The Breakdown - The Federal Reserve Shares Its Thinking About a US CBDC

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Abra, and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, January 21st, and today we are talking about the Fed's long-awaited central bank digital currency paper. This is meant to give a sense of where the Fed is. how they're thinking about different issues regarding a CBDC, whether they're leaning towards it, whether they're leaning away from it. All of these things were kind of wrapped up in expectations. So we're going to talk about what they actually said, whether it met those expectations,

Starting point is 00:00:48 and what comes next. First up, however, if you are enjoying the breakdown, please go subscribe to it, give it five stars, leave a review, or if you want to dig deeper into the conversation with some other smart people, join the Breakers Discord. You can find a link in the show notes, or you can go to bit.ly slash breakdown pod. Lastly, as always, a disclosure in addition to them being a sponsor, I also work with FTX. So what we're going to do for the majority of this show is go through the paper more or less in the order that it's written. I want you guys to have a sense, a crib notes version of what the Fed is putting out there into the world, and then we'll talk about a few immediate reactions.

Starting point is 00:01:31 Let's start with the setup, how the Fed describes what challenges exist, exist in the current money system we have. First, they do note more than 7 million unbanked Americans, a little over 5% of the population. On top of that, they quote 20% of Americans who have bank accounts, but rely on less than optimal products like money orders, check cashing services, or payday loans. Another big area of challenge they identify is cross-border payments, which they say have slow settlement, high fees, and limited accessibility. They pin those problems on a number of different reasons, including the mechanics of currency exchange, variable legal norms and tech infrastructure between countries, time zone issues, intermediary coordination issues, and money laundering

Starting point is 00:02:15 rules. But whatever the case, they put the average cost of remittances at 5.41% of the notational value of the money being transferred. And of course, they say this impacts families and smaller businesses. Quote, reducing these costs could benefit economic growth, enhance global commerce, improve international remittances and reduce inequality. So, not a bad setup, a lot of the same arguments you've heard for stable coins and other cryptos in the past. Now, how do they discuss cryptocurrencies? Well, one, they say they're not widely adopted for payments, and the reason they point to is price volatility, difficulty of using without service providers, transaction throughput issues, energy footprint, and the

Starting point is 00:02:56 risk of loss, theft, and fraud. Now, one interesting and very clearly political note is they almost entirely decide not to discuss existing USD stablecoins. They basically just reiterate a set of facts from the president's working group report and more or less point to that as the canonical position of this administration on stable coins. So in case you aren't as familiar with that report, they say effectively that, quote, well-designed and appropriately regulated stablecoins could support, quote, faster, more efficient, more inclusive payment options. But there are a range of concerns, which include destabilizing runs, disruption in payment systems, and concentration of economic power, not to mention gaps in the authority of regulators to reduce those risks.

Starting point is 00:03:38 As I've said many, many times on this show, I think one of the questions that will come up over the course of this discussion about CBDCs is whether the U.S. should find a way to just absorb the existing U.S.D. Stablecoin infrastructure as the start or entirety of a digital dollar approach. And if that's the case, this discussion of Stable Coins is going to be particularly relevant. But that's all they talk about in the report, so we'll move on. Now let's get into how they discuss a potential central bank digital currency in the U.S. In many ways here, they are in fact positioning it relative to other types of stable coins. Quote, as a liability of the Federal Reserve, however, a CBDC would not require mechanisms

Starting point is 00:04:18 like deposit insurance to maintain public confidence, nor would a CBDC depend on backing by an underlying asset pool to maintain its value. A CBDC would be the safest digital asset to the public with no associated credit or liquidity risk. Now, one thing you should note for the entirety of this paper is this idea that a U.S. issued digital dollar would have no associated credit or liquidity risk is just a fundamental assumption of how the Fed is thinking about it. That's not surprising at all, even though many Bitcoiners don't have as much confidence as the Fed does in the long-term destiny of the U.S. dollar. This is a really important part of how they're seeing things and the value of a central bank digital currency. Now, what are the components?

Starting point is 00:04:58 that they would be looking for in a digital currency. They do mention right away privacy protected. However, the way that they get into that is very limited. The entirety of the discussion in this section is, quote, protecting consumer privacy is critical. Any CBDC would need to strike an appropriate balance, however, between safeguarding the privacy rights of consumers and affording the transparency necessary to deter criminal activity. For those keeping track at home, the two sentences they're using to describe the importance of a CBDC being privacy protected have five words related. to the importance of privacy. Protecting consumer privacy is critical, followed quickly by 26 words discussing why that privacy couldn't go so far because we have to deter bad people.

