Cap Hill Crypto

Week of May 27, 2022

Good morning, and thank you for subscribing. CBDCs are the main focus this week.

Top Points

  • House Financial Services Committee explored the benefits and risks of a U.S. Central Bank Digital Currency ("CBDC") at a hearing with the Vice Chairman of the Federal Reserve ("Fed"), Lael Brainard.

  • Senators Tom Cotton (R-AR), Marco Rubio (R-FL), and Mike Braun (R-IN) introduced a bill to prohibit U.S. companies from offering or hosting apps that accept China's digital currency as payment.

Legislators explore potential benefits and risks of a U.S. CBDC at House Financial Services Committee hearing.

Key Takeaway: No final decision has been reached as to whether the Fed will ultimately issue a U.S. CBDC. But Vice Chair Brainard focused more on the purported benefits of a CBDC—e.g. preserving U.S. dollar ("USD") dominance, financial inclusion, and financial stability—than potential concerns. She also pushed back against privately issued stablecoins replacing the need for a CBDC entirely, but made clear the two can co-exist. The lack of clarity from the Vice Chair as to whether the Fed requires authorizing legislation from Congress suggests that the Fed may not necessarily wait for additional Congressional action before issuing a CBDC.

Here are the primary recurring issues from the hearing.

Key Issues:

Does the Fed have the authority to create a CBDC without additional Congressional action?

In January of this year, the Fed released a policy paper on CBDCs expressly stating:

  • "The Federal Reserve does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law." See "Money and Payments: The U.S. Dollar in the Age of Digital Transformation" here, pg. 3 (emphasis added).

Despite repeated attempts, lawmakers could not get a clear answer as to what "clear support" means here.

  • For example, does Congress need to pass specific authorizing legislation or is that just "ideally"? Could the President issue an Executive Order? Or could mere inaction by Congress and the Executive Branch signal sufficient support for the issuance of a CBDC?

  • Vice Chair Brainard refused to provide specifics.

  • At the end of his questioning, Ranking Member McHenry stated that Vice Chair Brainard would hear further from him on this issue.

What problems would a CBDC solve that privately issued stablecoins could not?

  • Vice Chair Brainard asserted that a CBDC may be necessary despite privately issued stablecoins because a CBDC could offer superior stability and interoperability.

  • In other words, while private stablecoins are susceptible to bank runs, a CBDC, according to the Vice Chair, would be better protected from such risks.

    • As expected, on this point, Vice Chair Brainard and crypto-skeptic members cited Terra and USDT's recent de-pegging as examples of the financial risks posed by private stablecoins.

  • According to the Vice Chair, widespread "private monies" like stablecoins and crypto could lead to "fragmentation of the U.S. payment system into so-called-walled gardens." Conversely, in theory, a CBDC would be as widely accepted as USD, thus avoiding the issue of fragmentation.

  • The Vice Chair also repeatedly urged Congress to consider the risks of falling behind other countries who are already developing CBDCs, should Congress ultimately decide a CBDC is necessary.

But there was pushback.

Several members questioned whether a CBDC is necessarily safer or less fragmented than a payment system based on private stablecoins.

  • For example, Rep. Jake Auchincloss (D-MA) posited that if an appropriate regulatory regime were in place, a stablecoin issuer could be required to back their stablecoin 1-to-1 with USD. In that scenario, how could a CBDC, also backed by USD on a 1-to-1 basis, be any more secure?

    • Here, the Vice Chair referenced private money market funds previously "breaking the buck" (i.e. the net asset value fell below $1), despite being considered a risk-free investment by many.

  • Rep. Auchincloss also asserted that, in theory, private stablecoins could become completely interoperable, thus alleviating fragmentation concerns.

Vice Chair Brainard stated that a CBDC and privately issued stablecoins could coexist and complement each other.

  • "In some future circumstances, CBDC could coexist with and be complementary to stablecoins and commercial bank money by providing a safe central bank liability in the digital financial ecosystem, much like cash currently coexists with commercial bank money."

How would a U.S. CBDC impact U.S. Dollar dominance?

  • To start the hearing, Chairwoman Maxine Waters (D-CA) raised the importance of preserving the role of the U.S. Dollar, particularly when other countries, like China, are already working on CBDCs.

  • While Vice Chair Brainard shied away from saying that a CBDC is "essential" for maintaining USD dominance, she assured the Chairwoman that it's an important consideration.

