Translation: Federal Reserve Board Member Randal Quarles: Developing a digital dollar is futile, better to embrace stablecoins.

Federal Reserve Board Governor Randal K. Quarles delivered a speech at the Utah Bankers Association Annual Convention on June 28, expressing his views on whether the United States needs to develop a central bank digital currency (CBDC) and commenting on cryptocurrencies and stablecoins. Overall, he believes that the disadvantages of developing a CBDC outweigh the benefits and suggests using stablecoins in conjunction with existing financial payment systems for improvement.

This article is translated from a publication by Federal Reserve Board Governor Randal K. Quarles titled "Parachute Pants and Central Bank Money", with the title to be determined separately if needed. For any ambiguities, please refer to the original text.

Translation of the original text:

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Parachute Pants and Central Bank Digital Currency

I have been reflecting on America's enthusiasm for novelty over the past few centuries, and how it relates to this speech. Overall, it has made America a cradle of many scientific and practical innovations that have transformed life in the 21st century, greatly changing life in the 19th century, and providing good services to us and the world.

However, Americans are easily influenced by boosterism and fear of missing out (FOMO) to the same extent, which sometimes can lead to a significant halt in critical thinking and occasionally result in rash, deceptive enthusiasm or short-lived trends.

Sometimes in hindsight, the consequences can be puzzling or embarrassing, like the sudden surge of millions of Americans wearing parachute pants in the 1980s. But the consequences could also be more serious.

This brings us to today's topic: "Central Bank Digital Currency" or "CBDC." In recent months, public interest in the "digital dollar" has peaked. Many experts and commentators have suggested that the Federal Reserve should issue a CBDC, as it may be necessary.

However, before we become overwhelmed by new things, I believe we need to critically analyze the claims made about CBDC.

When I express my views on this issue and other issues related to CBDC, I speak for myself as a member of the Board and not on behalf of the Board itself or any other Federal Reserve policymakers. Indeed, as you have seen, Chairman Powell recently announced that we are preparing a comprehensive discussion paper on this issue, which will be the first step in a thorough public process for conducting this critical analysis, so I do not want to prejudge.

But I do want to offer some thoughts on "the questions I believe we need to address in this process," "how I will consider these questions," and "what I think any proposal to create a U.S. CBDC must meet clear high standards."

So, let's start with a basic question: What problem will CBDC solve? To answer this question, we first need to define the term CBDC and evaluate the current state of the U.S. payment system.

What Does "CBDC" Mean?

The Bank for International Settlements defines CBDC as "a digital payment instrument denominated in the national unit of account, which is a direct liability of the central bank."

My first observation is that the public primarily already transacts in digital dollars: sending and receiving electronic balances in our commercial bank accounts. These digital dollars are not CBDC as they are liabilities of commercial banks, not the Federal Reserve. However, it is important to note that digital dollars from commercial banks are insured up to $250,000 within the Federal Deposit Insurance Corporation, which means that for deposits up to that amount, essentially all retail deposits in the U.S. are as sound as liabilities of the central bank.

The Federal Reserve also provides digital dollars directly to commercial banks and certain other financial institutions. Federal law allows these financial institutions to hold accounts at the Federal Reserve and receive payment services from the Federal Reserve. Balances in Federal Reserve accounts play a vital financial stability role by providing secure and liquid settlement assets for the U.S. economy.

In conclusion, the dollar is already highly digitalized. The Federal Reserve provides digital dollars to commercial banks, and commercial banks provide digital dollars and other financial services to consumers and businesses. This arrangement serves the nation and the economy well: the Federal Reserve maintains the public interest by promoting U.S. economic health and broader financial system stability, while commercial banks compete to attract and efficiently serve customers.

So, given the existing digitalization of the dollar, how does CBDC differ from the digital dollars we use today? The key distinction is that when most commentators speculate on a Federal Reserve CBDC, they assume the public could obtain it directly from the central bank. This type of CBDC could take different forms. One is an account-based model, where the Federal Reserve would provide individual accounts directly to the public. Account holders would send and receive funds to and from their Federal Reserve accounts by signing or crediting.

Another CBDC model might involve CBDC not maintained in Federal Reserve accounts. This form of CBDC would be closer to digital cash equivalents. Like cash, it represents a claim on the Federal Reserve, but it may transfer peer-to-peer (like banknotes) or through intermediaries.

I am skeptical of whether the Federal Reserve has the legal authority to pursue either of these CBDC models without legislation. Nevertheless, the recent clamor for CBDC opens up exploration of its benefits, costs, and practicality, which may be appropriate for post-legislation conditions. Let's first look at how a Federal Reserve CBDC might fit into the current U.S. payment system.

Current U.S. Payment System

The payment services between the Federal Reserve and private banks already provide a range of options to facilitate efficient electronic dollar payments. Some statistics related to major dollar payment systems can serve as illustrations. The Federal Reserve's large-value payment service (Fedwire Funds Service) processes nearly $4 trillion in payments daily. These payments settle immediately in Federal Reserve bank accounts. A private entity (clearinghouse) operates a large-value payment system that settles nearly $2 trillion in payments daily. These payments do not settle in Federal Reserve accounts but are supported by balances on the Federal Reserve Bank's books.

