Giving the dollar a digital makeover

Gm, degens. Hear me out: Central bankers are like barbers. All it takes is one bad experience—a suddenly crooked hairline or a destabilizing interest rate strategy—to totally tarnish your reputation with the masses.

And reputation matters. So today, let’s explore the ways the world’s largest central bank, the U.S. Federal Reserve, is carving out a reputation of its own within today’s digital dollar debate.

—Vincent

Jerome Powell: Regulation > Innovation

At a conference hosted by the Bank of France last week, U.S. Federal Reserve Chair Jerome Powell said that there were “significant structural issues in the DeFi ecosystem” and warned that, despite the economy’s escaping relatively unscathed from this crypto winter, future downturns might be more bleak for the world beyond crypto.

Powell had few details on how the US might innovate with the US dollar to compete with crypto, however. In a panel with the ECB’s Christine Lagarde and other central bankers, Powell mainly focused on the regulation of crypto whereas his ECB counterpart focused on innovation and the need for a central bank digital currency (CBDC).

CBDCs are central bank issued and maintained, and few have made it out of the proof-of-concept stage. Many crypto proponents think that CBDCs would be redundant in a world where stablecoins exist. (Powell also noted that stablecoins need regulation to ensure their reserves can always be redeemed one-for-one to the US dollar and don’t lose their peg).

Crypto folks are also concerned that CBDCs are a way for governments to keep control of the monetary system. For several countries, this reasoning does drive a significant portion of their thinking around digital currencies.

Based on Powell’s comments, the US seems to be operating from a more confident position. Thus, US policymakers have mainly focused on reining in financial excesses in crypto instead of on developing a digital currency now that could compete with the industry.

Same old song: Powell reiterated that the Executive Branch and Congress would have to approve a digital dollar for it to launch. “So, we see this as a process of at least a couple of years, where we’re doing work and building public confidence in our analysis and in our ultimate conclusions, which as I say, we certainly haven’t reached yet,” Powell said.

A different tack: Lagarde suggested that innovating in CBDCs was crucial to preserving the euro’s reserve status. “If we are not in that game, if we are not involved in experimenting, in innovating, in terms of digital central bank money, we risk losing the role of anchor that we have played for many, many decades,” said Lagarde.

The irony: Villeroy de Galhau—the governor of the Bank of France—pointed out the incongruence between Lagarde and Powell, saying he would have guessed the Europeans would be focused on crypto regulation while the Americans would be focused on crypto innovation since the Fed is behind its peers.

Why is that, Jay? For its part, the Fed has already published a paper on the pros and cons of a CBDC and published open-source software that a CBDC would theoretically run on.

Powell noted that the Fed plans to roll out its FedNow system, which will offer instant settlement for payments, in 2023. What a CBDC offers which FedNow doesn’t would be free cross border payments. (Although, cheaper cross border payments are possible without CBDCs).

Nevertheless, other countries are advancing CBDCs on a quicker timeline than the Fed. This past week China expanded its CBDC trial to four provinces, according to the South China Morning Post. The government is incentivizing citizens to use the e-CNY digital currency by giving them cash rewards and then asking merchants to accept the currency.

The government has also allowed businesses to use e-CNY in corporate loans and taxes, further expanding its use and building trust in the new digital currency.

The Federal Reserve is hesitant in part because:

• It’s not sure if it has the authority (under the Federal Reserve Act) to issue a CBDC on its own.

• US lawmakers are reticent about creating a digital currency when the dollar already holds the status of being the world’s reserve currency.

• Crypto replayed some of the mistakes of the 2008 financial crisis (which the US started).

What to watch for next: Dollar hegemony isn’t guaranteed, and the Fed is exploring CBDCs in part because it views private and foreign digital currencies as potential future threats to its payments system. The Fed may be forced to speed up its CBDC plans if other CBDCs begin to threaten the dollar.

And that’s what you need on your radar this week in crypto. Does the world need a CBDC? Will the dollar maintain its dominance in the face of growing global crises? Let us know what you think and tune in Tuesday for the next Coinsider Radar.