidly digitizing economy, the proliferation of new types of digital money, including stablecoins, could present risks to both individual users and the financial system as a whole. A CBDC could provide the public with broad access to digital money that is free from credit and liquidity risk.

A CBDC might also help level the playing field in payment innovation for private-sector firms of all sizes. A CBDC could serve as a safe and robust form of digital money that could allow private-sector innovators to focus on new access services, distribution methods, and related service offerings.

A CBDC might generate new capabilities to meet the evolving speed and efficiency requirements of the digital economy. Depending on the design, a CBDC may improve cross-border payments, support the dollar's international role, and promote financial inclusion.

Key risks and policy considerations

Although the introduction of a CBDC could benefit consumers and the broader financial system, such a potential step also raises complex policy issues and risks.

A CBDC could fundamentally change the structure of the U.S. financial system, altering the roles and responsibilities of the private sector and the central bank. A widely available CBDC could serve as a close substitute for commercial bank deposits or other low-risk assets such as government MMFs and Treasury bills. A shift away from these assets could reduce credit availability or raise credit costs for households, businesses, and governments. In times of stress, the ability to convert other forms of money into CBDC could make runs on financial firms more likely or more severe.

Additionally, depending on the design, a CBDC could affect the efficacy of monetary policy implementation. Any CBDC would also need to be extremely resilient to operational disruptions and cybersecurity risks, and it would need to strike an appropriate balance between safeguarding consumer privacy and affording the transparency necessary to deter criminal activity.

Next steps

The Federal Reserve has not advanced any specific policy outcome and will not be making any imminent decisions about the appropriateness of issuing a U.S. CBDC. Rather, it is seeking input from a wide range of stakeholders that might use a CBDC or be affected by its introduction.³

Russia's invasion of Ukraine and subsequent international sanctions disrupted global trade in commodities, leading to surging prices and heightened volatility in agriculture, energy, and metals markets. These markets include spot and forward markets for physical commodities as well as futures, options, and swaps markets that involve an array of financial intermediaries and infrastructures. Stresses in financial markets linked to commodities could disrupt the efficient production, processing, and transportation of commodities by interfering with the ability of commodity producers, consumers, and traders to lock in prices and hedge risks. Such stresses can also increase liquidity and credit risks for financial institutions that are active in commodity markets. To date, however, the financial market stresses do not appear to have significantly disrupted broader economic activity or created substantial pressure on key financial intermediaries, including banks.

Commodity price dynamics since the invasion

Russia is a major global exporter of oil, natural gas, and certain metals. The invasion and sanctions disrupted supplies of some commodities. Although Russian energy exports have generally kept flowing, market participants are highly concerned with future prospects. In addition, both Russia and Ukraine are major exporters of grain, and the ongoing war as well as sanctions on Belarus's fertilizer exports are seen as likely to disrupt future production of grain and other agricultural commodities.

In this environment, prices for many commodities have risen sharply, on net, and fluctuated dramatically in response to geopolitical developments (figure A). A notable exception has been natural gas for delivery in North America, where the price has been relatively stable due to limited capacity for shipping North American natural gas to Europe to replace Russian exports.

Figure A. Front-month futures prices

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Note: The data for Dutch natural gas start in 2005. Dutch Title Transfer Facility (TTF) natural gas is quoted in euros per megawatt hour; the price has been converted into dollars per metric million British thermal units (MMBtu). SRW is soft red winter. WTI is West Texas Intermediate. The shaded area with a top cap represents an expanded window focusing on the period from January 1, 2022, onward.

Source: Bloomberg Finance L.P.

Commodity trading, clearing, and settlement

The simplest commodity transactions occur in spot markets, where a seller immediately delivers the commodity to a buyer for cash. A buyer and a seller who wish to plan ahead can also engage in a bilateral forward contract, establishing a price and future date at which delivery will occur.

Commodities are also traded on futures exchanges, which standardize contract terms (such as expiration dates and the precise definition of the reference commodity) and establish trading rules (such as limits on the size or speed of price changes). Since the invasion, for most commodities, futures trading volumes and open interest—the number of contracts outstanding at the end of the day—have remained in normal ranges. However, in the key contract for natural gas in Europe, trading volume spiked to unprecedented levels in late February and early March, indicating rapid changes in market participants' positions. This spike occurred even as open interest continued to trend downward for the year to date as participants somewhat reduced their exposure to the market on net (figure B).

