Mar 25, 2022 4 min read cryptocurrency

The US is sanctioning a Central Bank Digital Currency and it is on its way

In financial theory, risk-free assets such as a Treasury bill are the corner that the rest of the market relies on. Borrowing and lending at a risk-free rate improve the performance of all the assets in the market. Investors using a risk-free asset can create portfolios with higher returns or lower risks than are otherwise available to investors. The superior performance of portfolios which buy or sell the risk-free asset is a result of financial mathematics. A market with a risk-free asset is inherently better for investors than one without it. Blockchain-based markets are no different from other markets in benefiting from a risk-free asset.

As a result, the development of a risk-free crypto asset, like a true Stablecoin, is a critical element in the eventual success of the cryptocurrency market. Until the cryptocurrency market is fully integrated with the rest of the capital markets, Stablecoins are needed by investors to achieve the efficient use of crypto coins. And they will have a healthy demand because there are no alternatives to Stablecoins as a proxy for a riskless crypto asset.

The edict this month by the White House on investigating the use of Stablecoins represents a critical phase of the use of Stablecoins. The Federal government recognizes the need for a riskless asset, but the Fed is extremely uncomfortable with Stablecoins. The result is that the creation of a US cryptocurrency, a CBDC, is just a matter of time. CBDC will come at the expense of Stablecoins and other financial assets.

What are Stablecoins

Stablecoins investments have grown to about $110 billion outstanding, but their legal state is not certain. Are they a currency, a commodity, or security for regulatory purposes? The SEC thinks that securities laws are the governing law for Stablecoins. But Stablecoins are in for a great deal of regulatory flux.

Stablecoins will have a cryptocurrency competitor, the Central Bank Digital Currency (CBDC). However, a CBCD will have a clear regulatory status. CBDCs are simply a digital token representing a fiat currency like the digital yuan or e-CNY featured at the Beijing Winter Olympics. CBDCs are legal tender of the country issued and were clearly a concern in President Biden’s proposal.

What did the President announce?

On March 9, 2022, President Biden signed a Presidential Order instructing a myriad of Federal agencies to study the regulation of digital assets including cryptocurrencies. The long-awaited proclamation noted that digital assets had grown from $14 billion to over $2 trillion.

About 16% percent of adult Americans participated in cryptocurrencies and more than 100 countries were looking into the use of CBDCs. The Order placed the entire Federal regulatory apparatus on notice to enact rules “to Protect Consumers, Financial Stability, National Security, and Address Climate Risks.”

Many in the cryptocurrency world responded positively to the news. Others, many of whom were more familiar with the process inside of the Washington Beltway, were much more sanguine. This type of call for expansive regulation is often death by a thousand cuts for an industry. Steve Forbes said,

All this is a sure-fire recipe for strangulation by red tape. [1]

The one area which is “urgent” under the proposed rules is CBDC. The White House directive on CBDC said:

Explore a U.S. Central Bank Digital Currency (CBDC) by placing urgency on research and development of a potential United States CBDC, should issuance be deemed in the national interest. The Order directs the U.S. Government to assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests. The Order also encourages the Federal Reserve to continue its research, development, and assessment efforts for a U.S. CBDC, including development of a plan for broader U.S. Government action in support of their work. This effort prioritizes U.S. participation in multi-country experimentation and ensures U.S. leadership internationally to promote CBDC development that is consistent with U.S. priorities and democratic values. [2]

The White House is not the only body to see CBDC as important. The Federal Reserve, along with the President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have also studied the issue.

The regulations reflect international concerns

We can get a substantial additional clue about the direction of future Crypto regulations from the Fed. A recent speech by Governor Brainard made it clear where the US stands. The pressure from China to implement a US CBDC is apparent in order to preserve the status of the dollar. Governor Brainard said:

Decisions by other major jurisdictions to issue CBDCs could bring important changes to global financial markets that may prove more or less disruptive and that could influence the potential risks and benefits of a U.S. CBDC. Thus, it is wise to consider what the future states of global financial markets and transactions would look like both with and without a Federal Reserve-issued CBDC. For example, the People’s Bank of China has been piloting the digital yuan, also known as e-CNY, in numerous Chinese cities over the past two years. [3]

Whether there is a need for the CBDC to improve the operational efficiency of money markets is the subject of debate but might be immaterial in a global competition. The CBDC can be expected to restructure US money markets, shifting investors out of money market funds with their gates and fees into CBDC funds.

Fed President Powell has made it very clear that he is uncomfortable with Stablecoins but still uncertain about the exact parameters a CBDC would have. But we can bet that a US CBDC is on its way and sooner than most expect.