The Breakdown - The US Appears in No Rush on CBDCs

Starting point is 00:00:00 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 nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, August 22nd, and today we are discussing whether the U.S. digital dollar discussion is really going anywhere. Before we get into that, however, if you are enjoying the breakdown, please go subscribe. to it, leave it a rating, leave it a review, or if you want to dig deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show,

Starting point is 00:00:49 I also work with FTX. All right, guys, welcome to a new week. Hopefully it starts a little better than last week ended. This was definitely a good weekend to touch grass, so I hope you have the chance to do that. But today, we are looking forward to one of the conversations that I think many of us would have thought would have characterized or defined this year, but has kind of been on the backburner. A key theme of 2020 is the U.S. actually trying to catch up with the crypto industry on regulation. The year kicked off with the Biden executive order. And while there had been much speculation that the White House was going to come down hard on crypto, instead the EO was a measured document that set a linguistic framework that most subsequent discussions have followed. That is, of course,

Starting point is 00:01:35 the need on the one hand to preserve space for innovation, while on the other to protect consumers. Importantly, the executive order did not do any rulemaking. It was a document that was all about studying each part of this industry to try to come up with considered recommendations and to do so in a way that was truly cross-governmental, and not subject to the same sort of agency infighting that we've seen characterize a lot of the regulatory discussion. Subsequent to the EO, we've gotten legislation like the Responsible Financial Innovation Act, which was a bipartisan act introduced by Senators Kirsten Gillibrand from New York and Cynthia Lummis from Wyoming. Now, the Responsible Financial Innovation Act was super comprehensive legislation. It really dealt end-to-end with a huge

Starting point is 00:02:19 swath of this industry, but the challenge is that the more comprehensive the legislation, the harder it is to get through. It seems then that perhaps, Perhaps one of the secondary goals of the RFIA might have been to set a framework for other legislation around more discrete areas within the crypto industry. In other words, while the RFIA itself might not get voted on, other senators or congresspeople might take specific parts of that legislation, such as the idea of ancillary assets which are somewhere in between a security and a commodity. However, I don't think that it's ancillary assets that are likely to see the first legislative efforts. I think that belongs to stablecoins. From a regulatory point of view, stablecoins have been higher on the agenda than many other crypto-related areas.

Starting point is 00:03:03 There are a couple of reasons for this. A big part of it is that, in my estimation, the entire crypto industry smashed into view for most U.S. legislators when Facebook announced its Libra project in June of 2019. At the time, the stable coin industry, as we know it, was minuscule. Tether had a market cap of around 3.5 billion at the time in USDC wasn't even really a thing. In other words, it wasn't big enough to get notice. What was noticeable, however, was when a company with a user base of over 2 billion people said that they wanted to create their own version of a stable coin, their own version, in effect, of money.

Starting point is 00:03:41 There were a few things that regulators reacted strongly to right away. First, Facebook was already persona non-grata on the hill. The Democrats were still angry about Trump's election. and the potential role of Russian bots through Facebook in that process. Republicans, meanwhile, were angry about what they considered a growing trend of deep platforming conservative voices. So even before they started talking about inventing their own money, Facebook was going to have a tough time pushing through anything sensitive. A second big hit against this idea was that Facebook wasn't planning to domicile the company

Starting point is 00:04:11 in the United States. Instead, it would be set up in Switzerland. And third, it wasn't a U.S. dollar-denominated stable coin. Instead, it was a basket approach where the US dollar only made up 50% of the reserve basket. This was similar, in fact, to what John Maynard Keynes had proposed as an alternative to the U.S. dollar at Bretton Woods, a global reserve standard that wasn't tied to any one country's currency. Given how hard the U.S. pushed for that not to happen then, it's no surprise that Congress and the Senate thought that this would undermine the dollar today as well. Anyway, we know how the Libra saga ended. Earlier this year, the last gasps of that project faded into nothing. Indeed, the lingering impact for the crypto industry itself