Figure B. Trading volume and open interest of commodity futures

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Source: Bloomberg Finance L.P.

Futures are cleared at CCPs, which stand between buyers and sellers to guarantee that contracts will be fulfilled. To manage their risks, CCPs require initial margin (that is, collateral posted to the CCP), collect variation margin (that is, daily or more frequent cash payments to cover mark-to-market changes in value), and maintain additional resources to cover losses in the event of a participant's default. CCPs require participants to post sufficient initial margin to cover at least the 99th percentile of potential price changes over a defined period of risk, typically one or two days for commodity futures. Because the size of potential price changes can rise rapidly during volatile periods, CCPs typically set initial margin requirements above this minimum level when markets are calm, reducing the need to raise requirements during stress. Still, as volatility rose in response to geopolitical developments in February and March, CCPs substantially increased initial margin requirements. The initial margin requirement tripled for the main wheat futures contract, and for oil it rose to match the May 2020 peak (figure C).

Figure C. Initial margin for front-month futures in dollars

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Note: SRW is soft red winter; WTI is West Texas Intermediate; TTF is Title Transfer Facility.

Source: CME Group Inc.; Intercontinental Exchange, Inc. (made available in accordance with ICE Terms of Use).

The initial margin increases were partly due to increases in contract values, but requirements also rose as a percentage of contract values—a more precise indicator of the risk that collateral can absorb (figure D). For European natural gas, initial margin as a percentage of contract value had been rising since late 2021 and soared to 80 percent of the contract value as the Russian invasion continued. Initial margin as a percentage of contract value also reached the top of the historical range for wheat and U.S. natural gas but remained well below the 2020 peak for oil. Despite the margin increases, daily price moves in wheat futures exceeded the CCP's initial margin requirement at the contract level on seven trading days from February 22 through the end of the first quarter, far above the expected frequency for a 99 percent coverage level.

Figure D. Futures margin as a percentage of contract value

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Note: SRW is soft red winter. The data for U.S. (Henry Hub) natural gas and West Texas Intermediate (WTI) oil start in 2009. The data for Dutch Title Transfer Facility (TTF) natural gas start in 2016. The shaded area with a top cap represents an expanded window focusing on the period from January 1, 2022, onward.

Source: Federal Reserve calculations based on data from Bloomberg Finance L.P.; CME Group Inc.; Intercontinental Exchange, Inc. (made available in accordance with ICE Terms of Use).

Commodity futures can be cash settled or physically settled. For a contract settled in cash, participants exchange payments at the expiration date based on a price for the underlying commodity. In a physically settled contract, participants who hold short positions at expiration deliver the commodity at a specified time and place in return for payment of the determined settlement price. Short sellers include commodity producers, such as farmers or miners, who are hedging the risk of a price decrease on their output, as well as traders speculating on the direction of prices. Short sellers who do not own a sufficient, immediately deliverable amount of the commodity generally seek to close their positions by buying an offsetting long contract before expiration. However, if the commodity is in limited supply, buying a long contract to offset a short may be expensive. Additionally, when market liquidity is constrained, covering by short sellers may cause prices to rise more sharply than normal.

In early March, at the London Metal Exchange, the prospect of interruptions in Russia's nickel exports generated heavy pressure on short sellers of nickel, whose concentrated positions appeared to amplify the shock. The exchange experienced unprecedented price spikes that caused severe financial stress for some participants. In order to recover, the exchange cancelled trades at the peak prices and called a multiday trading halt. In markets for other commodities, traders, exchanges, and CCPs managed through the stress without severe incidents.

Commodity derivatives, particularly swaps, are also traded in OTC markets. The terms of OTC commodity derivatives can be customized to help participants precisely hedge particular risks. OTC commodity derivatives are not always guaranteed by CCPs or subject to the same uniform risk-management rules as exchange-traded derivatives.

Implications for commodity producers and consumers

Businesses that produce commodities or that use commodities to produce other products and services often rely on futures to hedge price risk. For example, a wheat farmer or grain elevator may take a short position in wheat futures to hedge the risk of receiving a low price on the crop, while a flour mill may take a long position in wheat futures to hedge the risk of having to pay a high price for inputs. Commodity trading firms are also important users of commodity futures. These firms move commodities from producers to consumers, sometimes storing or processing them along the way. A trading firm's physical exposures can be both long (for example, ownership of a tanker full of oil) and short (for example, a commitment to deliver oil to a refinery) and, correspondingly, may be hedged with both short and long futures positions. A market participant that primarily uses futures to hedge its physical risks is known as a hedger.

