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On this episode of “The Breakdown,” NLW analyzes a stablecoin-focused speech from Randal Quarles, vice chair of the Federal Reserve, starting with a primer on developing trends related to the topic, including:

• CBDC discussion, investigation and development across global powers
• The ability of stablecoins to make a U.S. CBDC redundant

The conversation around central bank digital currencies (CBDCs) is growing louder. In China, the digital yuan continues to roll out through lottery tests and, more recently, for use in the Beijing subway. Today, the European Central Bank announced a new two-year “investigation” period during which the ECB will prepare for a larger digital euro design phase with user consultation, regulatory discussions and market analysis.

Still, NLW argues that we can’t view the rise of public CBDC discussions in the absence of the growing adoption of private stablecoins. While these private, fiat-pegged stablecoins seem increasingly in the regulatory crosshairs, Federal Reserve Vice Chair Randal Quarles recently argued the U.S. central bank and policy makers shouldn’t fear them – and that, indeed, when regulated properly, stablecoins might make the need for a CBDC redundant.

See also: Jerome Powell: CBDC Report Coming in Early September

The Breakdown is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Razor Red” by Sam Barsh. Image credit: Andrew Harrer/Bloomberg/Getty Images, modified by CoinDesk.

Transcript

What’s going on guys, it is Wednesday, July 14, and today we are talking about quite a remarkable speech on stablecoins and central bank digital currencies from the vice chair of the Federal Reserve. However, to set this up, we need to discuss a couple of trends that are useful for contextualizing this discussion. The first is the increasing conversation around central bank digital currencies. I don’t need to go through everything again but briefly, if you’re new to this topic, a CBDC is a new type of digital fiat money. Governments are interested in this for a variety of reasons, there are potential efficiencies and cost gains, there could be reduced settlement times. Some think that CBDCs could enable more of the unbanked and underbanked to access quality financial services. Governments are also excited about the possibilities of easier interactions with their citizens. The difficulty of distribution of COVID-19 aid was a major motivator for people to start paying attention to CBDCs and was, in fact, the first time many politicians had even considered them. This was especially true for Democrats in the U.S. and for the European establishment. There are also micro monetary policy opportunities, CBDCs present a scalpel compared to the hammer of current tools. 

And then there are surveillance opportunities which, in the well-heeled prim and proper Western world, are seen as exciting by officials as a way to reduce financial crime and money laundering. In other parts of the world less concerned with citizen rights like privacy, the surveillance capacities are more generally appealing as an unabashed tool of social control. Whatever the motivation, the last few years have seen a major shift in the discourse and CBDCs seem very much on the menu. 

China is out in the lead in terms of how far along with practical implementation they are. They have set out to explicitly be the first major nation to get there. They’ve been running trials via lottery and cities around the country for the last year, giving away millions of digital yuan that can be spent with select retailers. More recently, they’ve also started enabling the digital yuan for payment of key services like the subway in Beijing. Many other smaller countries are also at various stages of research and even trial. But, in terms of other big settlement currencies, Europe has also recently made headlines around CBDCs. The European Central Bank announced today that it will move from discussion to investigation around a digital euro and, you’ll have to forgive these officials for the glacial pace they move at, the ECB is now starting a 24-month investigation phase. 

ECB President Christine Lagarde has been talking about this all year, saying earlier in March that it could be launched within four years. Today she said: “It had been nine months since we published our report on a digital euro. In that time, we’ve carried out further analysis, sought input from citizens and professionals and conducted some experiments with encouraging results. All of this has led us to decide to move up a gear and start the digital euro project. Our work aims to ensure that in the digital age, citizens and firms continue to have access to the safest form of money: central bank money.” 

Now, there are three aspects of this investigation phase. The first is “Possible Functional Design Based on User Needs,” so this is focus groups, prototyping and conceptual work. The second is to highlight potential changes necessary in the EU legislative framework. In other words, make sure that there are mandates for the ECB to implement a digital euro as it needs to. The third is to identify potential market impacts and define the business model for quote, “supervise intermediaries.” So, while the terminology moving from discussion to investigation, sort of sounds like policy speak gobbledygook, there is at least something of a structure for what this new phase will consist of. 