Starting point is 00:04:52 is that some of the teams have gone on to form new layer ones like Aptos and Sui. But regulators never fully stopped paying attention to stable coins. In the wake of that Libra announcement, the discourse of regulators went in two directions. The first was how should we regulate stable coins? And the second was should we make our own stable coin, aka a central bank digital currency. Many countries, China most notably, race towards their own sovereign CBDC. Why a country like China would want to be a leader in CBDC is an interesting and important question to ask. In the U.S., however, the history of financial innovation tends to be a hybrid of private sector innovation that gets brought into and formalized by the official system through the

Starting point is 00:05:34 sanctioning of the U.S. government. Given that, even if the U.S. decided that it did want some of the benefits of a digital dollar. Might it be that the better path than creating its own new digital currency would be in absorbing the existing USD stablecoin infrastructure that exists in the private sector? So with that background in mind, let's check in on the status of the discussion of a U.S. digital dollar. And since one of the nicknames of that potential coin is Fed coin, let's start with the Federal Reserve. During a congressional hearing in June, Fed Chair Jerome Powell told lawmakers that a CBDC is, quote, something we really need to explore as a country, and that, quote, it should not be a partisan thing. It's a very important potential financial innovation that will affect all Americans.

Starting point is 00:06:18 Our plan is to work on both the policy side and the technological side in coming years and come to Congress with a recommendation at some point. Interestingly, Powell directly addressed this idea of whether the existing stable coin should be the digital dollar. He said one question around CBDCs is do we want a private sablecoin to wind up being the digital dollar? I think the answer is no. If we're going to have a digital dollar, it should be government guaranteed money, not private money. This is the first time that I at least have noticed him dealing with that specific aspect of this. However, I don't think it's quite as binary as he's presenting here. In other words, the scenario in which something like USDC becomes a core piece of the official sanctioned digital dollar infrastructure

Starting point is 00:07:00 would not likely have the same consortium of ownership and the same structure of ownership as it does now. In any case, America's slowness to really dig deep into CBDC kind of puts it out of sync with the rest of the world. According to the Atlantic Council, 105 countries representing more than 95% of global GDP are currently researching or developing CBDCs. However, so far, only 10 nations have launched some form of them, with all of those being currencies operating in small economies with very little float. The largest trial to date is the Chinese digital yuan, which is still mostly focused on domestic use. The Atlantic Council rates the UK and the U.S. as the furthest behind in development of a CBDC among G7 economies. In a congressional hearing entitled The Promises and Perils of Central Bank Digital Currencies, held in July last year, Congressman Jim Himes recognized, quote, the long-term consequences if we lose our competitive edge to countries like the People's Republic of China.

Starting point is 00:07:54 While more recently FedShare Powell noted that the U.S. should, quote, not seed its competitive advantage, we must not rush the process for the sake of simply keeping up. He pointed out then that despite all rumors to the contrary, the U.S. dollar's dominance as the global reserve currency had not significantly decayed despite the lack of a CBDC or efforts towards a nude type of digital dollar. These small snippets in some ways capture a lot of the discourse in the U.S. around this issue. On the one hand, the U.S. is undisputedly the global economic leader of the world, and the dollar has been the world's reserve currency since Bretton Woods coming at the end of World War II. However, will we always be and will the dollar always be?

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Starting point is 00:10:33 framed the U.S. as being caught in an innovator's dilemma. As the dominant incumbent in global currency issuance, the U.S. faced off against more nimble disruptors who were adding features to rival products including private stable coins and foreign CBDCs, which presents the U.S. with a choice. Should it adopt the same technology path as rivals to compete or try to snuff out competition using market power? What's clear is that right now, the U.S. dollar's status as the Global Reserve, pretty secure. That means that there is no pressing and obvious need for the U.S. to quote-unquote catch up with other nations' CBDC programs. Indeed, even those who think that the U.S. dollar's status is in jeopardy are looking at much longer-term factors like the weaponization

