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Let’s skip over “Crypto Mom” Hester Peirce. The cryptocurrency community has now fallen in love with a new U.S. regulator. A speech this week by Randal Quarles, the Federal Reserve's vice chairman for supervision, was hailed by prominent crypto scholars as a manifesto for how the U.S. government can harness the power of cryptocurrency innovation to serve its international interests and establish a broader "soft power" role for the dollar in the global economy. What caught their attention: Quarles believes that stablecoins could encourage international use of the dollar by making cross-border payments faster and cheaper, and that they could potentially be deployed faster and with fewer drawbacks than central bank digital currencies (CBDCs). For many, this is good news. Stablecoin proponents argue that the U.S.’s light-touch regulatory stance on private issuers of these dollar-pegged tokens, which are often built on open-source platforms like Ethereum, will allow for more digital dollar innovation. Nic Carter, a partner at Castle Island Ventures, said Quarles’ speech will be remembered as a landmark one. Dante Disparte, Circle’s chief strategy officer, said essentially the same thing. Just three days ago, Eric Rosengren, president of the Federal Reserve Bank of Boston, which has been conducting CBDC experiments with the MIT Digital Currency Initiative, issued a warning that stablecoins posed risks to financial stability. He described stablecoins as a “new disruptor” in credit markets. Still, the ideas of people like Quarles are important in this regard. If the U.S. follows his advice, it could mean that the dollar could expand its influence rather than lose its status as the world’s reserve currency, as some scholars of monetary and geopolitical trends predict. In this scenario, the dollar would move beyond its current role as the unit of account for global trade and a key reserve asset in capital markets, becoming commonplace in everyday transactions outside the United States. If so, that would be a good thing. To promote monetary innovation and improve financial inclusion, global transactions must be freed from heavy-handed regulation and Wall Street gatekeeping. Permissionless Innovation Open blockchain platforms will be more creative than closed-door CBDCs developed by central banks, which are hardly known as hotbeds of innovation. The reason DeFi has such amazing innovation is that it is a permissionless environment. Developers do not need approval from a company’s board of directors to build on a specific platform. Since users can move assets freely within the DeFi ecosystem without going through intermediaries like banks, the flow of value and investment helps incentivize and drive this innovation. The question is, how far is the U.S. government willing to go to promote this kind of free innovation? If anything, the regulatory trend in the U.S. is toward more control, not less. With U.S. support, the Financial Action Task Force last year extended its “travel rule” to custodial cryptocurrency exchanges, requiring them to not only apply know-your-customer KYC and anti-money laundering protocols AML, but also to track the identities of non-custodial wallet holders who transact with customers. While the non-custodial nature of DeFi platforms has temporarily kept the field under some degree of regulation, many lawyers believe that stricter regulations for DeFi are coming. More specifically, a bill introduced to the U.S. House of Representatives last December would require stablecoin issuers to apply for a banking charter. All of this will hinder progress. If regulation does help protect financial stability, then it may be a price worth paying. However, if there is too much regulation, we will not be able to fulfill the promise of enabling ordinary people to make dollar payments quickly and easily around the world. The convenience of stablecoins stems from their nature as bearer instruments. They are digital versions of cash whose value is independent and can be transferred peer-to-peer automatically. If KYC and AML requirements are applied to these transactions, which essentially require an entity (such as a bank) to regulate them, the transactions lose this person-to-person nature. As such, stablecoins will essentially face many of the same limitations as the current banking system, where cross-border payments remain expensive and cumbersome for billions of excluded people, especially those in developing countries. At the fork in the road, what choice should you make? The United States now has two choices. First, it could follow Quarles’s advice and foster an open, stable, Bitcoin-powered system that enables more people around the world to use the dollar as their currency of choice. This would be a very different model for reserve currencies than the current one. It would generate seigniorage for the U.S. government and a competitive advantage for U.S. producers. We can see it as a step forward in U.S. “soft power”, while authoritarian governments in other countries inevitably pursue centrally controlled models for their digital fiat currencies and are powerless to compete. However, this model comes at a price: Washington will need to give up some of the "hard power" it currently possesses, including the ability to control global financial flows, seize assets and put pressure on enemies. The second option is to double down on the existing system, but in digital form. While there are a variety of models for CBDCs, including those that offer some degree of privacy to users, international transactions will almost certainly require bank-based gatekeeping powers similar to the existing system. In this scenario, competition with another country would be more like a direct head-on clash, with the two countries’ CBDCs competing directly with each other. In that world, there is no guarantee that a digital dollar would outperform a digital yuan. Which choice will be made in the end? |