If you’re interested in getting a broader sense of how Europe is thinking about this, check out the blog post published today called “Preparing for the Euro’s Digital Future.” It’s from Fabio Panetta, a member of the executive board of the ECB, and there’s a lot of stuff in here that reveals how they’re thinking. One interesting note is that the ECB is clearly seeing this, at least in part, through the lens of anti-data and anti big tech monopoly action. Quote, “Being offered by the Central Bank, which has no commercial interest in monetizing the data of users, the digital euro would help to protect people’s privacy against commercial usage or unjustified intrusion. An appropriate transparent governance setup that complies with European regulation on data protection would further guarantee that users’ personal data are only accessible to legitimate authorities with a view to preventing illicit activities such as money laundering or terrorist financing.” Panetta ends that quote, “Our aim is to be ready at the end of these two years to start developing a digital euro which could take around three years. A digital euro will be successful if it adds value for everybody involved: citizens, merchants and financial intermediaries, we want to design the digital euro to be such a success.” So there you go. The digital euro is about adding value to financial intermediaries, I guess. 

However, as we’re discussing this new phase of global work on CBDCs, we can’t look at these public sector efforts and discussions without recognizing that there was a private sector proxy developing in parallel. I’m talking, of course, about stablecoins. Indeed, one can argue that the development of private stablecoins is inextricably linked to the policy discussion around public CBDCs. This linkage started profoundly and clearly when Facebook announced Libra, even though that particular project was stillborn. It was the starting gun for regulators and policymakers around the world to have a serious and frank discussion with themselves about the power to make money and the changing nature of digital value. It didn’t help that the governments around the world were already quite nervous about Facebook and big tech’s growing power in general. 

More recently, though, the targets in the crosshairs have moved from big tech to the stablecoins that already exist. There has been a growing chorus of questions around rules and regulations surrounding private stablecoin issuers. Over his less than year in office, former acting Comptroller of the Currency and now Binance.US. CEO Brian Brooks issued a set of guidance that allowed banks to interact with and provide services for stablecoin issuers. All of that OCC guidance is now under review by the new Biden administration OCC, led by Michael Hsu. Last year also saw the introduction of the Stable Act, which was itself another reaction to how quickly Brooks was moving to legitimate private sector stablecoins. 

And, of course, this year over the span of the bull market, Tether FUD has been on display. I’ve said it before and I’ll say it again. I don’t have any problem with people questioning Tether’s reserve policies, or really anything about Tether itself. It’s completely within Tether’s power to address those types of concerns. What I take issue with is baseless arguments that bitcoin is simply manipulated and propped up by tether or that tether poses some systemic risks so great it delegitimates bitcoin. I find that these types of arguments in general are not posed by people who are good faith actors trying to understand how the world of currencies and money is changing and what role bitcoin might have and stablecoins might have, but people who’ve decided to be diametrically opposed to this entire new space, particularly Bitcoin, and are just looking for another way to critique it. That certainly doesn’t apply to all other critics. So I don’t want to paint with too broad a brush, but it’s far more than I’d like.

Either way, no matter how much FinTwit has the hots for a never ending string of Tether FUD podcasts, the simple fact of the matter is that tether is less risky today than it was six months ago, thanks to their settlement with the New York Attorney General. Said settlement has a lot of benefits for everyone involved, including reserve adaptations from Tether. But it also, among other things, reduces the likelihood of U.S. regulators taking even more dramatic action against Tether. Likewise, USDC is clearly trying to accelerate self regulation ahead of any future regulatory scrutiny. When Circle announced that it was going public via SPAC last week, one of the things that CEO Jeremy Allaire specifically called out was that it intended to become much more transparent about reserves and reserve attestations. I pointed out on my show about that, one commentator who said that it seemed like Circle was effectively trying to front-run possible legislation. 

Now, in all of this, it’s probably fair to characterize the default U.S. regulatory position vis-à-vis private stablecoins as, skeptical, to say the least. To wit, why do you need this if you already have the U.S. dollar? And what’s more, if and when the U.S. dollar becomes a truly digital dollar, in other words, a digital bearer instrument, those private stablecoins with all the risks and questions associated become especially superfluous, right? This line of thinking and how common this line of thinking is, was why a recent speech by Randal Quarles was so remarkable. Quarles was the first vice chair of the Federal Reserve for supervision as well as the chair of the Financial Stability Board, at the 113th annual Utah Bankers Association convention in Sun Valley, Idaho, he gave a speech at the end of June called “Parachute Pants and Central Bank Money.” The speech is, at core, a question about the logic and urgency of a central bank digital currency for the U.S. 