Starting point is 00:05:39 This was a terrible start to the privacy discussion, an issue that we'll come back to in the future. What other characteristics of a U.S. CBDC are they seeing? Well, they're saying that it would need to be intermediated. That means that rather than citizens having an account directly with the Federal Reserve, a Fed account or something of the like, it would be the private sector, commercial banks, and non-regulated financial institutions that would offer accounts in digital wallets. There would be an open market for CBDC services. Now, there is some confusion on Twitter about the idea of a retail versus a wholesale CBDC. I saw a number of people, even with nice titles from prestigious university,

Starting point is 00:06:16 saying that this intermediation meant that the Fed was focused on a wholesale CBDC, but intermediation is not what makes a CBDC wholesale or not. A wholesale CBDC is a CBDC that is used in. entirely for interbank settlement versus a retail CBDC, which is used by the end user like any other form of money or cash to buy products, goods, services day and day out. In other words, a retail CBDC can be intermediated. It can be run through the rails of the commercial financial system. And that's what the Fed is talking about. Nexto is a trusted and easy to use crypto platform where you can buy cryptocurrencies at the touch

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Starting point is 00:07:49 Visit Abra.com or download the app or download the app from the Google Play or Apple App Store today. Abra, Conquer Crypto. The breakdown is sponsored by FTX. FtX is the safe, regulated way to buy and sell Bitcoin and Bitcoin and Bitcoin. other digital assets. Trade crypto with up to 85% lower fees than top competitors. FtX U.S. is also the only leading exchange that supports both Ethereum and Solana NFTs. You can trade NFTs with no gas on FTXUS, and gas is subsidized when you withdraw off the platform. Help support the breakdown and visit FtX.us. Today. That's FtX.U.S. The last characteristic they talk about is identity verified.

Starting point is 00:08:38 CBDC intermediaries would need to verify the identity of a person accessing it. Again, not a surprise, but this is where a lot of the consternation comes from privacy advocates who look at what we're potentially losing in cash, the last anonymous form of money. In terms of uses of a CBDC, they discussed that transactions would need to be final and real time, quote, allowing users to make payments to one another using a risk-free asset, and also very, very slightly for about one sentence discusses programmability. quote, additionally a CBDC could potentially be programmed to, for example, deliver payments at certain times. Now, let's get into the benefits versus risks, and on the benefits side, the report says that a CBDC could potentially serve as a new foundation for the payment system and a bridge between different payment services, both legacy and new.

Starting point is 00:09:27 It could also maintain the centrality of safe and trusted central bank money in a rapidly digitizing economy. One of the hallmarks of this paper is that it says a lot of the quiet parts loud. And while it doesn't get deep into stable coins, as you can tell from that last line that I just quoted, they do care about keeping the U.S. dollar at the center of a new digital economy. Indeed, while there are a few different potential benefits they talk about, one is safely meeting future needs and demands for payment services, quote, removing credit risk and liquidity risk from digital money, and a second being improving cross-border payments,

Starting point is 00:10:02 a third being financial inclusion. The one that I took most note of was support dollars' international role. Quote, another benefit of a U.S. issued CBDC could be to preserve the dominant international role of the U.S. dollar. The dollar is the world's most widely used currency for payments and investments. It also serves as the world's reserve currency. The dollar's international role benefits the United States by, among other things, lowering transaction and borrowing costs for U.S. households, businesses, and government. The dollar's international role also allows the United States to influence standards for the global monetary system. Today, the dollar is widely used across the globe because of the depth and liquidity of U.S. financial markets, the size and openness

Starting point is 00:10:40 of the U.S. economy and international trust in U.S. institutions and rule of law. It is important, however, to consider the implications of a potential future state in which many foreign countries and currency unions may have introduced CBDCs. Some have suggested that if these new CBDCs were more attractive than existing forms of the U.S. dollar, global use of the dollar could decrease, and a U.S. CBDC might help preserve the international role of the dollar. This is one of the biggest reasons that I believe a U.S. issued CBDC is completely and totally inevitable. What's fascinating to me is that they're being so clear about this as an argument for it. And I think that's good. I think it's better to have the public have a chance to actually debate the U.S. dollar's international role as a potential stated benefit of this,

Starting point is 00:11:24 rather than have it as some background thing that they're not really talking about. But let's talk about what they identify as risks. The first risk they point to is changes to financial sector market structure. This section is all about the relationship with commercial banks. And while a little wonky is super important, quote, banks currently rely in large part on deposits to fund their loans. A widely available CBDC would serve as a close, or in the case of an interest-bearing CBDC near-perfect substitute for commercial bank money. This substitution effect could reduce the aggregate amount of deposits in the banking system, which could in turn increase bank funding expenses and reduce credit availability or raise credit costs for households and businesses. Similarly, an

Starting point is 00:12:06 interest-bearing CBDC could result in a shift away from other low-risk assets, such as shares in money-market mutual funds, treasury bills, and other short-term instruments. A shift away from these other low-risk assets could reduce credit available or raise credit costs for businesses and governments. Now, they basically have two solutions for these concerns, either making the CBDC worse by making it not interest-bearing or controlling how much people hold of it, which very quickly were into the Seems Great, thanks for making decisions for me, area of this conversation. Other risks, safety, and stability because a CBDC would be seen as the safest asset out there, and there would be such easy convertibility from commercial bank deposits,

Starting point is 00:12:43 a CBDC could amplify runs in times of stress as people move from commercial bank deposits to the CBDC. Privacy and data protection and prevention of financial crimes. Frankly, this section basically just said that a CBDC would have to follow all the same rules as banks. But the longest and clearly the section of concern that they are most interested in is the risk to the efficacy of monetary policy implementation. This is far beyond the scope even of this show, and I highly recommend you go check it out because, like I said, it's by a factor of about two or three, the longest discussion in the risk section and clearly where their heads are at. They're now seeking comments and next steps and have no sort of conclusion that indicates where they're leaning one way or the other. They say the Federal Reserve will only take further steps towards developing a CBDC if research points to benefits for households, businesses, and the economy overall that exceed the downside risks and indicates that CBDC is superior to alternative methods.

