Full text of Fed's speech on CBDC: A comprehensive macro understanding of stablecoin, Bitcoin and CBDC

Parachute Pants and Central Bank Money

Original source: Randal K. Quarles, Federal Reserve Vice Chairman for Supervision

0x29, 0x49, beat BlockBeats

In the early hours of June 29, Randal K. Quarles, the Federal Reserve's vice chairman for supervision, delivered a speech titled "Parachute Pants and Central Bank Digital Money."

"Parachute pants" are an allusion to the clothing that suddenly became popular in the US in the 1980s. In this speech, the deputy chairman of the Federal Reserve used the term to express his attitude towards central bank digital currency (CBDC). In his opinion, he could not see the advantages of US dollar CBDC, on the contrary, he could see the problems that might result if US dollar CBDC appeared. But he's not biased against cryptocurrencies. In this speech, he spoke highly of the dollar stablecoin and recognized its innovation.

In the current period of market sentiment and regulatory uncertainty, RushBlockbeats hopes that this article will provide readers with a fresh perspective to think about. The following is the full text of RushBlockbeats' speech to the Vice Chairman of Regulation of the Federal Reserve:

I've been reflecting recently on the influence of America's centuries-old passion for novelty. Overall, this is good for us and the world, because it makes America the home of many of the scientific and practical innovations that are transforming life in the 21st century. It has served us and the world well since the beginning of life in the 19th century.

But when the enthusiasm for the new combines with the American agitationism and fear of missing out, it can sometimes lead to massive pauses in our critical thinking, and even the occasional impatience, paranoid fever, and fads.

Sometimes, many of the results are puzzling and embarrassing in hindsight, as when millions of Americans suddenly started wearing parachute pants in the 1980s. Of course, some things may have more serious consequences

Which brings us to today's topic: Central Bank Digital Currency, or CBDC.

Public interest in "digital dollars" has reached a climax in recent months. Many experts and commentators have suggested that the Fed should issue CBDCs. But before we get carried away by the novelty, I think we need a careful critical analysis of CBDC.

Views expressed are expressed solely on behalf of members of the Board of Governors and not on behalf of the Board of Governors or any other Fed policy maker.

Chairman Powell recently announced that the Fed is preparing a comprehensive discussion paper on this issue, the first step in an open process for critical analysis. I don't want to prejudge this event, but I will lay out some of the issues we need to address in the process, how I think about them, and some of my views on the need for high standards to be defined in any proposal to create a US CBDC.

The first basic question: what problem will CBDC solve? Before we can answer this question, we first need to define the term CBDC and assess the current state of the U.S. payment system.

What does "CBDC" mean?

The BIS defines a CBDC as "a digital payment instrument, denominated in a national unit of account, that is a direct liability of a central bank."

My first point is that the general public has generally traded in digital dollars through the transfer and transfer of electronic balances in commercial bank accounts. Of course, these numbers are not CBDC dollars, because they are commercial bank liabilities, not the Fed. However, it is important to note that commercial bank digital dollars can be insured up to $250,000 under federal insurance.That means deposits of less than $250, 000 in commercial banks are as sound as central bank liabilities.

The Fed also provides digital dollars directly to commercial banks and certain other financial institutions. Federal law allows these financial institutions to open accounts with the Fed and receive payment services from the central bank. The balances in the Fed's accounts perform an important financial stability function by providing the US economy with safe and liquid settlement assets.

In short, the dollar is highly digital.The Federal Reserve provides digital dollars to commercial banks, which provide digital dollars and other financial services to consumers and businesses. This arrangement serves the country and the economy well: the Fed serves the public interest by promoting the health of the American economy and the stability of the broader financial system, while commercial banks compete to attract and effectively serve customers.

So how is CBDC different from the digital dollars we use today, given the digitization of the dollar?