Starting point is 00:11:13 of the dollar that came with Russian sanctions this year, much more so than any sort of technological competition around digitization. Just to put some numbers around the U.S. dollar's dominance, the U.S. dollar represents 60 percent of global reserves. It's one pair in a 88% of global currency trades, 60% of international banking liabilities, and more than 65 countries peg their currencies to the U.S. dollar. Outside of the Fed and that one hearing last year, though, have we seen anything else about a central bank digital currency in the U.S.? In that Biden executive order on crypto, CBDCs were an important piece of the studies to be completed. The goal, as expressed by the EEO, was to determine whether issuing a CBDC was ultimately, quote,

Starting point is 00:11:55 in the national interest. At the time, the intention of various groups within the government that were already working on CBDC technology was to launch five pilot programs to test prototype systems. Since the EO, we actually haven't seen any major updates on these pilots, and it's unclear whether the EO had some sort of freezing effect on them. The research papers on the topic of CBDC development and deployment that were requested by the executive order are due back from Treasury and other agencies starting in mid-September. What's clear is that there's not consensus that it's a direction we should be going. One of the surprise narratives to some in the policy space has been the profound rejection of a CBDC from

Starting point is 00:12:32 traditional financial institutions. Existing banks note that allowing the public to hold accounts directly with the Fed would disrupt their capital base, which of course would undermine the entire model of private banking that had served the U.S. reasonably well for generations. In August last year, J.P. Morgan warned that a U.S. CBDC could lead to an exodus of as much as 30 percent of commercial bank's funding base in the form of deposits. The Institute for International Finance, which consists of 450 member banks, including major U.S. banks like J.P. Morgan and Goldman Sachs, issued similar warnings to the European Central Bank in June. They requested, quote, a clear qualitative and quantitative impact assessment of the range of possible designs of a digital

Starting point is 00:13:11 euro, looking at the various risks to financial stability. Fabio Panetta, a member of the Executive Board of the ECB, admitted that responses to a CBDC questionnaire put out by the central bank had been, quote, not that enthusiastic to put it mildly. The Cato Institute, a liberty The authoritarian think tank put out research in July, analyzing more than 2,000 responses to the Federal Reserve's call for public comments about a CBDC. It found that more than two-thirds of respondents objected to the idea. The main concerns were loss of privacy and damage to the U.S. financial system. Nicholas Anthony, the Kato Institute's policy analyst, said, quote, the fact that two-thirds of the over 2,000 commenters are pushing back against the idea of a

Starting point is 00:13:49 CBDC shows not only that this is not the niche issue it was a few years ago, but also that Americans recognize the very real risk a CBDC could pose to their financial freedom. So basically, on the one hand, you have banks who are saying, if consumers get the choice to hold their accounts with us versus holding their accounts with the government directly, a huge portion of them are going to find holding their money with the government directly to be more safe and more appealing than holding it with us. That's where the threat to commercial deposits that they're discussing comes in. Another entire separate critique is the ability that a central bank currency would give the government to surveil private transactions.

Starting point is 00:14:24 On the flip side, supporters of a U.S. CBDC have cited national security benefits in a race against foreign competitors, environmental concerns with printing physical banknotes, and the ability to improve trust in the financial system through increased transparency. Officials of the Fed for their part have definitely not taken a strong position and said clearly that they will not act without instruction from Congress in the White House. Thomas Cowan, who is part of the CBDC research team at the Boston Fed, estimated that it would take at least five years to implement a CBDC system. A white paper that that team released in February actually laid out one of the directions that this could go then.

Starting point is 00:14:59 By the time a U.S. CBDC is issued, they wrote, regulated stable coins could provide solutions that a CBDC may have been designed for, such as boosting financial inclusion, cutting transaction costs and settlement time, increasing access to U.S. and even expanding the dollar's role as the global reserve currency. And that gets us back again to this question of whether even in the world where the U.S. want some of the benefits of digital currency, does it choose to go it alone, or does it choose to tap into the existing private market infrastructure? This is probably part of the reason why, over the summer, it had seemed like stablecoins were going to take the priority role in legislation.

