Fed No. 2: Digital currencies, stablecoins, and the evolving payments landscape
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, Author: Lael Brainard, reprinted with authorization by Odaily.
This long speech by Federal Reserve Governor Lael Brainard is a very important speech on the Fed's position on digital currency-related issues. Due to her background in international economic diplomacy, Lael Brainard often speaks on behalf of the Federal Reserve on monetary policy issues. In May 2018, she spoke that Bitcoin is due to its huge volatility, limited throughput, unpredictable transaction costs, and lack of governance. Reasons such as transparency and transparency limit its use as a payment tool and unit of account.
The Fed has relatively few speeches on issues such as stablecoins and central bank digital currency (CBDC). This article relatively systematically explains the Fed's position and logic on these hot issues.
The summary of Lael's speech is as follows: The United States/Federal Reserve has a long history and experience in issuing and managing private currencies, including currencies or assets issued by non-bank institutions to assist transactions within a specific network, such as gift cards, points and virtual game currencies, etc. . As the scale and scope of private networks expand, their network externalities allow the development of payment systems based on digital platforms, such as Alipay and WeChat Pay in China. The most unique feature of Libra as a stable currency project is that it has active users of one-third of the world's population, and through its payment system, the Libra network can quickly expand to a global scale. Libra, and any stablecoin project of global scale and scope, will have to resolve a host of legal and regulatory challenges to go live. The central banks of many countries are promoting central bank digital currencies. The Fed will not join in the fun, but let's see how others are doing. The Federal Reserve supports innovation in the payment field and is happy to see innovations that have a long-term impact on the payment system in the next few years, including the option of a stable currency.
The speech reflects that the Federal Reserve has a clear understanding of the network externalities of large platforms and the substitution of global stablecoins for traditional legal currencies, which may bring about the effect of digital dollarization, replacing the currencies of financially weak countries, and even other developed economies. The sovereign currency of China is also highly permeable. Obviously, the Federal Reserve has regarded China's Alipay and WeChat Pay as models for obtaining a new currency "hegemony" through network effects, and appreciates that Libra has the same network platform and a larger user base. The Federal Reserve favors private institutions rather than central banks to drive global stablecoin innovation.
The author has always believed that Libra represents the extension of the US dollar hegemony in the digital economy world, and the speech of Director Lael is a good explanation for this judgment. The main scenario for Libra in the future is not in the United States but in countries or regions that may be "dollarized" because "the current domestic system already has advantages." Libra's network platform and user base of nearly one-third of the world's population are the best tools to achieve digital dollarization, and its power may far exceed traditional "dollarization". Not against Libra.
The fate of Libra depends only on the Federal Reserve, because the Federal Reserve actually assumes the role of the global central bank and has authority in the top-level system design and policy formulation of the monetary system. Libra's encounter in the U.S. Congress is just a smoke bomb and a political show. The secondary purpose is to balance the interests of domestic interest groups in the United States. The main purpose is to create "sorrow" for Libra and win widespread sympathy around the world, which is conducive to its acceptance in countries and regions outside the United States. , so Libra is destined to be finally released.
We also need to deeply understand that Libra will bring greater challenges to China's maintenance of currency sovereignty and the internationalization of the RMB. The Chinese government regards blockchain as a breakthrough for independent innovation of core technologies, and emphasizes application scenarios such as digital finance and digital asset transactions. This is a completely correct and wise decision to take precautions and occupy the commanding heights of the digital economy.
Digital Currencies, Stablecoins, and the Evolving Payments Landscape
Technology is driving rapid changes in the way we pay and our concept of "money". From coin transactions to the use of banknotes, to the electronic debiting and crediting of funds on bank accounts, technological advancements have a long history of challenging popular notions of money. Today, efforts by global stablecoin networks such as Facebook’s Libra are writing the next chapter in the monetary story, which raises threshold questions about legal and regulatory safeguards, financial stability, and monetary policy. Because of its potential global reach, Facebook's Libra adds even more urgency to those debates about what form a currency can take, who can issue it, and how payments will be recorded and settled.