Starting point is 00:13:39 Furthermore, the Federal Reserve would only pursue a CBDC in the context of broad public and cross-governmental support. So what do I think about all this? First, it is extremely non-committal. I don't think we really should have expected anything else. I think the more surprising thing is, with the way that this report is right now, I'm not sure why it took till now to get it. Like, give four interns a bunch of coffee and a few crypto podcasts, and they could have written this in a weekend. Still, it's here now, and I'm glad that the conversation is finally happening out in the light of day.

Starting point is 00:14:09 Second, it very clearly glosses over the privacy-preserving property of cash that many of us in the Bitcoin and crypto space care most about. As much as they say cash would not be taken away, it's clear that this would add more, not less surveillance to the money system. Finally, I just want to double-click on the note that there is clearly a lot of thinking around monetary policy implications, which, of course, is the Fed that's to be expected. But there's a lot more questions than theses or clarity here, and a part of the discussion that I anticipate being super salient for them going forward. How did others react to this? Alex Gladstein from the Human Rights Foundation said TLDR, an American CBDC would replace privacy

Starting point is 00:14:47 protecting paper cash with a tool of surveillance and control. In short, the Fed is laying the case for the end of privacy and public money in the introduction of a programmable tool which empowers the state at the expense of the private sector and serves as an excuse for increased inflation. Now, the Fed, for their part, had tweeted, would a U.S. CBDC replace cash or paper currency? The Federal Reserve is committed to ensuring continued safety availability of cash, considering CBDC is a means to expand safe payment options not to reduce or replace them. This is the same tone that Christine Lagarde over in the EU has been trying to strike that any CBDC is not a replacement for, it's just an augmenter of cash.

Starting point is 00:15:23 How true that is in practice, I think is where the skepticism comes from. Senator Cynthia Lummis says I'm encouraged that the Fed recognizes what I've said all along, that protecting consumer privacy is critical in a CBDC. I'm genuinely undecided whether there is a legitimate need for a CBDC when we have stablecoins, and I look forward to working with Chair Powell and Governor Brainer to figure this out. Senator Pat Toomey writes, Cryptocurrency's digital assets and their underlying technologies offer tremendous potential benefits.

Starting point is 00:15:48 As such, I'm glad the Federal Reserve has constructively contributed to the necessary ongoing public discussion regarding the issuance of a CBDC. While mentioning the importance of CBDC privacy, I'm concerned the Fed doesn't clearly explain how it would protect consumer data. There's also a question in my mind whether the report implies that a CBDC would not allow for direct peer-to-peer transactions. This is fundamental. Today's report is an important step by the Fed in acknowledging the first.

Starting point is 00:16:11 permanence of crypto and their underlying technologies, I look forward to working with the Federal Reserve and my colleagues in Congress to consider the authorization of a properly designed CBDC. Echoing that are lots of people. The privacy issue is the most important issue. Rohan Gray, who's no friend to crypto but is aligned on this issue of privacy, writes, the Fed's report on CBDCs is out and predictably. On the most important issue of all, protecting slash maintaining cash like privacy,

Starting point is 00:16:38 there is no analysis, just assertion that anonymity is non-viable because greater scale velocity of digital. Very disappointing. Presently, and for thousands of years, individuals are-slash-have-beenable to transact with cash anonymously and do not need slash have not needed to sign up or provide their identity in order to make transactions with public money. Eliminating that capacity in the digital age is extreme. Or, to put it another way, designing a digital dollar to preserve the anonymity respecting features of cash in the digital age is a small-C-conservative defense of existing freedoms, not a handout to criminals or money-launderers.

Starting point is 00:17:11 we don't have to rely on the Fed to have a change of heart because the creation of a digital dollar is not the exclusive purview of a bunch of macroeconomically trained bureaucrats. It's a core constitutional question that the elected branches have final say over. Perfect way to end. If you are interested in these issues, the best thing you can do is go leave a comment on this paper. I have heard over and over again from friends in Washington that they do pay attention. They pay attention not only to the specific comments, but also to the volume of comments. So get in there, make a comment, make it happen. to say thanks again to my sponsors nexo.io, Abra and FTX. And thanks to you guys for listening.

Starting point is 00:17:48 Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The Federal Reserve Shares Its Thinking About a US CBDC

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