The U.S. Department of Treasury, in coordination with various federal entities, released three anticipated reports on digital assets: (i) a U.S. central bank digital currency (CBDC) report entitled "The Future of Money and Payments";1 (ii) a discussion of "Crypto-Assets: Implications for Consumers, Investors, and Businesses"; and (iii) an "Action Plan to Address Illicit Financing Risks of Digital Assets," discussed here.
In response to President Biden's March 2022 Executive Order on Ensuring Responsible Development of Digital Assets, the CBDC report addresses the current state and future trajectory of U.S. money and payment systems in light of developing technology in instant payment systems and stablecoins. It also addresses the potential benefits and risks of these recent innovations, along with a potential CBDC framework.
Treasury's recommendations focus on three key objectives: developing a future system of money and payments that promotes U.S. values, fosters inclusion, and minimizes risks. These four recommendations involve:
- Advancing work on a CBDC, in case one is determined to be in the national interest.
- Encouraging use of instant payment systems to support a more competitive, efficient, and inclusive U.S. payment landscape.
- Establishing a federal framework for payments regulation to protect users and the financial system, while supporting responsible innovations in payments.
- Prioritizing efforts to improve cross-border payments.
It's worth noting, however, that even if a CBDC is "determined to be in the national interest,"2 Treasury Undersecretary for Domestic Finance, Nellie Liang, has acknowledged that the necessary research and development of the technology "could take years."
Below are four additional takeaways from the CBDC report:
1. The report is largely optimistic in its outlook regarding the benefits from digital assets and blockchain technology on the financial system—particularly in the case of a CBDC—but notes further research is needed.
Readers may be surprised to discover that the potential benefits of digital assets and blockchain technology receive comparable, if not greater, coverage in the CBDC report than the discussion of risks. Across instant payment systems, stablecoins, and a CBDC, the CBDC report appears least optimistic about the role of stablecoins as a form of retail payment, as discussed in more detail below.3 This perspective is consistent with the view articulated by Federal Reserve Board Governor Lael Brainard, most recently in a speech last May, where she cautioned that widespread use of private monies "could fragment parts of the U.S. payment system in ways that impose burdens and raise costs for households and businesses."4
Putting aside its grim view of stablecoins, the CBDC report identifies potential uses and efficiency gains from both instant payment systems and stablecoins, including the further reduction of transaction inefficiency by reducing the requisite number of intermediaries required in cross-border payments.
The report also notes that the design of a centrally governed digital currency with instant settlement capacity could vastly improve both the wholesale and retail financial markets in numerous ways, particularly given the efficiency and settlement benefits a CBDC could provide through transaction programmability and automation.5 Similar to the functionality of smart contracts, the report describes a number of potential applications for automated transfers, including payroll, government, and bill payments while noting the need for careful evaluation to ensure that risks arising from bugs in the code or inability to stop payments can be sufficiently mitigated.6
The CBDC report discusses the likelihood that a CBDC could surpass existing methods of domestic and cross-border transactions. Unlike FedWire, which currently would have limitations in transaction timing based on Fedwire operating hours, a CBDC would not be limited by finite hours of daily operation, allowing smoother intraday liquidity management.7 In addition, coordinated development of a U.S. CBDC with foreign counterparts (a high-priority objective in the report) could rehaul the cross-border payment system—reducing frictions inherent in the correspondent banking system and drastically lowering the time of international transactions from days to seconds,8 while similarly lowering the expense.