Small-value payments typically settle more slowly than large-value payments, but various ways to speed up settlement are already in place or in progress. For example, the Clearing House developed a real-time payment service focused on small-value payments. Similarly, the Automated Clearing House (ACH) network, a batch payment network developed in the early 20th century, now offers same-day settlement for ACH payments. The Federal Reserve is developing a real-time payment service: FedNow℠, which will allow recipients of small-value payments to access their funds in their commercial bank accounts almost immediately.

The payment system is not perfect: certain types of payments should be faster and more efficient. For example, cross-border payments remain a key area of concern, as they often involve high costs, slow speeds, and lack of transparency. The Financial Stability Board, which I chair, developed a roadmap last year to address these issues. Additionally, private stablecoins (which I will discuss in more detail later) may facilitate faster and cheaper cross-border payments.

Furthermore, certain types of payments are not fully digitized or are influenced by ongoing competition between companies with competitive economic interests. For instance, paper checks are still widely used for certain types of payments (although the interbank check collection process is now almost entirely electronic). Debit and credit card payments provide a convenient digital platform for consumers and retailers, but there is still considerable controversy over who bears the economic burden of card transaction costs between banks and retailers.

Finally, more Americans can benefit from digital payments by increasing access to banking services, which can be promoted through wider adoption of low-cost basic bank accounts. In summary, while the U.S. payment system is very good, albeit imperfect, it has been undergoing significant improvements.

Policy Considerations

However, proponents of a Federal Reserve CBDC believe that it will address many significant issues. For example, they suggest that a Federal Reserve CBDC may be necessary to safeguard the dollar's critical role in the global economy. Some also argue that a CBDC will overcome long-standing economic inequalities in American society.

As we begin to analyze these issues at the Federal Reserve, I must be convinced that a CBDC is an excellent tool to address any of the above issues, which I am skeptical about. And I must be convinced that the potential benefits of developing a Federal Reserve CBDC outweigh the potential risks.

Let's look at some arguments put forth by CBDC supporters. The first argument is that the Federal Reserve should develop a CBDC to protect the dollar from threats posed by foreign CBDCs and to counter the continued proliferation of private digital currencies.

Starting with the threat of foreign CBDCs, this argument assumes that some foreign currencies will pose a significant threat to the dollar by providing digital currencies through central banks rather than existing digital payment systems. These foreign currencies are highly digitalized in the current international banking system in a manner similar to the dollar, but have not posed a significant challenge to international currencies.

I believe that as the global economy and financial system continue to evolve, some foreign currencies (including some foreign CBDCs) will inevitably see more use in international transactions than currently. However, the dollar's role in the global economy depends on several fundamentals, including the strength and size of the U.S. economy; extensive trade connections between the U.S. and other regions of the world; deep financial markets, including U.S. government debt; the dollar's long-standing stable value; the convenience of converting dollars into foreign currencies; the rule of law and strong property rights in the U.S.; and a reliable U.S. monetary policy. These fundamentals are unlikely to be threatened by foreign CBDCs, much less because they are CBDCs.

Supporters of CBDCs also argue that private digital currencies pose a threat to the dollar. Private digital currencies come in various styles, but I categorize them into two types: stablecoins and non-stablecoins, or cryptocurrencies such as Bitcoin. Let's start with stablecoins. The value of stablecoins is tied to one or more other assets, such as sovereign currencies. Several existing and upcoming stablecoins are pegged to the value of the dollar.

Some argue that the U.S. must develop a CBDC to compete with dollar-pegged stablecoins. Stablecoins are a significant development and raise some challenges. For example, how will widespread adoption of stablecoins affect monetary policy or financial stability? How will stablecoins affect the commercial banking system? Do stablecoins pose a fundamental threat to the government's role in money creation?

In my view, we need not fear stablecoins. The Federal Reserve has historically supported responsible private sector innovation.

Continuing the tradition, I believe we must carefully consider the potential benefits of stablecoins, including how a stablecoin pegged to the dollar may help uphold the dollar's global economic position. For example, a global network of stablecoins pegged to the dollar could facilitate faster and cheaper cross-border payments to promote dollar usage, and may be deployed faster and with fewer downsides compared to CBDCs. Concerns about stablecoins mass-producing private money and challenging monetary sovereignty are puzzling, as the existing system already includes and indeed relies on money created daily by private companies.

We do have a legitimate and highly regulatory interest in the construction and management of stablecoins, especially regarding financial stability issues: assuming stablecoins are widely used, a pool of assets anchoring stablecoin values, if used to invest in various currency denominations, could introduce stability risks; if it's partial reserves rather than full reserves; if stablecoin holders do not have clear claims to underlying assets; or if the pool does not invest in the most liquid mainstream instruments like central bank reserves and short-term sovereign debt. All these factors pose risks: certain triggering events could lead to a large number of stablecoin holders exchanging all their coins for other assets at once, and the stablecoin system may not be able to meet this demand while maintaining a reasonable stable value.

