Author: Lael Brainard
Source: first class warehouse
Editor's Note: The original title is "Digital Currency, Stabilizing Coins, and Evolving Payment Patterns"
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Technology is driving rapid changes in payment methods and the concept of “money”. From coin trading to the use of banknotes to electronic debit and credit of bank account funds, advances in technology have changed the mainstream concept of money. Now the global stable currency network (such as Facebook's Libra, etc.) is working hard to open a new chapter in the currency field, which has led to issues related to law, regulatory system, financial stability and monetary policy. Due to its potential global influence, Facebook's Libra has become urgent about the form in which money can be used, who can issue it, and how to record and resolve payments.
Traditional currencies have three functions: as a medium of exchange, to make payments more convenient; as a means of value storage for future use; or to simplify transactions by providing a common unit of calculation to compare the value of goods and services.
Ten years ago, Bitcoin was hailed as a new type of digital currency that could solve the friction in payment. It is also used as a unit of account and value storage, without centralization management. The emergence of Bitcoin has created a new class of payment instruments and assets that can be traded through a set of distributed ledger-supported payment tracks. Compared to traditional record-keeping systems built on a single ledger managed by a trusted centralized entity, distributed ledger technology allows for sharing, tamper-proof, and can be updated by anyone with sufficient computing power. But Bitcoin and some other early cryptocurrencies have shown great volatility, limited throughput, unpredictable transaction costs, limited governance or no governance, and limited transparency, limiting them as a means of payment and The utility of the accounting unit.
Stabilized coins are specifically designed to overcome the huge volatility exhibited by the first generation of cryptocurrencies, which limits the scope of payment of cryptocurrencies and the utility as a unit of account. As the name implies, Stabilizing Coins aims to maintain currency stability by linking digital currencies to an asset or a basket of assets, such as commercial bank deposits or government-issued bonds. The stable currency is also different from the original cryptocurrency. The stable currency may also be issued by a centralized entity and in some respects depends on third-party agencies.
Just as any currency, its value as a medium of exchange will increase as the size of the network increases. Due to the related network externalities, the function of the stable currency payment system will also depend on its widespread adoption. Given the 2.7 billion monthly activity on the Facebook platform, the Libra Stabilization Coin project stands out because of its foundation to quickly reach the global scale of users in the payment system.
To assess the efforts of a stable currency issuer to provide three functions of currency, the first thing to consider is the existing arrangements for the issuance, regulation, and transfer of money. Central bank currency and commercial bank currency are the foundation of the modern financial system. The central bank's currency consists of physical cash and deposits deposited with the central bank. The central bank's currency is important for the payment system, representing a secure settlement asset and allowing users to exchange central bank debt, and is confident in the central bank's acceptance and reliability. In addition, central banks can provide funding when faced with pressure and play a key role in providing liquidity.
Commercial bank currency refers to deposits in commercial banks. It is widely used, in part because people believe they can convert it to another commercial bank or central bank's liabilities, such as physical cash. This confidence is largely due to the insurance nature of bank deposits and the requirement for commercial banks to accept regulatory and deposit insurance. Consumers and businesses also use the money in transactions because of its convenience and usability, which in turn increases the size of the network that uses the money.
Non-bank private funds or assets can also facilitate transactions between user networks. In some cases, such as airline miles, such assets may only have value within the network. In other cases, the issuer of assets within the network can guarantee that it can be converted into a sovereign currency. Consumers believe that companies that issue such currencies will be able to repay these debts. Many American consumers have experience with non-bank private funds, such as gift cards, loyalty cards, and virtual game currency. Although some are relatively limited in size and use, some non-bank money networks are also very large. Starbucks reported that as of September 2018, its stored-value card debt was $1.6 billion, exceeding the deposits of many savings institutions.
As the size and scope of such private networks expands, the convenience and benefits of conducting transactions within the network are also growing in a self-enhancing dynamic manner known as network externalities. The benefits of these networks can be enhanced by proactively using network data for a variety of purposes, from assigning and pricing credits to sharing comments to prioritizing the information pushed to users. In China, consumers and businesses are involved in the two mobile networks, Alipay and WeChat. According to data from some accounts, the two networks handled more than $37 trillion in mobile payment services last year. These networks operate in China in RMB, and the balance can be transferred to and from the bank or credit card account.
