The Breakdown - The Federal Reserve Has Its ‘Come to Satoshi’ Moment

Episode Date: February 6, 2020

That’s the way Meltem Demirors described Federal Reserve Governor Lael Brainard’s remarks at Stanford yesterday. For the first time, the Fed has said it is actively researching and experimenting with digital currencies and distributed ledger technologies. This is a change in tone from a Fed that, when asked previously, has more or less dismissed digital currencies.  On this episode, @nlw looks at Brainard’s speech, along with: the latest from Japanese lawmakers proposing a digital currency to counteract the influence of a forthcoming Chinese digital yuan; a Bank for International Settlements digital currency working group with six major central banks; and the potential implications of CBDCs on bitcoin. 

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond, with your host, NLW. The Breakdown is distributed by CoinDesk. Welcome back to The Breakdown. It is Thursday, February 6th, and today we are talking central bank digital currencies and in particular new comments from the U.S. Fed that suggests that finally the U.S. Federal Reserve is giving. getting off the sidelines at least a little bit and is actively engaging in the conversation about central bank digital currencies that is taking over all over the world that was at the center of Davos a few weeks ago. And that is clearly an essential part of the economic conversation, the macroeconomic conversation going forward. So we'll be looking at that. We'll be also looking at a little bit more CBDC information coming out of a new working group from the Bank of

International Settlements and from the government of Japan. So it is a regulatory day with big implications. The Federal Reserve has its come to Satoshi moment. That's how Meltem Demir's described what has just happened with the Federal Reserve in a tweet thread today about this topic. So yesterday, February 5th, Governor Lael Brainerd, who's one of the Federal Reserve governors, gave a speech at the symposium on the future of payments at the Graduate School of Business at Stanford called the Digitalization of Payments and Current. some issues for consideration, which has to be one of the most boring names of a speech of all time. But I digress.

So in the speech, she basically goes through a huge amount of background on digital players and how technology firms and big tech are driving new potential business models and new focus on new business models as it relates to payments and other parts of the financial economy. She touches on real-time infrastructure. But the real interesting part, and it feels like the meat of the speech, is about her take on the digitalization of currencies and what it means and where the U.S. fits in all of this. So she goes through and kind of gives, I think, the party line on a few different things.

So I want to give you a brief sample of the speech as she goes through the existing crypto infrastructure before. She says, a decade ago, Bitcoin was heralded as a new kind of digital money that would serve as a store of value, means of exchange, and unit of account delinked from any sovereign currencies without the need for centralized governments. Bitcoin has not achieved widespread acceptance as a means of payment or unit account because of its extreme volatility, as well as limited throughput capacity, unpredictable transaction costs, limited or no governance, and limited transparency. So this is, of course, what we've heard over and over again as it

relates to Bitcoin, which is pretty much a dismissal of it based on its decade-long history and its inability to have more of a dent in the consumer markets. I've said this before. I'll say it again. I don't think it's a bad thing that the U.S. government's leering eye is not pointed at Bitcoin in particular when it comes to what it views as a threat to dollar dominance at this stage. But let's move on. Secondly, she talks about stable coins. So this is back to her speech. Stable coins were designed specifically to overcome the volatility of first generation cryptocurrencies by tying the digital currency to an asset or basket of assets. such as commercial bank deposits or government-issued bonds. Unlike first-generation cryptocurrencies,

they may be issued by a central entity and rely on third-party institutions for some aspects. But even within this broad class of digital currencies, stablecoins vary widely in their underlying reference assets and associated exchange rate, the ability to redeem the stable coin claims for the underlying assets, and the extent to which a central issuer is liable for making good on redemption rights. So again, we're still in the territory of, this stuff doesn't scare us, this stuff didn't do what it said it was going to do, but then we get to the next line. And I'm just going to read the speech exactly because it says it better than I could. Quote, because Facebook has an active user network of one third of the global population,

the company's Libra Global Stablecoin Project has imparted urgency to the debate over what form money can take, who or what can issue it, and how payments can be recorded and settled. So here we have the real point and why we're having this conversation now. It's that all of these things they may be interesting, they may be somewhat worrisome for the future, but they don't register as an actual threat, as an actual issue that the Federal Reserve has to consider, until Facebook, with its one-third of the global population coming with it, starts to get in on the game. And so here we have the reason that the Federal Reserve is now engaged in the conversation about CBDC, or at least part of the reason, right? Because ultimately, it wasn't just the introduction of Libra that

has served as a starting gun for the conversation about CBDCs and central banks getting their own digital currencies. It's been the combination of Libra and China's response to Libra. China has made aggressive postures ever since Libra was announced that they were going to be a first mover. They were going to bring their own digital currency to market faster than Libra could. They specifically called out Libra as a reason that they were accelerating their process, which had started five years earlier in 2014. And by the way, for the rest of the world, China remains a major threat. So let's jump over to Japan for a second before we finish off on the Federal Reserve Governor's speech.

