Could stablecoins be undone by a Federal Reserve that takes consumer deposits? Would retail banks be hobbled?
During Jerome Powell’s Jan. 11 United States Senate confirmation hearings, Sen. Patrick Toomey posed a question to the incumbent-and-future Federal Reserve chief: “If Congress were to authorize and the Fed were to pursue a central bank digital dollar, is there anything about that that ought to preclude a well-regulated privately-issued stablecoin from co-existing with a central bank digital dollar?”
“No. Not at all,” the central banker answered — a response that surely brought some relief to the crypto community. At least the Fed wasn’t seeking to ban stablecoins. That bullet had apparently been dodged.
But, Toomey raised a significant and abiding question: Can stablecoins and a Federal Reserve digital dollar really coexist? If individual Americans were to have retail accounts with the Federal Reserve — as Toomey posited in what may have been an exaggerated scenario — “and the Fed becomes the retail banker to America,” why does one even need stablecoins? Or traditional retail banks for that matter?
Indeed, in a discussion paper released on Jan 20, the Fed cited various potential risks associated with a digital dollar, including that a CBDC could effectively replace commercial bank money. That paper was aimed at eliciting public comment, while elsewhere the Fed has indicated no interest in rushing out a digital currency despite the efforts of other countries like China.
Not all assumed the two could co-exist. “A widely and easily accessible digital dollar would undercut the case for privately issued stablecoins,” Eswar Prasad, professor of economics at Cornell University and author of the book, The Future of Money, told Cointelegraph, though “stablecoins issued by major corporations could still have traction, particularly within those corporations’ own commercial or financial ecosystems.”
Others envisioned separate and distinct use cases for stablecoin and central bank digital currencies, or CBDCs, a group that would include a future U.S. digital dollar. “There are definitely some distinct use cases for each,” Darrell Duffie, Adams distinguished professor of management and professor of finance at Stanford University’s Graduate School of Business, told Cointelegraph. “For example, the Fed is unlikely to give CBDC accounts to a wide spectrum of foreign consumers,” and dollar-pegged stablecoins could be very useful for making cross-border payments and settlements — fulfilling a real business need, he suggested.
Distinct purposes?
Would there, indeed, be distinct uses for a digital dollar and privately issued stablecoins — or are stablecoins likely to be superseded by CBDCs all around the world eventually?
“Stablecoins are different from most CBDCs in their construct and purpose,” Matt Higginson, a McKinsey partner who leads the consulting firm’s global blockchain and digital assets initiatives, told Cointelegraph. CBDCs are usually intent on improving financial inclusion, reducing the cost of cash and, to some degree, tracking financial transactions (for Anti-Money Laundering purposes, for example). Stablecoins, by comparison, are dollar-pegged tokenized cash aimed at improving the speed and efficiency of payments. “Their premises are really quite different, so there is no reason they shouldn’t co-exist,” said Higginson.
A digital dollar isn’t really about technology or efficiency, Jonas Gross, chairman of the Digital Euro Association, told Cointelegraph. As with CBDCs generally, it “could be more efficient or stable for handling a high throughput of retail transactions, where DLT is not needed, or where people prefer the safety, soundness and interoperability of a central-bank backed currency.”
Stablecoins, in comparison, “focus on the technological aspects, allow efficient payments due to removing intermediaries and novel innovative business models,” Gross said. The two could find different constituencies and could presumably co-exist.
Some countries, too, might prefer to dollarize their economies with a USD stablecoin, Duffie added. “And, some might get dollarized against the wishes of their central banks.” Not all CBDCs need to be blockchain-based or based on digital ledger technology, either, as Duffie noted, further explaining:
“Suppose a CBDC is not based on DLT, and we want to take advantage of smart contracting or other DLT applications, whether wholesale or retail. Stablecoins could serve a useful role there.”
Even Prasad didn’t rule out the possibility of coexistence: “Stablecoins and central bank digital currencies could be seen as complementary payment mechanisms, even if they might step on each other’s toes in that function.”
A change of heart?
At his confirmation hearing, Powell appeared to be more kindly disposed toward cryptocurrencies than in July 2021 when he told lawmakers: “You wouldn’t need stablecoins; you wouldn’t need cryptocurrencies, if you had a digital U.S. currency,” using that as an argument in favor of a Fed digital dollar. What might have prompted this sea change, assuming that’s what it was?
“U.S. institutions, such as the Fed and regulators, seem to have understood that stablecoins can provide tremendous support for the U.S. dollar,” opined Gross. Why? “The largest stablecoins are all backed by the U.S. dollar,” and if they were to strengthen their position as a means of payment in the crypto space, “this means that the U.S. dollar gains in importance.”
Prasad had another take as the Fed chair’s softer stance on stablecoins might be the result of “him having taken comfort from actions under consideration by Congress and various regulatory agencies to bring such private cryptocurrencies under tighter regulatory oversight.”
Subverting monetary policy?
Crypto critics have even suggested that popular stablecoins might eventually undercut traditional monetary policy operations. Are they right? “If denominated in U.S. dollars, with stability, I don’t see a case that a stablecoins would undermine monetary policy transmissions,” said Duffie, adding: “Actually, I would draw the opposite conclusion.”
Prasad differed: “Stablecoins that undermine the medium-of-exchange function of central bank money could add to already substantial uncertainties in the transmission of monetary policy to economic activity and inflation.”
Higginson, for his part, viewed the notion that stablecoins could affect monetary policies as misguided. “Stablecoins are almost fully reserved,” which means a real dollar is set in reserve for almost every tokenized stablecoin dollar, he said, further telling Cointelegraph:
“The obvious conclusion to that is that it doesn’t change monetary policy at all because you are not changing the supply of dollars in the economy.”
“Retail banker for America?”
Lastly, Sen. Toomey raised a scenario during the confirmation hearings whereby “individual Americans [would] have retail accounts with the Fed, and the Fed becomes the retail banker for America.” Both he and Powell agreed that this role would be well beyond the “history, expertise, experience or capabilities” of the U.S. Federal Reserve. Still, is such a role unthinkable?
“Historically, central banks have stayed away from having direct retail relationships,” Higginson told Cointelegraph. “That’s why our commercial banking system exists.” Central banks rarely issue currency directly to consumers, for instance.
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Moreover, the properties of stablecoins are different from those of most current or projected CBDCs “in that, stablecoins are being launched with this smart contract functionality that makes them programmable,” continued Higginson. This opens possibilities for their use that go beyond what we think about in terms of a traditional central bank digital currency.
Nevertheless, the idea of “retail banker to America” may not be so easily put to rest. A recent EY report, for example, summoned up the same circumstance — indeed, describing a CBDC that took consumer deposits as “an existential threat” to financial services firms, including retail banks. Wrote EY:
“If customers can keep their money with a central bank, they have no need for a retail bank, and firms will see their interest rate margins contract precipitously.”
Still, nothing is for sure. “The Presidents’ Working Group Report on Stablecoins tells us that the path to the introduction of useful and compliant stablecoins is far from clear,” said Duffie, concluding: “Legislation may be needed, and that’s not an easy or predictable matter.”