Stable currency with global scale and scope
Stabilizing coins depend on their design and claims structure (similar to private non-bank liabilities). Stabilizing coins are eager to implement the functions of traditional currencies and do not rely on confidence in the issuer (such as the central bank) to support the currency. In fact, for some potential stable currencies, the assessment indicates that the user may not have any rights to the underlying asset or the entire system.
We see large-scale payment networks on existing digital platforms such as Alibaba and WeChat growing, while smaller payment platforms such as Tether, Gemini and Paxos are also being issued. What makes Libra unique is that it has an active user network representing more than one-third of the world's population and a private digital currency that is opaquely linked to a basket of sovereign currencies. So it’s no surprise that Facebook’s Libra has attracted the attention of legislators and authorities.
Libra and any stable currency project of a global scale and scope must address a range of core legal and regulatory issues before they can become a payment method. Here, I want to highlight a few issues.
First, adhering to the rules and regulations of KYC (know your customers) is critical to ensuring that stable currencies are not used for illegal activities and illegal financing. Libra's business model is essentially cross-border, so every participant in the system that is considered a financial institution needs to ensure compliance with anti-money laundering laws in each country. Libra's global reach may require a consistent global anti-money laundering framework to reduce the risk of illegal transactions.
Second, stable currency issuers designed to facilitate consumer payments must clearly demonstrate how to ensure consumer protection. Consumers need to be educated about how their rights in digital wallets differ from their bank accounts. In the United States, as elsewhere, legal and regulatory protections have been implemented on bank accounts so that consumers can reasonably expect their deposits to receive a certain amount of insurance, fraudulent transactions should be borne by the bank, and transfers made within the specified time limit, and Clear, standardized disclosure of account fees and interest payments. We are not only unclear whether Libra will take similar protection measures, nor do we know what recourse consumers have, but because consumers seem to have no rights to stabilize the underlying assets of the currency, it is not even clear how much price risk consumers will face. . What needs to be reminded of consumers is that, legally speaking, the stable currency may be completely different from the currency issued by sovereignty. It is important to clarify which legal entities are responsible for the security of personally identifiable information and transaction data, and how personal data will be stored, accessed and used. The large number of network intrusions that have occurred in the past few years has highlighted the importance of these issues.
Furthermore, it is necessary to clarify the ongoing financial activities of the various participants in the Libra ecosystem so that the jurisdiction can assess the adequacy of existing regulatory and enforcement mechanisms. As the legal seat of the Libra Association, Switzerland is particularly interesting. The Swiss authorities have established three new categories to facilitate their functional supervision: “payment tokens” refer to cryptocurrencies used for payment or value transfer; “practical tokens” are blockchain-based applications; “Asset tokens” are cryptographic assets similar to stocks, bonds and derivatives. If some innovations do not fall into one category, they may not be mutually exclusive.
In the United States, regulators are more extensively studying the specific functions of specific stable and cryptocurrencies to determine if they are appropriate for the existing regulatory structure and whether additional authorization or guidance is required. According to relevant laws, US market regulators have the right to supervise products that are judged to be securities or commodity futures. At the state level, the New York State Financial Services Authority has established Bitcoin licenses for entities associated with virtual currencies. The Federal Reserve Board and other federal banking institutions have oversight power over banks, and in many cases they have companies that regulate and review services to banks. Neither the Federal Reserve nor any other regulatory agency has the absolute power to run a payment system in the United States. Although the Financial Stability Oversight Board has the authority to designate systemically important non-bank financial companies, financial market instruments, or payment, clearing and settlement activities on a case-by-case basis, it is unclear whether any cryptocurrency issuer meets statutory designation requirements. .
Stabilizing coins and the more common cryptocurrency pose a challenge to long-lived currencies, where long-term currency means that payments must be recorded in a central distributed ledger managed by a single entity. In fact, the establishment of the bank is to fulfill this central distributed ledger function. Distributed ledger technology allows for direct point-to-point asset transfers, potentially eliminating the need to trade through intermediaries. While distributed ledger technology can provide advantages by enhancing operational flexibility, increasing transparency, and simplifying record keeping, the openness and immorability of transaction books also pose risks, such as data privacy issues and legal complexity.