Starting point is 00:15:35 At the same time, that urgency probably had less to do with the potential that stable coins play a CBDC-like role in the U.S., and more to do with concerns of systemic risk. In notes from the July FOMC meeting, the Federal Reserve, quote, noted that these assets, including stablecoins, were subject to vulnerabilities, such as runs, fire sales, and excessive leverage. While the recent turmoil and digital asset markets had not spread to other asset classes, these participants saw digital assets rising importance and growing interconnectedness with other segments of the financial system as underscoring the need to establish a robust supervisory and regulatory framework for this industry that would appropriately limit potential systemic risks.

Starting point is 00:16:12 Over the summer, it appears that there were lots of debates between Democrats and Republicans on potential stablecoin legislation. Reports have cited disagreement between those two sides on issues such as the level to which regulations needed to include consumer protections. Republicans were apparently focused on passing minimum viable regulations, which would focus on ensuring that stablecoin reserves were sound incredibly audited, while Democrats and the Treasury were pushing for more stringent consumer protections, including the segregation of customer funds to enable recovery in the event of bankruptcy. This matter has now been postponed until Congress resumes in September, but I still think it will be the first part of crypto that Congress really digs into. Said Congresswoman Maxine Waters,

Starting point is 00:16:51 quote, although the ranking representative Patrick McHenry, Secretary Janet Yellen and I, have made considerable progress towards an agreement on the legislation, we are unfortunately not there yet, and will therefore continue our negotiations over the August recess. I look forward to coming to an agreement in the near future and marking up bipartisan legislation when we return. Still, as you can see, this really isn't stable coins as a CBDC alt. This is about answering some very basic, questions around stable coins like who gets to issue them? What sort of disclosures and attestations did there need to be? Are there going to be rules around what type of collateral has to back them, etc? I think the stable coin legislation that we get in the fall, if we get legislation in the fall,

Starting point is 00:17:29 will be around these topics. In the crypto community, it's pretty clear how people feel about CBDCs. I would characterize the average stance as being not just skeptical of them, but seeing them as a dystopian co-optation of what crypto and blockchains has wrought to the financial system. Eric Voorhees, the founder at Shapeshift, wrote, CBDCs are not solutions for consumers, they are solutions for the state. The problem they solve is simple. How do we monitor and control all financial activity among the populace? What's clear, I think, when we look at all of this, is that the U.S. by virtue of its place as having the world's reserve currency is just not in a rush when it comes to figuring out the long-term role of a digital dollar. Elected officials feel

Starting point is 00:18:12 rightly or wrongly that we have the benefit of time. I think that it's interesting that you have the Boston Fed who has been researching this, saying that in the time scale it would take to implement a Fed coin, that many of the benefits of such a coin might be accrued from a better regulated stable coin sector. I think it's interesting that Federal Reserve Chair Jerome Powell is actually addressing that issue directly now, even if at the moment he's saying that a government-owned currency is the only model that makes sense to him. In either case, I do think that when Congress has back in September, we will see legislation around stablecoins, and I think it'll be legislation that has a good chance of passing. It could be that bipartisan stablecoin legislation is exactly

Starting point is 00:18:53 what's needed, in fact, to get Congress and the Senate to really focus on the rest of the issues around crypto brought up in more comprehensive legislation like the Responsible Financial Innovation Act. Whatever happens, I think the fall is going to be interesting, and 2022 and 2023 will continue to be the years that, for good or ill, the U.S. gets crypto legislation. on the books. For now, I want to say thanks again to my sponsors, Nexto, chain analysis and FtX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital assets and enterprises summit or ideas. The event facilitates capital flow and market growth by connecting the digital

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The Breakdown - The US Appears in No Rush on CBDCs

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