As we discussed last week, Japan has been working, or specifically a group of around 70 lawmakers from Japan's leading party, their Liberal Democratic Party, have been working. on proposals around issuing a digital currency. They are now set to release details tomorrow, Friday, February 7th. And interestingly, they continue to be very, very clear and very, very transparent that the reason they are putting the pedal to the medal on this issue has to do with China. This is a quote from the Vice Minister for Foreign Affairs, Norahiro Nakayama, who says, we sense the digital yuan is a challenge to the existing global reserve currency system and currency hegemony. Without the U.S., we cannot counter China's efforts to challenge the existing reserve

currency and international settlement system. He added, and this is the block now that I'm reading from, he added that China's digital currency has a, quote, high chance to becoming the standard within the country's one-belt, one-road digital economy initiative. So for those who are not familiar, China's one belt one road is basically the way that they are expanding the Chinese economy all over the world through infrastructure projects in the region, but also as far afield as Africa. They see this as an investment in their long-term place in the global economy. But when it comes to issuing a new currency, places like Japan are seeing that network, that economic network they've built as the place where they're going to immediately put that

currency to use and get continued or growing economic dominance there. Japan, of course, is not the only government, the only central bank who is looking at a central bank digital currency. This is a major topic. This is a major focus, as we saw coming out of Davos. Another story on CoinDesk today comes from a group of six central banks that are working with the Bank of International Settlements as a working group to figure out and study the feasibility basically of CBDCs. So this working group includes banks from the UK, Sweden, Switzerland,

Canada, Japan, and the EU. And they are going to, or they're prepared to report their results in mid-April at a conference in Washington. So over here you have Japan whose lawmakers are creating proposals with the specific intent to get the Federal Reserve on board to help counter the influence of China. Over in another part of the world, you have a Bank of International Settlements Group who is studying. the feasibility of central bank digital currencies and hoping to use that to help other central banks make decisions about this. And then you have governments that are even farther along. We spoke last week about Cambodia who intends to actually launch their digital currency

this year, this calendar year. Well, Meltem de Mirrors wrote all about Cambodia as a central example of basically what's happening around the world as it relates to central bank digital currencies. I thought this point was particularly salient as she looked at the Cambodian case. So in her tweet threads, she says that one of the reasons that Cambodia is focused on this is to reduce dollar dependence. Eighty-four percent of transactions in Cambodia are done in dollars. Because the NBC, the National Bank of Cambodia, controls the basket backing the token, it can prioritize the local currency over USD. I would expect many, quote, dollarized economies will be excited about reducing USD usage. So this is a really, really important point. Around the world, there are so many countries where people in those countries prefer to use the U.S. dollar rather than their local currency because of stability issues, because it is just more likely to hold its value. It's not subject to the same local political changes and travails. And they potentially see in those places, the governments see the central bank digital currencies as a way to shift that power balance and shift again back.

towards the local currency versus the dollar itself. So where does this leave the U.S.? Let's go back to Brainerd speech at Stanford yesterday and see how she contextualizes all of this CBDC interest that's happening and where the dollar fits. So she says, the prospect for rapid adoption of global stable coin payment systems has intensified calls for central banks to issue digital currencies in order to maintain the sovereign currency as the anchor of the nation's payment system. In a Bank for International Settlement Survey of 66 central banks, more than 80% of central banks report being engaged in some type of CBDC work. The motivations for this work range from payment safety and robustness for advancing economies to payments efficiency for emerging

economies. The latest survey suggests there is greater openness to issuing a CBDC than a year ago, and a few central banks report that they are moving forward with issuing a CBDC. Building on the tremendous reach of its mobile payments platform, China, is reported to be moving ahead rapidly on plans to issue a digital currency. And here's the real nut of it. And this is the part that was the headline for the block and for CoinDesk and for everyone else in the space. Given the dollar's important role, it is essential that we remain on the frontier of research and policy development regarding CBDCs. Like other central banks, we are conducting research and experimentation related to distributed letter technologies and their potential use cases for digital currencies, including the potential

for a CBDC. We are collaborating with other central banks as we advance our understanding in central bank digital currencies. So this is the big shift, right? It's not just that they are talking about CBDCs. It's that for the first time, the Fed has said that they are actively researching them. They are actively conducting experimentation, whatever that means. This is actually, in some ways, if you take a step back, it seems absurd that we're having a whole episode about this and there's articles on every publication about this because they're just saying, hey, we're researching and we're doing some experimentation, right? They're not committing anything. They're not saying it's something that the U.S. is definitely going to do. But the reason that this is worth paying attention to and that this