The key difference is that when most commentators speculate about the Fed CBDC, they assume that the public will have access to it directly from the central bank. CBDCs of this nature can take different forms. One is an account-based model, in which the Fed would offer individual accounts directly to the public. Like accounts currently offered by the Fed to financial institutions, account holders would send and receive funds to their Fed account through debits or credits.

A different mode of CBDC might involve CBDCs that are not held in Fed accounts. This form of CBDC would be closer to the digital equivalent of cash. Like cash, it represents a claim against the Fed, but it may be transferred between people (such as banknotes) or through intermediaries.

I question whether the Fed has the legal authority to push these CBDCs without legislation. However, if such legislative authority is granted, it will be necessary to discuss the benefits, costs, and practicality of implementing CBDC in the United States.

Next let's see if the Fed CBDC fits into the current US payment system.

The state of the U.S. payment system

Payment services between the Federal Reserve and private sector banks already offer a range of options to promote efficient electronic payments in dollars. Some statistics about the major dollar bulk payment systems are telling. The Fed's Fedwire Funds Service processes nearly $4 trillion in payments a day. A private sector entity (the clearinghouse) operates a wholesale payments system that clears nearly $2 trillion in payments every day. These payments are not settled in the Fed account, but they are backed by balances on the Fed's books.

Small payments tend to be settled more slowly than large ones, but various efforts to speed up settlement have been completed or are under way. Clearinghouses, for example, have developed an instant payment service that focuses on small payments. Similarly, a batch-based payment network Automated Clearing House (or ACH) network developed in the 20th century now enables same-day settlement of ACH payments. And the Federal Reserve is developing an instant payments service, "FedNow℠", that will soon allow recipients of small payments to access money in their commercial bank accounts instantly.

Of course, these payment systems are not perfect, and some types of payments should be faster and more efficient. Cross-border payments, for example, remain a key area of concern, as they often involve high costs, slow speed and a lack of transparency. The Financial Stability Board of international organizations, which I chair, last year laid out a road map to address these issues. In addition, private sector stablecoins could facilitate faster and cheaper cross-border payments (more on that later).

In addition, some types of payments have not yet been fully digitized, and some types of payments have long been debated among companies with competing economic interests. Paper checks, for example, are still widely used in some areas, although the interbank check collection process is now almost entirely electronic; Debit and credit card payments provide a convenient digital platform for consumers and retailers, but there is considerable controversy among banks and retailers over who gets the economics of the fees associated with card transactions.

Finally, Americans could benefit from digital payments by promoting increased use of banking services by Americans through wider use of low-cost base bank accounts.

To sum up, America's payment system is very good, and while it is not perfect, it has been greatly improved.

Policy considerations

Supporters of the Fed's CBDC, however, argue that it could solve many important problems. For example, they suggest that the Federal Reserve CBDC needs to defend the dollar's critical role in the global economy. Others argue that CBDC will address the economic inequalities that have long existed in American society. When we at the Fed started to analyze these issues, I had to make sure that the CBDC was a good tool for solving these problems. I doubt it. At the same time, I have to be extremely convinced that the potential benefits of CBDC outweigh the risks.

Let's look at some of the arguments made by CBDC supporters. The first is that the Fed should issue a CBDC to protect the dollar from threats posed by foreign CBDCs on the one hand and the continued spread of private digital currencies on the other.

First, we start from the perspective of the threat of foreign CBDCs, which assume that if digitalization were to happen directly through the CBDC model rather than through the current digital payment system, then some foreign currencies would suddenly challenge the dollar. (To be clear, these foreign currencies are all highly digitized in the current international banking system in the same way that the U.S. dollar is, but do not yet pose a major challenge to international currencies.) If the Fed does not offer something similar, the argument goes, the dollar will lose its place in the global economy.