The potential law enforcement benefits of a CBDC's programmable controls are also explored in the report. Opportunities for improved crime detection and prevention, as well as compliance, especially in the areas of anti-money laundering and prevention of terrorism finance (AML/CFT), are considered valuable, for example, through the automation of suspicious activity report (SAR) filings.9
The report stresses how the accessibility and functionality of a properly designed CBDC could further the President's policy and national security interests, in both the financial and broader context. For instance, the report notes that a CBDC could serve unbanked and underbanked populations through the provision of an accessible, low-cost alternative to traditional private-sector financial services.10 Furthermore, a CBDC designed for the public good could provide valuable national security benefits, offering safe financial services and access to reliable assets even in times of extreme financial stress (or other disruptive crises, such as national disasters, when traditional institutions may be vulnerable.)11
Finally, the enhanced data collection from the private sector made possible by a CBDC could permit financial institutions to obtain unprecedented insight into patterns and trends in money laundering and terrorist financing controls, allowing faster detection and response to positive or negative trends in the financial system.12 The report notes that the collection and storage of this data "would pose obvious privacy and cyber security risks, but it could also offer opportunities for proper authorities to leverage the data in supervision and law enforcement efforts." While the report pays no more than a mention to privacy and cyber security risks in its discussion of AML/CFT controls, it does provide more robust discussion in the final part of the report (as discussed below).
2. Regulators appear receptive to private-sector participation in the development and innovation of a potential CBDC, and the challenges associated with interoperability receive due attention.
Another notable aspect of the report is its apparent enthusiasm for public and private cooperation. This includes broad support for private-sector financial innovation and experimentation, subject to applicable rules and regulations, as well as explicit openness to private-sector collaboration in the development of a central currency framework, whose code is envisioned to be open source.13
Public-private cooperation could potentially be a permanent CBDC feature. The report suggests that a CBDC could function like a foundational skeleton upon which the private sector could build applications to carry out financial and other useful services as innovation and demand continue to progress. This model is reminiscent of the popular blockchain Ethereum, which similarly permits developers to build layer 2 applications on its foundational blockchain ledger.14
Though the Report suggests that the most likely design of a CBDC blockchain would be a two-tiered system—i.e., a system intermediated by banks and non-bank financial institutions, (rather than a fully decentralized, or a peer-to-peer, system)—there is a clear need to attract and retain the participation of private innovators in order for a CBDC to be successful.15
In addition, the report notes the significant challenges surrounding interoperability across U.S. and foreign CBDCs. In order for multiple CBDC systems to be compatible with each other, they would "require advance cooperation between jurisdictions during the development phase to establish common standards and legal frameworks."16
3. The report is generally positive on instant payment systems, but skeptical in its discussion of stablecoins, particularly given associated run risk.
The report cites the current development of FedNow, the Federal Reserve's instant payment service akin to RTP (real-time payments), which will not be accessible to depository institutions at least until 2023.17 While FedNow is behind other instant payment systems in terms of industry acceptance and adoption, both RTP and FedNow share a common goal of allowing banks and consumers to efficiently and seamlessly transfer funds 24/7/365. The report is (unsurprisingly) supportive of FedNow as a system that can effectively meet these goals in the near term.
Unlike a CBDC—which the report suggests could bolster the government's interest in supporting the "singleness of the currency"—stablecoins are considered to represent a private alternative to public money that threatens that mission. Where instant payments provide cheap, fast, and broadly accessible payment services, the report contends that the risks inherent in stablecoins are aggravated by the lack of federal regulatory oversight, making stablecoins vulnerable to value-crashes and runs.
Though never mentioned, the report's stablecoin discussion is likely colored by recent events—namely, the collapse of the popular algorithmic "stablecoin" Terra in May.18 Like the PWG Stablecoin Report from November 2021, the report here recommends that Congress enact legislation providing a regulatory framework for stablecoins to address various risks.19
4. Besides a federal legislative framework for stablecoins, the report calls for a federal legislative framework for payments regulation, capturing a much broader group of nonbank payment providers than just stablecoin issuers.
Echoing calls of Acting Comptroller Michael Hsu on the risks associated with unsupervised and unregulated nonbanks performing bank-like activities, the CBDC report notes that if these firms are not "adequately regulated and supervised, there may be risks to consumers, the financial system, and the broader economy."20 While efforts to regulate nonbank stablecoin issuers have emerged in various Congressional proposals this year, the report appears to lean towards recommending a separate, more comprehensive legislative regime across all nonbank companies involved in the issuance, custody, or transfer of money or money-like assets.