  • According to the Vice Chair, the two key benefits of USD dominance are:

    • (1) lower borrowing costs and

    • (2) lower transaction costs for U.S. "households, businesses, and government."

How would a CBDC impact the traditional banking system?

  • Vice Chair Brainard cautioned that a CBDC may serve as a substitute for traditional commercial bank money, thus reducing the aggregate amount of deposits in the banking system.

    • In particular, in times of financial stress, risk-averse users may move bank account funds into CBDC accounts, triggering private bank runs, and potentially threatening financial stability.

  • To mitigate such risks, Vice Chair Brainard suggested two policies for consideration:

    • (i) making the CBDC non-interest bearing; and/or

    • (ii) placing caps on how much CBDC a consumer could hold or transfer.

Would a CBDC contain privacy protections for consumers?

Several members raised privacy concerns and asked whether a CBDC would provide the federal government expansive powers to surveil how Americans use their money.

  • For example, Rep. John Rose asked whether a CBDC would make it easier for the federal government to block individuals it disagreed with from accessing the financial system.

  • In response to these concerns, Vice Chair suggested a CBDC would be no different than deposits in bank accounts.

  • In fact, Vice Chair Brainard believes that CBDC deposits would ultimately be intermediated by banks so "there would be no direct connection between the Federal Reserve and consumers."

For a more detailed play-by-play of the hearing, check out this thread.

So what's next?

Considering the hearing left many open questions (e.g. Will the Fed issue a CBDC? If so, when? and What Congressional action, if any, is necessary for the Fed to do so?) expect further follow up from members through letters to the Fed or proposed legislation.

There are already bills in the House and Senate to prohibit the federal reserve from issuing a U.S. CBDC directly to individuals.

  • In the House, Rep. Tom Emmer sponsors H.R. 6415.

  • In the Senate, Senators Ted Cruz (R-TX), Mike Braun (R-IN) and Chuck Grassley (R-IA) sponsor S. 3954.

Senator Tom Cotton (R-AR) leads bill to prohibit the use of a digital currency payment system operated by China.

  • The bill is titled the "Defending Americans from Authoritarian Digital Currencies Act."

  • It would prohibit companies that own or control an app store in the U.S. from:

    • (1) supporting or enabling a transaction in e-CNY on its app store within the U.S; or

    • (2) carrying or supporting any app in its app store within the United States that supports or enables transactions in e-CNY. See § 4(b).

  • eCNY is the digital Yuan—China's version of a CBDC.

  • According to Senator Cotton, the legislation is necessary because "[t]he Chinese Communist Party will use its digital currency to control and spy on anyone who uses it. We can’t give China that chance—the United States should reject China’s attempt to undermine our economy at its most basic level."

  • Senators Marco Rubio (R-FL) and Mike Braun (R-IN) are original cosponsors.

  • The bill has been referred to the Senate Committee on Commerce, Science, and Transportation.

  • ​Here is the full text.

Look Ahead

  • After last week's hype that Senator Lummis might introduce her crypto bill with Senator Gillibrand this week, she announced on Monday that June 7th will be the official release date.

  • President Biden's Executive Order on digital assets requires federal agencies to submit various policy reports to the President by certain dates. The first report, due June 7th, is on "how to strengthen international law enforcement cooperation for detecting, investigating, and prosecuting criminal activity related to digital assets." §8(b)(iv).

    • ​Here's a chart summarizing the reports and when we can expect to see them.

Worth The Read

  • Seth Green's Bored Ape Yacht Club ("BAYC") NFT was stolen and then sold, raising the legal issue of who now owns the commercial rights to use the BAYC NFT. This article examines some of the preliminary legal analysis. Warning: may trigger flashbacks to law school final/bar exam questions.

  • The CFTC hosted a roundtable to discuss FTX's proposal to offer margined derivative trading directly to customers, rather than going through traditional intermediaries like clearinghouses. Here is a summary article.

Trivia

Last Week's A: Papa Johns cooked up the notorious "Bitcoin Pizza." Hope everyone enjoyed their Bitcoin Pizza Day (May 22) btw!

This Week's Q: The Central African Republic ("CAR") recently adopted Bitcoin as legal tender. What is CAR's capital? Bonus Points: What fiat currency is the other official legal tender of the CAR?

Thank you for subscribing, and please enjoy your Memorial Day Weekend.

Sincerely,

GSL