I think it is inevitable that as the global economy and financial system continue to develop, some foreign currencies, including some foreign CBDCs, will be used more in international transactions than they are now. However, it seems unlikely that the dollar's status as the world's reserve currency, or its dominant role in international financial transactions, will be threatened by foreign CBDCs. The role of the dollar in the global economy depends on multiple basis, including America's economic strength and scale, extensive trade ties between the United States and other countries in the world, financial markets, including Treasury bonds, the stable value of the dollar over time, convert dollars to the convenience of foreign currency, the rule of law and a strong property rights, and the sound monetary policy. None of this is likely to be threatened by foreign currencies, and certainly not by foreign currency CBDCs.

Supporters of CBDC also say private digital currencies pose a threat to the dollar. There are many styles of private digital currencies, but for this reason I've divided them into two categories: stablecoins and unstable ones, or crypto assets such as Bitcoin.

Let's start with stablecoins, whose value is tied to one or more other assets, such as sovereign currencies. There are a variety of existing and potential stablecoins pegged to the value of the dollar.

Some argue that the US must issue CBDCs to compete with the dollar stablecoin. Stablecoin is an important development, important enough to raise a lot of questions. For example, how will widespread stablecoin adoption affect monetary policy or financial stability? How does stablecoin affect the commercial banking system? Does stablecoin pose a fundamental threat to the government's role in money creation?

In my opinion, we need not be afraid of stablecoins. The Federal Reserve has historically supported responsible private sector innovation. In keeping with this tradition, I believe that we must fully consider the potential benefits of stablecoins, including the role that dollar stablecoins could play in supporting the dollar in the global economy. For example, a global dollar stablecoin network could encourage the use of dollars through faster and cheaper cross-border payments, and it would likely be faster to deploy and have fewer drawbacks than a CBDC. Given that our current system involves (indeed depends on) the creation of money by private companies on a daily basis, the argument that stablecoin represents an unprecedented level of private money creation, thus challenging our monetary sovereignty, is puzzling.

We do have a legitimate and strong regulatory interest in how stablecoins are structured and managed, particularly with regard to financial stability issues. The asset pool that is an anchor of stablecoin value (if stablecoin use becomes widespread enough) poses a stability risk in the following cases: if it is invested in multiple denominations; If it's fractional reserves instead of full reserves; If the stablecoin holder has no clear requirement for the underlying asset; Or if the pool invests in assets other than the most liquid, such as central-bank reserves and short-term sovereign bonds. All of these factors create an "operational risk" -- some trigger event could cause a large number of stablecoin holders to convert all their coins into other assets at once, and the stablecoin system would not be able to meet this demand while maintaining a reasonable stable value. But these problems are apparently solvable. In fact, some stablecoins have been used to solve these problems. When our concerns are addressed, we should say "yes" to these products, rather than trying to find a way to say "no." Indeed, combining urgent improvements to existing payment systems, such as various instant payment schemes, with the cross-border efficiency of a properly structured stablecoin may well make issuing CBDCs redundant.

In contrast to stablecoins, crypto assets such as bitcoin have nothing to do with the value of assets such as sovereign currencies. Instead, they seek to create value in tokens in other ways, often through mechanisms inherent in ensuring scarcity, such as the mining process for bitcoin, or features such as "anonymity" that traditional payment systems cannot match. Some people assert that the US must issue CBDCs to combat cryptocurrencies, which seems to be wrong. The mechanism used to create the value of such crypto assets also ensures that the value is highly volatile, similar to the volatile value of gold and, like Bitcoin, a large part of its value comes from its scarcity. And like Bitcoin, it won't play a significant role in the payments and money systems of today. However, unlike gold, which has industrial uses and aesthetic properties beyond its residual financial role, Bitcoin's main added appeal is its novelty and anonymity. Anonymity makes it a target for scrutiny by law enforcement, and novelty is a rapidly wasted asset. Gold will always shine, but the novelty will fade away. As a result, Bitcoin and its ilk will almost certainly remain a risky speculative investment rather than a revolutionary payment method, so it is highly unlikely that they will affect the role of the dollar or require a response from the CBDC.

