Federal Reserve CBDC Speech: A Comprehensive Macroeconomic Understanding of Stablecoins, Bitcoin, and CBDCs

This article is sourced from BlockBeats, authored by Randal K. Quarles.

In the early hours of June 29, Federal Reserve Vice Chairman Randal K. Quarles delivered a speech titled "Parachute Pants and Central Bank Digital Currency."

"Parachute pants" is a metaphor that refers to a fashion trend that suddenly became popular among Americans in the 1980s. In this speech, the Vice Chairman of the Federal Reserve used this term to express his attitude towards Central Bank Digital Currency (CBDC). In his view, he does not see the advantages of a dollar CBDC; rather, he can foresee the potential problems that may arise if a dollar CBDC were to be introduced. However, he is not biased against cryptocurrencies; in this speech, he praised dollar stablecoins and recognized the innovation they represent.

This is a macro summary from the U.S. regulatory perspective on stablecoins, Bitcoin, and CBDC. In a time of poor market sentiment and unclear regulations, BlockBeats hopes this article can provide readers with new perspectives.

Here is the full translation of BlockBeats' coverage of the Federal Reserve Vice Chairman's speech:

I have been reflecting on the impact of America's enthusiasm for novelty over the past few centuries. Overall, this has been beneficial for us and the world, as it has made the United States the birthplace of many scientific and practical innovations that have changed life in the 21st century. Starting from life in the 19th century, it has served us and the world well.

However, when enthusiasm for new things combines with Americans' susceptibility to populism and fear of missing out, it can sometimes lead to a massive suspension of our critical thinking, occasionally resulting in impatience, delusional fervor, and trends.

At times, many outcomes seem perplexing and embarrassing in hindsight, much like in the 1980s when millions of Americans suddenly began wearing parachute pants. Of course, some things may have more serious consequences.

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

In recent months, public interest in the "digital dollar" has reached a peak. Many experts and commentators have suggested that the Federal Reserve should issue a CBDC. However, before we become intoxicated by this novelty, I believe we need to conduct a careful critical analysis of CBDC.

The views expressed here represent the opinions of the board member speaking and do not represent the board itself or any other Federal Reserve policymakers.

Chairman Powell recently announced that the Federal Reserve is preparing a comprehensive discussion paper on this issue, which is the first step in conducting a critical analysis public process. I do not want to prejudge this event, but I will outline the issues we need to address in this process, how I think about these issues, and some views on what I believe any proposal to create a U.S. CBDC must clearly meet high standards.

The first fundamental question is: What problem will CBDC solve? Before answering 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 Bank for International Settlements defines CBDC as "a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank."

My first point is that the general public is already widely transacting in digital dollars by transferring electronic balances in and out of commercial bank accounts. Of course, these digital dollars are not CBDC, as they are liabilities of commercial banks rather than the Federal Reserve. However, an important point is that digital dollars in commercial banks are insured up to $250,000 under federal insurance. This means that deposits below $250,000 in commercial banks are as robust as central bank liabilities.

The Federal Reserve also directly provides digital dollars to commercial banks and certain other financial institutions. Federal law allows these financial institutions to open accounts at the Federal Reserve and receive payment services from it. Balances in Federal Reserve accounts play an important financial stability role by providing safe and liquid settlement assets for the U.S. economy.

In summary, the dollar is already highly digitized. The Federal Reserve provides digital dollars to commercial banks, which in turn offer digital dollars and other financial services to consumers and businesses. This arrangement serves the nation and the economy well: the Federal Reserve serves the public interest by promoting the health of the U.S. economy and the stability of the broader financial system, while commercial banks compete to attract and effectively serve customers.

So, considering the existing digitization of the dollar, how does CBDC differ from the digital dollars we use today?

The key difference is that when most commentators speculate about a Federal Reserve CBDC, they assume that the public could access it directly from the central bank. This nature of CBDC could take different forms. One is an account-based model, where the Federal Reserve would provide individual accounts directly to the public. Just like the accounts the Federal Reserve currently offers to financial institutions, account holders would send and receive funds to and from their Federal Reserve accounts via debits or credits.