Federal Reserve Governor Lael Brainard
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revaluation of currency
Money traditionally serves three purposes. Money facilitates payments as a medium of exchange, acts as a store of value that can be relied upon for future use, and simplifies transactions by providing a common unit of account to compare the value of goods and services.
Ten years ago, Bitcoin was announced as a new type of digital currency that could solve friction in payments and act as a unit of account and store of value without the need for centralized governance. The advent of Bitcoin created an entirely new payment instrument and asset class, exchanged over a set of payment trajectories supported by distributed ledger technology. Distributed ledger technology can allow for a shared, tamper-proof ledger that, unlike traditional record-keeping systems built on a single ledger managed by a trusted central entity, can be updated by anyone with sufficient computing power. But early iterations of Bitcoin and some other cryptocurrencies exhibited extreme volatility, limited throughput capabilities, unpredictable transaction costs, limited or no governance, and limited transparency, which limited their usefulness as a payment and unit of account.
Stablecoins are specifically designed to overcome the large fluctuations in value exhibited by first-generation cryptocurrencies, which limit their range of payments and utility as a unit of account. As the name suggests, stablecoins aim to maintain a stable value by pegging a digital currency to an asset or basket of assets, such as commercial bank deposits or government-issued bonds. Stablecoins also differ from the original cryptocurrencies in that they may be issued by a central entity and rely in some ways on third parties.
Just as the value of any currency as a medium of exchange increases with the size of the network used, the strength of a stablecoin payment system will also depend on its ability to achieve widespread adoption due to associated network externalities. Given the 2.7 billion monthly active users on the Facebook platform, the Libra stablecoin project stands out for the speed at which its network has reached global scale in the payment system.
Commercial bank currency refers to commercial bank deposits. It is widely used, partly due to the confidence that it can be converted into another commercial bank or a central bank liability, like physical cash, if desired. Much of this confidence is due to the fact that bank deposits are insured, and commercial banks are subject to supervisory, regulatory and deposit insurance requirements. Consumers and businesses also use the currency in transactions because of its convenience and availability, which in turn expands the network that uses it.
Non-bank private currencies or assets can also facilitate transactions between network users. In some cases, such as airline miles, such assets may only have value within the network. In other cases, the issuer of an asset in a network can guarantee convertibility into a sovereign currency. Consumers trust the companies that issue these currencies to meet these responsibilities. Many U.S. consumers have experience with non-bank private currencies, including gift cards, loyalty points, and virtual gaming currency. While many of these currencies are relatively limited in size and purpose, some non-bank currency networks are large. Starbucks reported $1.6 billion in stored-value card liabilities as of September 2018, more than deposits at many depository institutions.
As the size and scope of such private networks grow, so does the ease and benefit of transacting within the network with self-reinforcing dynamics (known as network externalities). These network advantages are likely to be enhanced through the active use of network data for a variety of purposes, from credit allocation and credit pricing, to sharing reviews, to prioritizing information pushed to users. In China, consumers and businesses participate in two mobile networks, Alipay and WeChat Pay, which according to statistics processed more than $37 trillion in mobile payments last year. These networks operate within China with RMB as the unit of account, and balances can be transferred in bank or credit card accounts.
Stablecoins with global scale and scope
We have seen the growth of large-scale payment networks on existing digital platforms such as Alibaba and WeChat, as well as stablecoins with smaller issuance sizes such as Tether, Gemini and Paxos. What sets Facebook's Libra apart is a network of active users representing more than one-third of the global population while issuing a private digital currency opaquely linked to a basket of sovereign currencies. It should come as no surprise that Facebook's Libra is coming under scrutiny from lawmakers and authorities.
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Stablecoin Tether
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Libra, in fact, any stablecoin project of global scale and scope, must solve a series of core legal and regulatory challenges before it can go live. I would like to emphasize a few issues in particular.
First, compliance with rules and regulations for customer identification is critical to ensuring that stablecoins are not used for illicit activities and illicit financing. Libra's business model is cross-border in nature, and as such, each participant in the system is treated as a financial institution that needs to ensure compliance with the anti-money laundering laws of each jurisdiction. Libra's global operations may require a consistent global anti-money laundering framework to reduce the risk of illicit transactions.
