Threat Management, Industry Regulations, Governance, Risk and Compliance

Federal Reserve report casts concerns on central bank digital currency

People walk through the North American Bitcoin Conference held at the James L Knight Center on Jan. 18, 2022, in Miami. The conference is a three-day event on Bitcoin, NFTs, the metaverse, Defi, DAOs, stablecoins, blockchain and more. (Photo by Joe Raedle/Getty Images)

Despite rapidly growing support from the U.S. financial community for stablecoin cryptocurrency, a new report from the Federal Reserve Bank raises questions about the potential risks of instituting a central bank digital currency (CBDC).

"While a CBDC could provide a safe, digital payment option for households and businesses as the payments system continues to evolve, and may result in faster payment options between countries, there may also be downsides,” according to a press release from the Federal Reserve Board of Governors announcing the study. “They include how to ensure a CBDC would preserve monetary and financial stability as well as complement existing means of payment.”

“Other key policy considerations include how to preserve the privacy of citizens and maintain the ability to combat illicit finance,” it continued.

For more than two years, U.S. banks, financial technology players and payment companies have been ramping up their support for stablecoins. U.S. banking heavyweights have thrown their weight behind stablecoins, including JP Morgan Chase & Co., which last August launched an in-house bitcoin fund for its private banking clients.

Several banks large and small have announced they would begin minting their own stablecoins, including New York Community Bank last month. According to research cited by the U.S. Treasury Department, the market capitalization of stablecoins issued by the largest stablecoin suppliers exploded nearly five-fold from $21.5 billion in October 2020 to more than $127 billion a year later.

Earlier this month, a group of U.S. banks launched a consortium to issue their own stablecoin, USDF, as a means of sidestepping potential risk concerns from banking regulators. Nearly a year ago, March 2021, Visa announced it would begin settling stablecoin transactions as a further means of establishing an infrastructure to support the digital currency and legitimize it so it can be supported by the central bank.

Arguably, the draw of digital currencies in general comes largely from the lack of audit trail and inherent privacy. And experts believe that will appeal greatly to Millennials and Gen Z, especially.

"One of the trends that are taking place throughout the world, is that the younger generation is becoming more familiar with privacy preserving technologies in general,” according to Keegan Francis, a crypto and bitcoin specialist with Finder. “This is in large part because of their association and interactions with cryptocurrencies, which use cryptography in one way or another, inherently a privacy preserving technology.”

Francis predicted that as today’s young people continue to age up and expand their wealth, currencies like stablecoin will inevitably grow increasingly popular, despite potential risk and regulatory concerns.

After all, said Francis, “One of the easiest ways to hack a system is with the help of the person with the keys in the first place. The most vulnerable part of any security system is not the tech, but the people running it. So again, as more people become familiar with the way that general security works, our systems are predictably going to become stronger.”

Several U.S. financial firms and cryptocurrency companies like Figure have been pleading their case to U.S. financial regulators including the Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corp for months. Financial industry supporters of stablecoin have been upping their efforts to win over regulators since the President’s Working Group on Financial Markets last fall suggested that stablecoin issuers should be required to adhere to the same supervision and rules as all other conventional U.S. banks.

“Consumers and businesses have long held and transferred money in digital forms, via bank accounts, online transactions, or payment apps. The forms of money used in those transactions are liabilities of private entities, such as commercial banks,” said the Federal Reserve release. “Conversely, a CBDC would be a liability of a central bank, like the Federal Reserve.”

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