His starting point is that the dollar system is already highly digitized. So what he’s really interested in is how a CBDC would add new benefits or would solve existing problems. He looks first at the argument that quote, “The Federal Reserve should develop a CBDC to defend the U.S. dollar against threats that would be posed by foreign CBDCs on the one hand, and the continued spread of private digital currencies on the other.” With regard to that first part foreign currencies, he says quote, “I think it’s inevitable that as the global economy and financial system continues to evolve, some foreign currencies, including some foreign CBDCs, will be used more in international transactions than they currently are. It seems unlikely, however, that the dollar’s status as a global reserve currency or the dollar’s role as the dominant currency in international financial transactions, will be threatened by a foreign CBDC. The dollar’s role in the global economy rests on a number of foundations, including the size and strength of the U.S. economy, extensive trade linkages between the United States and the rest of the world, deep financial markets, including for U.S. treasury securities, the stable value of the dollar over time, the ease of converting U.S. dollars into foreign currencies, the rule of law and strong property rights in the United States, and last but not least, credible U.S. monetary policy. None of these are likely to be threatened by a foreign currency and certainly not because that foreign currency is a CBDC.”

Now, with regard to private digital currencies, Quarles divides them into stable coins and not stable coins. He is, in his analysis, pretty dismissive of bitcoin’s potential to compete with the dollar, basically saying that it’s a novelty. Quote, “Some commentators assert that the United States must develop a CBDC to counter the appeal of cryptocurrencies, this seems mistaken. The mechanisms used to create such crypto assets value also ensured that this value will be highly volatile, rather similar to the fluctuating value of gold, which, like bitcoin, draws a significant part of its value from its scarcity and like bitcoin, does not play a significant role in today’s payments or monetary system. Unlike gold, however, which has industrial uses and aesthetic attributes quite apart from its vestigial financial role. bitcoins principle additional attractions are its novelty and its anonymity. The anonymity will make it appropriately the target for increasingly comprehensive scrutiny from law enforcement and the novelty is a rapidly wasting asset. Gold will always glitter but novelty by definition fades. Bitcoin in its ilk will accordingly, almost certainly, remain a risky and speculative investment rather than a revolutionary means of payment, and are therefore highly unlikely to affect the role of the U.S. dollar or require a response with the CBDC.”

Still, even with all of this, what has really gotten people’s attention is Quarles’ discussion of stablecoins, something like we said, that’s an increasing concern for many in positions of power. So let’s read what he has to say about this. “Some commentators argue that the United States must develop a CBDC to compete with U.S. dollar stablecoins. Stablecoins are an important development that raise difficult questions. For example, how would widespread adoption of stablecoins affects monetary policy or financial stability? How might stablecoins affect the commercial banking system? Do stablecoins represent a fundamental threat to the government’s role in money creation? In my judgment, we do not need to fear stablecoins. The Federal Reserve has traditionally supported responsible private sector innovation. Consistent with this tradition, I believe that we must take strong accounting of the potential benefits of stablecoins, including the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy. For example, a global U.S. dollar stablecoin network could encourage use of the dollar by making cross border payments faster and cheaper. And it potentially could be deployed much faster and with fewer downsides than a CBDC. And the concern that stablecoins represent an unprecedented creation of private money and thus challenge of monetary sovereignty is puzzling, given that our existing system involves, indeed depends, on private firms creating money every day.”

Now, this doesn’t mean in Quarles’ estimation that there shouldn’t be regulation. In fact, the legitimate recognition of private stablecoins would come with more, not less legislation. Quote, “We do have a legitimate and strong regulatory interest in how stablecoins are constructed and managed, particularly with respect to financial stability concerns. The pool of assets that acts as the anchor for a stablecoin’s value could, if the use of the stablecoin became widespread enough, create stability risk if it is invested in multiple currency denominations, if it is a fractional rather than full reserve, if the stablecoin holder does not have a clear claim on the underlying asset or if the pool is invested in instruments other than the most liquid possible, principally central bank reserves and short term sovereign bonds. All of these factors create run risk, the possibility that some triggering event could cause a large number of stablecoin holders to exchange their coins all at once for other assets, and that the stablecoin system would not be able to meet such demands while maintaining a reasonably stable value. But these concerns are eminently addressable. Indeed, some stablecoins have already been structured to address them. When our concerns have been addressed, we should be saying yes to these products rather than straining to find ways to say no. Indeed, the combination of imminent improvements in the existing payment systems such as various instant payment initiatives, combined with the cross border efficiency of properly structured stablecoins, could well make superfluous any effort to develop a CBDC.”