Another different CBDC model might involve CBDC that is not held in Federal Reserve accounts. This form of CBDC would be closer to a digital equivalent of cash. Like cash, it represents a claim on the Federal Reserve, but it could be transferred between people (like banknotes) or through intermediaries.

I am skeptical about whether the Federal Reserve has the legal authority to implement these CBDC models without legislation. However, if such legislative authorization were granted, then we would need to explore the benefits, costs, and practicality of implementing CBDC in the United States.

Next, let’s look at whether a Federal Reserve CBDC is suitable for the current U.S. payment system.

The Current State of the U.S. Payment System

The payment services between the Federal Reserve and private sector banks have provided a range of options to facilitate efficient electronic dollar payments. Some statistics related to major dollar large-value payment systems illustrate the point. The Federal Reserve's large-value payment service (Fedwire Funds Service) processes nearly $4 trillion in payments daily. A private sector entity (clearinghouse) operates a large-value payment system that settles nearly $2 trillion in payments each day. These payments are not settled in Federal Reserve accounts, but they are backed by balances on the books of the Federal Reserve Banks.

Settlement speeds for small payments are often slower than for large payments, but various efforts to accelerate settlement speeds have been completed or are underway. For example, clearinghouses have developed an instant payment service focused on small payments. Similarly, a batch-based payment network, the Automated Clearing House (ACH), developed in the 20th century, can now achieve same-day settlement for ACH payments. The Federal Reserve is also developing an instant payment service, "FedNow℠," which will soon provide instant access for recipients of small payments to their commercial bank account funds.

Of course, these payment systems are not perfect, and certain types of payments should have faster and more efficient characteristics. For instance, cross-border payments remain a key area of concern, as they often involve high costs, low speeds, and a lack of transparency. The international organization I chair, the Financial Stability Board, developed a roadmap last year aimed at addressing these issues. Additionally, private sector stablecoins may facilitate faster and cheaper cross-border payments (as discussed later).

Moreover, some types of payments are not fully digitized, and there are long-standing disputes among businesses with competitive economic interests regarding certain types of payments. For example, paper checks are still widely used in certain areas, even though 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 debate between banks and retailers over who will receive the fees associated with card transactions.

Finally, increasing the use of low-cost basic banking accounts can promote greater access to banking services for Americans, allowing them to benefit from digital payments.

In summary, the U.S. payment system is very good, and although it is not perfect, it is undergoing significant improvements.

Policy Considerations

However, supporters of a Federal Reserve CBDC argue that CBDC can address many important issues. For example, they suggest that a Federal Reserve CBDC is necessary to defend the dollar's key role in the global economy. Others believe that CBDC will address the long-standing issue of economic inequality in American society. As we at the Federal Reserve begin to analyze these issues, I must assure and ensure that CBDC is a good tool for addressing these problems. I am skeptical about this. At the same time, I must be particularly convinced that the potential benefits of CBDC outweigh the risks.

Let’s look at some of the points raised by CBDC supporters. The first point is that the Federal Reserve should issue a CBDC to protect the dollar from the threats posed by foreign CBDCs and the ongoing proliferation of private digital currencies.

First, starting from the perspective of the threat posed by foreign CBDCs, this argument assumes that if digitization were to occur directly through a CBDC model rather than through the current digital payment system, some foreign currencies would suddenly challenge the dollar. (It should be noted that these foreign currencies are already highly digitized in the current international banking system in the same way as the dollar, but have not yet posed a significant challenge to international currencies). According to this view, if the Federal Reserve does not provide a similar product, the dollar will lose its standing in the global economy.

