On April 7, 2022, the U.S Secretary of Treasury Janet Yellen delivered her first speech on digital assets at the American University’s Kogod School of Business Center for Innovation.
The speech comes in response to President Joe Biden’s executive order on crypto (E.O.), which called for a coordinated and comprehensive government approach to digital asset policy. To fulfill the objectives laid down in the E.O. and to produce foundational reports and recommendations related to these objectives, over the next six months, the U.S. Department of Treasury will be working closely with the White House and other relevant agency partners.
Further, Janet Yellen reminded the attendees that though digital assets may be relatively new, they are part of a larger trend – the digitization of finance – that has been in the making for decades. She acknowledged that though the U.S. Department of Treasury may not be able to predict the exact result of the foundational reports; however, it is not navigating without a compass. “Though digital assets may be new, many of the issues they present are not,” explained Janet Yellen.
Finally, Janet Yellen highlighted five lessons that should be applied to the U.S. Department of Treasury’s work on digital assets, as it navigates the opportunities and challenges posed by these emerging technologies.
Five lessons that will guide the U.S. Department of Treasury’s work on digital assets
[I] The U.S. financial system will benefit from responsible innovation
Janet Yellen noted that “innovation that improves our lives while appropriately managing risks should be embraced.” She primarily discussed innovative technologies that have transformed financial services over time. Though she recognized improvements in the payment systems she also stated that transactions still take too long to settle.
She explained the pitfalls of delay in settlements with an example: “If you live in a G7 country, you may pay below two percent in transaction and conversion fees to send money across the border. If you live in the developing world, you may pay as high as ten percent. These high costs disproportionately impact the 250 million-plus migrants around the world who spend an average of $200 to $300 in remittances to their families each month.”
While developing new technologies to improve the payment system, overcoming issues like processing time, cost, and technological barriers to access have to be prioritized. As a liability of the central bank, CBDC could become a form of trusted money comparable to physical cash. However, before developing CBDCs, she stated that thorough research has to be done to understand the risks and regulatory concerns that they may present. To ensure responsible innovation, the Biden administration is working on a report that will among other things, analyze the possible design choices related to a potential CBDC and its implications for payment systems, economic growth, financial stability, financial inclusion, and national security.
[II]When regulation fails to keep pace with innovation, vulnerable people often suffer the greatest harm
Janet Yellen pointed out that while making regulations for digital assets, the policymakers should not forget the lessons learned from the 2007-2008 Financial Crisis. She shed light on the fact that the economic distress from the Great Recession was “most acute and long-lasting for Black Americans and other Americans of color. We need to ensure that the growth of digital assets does not allow similarly dangerous risks to emerge or lead to disproportionate impacts to vulnerable communities.”
Janet Yellen reiterated some of the risks that were discussed in the President’s Working Group on Financial Market’s report on stablecoins, including systematic and consumer protection risks. Moreover, she also observed that currently, stablecoins are subject to inconsistent and fragmented oversight.
To peg their stablecoin to a dollar, most issuers claim that they back their coins with traditional assets that are safe and liquid. This way, whenever users want to trade their stablecoin back into a dollar, the stablecoin issuers have the money to make the exchange. Right now, however, no one can verify these claims, she stated. Moreover, in times, of stress, the uncertainty could lead to a run. In fact, the mere prospect of a stablecoin not performing as expected could result in a “run” on that stablecoin, which may occur when many stablecoin holders try to liquidate their holdings, resulting in a “fire sale” of reserve assets. Fire sales of reserve assets are especially detrimental as they may lead to disruption of critical market functions, depending on the type and volume of reserve assets involved.
“This is not hypothetical. A stablecoin run occurred in June 2021, when a sharp drop in the price of the assets used to back a stablecoin set off a negative feedback loop of stablecoin redemptions and further price declines.” she cautioned. “The PWG report on stablecoins assesses these risks and proposes concrete solutions. We are now working with Congress to advance legislation to help ensure stablecoins are resilient to risks that could endanger consumers or the broader financial system.” she said. While making regulatory frameworks, not just for stablecoins, but for the larger ecosystem of digital assets, the policymakers should strike a balance between promoting innovation and addressing risks, especially those that could disrupt the financial system and economy.
[III]Regulation should be based on risks and activities, not specific technologies
“When new technologies enable new activities, products, and services, financial regulations need to adjust. But, that process should be guided by the risks associated with the services provided to households and businesses, not the underlying technology,” explained Janet Yellen.
She urged the regulators to apply the principle of tech neutrality when addressing concerns related to tax evasion, illicit finance, and national security. She gave instances of when the regulators should take a tech-neutral approach — consumers, investors, and businesses should be protected from fraud and misleading statements regardless of whether assets are stored on a balance sheet or distributed ledger. Similarly, firms that hold customer assets should be required to ensure those assets are not lost, stolen, or used without the customer’s permission.
Janet Yellen stressed that it is illegal to launder money or avoid sanctions and irrespective of whether it is being done using checks, wires, or crypto. She also added that the U.S. Department of Treasury has been continuously monitoring innovations in digital assets and updating our rules and guidance to clarify the application of its AML/CFT framework to the digital asset ecosystem.
[IV]Sovereign money is the core of a well-functioning financial system and the US benefits from the central role the dollar and US financial institutions play in global finance
Monetary sovereignty and uniform currency have brought clear benefits for economic growth and stability and have established the U.S.’s dominance in the global financial system. For instance, the U.S. dollar is the most widely used currency for global trade and finance. It is by far the most traded currency, accounting for nearly 90% of the foreign exchange transactions and over half of the trading invoices. U.S. citizens, she observed, derive significant economic and national security benefits from the unique role the dollar and US financial institutions play in the global financial system. She reminded that E.O. has directed the U.S. Department of Treasury to consider whether and how the issuance of a public CBDC would support this role.
Further, she pointed out that issuing a CBDC would likely present a major design and engineering challenge that would require years of development, not months. Therefore, she shared President Biden’s urgency in pulling forward research to understand the challenges and opportunities a CBDC could present to American interests.
While researching the economic and national security implications of CBDC, she said that the following questions should be kept in mind
- What impact would a U.S. CBDC have on implementing macro stabilization policies and private credit creation?
- Could it make the financial system more equitable, accessible, and inclusive?
- How could it be designed to manage risks associated with national security and financial crime, while including privacy protections?
- How might a US CBDC interact with existing national currencies, foreign CBDCs, or private stablecoins?
[V] We need to work together to ensure responsible innovation
Ultimately, she highlighted that the government’s role should be to ensure responsible innovation — an innovation that works for all Americans protects our national security interests and our planet, and contributes to our economic competitiveness and growth. Such responsible, innovation, she said, should reflect thoughtful public-private dialogue and take account of the many lessons we’ve learned throughout our financial history. Janet Yellen concluded that “this sort of pragmatism has served us well in the past and I believe it is the right approach today.”
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