The global stable currency network may also pose a challenge to the banking business model. In extreme cases, extensive migration to one or more global stable currency networks may undermine the intermediary role of banks in payments. If consumers and businesses reduce their deposits in commercial banks and switch to stable currencies in digital wallets, this may reduce the bank's stable source of funds and visibility into transaction data, thereby preventing banks from providing credit to businesses and households. Ability. In other words, many banks may adapt by providing alternatives to peer-to-peer settlement and incorporating stable coins into their business models, either with financial technology companies that issue stable currencies, or as some banks have already done. Issue your own stable assets.
In addition, the widespread adoption of stable currencies may have an impact on the role of central banks and monetary policy. Payment is a cyclical system of the economy, and large-scale migration to a new stable currency network for payment purposes has proven to be a more extensive migration. If a large proportion of domestic households and businesses use global stability as a means of payment and value storage, this may reduce the need for physical cash and affect the size of the central bank's balance sheet. The way the central bank implements monetary policy is complex, and banks' participation in short-term financing markets may be affected.
For small, open economies or countries with weak monetary institutions, these effects are even more pronounced. The migration from sovereign currency to global stable currency may be similar to the process of dollarization, weakening the space for independent monetary policy. Large-scale use of stable currencies may also affect large developed economies that have broad links to the global financial system, including increased market volatility and cross-border transmission shocks.
Finally, a stable currency network with global reach may present financial stability risks. If not managed well, liquidity, credit, market or operational risks (alone or in combination) can lead to loss of confidence and typical runs. The Global Stabilization Currency Network raises many complex issues related to legally independent but interdependent operations and lacks a clear understanding of reserve management and the rights and responsibilities of market participants in the network. Potential ambiguities surrounding regulatory agencies' ability to provide regulatory and supportive liquidity and cross-border cooperation may amplify potential risks and spillovers.
Central bank's digital currency
Before the emergence of the stable currency, the rapid transfer of payments to the digital system spurred interest in the central bank’s issuance of digital currencies. In some jurisdictions, there has been a clear shift from cash to digital payments, which has naturally prompted authorities to begin exploring the transition of their own money to digital distribution.
The potential of the global stabilization currency system has increased interest in the central bank's digital currency. Proponents believe that the central bank's digital currency will be a safer option than a privately issued stable currency, as the central bank will be directly responsible. For example, Markus Brunnermeier, Harold James, and Jean-Pierre Landau provide important arguments.
Of course, the Federal Reserve Board and other central banks have begun to provide funds in digital form in traditional reserve or settlement accounts, namely central bank deposits. However, under the current circumstances, the central bank's digital currency usually refers to a new type of central bank debt, which can be directly held by households and enterprises without the intervention of commercial banks. According to this definition, the central bank's digital currency can be a flexible form of currency issued by the central bank. Compared with the traditional reserve, there are three differences: allowing a wider range of institutions and individuals to access it, and certain types of balances may be There may be no interest payments and it may be necessary to increase the government's visibility into end-user transactions.
In the United States, the current system has a very large advantage. First, the physical cash in dollars in circulation continues to increase, indicating strong demand. Second, the US dollar is an important reserve currency in the world, and it is vital to maintain public trust in sovereign currencies. Third, we have a sound banking system that meets the needs of consumers: we have a large number of banks, diverse scales and geographically dispersed locations. Finally, we offer a wide range of available and expanding digital payment options based on the existing institutional framework and applicable safeguards.
In addition, the central bank's universal digital currency, also known as the personal consumption currency, will bring profound legal, policy and operational issues. Let us consider the balance between privacy and illegal activities. If the purpose of the design is to be financially transparent and to provide measures to prevent illegal activities, then it is conceivable that the central bank digital currency for consumer use may require the central bank using the digital currency to maintain a record of all payment data, which has obvious difference. A system for recording personal payment information by government entities will mark a huge shift. A related question is whether the Fed has the right to issue currency in digital form and, if necessary, the right to create a digital wallet for the public.