Second, issuers of stablecoins designed to facilitate consumer payments must clearly demonstrate how they will ensure consumer protection. Consumers need to be educated on how their rights on digital wallets differ compared to bank accounts. In the United States, as elsewhere, legal and regulatory protections are put in place for bank accounts so that consumers can reasonably expect their deposits to be insured to a certain extent; fraudulent transactions are the responsibility of the bank; funds are transferred within a specified period; and Clear, standardized disclosures about account fees and interest payments. It’s unclear whether Libra has similar protections, how consumers have claims, and how much price risk consumers face, since they don’t appear to have rights to the stablecoin’s underlying assets. Consumers need to be aware that stablecoins are likely to have very different legal terms than sovereign-issued fiat currencies. Need to clarify who is responsible for the security of personally identifiable information and transaction data, and how personal data is stored, accessed and used. The high number of cyber-attacks in the past few years highlights the importance of these issues.
Third, it is necessary to define the financial activities performed by various participants in the Libra ecosystem so that different jurisdictions can assess the adequacy of existing regulatory and enforcement mechanisms. As the jurisdiction of the Libra Association, Switzerland is particularly important. Swiss authorities created three new categories to help regulate by function: "payment tokens" are cryptocurrencies used for payment or transfer of value; "utility tokens" are blockchain-based applications; "asset tokens" ” are cryptographic assets similar to stocks, bonds, and derivatives.
In the U.S., regulators are reviewing the specific features of specific stablecoins and cryptocurrencies more broadly to determine their suitability and compliance with existing regulatory structures and whether additional authorities or guidance are necessary. Under relevant laws, US market regulators have authority over products that are identified as securities or commodity futures. At the state level, the New York State Department of Financial Services established a BitLicense for entities related to virtual currencies. The Federal Reserve and other regulators have supervisory powers over banks, including in many cases the ability to regulate and review the companies that provide services to banks. The Federal Reserve and any other regulator lacks absolute authority over the payment system operating within the United States. While the Financial Stability Oversight Board does have the authority to designate systemically important non-bank financial companies; financial market utilities; or payment, clearing and settlement activities on a case-by-case basis, it is unclear whether any issuer of a cryptocurrency meets the criteria for designation. Statutory requirements.
Stablecoins and cryptocurrencies more generally challenge the long-held premise that payments must be recorded on a central ledger managed by a single entity. In fact, banks were created to perform this central ledger function. Distributed ledger technology allows for direct peer-to-peer asset transfers, potentially eliminating the need for transactions to go through intermediaries. Distributed ledger technology can provide advantages by enhancing operational resilience, increasing transparency, and simplifying record-keeping, but the publicity and immutability of transaction ledgers also pose risks, such as data privacy concerns and legal complexities.
These effects may be more pronounced in small open economies or those with weak monetary institutions, as the migration from sovereign currencies to global stablecoins may reduce the space for independent monetary policy, through a process similar to digital dollarization. Large-scale use of stablecoins could also affect larger advanced economies with extensive ties to the global financial system, including by increasing market volatility and spreading shocks across borders.
central bank digital currency
Finally, for stablecoin networks with global reach, there are financial stability risks. If poorly managed, liquidity, credit, market or operational risks (alone or in combination) can trigger a loss of confidence and a classic run. A global stablecoin network presents many complex issues related to legally separate but interdependent businesses, as well as a lack of clarity on the management of reserves and the rights and responsibilities of various market participants. Risks and the potential for spillovers may be exacerbated by potential ambiguity surrounding the ability of official authorities to provide oversight and support for liquidity and cross-border collaboration.
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central bank digital currency
The rapid shift of payments to digital systems, even before the advent of stablecoins, has sparked interest in issuing central bank digital currencies. In some jurisdictions, there has been a clear migration from cash payments to digital payments, which has naturally prompted monetary authorities to explore a move to digital issuance of their own.
The potential for a global stablecoin system fuels interest in central bank digital currencies. Proponents argue that central bank digital currencies would be a safer alternative to privately issued stablecoins because they would be a direct liability of the central bank. For example, Markus Brunnermeier, Harold James and Jean-Pierre Landau provided important arguments.