But these issues are clearly solvable, and in fact, some stablecoin constructions aim to address these issues. Once our concerns are addressed, we should say "yes" to these products instead of trying hard to say "no." Indeed, the imminent improvements to the existing payment system, such as various instant payment measures combined with well-structured, cross-border efficient stablecoins, may render the development of CBDCs unnecessary.

Compared to stablecoins, cryptocurrencies like Bitcoin and other digital assets are unrelated to the value of sovereign currencies. Instead, they seek to create value within the coins through other means, often through intrinsic mechanisms ensuring scarcity, such as Bitcoin's mining process, or features that traditional payment systems cannot match, such as inviolable anonymity.

Some commentators assert that the U.S. must develop a CBDC to counter the attractiveness of cryptocurrencies. This seems misguided.

The mechanisms used to create value in such cryptocurrencies also make that value highly volatile: similar to the volatile value of gold, cryptocurrencies like Bitcoin, whose value derives largely from its scarcity, and other digital assets like Bitcoin, do not currently play a significant role in payment or monetary systems.

However, they differ from gold in that gold, besides its limited financial role, also has industrial uses and aesthetic properties. The primary additional appeal of Bitcoin lies in its novelty and anonymity. Anonymity will make it a target for increasingly comprehensive scrutiny by law enforcement, and novelty is a fleeting asset.

Gold will always shine, but novelty is inherently ephemeral. Therefore, Bitcoin and its similar products are likely to remain speculative and risky investments rather than revolutionary payment methods, and they are highly unlikely to affect the role of the dollar or necessitate a response through the introduction of CBDCs.

The second general argument put forth by supporters of a Federal Reserve CBDC is that it will stimulate and promote innovation in the private sector. This is an intriguing question worth further exploration. However, what puzzles me is how a Federal Reserve CBDC would promote innovation in ways that private stablecoins or other new payment mechanisms cannot.

In my view, private institutions have already brought considerable innovation to the payment industry without a Federal Reserve CBDC. It is conceivable that a Federal Reserve CBDC, or even the prospect of establishing one, could hinder innovation by encroaching on that space.

In summary, the potential benefits of a Federal Reserve CBDC are not clear. Conversely, a Federal Reserve CBDC may bring significant and concrete risks. First, a Federal Reserve CBDC may pose significant challenges to the structure of our banking system, which currently relies on deposits to support the credit needs of households and businesses. If the Federal Reserve replaces commercial banks as the primary provider of funds to the public, it may limit the availability of credit, fundamentally altering the economy and exposing the public to a range of unforeseen and adverse consequences.

Among other potential issues, a dominant CBDC may disrupt the competition between commercial banks in attracting clients, suppressing consumer and other economic benefits.

A Federal Reserve CBDC may also become an attractive target for cyberattacks and other security threats. Bad actors may attempt to steal CBDCs, disrupt the CBDC network, or target non-public information about CBDC holders. The architecture of a Federal Reserve CBDC needs to be highly resilient to such threats and must remain resistant as bad actors employ increasingly sophisticated methods and strategies. Designing appropriate defenses for a CBDC network may be particularly challenging, as the entry points to a CBDC network may be much greater than the Federal Reserve's existing payment systems. Depending on design choices, anyone in the world could potentially access that network.

It is crucial that we ensure a CBDC does not facilitate illicit activities. The Bank Secrecy Act currently requires commercial banks to take measures to prevent money laundering. Policymakers need to consider similar anti-money laundering regimes for a Federal Reserve CBDC, but designing a CBDC that respects individual privacy while appropriately mitigating money laundering risks may be challenging.

In an extreme scenario, we could design a CBDC that requires CBDC holders to provide detailed information about themselves and their transactions to the Federal Reserve; this approach would minimize money laundering risks but raise serious privacy concerns. In another extreme scenario, we could design a CBDC that allows parties to transact entirely anonymously; this approach would address privacy concerns but increase significant money laundering risks.

The last risk is that developing a Federal Reserve CBDC may be costly and difficult for the Federal Reserve to manage. A Federal Reserve CBDC essentially could establish the Federal Reserve as a retail bank for the public. This would entail introducing large-scale, resource-intensive central bank infrastructure. We will need to consider the potential use cases of a CBDC, whether it is reasonable to expand the Federal Reserve's responsibilities into unfamiliar activities, and the risks of politicization.

In conclusion, I emphasize three points. First, the U.S. payment system is very good and getting better. Second, the potential benefits of a Federal Reserve CBDC are not clear. Third, I believe that developing a CBDC may bring significant risks.

Therefore, as we cautiously evaluate the case for developing a Federal Reserve CBDC, we have broken down the issues. Even if other central banks have successfully issued CBDCs, we cannot assume that the Federal Reserve should issue a CBDC. Chairman Powell's recent release is a genuinely open and undecided process, and while I clearly believe that the threshold for establishing a U.S. CBDC is high. The forthcoming discussion paper constitutes the first step in this process, and it is crucial to solicit public feedback. I look forward to reviewing the public's feedback on the discussion paper, which will provide valuable insights for the Federal Reserve's final assessment of a potential CBDC.