I’d like to just note here, if you go back and listen to some of my podcasts about CBDCs and stablecoins before, that I have said on at least a couple occasions that if you look just at a government producing a CBDC, the U.S. is far behind. If on the other hand, you include the use of private U.S. denominated stablecoins as an example of this new type of money, the U.S. has an enormous lead. That, effectively, is what Quarles is saying here. Quarles also goes in depth on what he sees as the still too unexplored risks of a CBDC. His main points are one that quote, “A Federal Reserve CBDC could create considerable challenges for the structure of our banking system, which currently relies on deposits to support the credit needs of households and businesses; two, it could undermine the value of banks competing for customers; three, could present a huge target for attacks and cyber threats; four, it would demonstrate the challenge of preventing illicit activities while also respecting rights.” 

Quote, “It may be challenging to design a CBDC that respects an individual’s privacy while appropriately minimizing the risk of money laundering. At one extreme, we could design a CBDC that would require CBDC holders to provide the Federal Reserve detailed information about themselves and their transactions. This approach would minimize money laundering risks, but would raise significant privacy concerns. At the other extreme, we could design a CBDC that would allow parties to transact on a fully anonymized basis. This approach would address privacy concerns, but would raise significant money laundering risks.” The fifth and final risk or question that he has is that it could be expensive for the Federal Reserve to design and maintain this thing. 

So, all in all, a lot of folks really like this speech. To give you just a couple sample reactions, Nic Carter tweeted, “So why do I like this talk so much? A number of reasons. First of all, he contests the framing of the CBDC enthusiasts, correctly pointing out that most dollars are digital. He also points out that most dollars are effectively Fed dollars, though through FDIC guarantees on commercial bank deposits. Quarles acknowledges the innovation present in the stable sector, while rejecting the notion that they are somehow competitive with central bank dollars. Stable issuers do not create money. Stables, the fiat convertible ones at least, are just a wrapper on commercial bank dollars. Quarles is one of the first central bankers I’ve seen seriously acknowledged the enormous honeypot risks inherent in a CBDC and the fact that most likely CBDC implementations would massively trade off against user privacy. He doesn’t try to force stables into some ill-fitting regulatory mold, instead acknowledging their utility while stressing that they can be rendered more credible, although he doesn’t elaborate much on how this would work. Quarles rejects the framing around the urgency of a CBDC. I am with him. Foreign countries with a reduced respect for property rights or liberty creating sino-CBDCs cannot and should not motivate us to create something similar. A domestic CBDC must stand on its own merits. One thing I find interesting is that these comments differ significantly from the tone of Quarles’ colleague Brainard who took a decidedly harsh tones on stables recently, encouraging to see this heterogeneity of opinion and hoping to hear more from quarrels on the topic.”

Tyler Cowen also wrote an op-ed in Bloomberg, called “The Crypto Revolution Will Not Be Public: Is a central bank digital currency, or CBDC, a solution in search of a problem?” The key line was this quote, “In a remarkably honest, yet radical speech last month about stablecoins, Fed governor Randal Quarles argued that current payment systems already incorporate a great deal of information technology, and they are improving rapidly. The implication is that a central bank digital currency, or CBDC is a solution in search of a problem. Quarles also suggested the Fed tolerate stablecoins just as central banking has coexisted, and indeed thrived, with numerous other private sector innovations. Stablecoins can serve as a private sector experiment, see if individuals and institutions truly desire a radically different payment system, in this case, based on crypto and blockchains. If they do, this system can evolve by having some but not all transactions shift towards a stablecoin.”

Galaxy Digital’s research brief also talked about this speech, calling it “surprising to say the least and in a positive way.” So for me, I think the big note here is the point that Nic made at the end, for as much as it seems like regulators all have clear views on these issues that frankly, differ from ours in this crypto space, there still seems to me to be an actually pretty wide open ability to shape some of the key policy discussions. Not everyone has to be interested in doing so, but I think that if you are, there’s room to actually make a pretty meaningful impact right now. So, as you’re thinking about that, I hope that this show is giving you a little bit more ammunition and some new ideas to explore. Until tomorrow, guys, be safe and take care of each other. Peace!