Crypto watchers eager for signals on Fed's digital dollar plans

WASHINGTON — The Federal Reserve has left the financial markets somewhat in suspense about whether the central bank is serious about issuing its own digital currency. But some clarity could be right around the corner.

The Fed is set to release a report next month detailing its thinking about a digital dollar, financial stability concerns regarding private stablecoins and other policy questions related to the digital payments sphere.

While the paper would likely kick off a further process of public dialogue and internal policymaking rather than bring resolution, many expect the Fed to use the report to signal whether the digital dollar will be a reality.

“The first thing they're going to have to decide is, do we go ahead with this at all?” said Mark Carey, co-president of the Global Association of Risk Professionals and a former Fed official.

The market will also be looking for signs of the Fed's expectations for private stablecoin issuers and how the central bank would address privacy concerns about a digital dollar, among other concerns.

Many in the private sector have warned that a Fed digital currency could threaten other stablecoin issuers, since consumers would prefer the safety of central bank support. The report could recommend steps for private issuers to take to inform users about which assets back their stablecoins in order to compete with the government.

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“This report could be a shot over the bow: Here's what the Fed intends to do on a digital currency, and if you want your currency to survive or coexist with a central bank digital currency, you're going to have to be as transparent, perhaps, as the Fed intends to be,” said Bruce Mizrach, a professor in the economics department at Rutgers University.

Fed Chair Jerome Powell said in a video message in May that the paper “represents the beginning of what will be a thoughtful and deliberative process,” and that he expected the Fed to solicit public feedback after the paper is published, in the hopes it will “stimulate broad conversation.”

Some observers warned that while the Fed could indicate its intentions around a digital dollar, it may still leave a lot unanswered.

“At some level, this is the Fed preparing its to-do list of what it needs to figure out,” said David Portilla, a partner at Cravath, Swaine & Moore, “but I don't anticipate it will come to too many firm conclusions at this stage.”

Still, industry experts have a long list of questions that they hope the paper will seek to clarify, including whether a digital dollar is necessary given how active the private sector has already been.

“The first thing I'd like to see is a further definition and clarity around the need for a CBDC,” said Stephen Gannon, a partner at Murphy & McGonigle. He noted that Fed Vice Chair for Supervision Randal Quarles and Fed Gov. Christopher Waller have been skeptical about the use cases for a digital dollar. “I think that's an indicator that there probably should be a little bit more clarity around: Is this all worth the candle?”

Carey expects the report to explore the pros and cons of a digital dollar. Many of those pros and cons have previously been addressed in speeches by Quarles and Waller, as well as Fed Gov. Lael Brainard, who has been more bullish on the need for a CBDC. Brainard has also pointed to the growing popularity of stablecoins as one of the reasons the Fed might decide to move forward with a digital dollar.

"Probably, the next thing you'll see is what we have seen over the last several months, which is some combination of speeches, and then more requests for comment,” Carey said.

There are a multitude of unknowns about how a digital dollar might work in the U.S. that the Fed is likely still contemplating.

For example, it’s unclear if the Fed is interested in a “direct” CBDC model, which would involve the Fed holding and maintaining individual accounts for digital dollar holders, or an “indirect” model in which digital dollars would be distributed through intermediaries such as banks or fintech companies.

While it’s doubtful that the Fed will come to any definitive conclusions in the paper, it may offer more information on how it might coordinate its digital payments efforts with other central banks, and what a potential timeline for a CBDC could look like, said Gannon.

“Chairman Powell has been very clear in saying, 'I want to do [a CBDC] right rather than do it fast,' ” he said. “But it would be helpful to have some stakes in the ground as to what, for example, sort of markers on the critical path does the team expect to be hitting.”

The Fed could also elaborate on how a digital dollar might balance privacy concerns while at the same time ensuring that a CBDC wouldn’t be used for criminal activities, like money laundering or terrorist financing.

Some have expressed concern that a “direct” CBDC model would enable the federal government to oversee the finance of U.S. citizens, and that the Fed would have to help police money laundering similar to the anti-laundering requirements currently imposed on banks.

At the same time, an “indirect” CBDC model may run counter to the financial inclusion goals of a digital dollar because users would likely have to hold accounts at banks.

The Fed is "very aware that the U.S. public both wants privacy, but does not want financing of illicit activities, certainly not facilitated by the Federal Reserve,” said Carey. “So it will be interesting to see if the report goes beyond that tension, or if it comes out more strongly, implicitly, on” an indirect model versus a direct model of distribution.

The Fed’s upcoming paper will also likely discuss whether a CBDC would eliminate the need for private-sector stablecoins, which are pegged to real-world assets and currencies.

Stablecoins have been of particular interest to financial regulators. Treasury Secretary Janet Yellen convened the President’s Working Group on Financial Markets in July to discuss stablecoins. That group is expected to issue recommendations in the coming months on how stablecoins might be regulated.

Powell also told lawmakers in July that stablecoins should be regulated to bring them more in line with standards for bank deposits and money market funds.

“I'm looking forward to what they say about how the Fed CBDC work is going to be impacted by the continued evolution of stablecoins,” said Gannon. “That is something that the chair was very clear about: If we had a CBDC, we wouldn't need stablecoins, but we do have stablecoins, and they're evolving all the time.”

The Fed is unlikely to disclose anything concrete on how stablecoins might be regulated in the future, especially as the President’s Working Group is still contemplating recommendations, said Portilla.

The paper "might put forward some ideas as to what that framework could be, but I also suspect that it may simply meditate on the risks and why a framework is necessary without proposing a particular framework,” he said.

Carey agreed, adding that he “would be surprised” if the report “had any surprises.”

“They have been crystal clear that the report is not going to take a position about whether the Fed should do a CBDC or its details or when it should be done,” he said. “It's just really going to ask a lot of questions and provide background in hopes of getting feedback and knowledge.”

The next step after the report, said Gannon, is getting those questions answered.

“I think this will be a detailed paper that will be teeing off a very robust set of public comments that will probably take some time to both produce and digest,” he said. The Fed "will probably come out after that with some policy initiatives, and then hopefully a series of progress reports on exactly where we are.”