The second argument of CBDC proponents is that the Fed's CBDC would provide a way to access digital payments for people who currently do not have bank accounts, due to expenses, lack of trust in banks or for other reasons. This is valuable, but I believe we can do more to promote financial inclusion by taking steps to provide these people with cheaper basic commercial bank accounts, such as those developed in partnership with the Financial Empowerment Cities Fund. Between 2011 and 2019, the proportion of households without a bank account is forecast to fall from 8.2% to 5.4%. Banks and regulators are working to reduce that even further. I am deeply unconvinced that CBDC is the best way to increase financial inclusion, and may not even be effective.

Finally, some argue that the Fed's CBDC will stimulate and foster innovation in the private sector. This is interesting and deserves further study. What puzzles me, however, is how the Fed's CBDC fosters innovation in ways that private sector stablecoins or other new payment mechanisms cannot. It seems to me that there has been quite a bit of private sector innovation in the payments industry without a CBDC, and it is conceivable that the Fed CBDC, or even a plan for a CBDC, might deter private sector innovation.

In short, the potential benefits of the Fed's CBDC are unclear. On the contrary, the risks that the Fed's CBDC might pose are very specific. First, the Fed CBDC could pose considerable challenges to the structure of our banking system, which currently relies on deposits to support the credit needs of households and businesses. The arrangement by the Federal Reserve to replace commercial banks as the primary provider of funds to the public could limit the availability of credit, fundamentally alter the economy, and expose the public to a range of unintended and adverse consequences.

Among other potential problems, the dominance of CBDCs could undermine the consumer and other economic benefits that commercial banks generate as they compete to attract customers.

The Federal Reserve CBDC could also be the target of cyberattacks and other security threats. Someone may try to steal a CBDC, or even disrupt the CBDC network or obtain non-public information about the CBDC holders. The architecture of the Federal Reserve CBDC needs to be highly resistant to such threats and will need to remain so as attackers employ increasingly sophisticated methods and tactics.

Designing appropriate defenses for CBDCs can be particularly difficult because there are likely to be many more access points in the CBDC network than in the Fed's existing payment system. Because by design choice, anyone in the world can access the network.

It is also important to ensure that CBDC does not facilitate illegal activities. The Bank Secrecy Act currently requires commercial banks to take measures to prevent money laundering. Policymakers will need to consider whether a similar anti-money laundering regime is feasible for the Federal Reserve's CBDC. Designing a CBDC that respects personal privacy while appropriately reducing the risk of money laundering may prove difficult at present.

In extreme cases, we could design a CBDC that requires CBDC holders to provide the Fed with detailed information about themselves and their transactions. This approach would minimize the risk of money laundering, but would raise significant privacy concerns. At the other extreme, we could design a CBDC that allows parties to trade on a completely anonymous basis. Such an approach would address privacy concerns, but could increase the risk of significant money laundering.

A final risk is that issuing Fed CBDCs could be very expensive and unmanageable for the Fed. The Fed's CBDC could essentially view the Fed as a retail bank for the masses. This would mean introducing a large, resource-intensive central banking infrastructure. We will need to consider whether the potential use cases for CBDC justify such costs and the expansion of the Fed's responsibilities into unfamiliar activities, and whether such expansion risks politicizing the Fed's mandate.

In conclusion, I would like to stress three points. First of all, the dollar payment system is very good and getting better. Second, the potential benefits of the Fed's CBDC are unclear. Third, I believe that issuing CBDCs may bring considerable risk.

So when we continue to seriously evaluate the issuance of the Fed CBDC, our job is done. Even if other central banks succeed in issuing CBDCs, we cannot assume that the Fed should. The process that Chairman Powell has recently announced is a truly open process and there are no conclusions, although obviously I think the bar for establishing a US CBDC is very high. The forthcoming discussion paper constitutes the first step in this process, and it is important to seek public opinion. I look forward to reviewing public comments on the discussion paper, which will inform the Fed's final assessment of potential CBDCs.

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