shift in tone is worth paying attention to has to do with just how big an issue in the global macroeconomy this question of digital currencies is. Now, of course, there is a caveat. Towards the end of the speech, Governor Brainer seems to intimate that the reasons that other countries might be interested in a CBDC may not apply to the U.S. and that this is fundamentally the difference between being the owner of the world's reserve currency versus everyone else. So she says, some of the motivations for a CBDC cited by other jurisdictions, such as rapidly declining cash use, weak financial institutions, and underdeveloped payment systems are not shared by the United States. Physical cash and circulation of the U.S. dollar continues to rise because of robust demand, and the dollar plays an important role

globally. We have a robust and diverse banking system that provides important services, along with a widely available and expanding variety of digital payment options. So what the U.S. is saying is that, look, we're paying attention to this. We understand that CBDCs are going to play an important role. We understand and are tracking the threats that they potentially represent to the U.S. dollar, but we are not going to commit to saying that we need to digitize a dollar, right? We're not going to go that far now. Still, this is the first speech from a Fed governor, the first statement from a Fed governor that actually admits that the U.S. is doing research in this area and is spending any amount of attention on it. That's a big deal. I do think, however, before we wrap up,

it's worth coming back to one other question, which is, what does this all mean for Bitcoin? As I mentioned before, I think it's to Bitcoin's benefit that the ire of the U.S. government is focused elsewhere at the moment. I think Bitcoin is still nascent, and I think that its ability to continue to exist and persist as a non-sovereign alternative to any of these CBDCs, to any other government money, is better served by a continued incubation period

where we grow and grow and grow and grow the audience of holders and believers and people who are invested in this ecosystem and making this thing work. So I think it's a good thing that there isn't that much focus, animosity or antagonism from the U.S. government towards Bitcoin at the moment. However, I think that Meltem in her same thread that we mentioned before has a really interesting point about what might happen in a world of balkanized digital dollars or balkanized digital currencies. So she says, the real question is, if every central bank

corporation and cult of personality decides to issue its own digital currency, what will be the neutral choice for international trade. Does the medium, i.e. blockchain-based token, change the message? The current circus that is central bank digital currencies has many people playing out this chess game in their heads and realizing why Bitcoin is so powerful. It belongs to no state, government, or country. And that is something we can all be excited about. So the point she's making is that, again, as this whole world of digital currencies comes online and we see this massive fragmentation in every government pushing for theirs, not someone else's. It could lead people to ask, well, what is an alternative to any of these things? And the thing that is sitting there right in the middle, at least for

some use cases, is the oldest, most powerful, largest example, the thing that started this whole movement, this whole space, Bitcoin. And I do think that Meltem's point about many people playing out this chess game in their heads and realizing why Bitcoin is so powerful, has some evidence. In the wake of many of the partners of the Libra Association, particularly Visa and MasterCard, leaving last year, David Marcus wrote, special thanks to Visa and MasterCard for sticking it out until the 11th hour. The pressure has been intense, understatement, and I respect their decision to wait until there's regulatory clarity for Libra to proceed versus the invoked threats by many on their business. Nick Sable responded and said, you might want to ask you.

ask yourself why the pressure has been so intense, and read some history that Bitcoin pioneers were aware of, for example, the failure of e-gold. Your failure to learn from history has caused you to, at great cost, recapitulate the failures from the past. Marcus responds, don't get me wrong. Already had a lot of appreciation for Bitcoin well before I started on this journey, but appreciation is growing. This is a significant moment in the evolution of digital currencies and the battle for the future of money. We're going to look back at this speech as the first statements about the U.S. looking at a digital dollar intentionally. And that's fascinating. Of course, read the articles about it, but I'll also link the copy of the

speech itself. What do you guys think? Is this whole CBDC thing overblown? Is it just the latest buzzword? Is this like enterprise blockchains all over again? Or is it something real? Is it something bigger? Is it a macro megatrend that we should be paying attention to more? What do you think the actual role of Bitcoin in all this is? Are CBDCs the anti-B Bitcoin? Do they actually compete with Bitcoin in a way that is a threat to Bitcoin? Or does Bitcoin, as Meltem suggests, maybe benefit in the context of these CBDCs competing with each other? I think these are big unanswered questions and certainly ones that I'm going to be spending a lot of time and attention on going forward. Anyways, guys, thanks as always for listening. I hope you enjoyed the episode and I will catch you

tomorrow with The Breakdown. Peace.