I believe that as the global economy and financial system continue to evolve, the use of some foreign currencies (including some foreign CBDCs) in international transactions will inevitably increase compared to now. However, the dollar's status as a global reserve currency, or its dominant currency status in international financial transactions, seems unlikely to be threatened by foreign CBDCs. The dollar's role in the global economy depends on multiple fundamentals, including the strength and size of the U.S. economy, extensive trade links between the U.S. and other countries, financial markets, including U.S. Treasury securities, the stable value of the dollar over time, the ease of converting dollars into foreign currencies, the rule of law in the U.S., strong property rights, and reliable monetary policy. These are unlikely to be threatened by foreign currencies, and certainly not by foreign CBDCs.

CBDC supporters also argue that private digital currencies pose a threat to the dollar. Private digital currencies come in various forms, but for this discussion, I will categorize them into two types: stablecoins and non-stablecoins, or crypto-assets like Bitcoin.

Let’s start with stablecoins, which are pegged to one or more other assets, such as sovereign currencies. There are various existing and potential stablecoins linked to the value of the dollar.

Some believe that the U.S. must issue a CBDC to compete with dollar stablecoins. Stablecoins represent an important development, significant enough to provoke our thoughts on many issues. For example, how will the widespread adoption of stablecoins affect monetary policy or financial stability? How do stablecoins impact the commercial banking system? Do stablecoins pose a fundamental threat to the government's role in money creation?

In my view, we should not fear stablecoins. The Federal Reserve has historically supported responsible private sector innovation. Consistent with this tradition, I believe we must fully consider the potential benefits of stablecoins, including the support that dollar stablecoins may provide for the dollar in the global economy. For instance, a global network of dollar stablecoins could encourage the use of dollars through faster and cheaper cross-border payments, and compared to CBDC, its deployment speed may be faster with fewer drawbacks. Given that our existing system involves (and is effectively dependent on) private companies creating money daily, it is perplexing to argue that stablecoins represent an unprecedented private money creation that challenges our monetary sovereignty.

We do have legitimate and strong regulatory interests in how stablecoins are constructed and managed, particularly regarding financial stability issues. For example, the asset pool that anchors the value of stablecoins (if their use becomes sufficiently widespread) presents stability risks in the following scenarios: if investments are made in multiple currency denominations; if it operates on a fractional reserve rather than a full reserve; if stablecoin holders do not have explicit claims on the underlying assets; or if the asset pool invests in assets other than the most liquid assets like central bank reserves and short-term sovereign bonds. All these factors can create "run risk"—certain triggering events may lead to a large number of stablecoin holders attempting to redeem their coins for other assets all at once, while the stablecoin system may not be able to meet this demand while maintaining reasonable stable value. However, these issues are clearly solvable. In fact, some stablecoins have already been used to address these problems. Once our concerns are resolved, we should say "yes" to these products rather than desperately trying to find ways to say "no." In fact, combining the urgent improvements needed in existing payment systems (such as various instant payment initiatives) with the cross-border efficiency of well-structured stablecoins could likely render the issuance of CBDC unnecessary.

In contrast to stablecoins, crypto-assets like Bitcoin are not tied to the value of sovereign currencies. Instead, they seek to create value in tokens through other means, often involving some inherent mechanisms that ensure scarcity, such as the mining process of Bitcoin, or characteristics like "anonymity" that traditional payment systems cannot match. Some assert that the U.S. must issue a CBDC to combat cryptocurrencies, which seems misguided. The mechanisms used to create the value of such crypto-assets also ensure that this value is highly volatile, similar to the fluctuating value of gold, with a significant portion of Bitcoin's value derived from its scarcity. Like Bitcoin, it does not play a significant role in today's payment and monetary systems. However, unlike gold, which has industrial uses and aesthetic properties in addition to its residual financial role, Bitcoin's primary additional appeal lies in its novelty and anonymity. Anonymity will make it a target for law enforcement scrutiny, while novelty is a quickly diminishing asset. Gold will always shine, but novelty fades. Therefore, Bitcoin and its counterparts are almost certainly going to remain risky speculative investments rather than revolutionary payment methods, making it highly unlikely that they will impact the role of the dollar or necessitate a response from CBDC.