Of course, the Federal Reserve and other central banks already provide money digitally in the form of central bank deposits held in traditional reserves or settlement accounts. In the current context, however, central bank digital currencies generally refer to a new type of central bank liability that can be held directly by households and businesses without the involvement of commercial bank intermediaries. Under this definition, a central bank digital currency could be a flexible form of central bank money that might differ from traditional reserves in three ways: it would be accessible to a wider range of institutions and individuals, certain types of balances might not pay interest, and Leading to a clearer understanding of end-user transactions by the government.
In the United States, the current system has compelling advantages. First, physical cash in circulation in U.S. dollars continues to rise, indicating strong demand. Second, the U.S. dollar is an important global reserve currency, and maintaining public trust in sovereign currencies is crucial. Third, we have a robust banking system that meets the needs of consumers: our banks are numerous, diverse in size, and geographically dispersed. Finally, we have made digital payment options widely available and expanded, building on existing institutional frameworks and applicable safeguards.
Furthermore, a central bank digital currency for general use (i.e., individual consumer use) would raise profound legal, policy, and operational questions. Let's consider the balance between privacy and illegal activity. If designed to be financially transparent and provide protections against illicit activity, it is conceivable that a central bank digital currency could require the central bank to keep a running record of all payment data using the digital currency. This is a significant difference from cash. A system in which government entities would record personal payment information would mark a sea change. A related question is whether the Federal Reserve has the authority to issue currency in digital form and, if necessary, establish digital wallets for the public.
Financial stability considerations are also important. The ability to convert commercial bank deposits into central bank digital currencies through a simple conversion certainly has the potential to be a run accelerator. Here too, the role of banks in providing financial intermediation could fundamentally change.
Having said that, some jurisdictions may move in this direction more quickly than others, based on the specific attributes of their payment and currency systems. At the Fed, we continue to analyze the potential benefits and costs of central bank digital currencies and look forward to learning from other central banks.
The Federal Reserve System
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Prudence reminds us not to rush to adopt untested approaches to central bank digital currencies, but we are actively investing in our payments infrastructure so that everyone can receive real-time payments. Every day, the U.S. payment and securities settlement systems turn over about $12.5 trillion. The Federal Reserve is committed to working closely with the private sector to promote a safer and more efficient payment system.
This summer, we announced that the Federal Reserve will launch the first new payment service in more than 40 years to help deliver real-time payments to everyone. Businesses can send and receive payments instantly and securely 24 hours a day, 7 days a week, 365 days a year. The initiative aims to provide a neutral platform for new innovations in faster payment services by the private sector. In addition to FedNowSM, we are exploring enhanced same-day settlement capabilities for Automated Clearing House (ACH) transactions, and expanding Fedwire® treasury services and National Settlement System hours of operation. We are working with industry to improve information sharing by improving the security of payment systems, for example, increasing our understanding of synthetic identity fraud, and identifying ways to classify fraud.
As the public and private sectors strive to reduce payment friction, one of the most important use cases is cross-border payments, such as remittances. Intermediary chains for cross-border payments are long, slow, cumbersome and opaque. Technology enables e-commerce to transcend national borders, but current cross-border payment solutions often represent complex workarounds rather than seamless end-to-end solutions. Authorities in different jurisdictions recognize that they must cooperate with each other and with the private sector across borders to address the very real cross-border frictions that exist today.
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Concluding Thoughts
As we evaluate various private currency proposals, our country has a rich and varied experience to draw upon, from the period when the colonial states issued their own state currency, to the decades when private commercial banknotes circulated in place of national currency. The Fed was created in part in response to the inability of many banks to meet their obligations when they issued banknotes, and the ensuing panics and runs. These experiences will help us understand the situation as we potentially enter another stage in the evolution of money and payments.
Today, consumers and businesses have a variety of payment options, including physical cash, checks, ACH transfers, debit and credit cards, and mobile-based payment solutions, among others. These often have clear legal rights and responsibilities. Over the next few years, we are likely to see far-reaching innovations in payments, with a plethora of new and emerging options including stablecoins.