Recent developments increased the cost of hedging in commodity futures markets in three ways:

1. Producers and trading firms needed funding liquidity to make variation margin payments to CCPs on short futures positions after price increases, even as these hedgers' physical holdings gained in value. Obtaining such funding can be difficult or costly, especially for smaller firms or on short notice. For example, Peabody Energy, the United States' largest coal producer, announced in March that it obtained a $150 million unsecured credit facility at a 10 percent interest rate to cover derivatives funding needs.
2. The risk of futures positions increased with higher volatility, even for participants whose combined physical and futures positions were perfectly hedged. The resulting higher initial margin requirements on exchange-traded futures meant that both short and long hedgers needed cash to post additional collateral to CCPs. In addition, some financial institutions reportedly asked customers to limit futures positions in light of the risks and associated capital requirements, which raise the institutions' costs of intermediating between customers and CCPs.
3. Market liquidity, the ease of entering or exiting a position, diminished as trading became more costly for end users and as market makers pulled back to manage their own risks. Bid-ask spreads widened, and the price effect of large trades increased (figure E; for more information, see the box "Recent Liquidity Strains across U.S. Treasury, Equity Index Futures, and Oil Futures Markets"). In wheat futures, for several consecutive days, the price rose by a daily limit set by the exchange. While these price limits were binding, trading volume appeared to be reduced, and for a time the May wheat futures price was significantly below implied prices in related markets, such as options, that were not subject to the same limits. Price changes also reached daily limits in corn futures at times.

Figure E. Wheat (soft red winter) futures liquidity measures

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Note: The shaded area with a top cap represents an expanded window focusing on the period from January 1, 2022, onward. Bid-ask spreads are expressed as a multiple of tick size (minimum price increment). The tick size for soft red winter wheat futures is 1/4 of $0.01 ($0.0025) per bushel.

Source: For top panel, Refinitiv, DataScope Tick History; for bottom panel, Federal Reserve Board staff estimates based on data from CME Group, Inc., DataMine, https://datamine.cmegroup.com.

Businesses that produce or use commodities are potentially vulnerable to these financial stresses, but, so far, the stresses do not appear to have significantly altered their production or usage. Higher hedging costs could, in principle, deter commodity producers from making investments that would increase output, users from expanding factories that employ commodity inputs, or trading companies from shipping commodities around the world. Such reactions to higher hedging costs could conceivably reduce the supply of commodities or prevent them from being put to the most productive use. The first sign that higher hedging costs were weighing on end users would likely be decreases in commodity futures positions of producers, consumers, and other hedgers. To date, hedgers' positions in major U.S. commodity futures contracts remain within historical ranges, even as Russia's invasion of Ukraine has roiled commodity markets (figure F). As previously mentioned, open interest in the key Dutch natural gas futures contract has trended downward, but the data are not broken out to show how much of the decrease is in the positions of hedgers.

Figure F. Producer, merchant, processor, and user positions in commodity futures

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Source: Bloomberg Finance LP.

Implications for financial intermediaries

Financial institutions such as banks and broker-dealers can be exposed to risks in commodity markets as a result of the institutions' own trades or as a result of guaranteeing their customers' futures trades. Most participants access commodity futures markets through financial institutions that are members of the relevant CCP. Members must cover any margin calls that their customers fail to meet. In addition, if a customer fails to deliver a physical commodity, the clearing member is liable for the replacement cost of the missing goods.

Banks and dealers frequently use futures to offset the risks from customized OTC transactions with their clients. For example, a bank might enter an OTC swap with a mining company to allow the mining company to hedge the price risk on its metal output over multiple years. The bank could then use exchange-traded futures to hedge the price risk of the swap. As long as the customer paid the amounts due under the swap, the bank would be hedged against movements in the price of the metal. However, if the customer defaulted, the bank could be left with an unhedged or partially hedged futures position.

Pressures on most large banks from exposures to commodity markets so far have been modest relative to the banks' sizable capital and liquidity resources, in part because the most extreme volatility has been confined to specific commodity markets such as nickel, wheat, and European natural gas, and because clients have largely been able to cover their obligations. Nevertheless, commodity markets are stressed. Ongoing and more widespread extreme volatility associated with the Russian invasion of Ukraine or other adverse shocks could pose greater challenges, especially if major clients were to require significantly more liquidity or if defaults were to become widespread.