While the stated benefit of such a regime would be to mitigate risks, the report also hints at a potential pathway for "allowing nonbank payment providers to participate directly in instant payment systems"21—likely an acknowledgment by Treasury that without the innovative technology provided by nonbank payment providers, it will be difficult to facilitate greater consumer access to, and use of, instant payment systems.
5. The report acknowledges the privacy implications of a CBDC, which could significantly expand government access to financial data, and recommends prioritizing research and development in the public and private sector into privacy-enhancing technology.
A final section of the report includes a candid discussion about the privacy implications of a CBDC. As seen in China's adoption of a digital yuan, a CBDC has the potential to vastly expand the government's access to consumer financial data, including sensitive financial information. Despite the potential value that such access would provide the government (ranging from crime and counter-terrorism to tax collection and surveillance), the report rightly cautions that privacy concerns would need to be prioritized in the development of a CBDC. This may require a "reevaluation of existing privacy standards" and an active emphasis on research and development of new privacy-protection technology.22
The report advances no tangible means to achieve this goal, leaving the technological advancements required to advance this issue between public and private researchers.23 The report suggests that governance structures should include consumer protections to prevent the disclosure of consumer financial information and protect the user from "undue government scrutiny."24 While the report states that the Federal Reserve and any third-party intermediaries should provide public guidance to users about how any financial information that must be collected will be used and protected, it is unclear if any of such guidance will be sufficient and effective to appropriately educate users and protect their privacy interests.25
The varied risks associated with stablecoins, the importance of improving cross-border payments, the potential of a U.S. CBDC, and the idea that the U.S. has a strong national interest in being at the forefront of responsible innovation in digital assets are all familiar themes from the Executive Order.
But among the three post-Executive Order reports issued by Treasury this September, this one stands out: it provides a refreshing look at the varied benefits of payments innovation, the challenges surrounding interoperability, the importance of privacy-enhancing technology, as well as the novel prospect of a comprehensive federal framework for nonbank payment providers—all topics for future robust discussion.
1 "CBDC Report" or "report."
2 CBDC Report at 45.
3 See Nellie Liang, Undersecretary for Domestic Finance, Remarks at Brookings Institution (Sep. 23, 2022); See also CBDC Report at 14 "Instant payment systems are an important upgrade to the current payment system. Stablecoins aspire to be a new type of money supported by a novel payments technology; however, stablecoins present a greater number of risks related to their financial and technological characteristics compared to instant payments and other existing forms of money and payments, making it more difficult to predict the impact of stablecoins on the future of money and payments."
4 Lael Brainard, Governor, Federal Reserve Board, Speech at the Consensus by CoinDesk: Private Money and Central Bank Money as Payments Go Digital (May 24, 2021).
5 CBDC Report at 20-21.
6 Id. at 21.
8 Id. at 22.
9 Id. at 27.
10 Id. at 37.
11 CBDC Report at 32-40.
12 Id. at 27.
13 Id. at 32.
14 See Ethereum.com, "What is Layer 2?" (Accessed Sep. 27, 2022).
15 See CBDC Report at 23.
16 Id. at 22.
17 Id. at 16.
18 See Krisztian Sandor & Ekin Genc, The Fall of Terra: A Timeline of the Meteoric Rise and Crash of UST and Luna, Coindesk (Aug. 19, 2022).
19 CBDC Report at 39.
20 Id. at 47.
21 Id. at 48.
22 Id. at 36.
25 Id. For a more detailed exploration of privacy design measures that could be deployed on a prospective U.S. CBDC, see Office of Science and Technology Policy, Technical Possibilities for a U.S. Central Bank Digital Currency 20-22(Sep. 16, 2022).