This may also have a profound impact on monetary policy. Some economists believe that the central bank's digital currency may solve the problem caused by the zero interest rate floor by directly transmitting monetary policy to the public. Implementing monetary policy in this way will effectively eliminate all physical cash and the right to impose negative interest rates or taxes on the digital currency held by the family. I personally strongly prefer to solve the effective lower limit by actively using our existing tools. I think the cost-benefit assessment of negative interest rates is not attractive in the current US environment.
Financial stability considerations are also important. The ability to convert commercial bank deposits into central bank digital currencies with a single stroke is certainly a catalyst for the run. In this regard, the role of banks in providing financial intermediation services may also change radically.
Finally, the introduction of central bank digital currency may present operational risks. First, this may require the Fed to develop operational capabilities to access or manage individual accounts, which may have hundreds of millions. There are also a number of other operational challenges, including electronic forgery and cyber risks. It is worth noting that the technology currently used in the private sector digital currency provides information technology with less reliability, integrity and scalability than the central banking system currently in use. Many of these technologies do not provide clear, predictable final settlement, which is the core focus of the payment system.
That is to say, according to the special attributes of payment and monetary system, some regions may develop in this direction faster than other regions. At the Fed, we will continue to analyze the potential benefits and costs of the central bank's digital currency and look forward to learning from other central banks.
Support payment innovation
Despite careful warning not to rush to try the untested central bank digital currency approach, we will actively support the development of payment infrastructure so that everyone can use real-time payments. The US payment and securities settlement system has a daily transaction volume of approximately $12.5 trillion. The Fed is committed to working closely with the private sector to promote a safer and more efficient payment system.
This summer, the Fed launched its first new payment service in more than 40 years to help everyone achieve real-time payments. The Fed will develop the FedNow service as a platform for consumers and businesses to securely send and receive payments 24 hours a day, 7 days a week, 365 days a year. This initiative aims to provide a neutral platform for the private sector to innovate in fast payment services. In addition to FedNow, we are also exploring the day-to-day settlement function of enhanced automatic clearing (ACH) transactions, extending the uptime of Fedwire® fund services and the National Clearing System. We are working with the industry to improve the security of payment systems, for example, to deepen our understanding of synthetic identity fraud and to identify a fraud classification method to improve information sharing.
One of the most important use cases when the public and private sectors work to reduce payment friction is cross-border payments, such as remittances. The intermediary chain for cross-border payments is long, slow, cumbersome and opaque. Technology enables e-commerce to cross national borders, but current cross-border payment solutions are complex approaches rather than seamless end-to-end solutions. Authorities in jurisdictions recognize cross-border cooperation with the private sector to address the importance of cross-border friction that exists today.
From the beginning of the issuance of our own currency in the colonial countries in our history, to the decades-old history of the circulation of private commercial banknotes to replace the national currency, our country has rich and diverse experience for us to draw on in the evaluation of various private currency proposals. Part of the reason for the Fed’s establishment was in response to the bank’s inability to fulfil its obligations to issue banknotes, and the consequent panic and run. When we have the possibility to enter another stage of currency and payment evolution, these experiences will help us get information.
Today, consumers and businesses have a variety of payment options, including cash, checks, ACH transfers, debit and credit cards, and mobile-based payment solutions. These often have well-defined legal rights and responsibilities. In the next few years, we may see far-reaching innovations in the payments arena, and a large number of new options (such as stable coins) will emerge.
The Fed remains convinced that the power of technology and innovation can change the financial system, reduce friction and delays, while maintaining consumer protection, data privacy and security, financial stability and monetary policy transmission, and preventing illegal activities and cyber risks. With these risks in mind, the Global Stabilization Currency Network should meet the high threshold of legal and regulatory safeguards before conducting business. We are closely monitoring new technologies to ensure that innovations are in line with our business responsibilities and broader public policy objectives, as reflected in the Federal Reserve Act. At the same time, we are upgrading our services to support innovation in new ways. And we will continue to build a safe and efficient payment system, including all forms of currency that we have been focusing on for more than a century.