The second point raised by CBDC supporters is that a Federal Reserve CBDC would provide a means for those who currently lack bank accounts due to expenses, distrust of banks, or other reasons to access digital payments. This is indeed valuable, but I believe we can more effectively promote financial inclusion by taking steps to provide these individuals with cheaper basic commercial banking accounts, such as those developed in partnership with the Cities for Financial Empowerment Fund. The proportion of unbanked households is estimated to have declined from 8.2% to 5.4% between 2011 and 2019. Banks and regulators are working to further reduce this proportion. I am very skeptical that CBDC is the best way to increase financial inclusion, and it may not even be effective.

Finally, some argue that a Federal Reserve CBDC would stimulate and promote innovation in the private sector. This is interesting and worth further exploration. However, I am puzzled about how a Federal Reserve CBDC would promote innovation in ways that private sector stablecoins or other new payment mechanisms cannot. In my view, the payment industry has already seen quite a bit of private sector innovation without CBDC, and it is conceivable that a Federal Reserve CBDC, or even a plan for a CBDC, could hinder private sector innovation.

In short, the potential benefits of a Federal Reserve CBDC are unclear. Conversely, the risks that a Federal Reserve CBDC may pose are very specific. First, a Federal Reserve CBDC could present significant challenges to the structure of our banking system, which currently relies on deposits to support the credit needs of households and businesses. An arrangement in which the Federal Reserve replaces 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 issues, a dominant CBDC could undermine the consumer and other economic benefits generated by competition among commercial banks to attract customers.

A Federal Reserve CBDC could also become a target for cyberattacks and other security threats. There may be attempts to steal CBDC or even disrupt the CBDC network or gain unauthorized access to information about CBDC holders. The architecture of a Federal Reserve CBDC would need to be highly resilient to such threats and require ongoing resilience as attackers adopt increasingly sophisticated methods and strategies.

Designing appropriate defenses for CBDC may be particularly challenging, as the access points to the CBDC network could be far more numerous than those of the Federal Reserve's existing payment systems. Depending on design choices, anyone in the world could potentially access the network.

Another very important point is that we need 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 similar anti-money laundering regimes are feasible for the Federal Reserve's CBDC. Designing a CBDC that respects individual privacy while adequately mitigating money laundering risks may currently pose significant challenges.

In extreme cases, we could design a CBDC that requires CBDC holders to provide the Federal Reserve with detailed information about themselves and their transactions. This approach would minimize money laundering risks but raise significant privacy concerns. Conversely, we could design a CBDC that allows parties to transact on a completely anonymous basis. This approach would address privacy concerns but could significantly increase money laundering risks.

The final risk is that the costs of issuing a Federal Reserve CBDC could be very high and difficult for the Federal Reserve to manage. A Federal Reserve CBDC could essentially turn the Federal Reserve into a retail bank for the public. This would mean introducing large-scale, resource-intensive central banking infrastructure. We would need to consider whether the potential use cases for CBDC justify this cost and the extension of the Federal Reserve's responsibilities into unfamiliar activities, as well as whether this extension would politicize the Federal Reserve's mission.

In conclusion, I emphasize three points. First, the dollar payment system is very good and getting better. Second, the potential benefits of a Federal Reserve CBDC are unclear. Third, I believe that issuing a CBDC could pose significant risks.

Therefore, as we continue to seriously evaluate the issuance of a Federal Reserve CBDC, our work is not done. Even if other central banks successfully issue CBDCs, we cannot assume that the Federal Reserve should issue a CBDC. Chairman Powell's recently announced process is a genuinely open process with no conclusions, although I clearly believe that the threshold for establishing a U.S. CBDC is high. The upcoming discussion paper constitutes the first step in this process, and it is important to seek public input. I look forward to reviewing public comments on the discussion paper, which will inform the Federal Reserve's final assessment of a potential CBDC.