New research from the Bank for International Settlements (BIS) reveals countries are plowing ahead with central bank digital currencies (CBDCs) despite little public appetite and crumbling rationales for proceeding.
CBDCs are knock-off versions of cryptocurrency run by central banks. According to a just-released BIS survey, nine of ten countries are exploring CBDCs and more than two-thirds state they will or might likely release one in the short to medium term.
CBDCs lack public support worldwide
CBDC alacrity comes despite little evidence of public clamor for digital versions of fiat money. For example, in the European Union public response has been intense and “overwhelmingly negative.” Two weeks after the European Commission invited public comment, over 11,000 responses poured in, few in support.
Similarly in the U.K., a recent poll showed 30% believe a “Britcoin” would be more harmful than beneficial and 24% think it could be beneficial. The rest were unsure.
In both instance fears over privacy and security topped the reasons people were distrustful of CBDCs.
In the U.S., the Federal Reserve released white paper in January that invited public comment. Privacy is likely to top concerns over a digital dollar as well. Americans’ fear would be justified. Just recently news reports revealed the FBI conducted as many 3.4 million warrantless searches of Americans in 2021. Moreover, the Center for Disease Control paid for data on millions of Americans cell phone locations.
Western populations do not support CBDCs
Adding to unease, justification for CBDCs are crumbling, particularly in the U.S. The Federal Reserve white paper revealed some expected, but not officially resolved design choices, that reduces supposed benefits.
For example, the Fed admits a U.S. CBDC would be “account based” (like credit cards as opposed to cash) and intermediated through private banks instead of direct Fed accounts. These design choices counter oft-asserted CBDC rationales. First, financial inclusion. Being intermediated through the private banking system means CBDC accounts will bear fees and will not mitigate the existing mistrust many unbanked people have toward banks and large institutions. As the Bank Policy Institute (BPI) stated:
Under an intermediated CBDC model, [unbanked] people would be required to establish an account at a bank or other financial company (including going through a full Know Your Customer process as required under anti-money laundering and sanctions rules), upload a digital wallet to a phone or computer, and then have their transactions monitored by the bank and perhaps by the government as well. No one has yet explained why a person reluctant to sign up for a bank account would embrace such a relationship. (Emphasis Added).
Further, Fed insistence on account-based CBDCs and attendant Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) monitoring would stifle another CBDC rationale: more efficient cross-border payments. As the BPI explains, AML/CFT requirements currently slow cross-border payments and using the different medium of CBDC would not solve this. Further CBDCs would have to be converted to local currency at each stage, this would come fees. A CBDC-to-CBDC system or multijurisdictional CBDC is years away.
Only global financial bodies support CBDCs
The BIS survey admits countries’ rationales for plowing ahead with CBDCs have little to do with stated reasons. They fear competition from cryptocurrencies, particularly stablecoins. Nearly 80 percent of advanced economies surveyed stated stablecoins had hastened their foray into CBDCs. Central bankers believe stablecoins pose risks to financial stability.
Yet authorities must weigh this fear against the financial instability CBDCs themselves would create. The Federal Reverse admits CBDC-triggered financial instability is a real concern:
Because central bank money is the safest form of money, a widely accessible CBDC would be particularly attractive to risk-averse users, especially during times of stress in the financial system. The ability to quickly convert other forms of money—including deposits at commercial banks—into CBDC could make runs on financial firms more likely or more severe.
When weighing CBDC pros and cons, the verdict should be clear. The public does not want them, official justifications lack credibility, and the potential downsides are not worth the risk.
The crypto market is suffering a severe correction. One asset feeling the pinch is LUNA, which along with its related nonprofit the Luna Foundation Guard (LFG) govern and support the stablecoin TerraUSD (UST). [Update: After the Terra Luna crash, authorities in South Korea and the U.S. are investigating founder Do Kwon].
UST is an algorithmic stablecoin. Instead of being backed by assets such as U.S. dollars, government securities, or commercial paper the volatile digital asset LUNA backs it. Users can theoretically always exchange $1 of LUNA for $1 of UST, which is how it maintains it dollar peg. But this depends on LUNA being valuable enough to support the exchange. According to CoinDesk, the Terra crypto ecosystem has dropped 53 percent in the past 24 hours. This has caused UST to drop as low as 35 cents, at the time of this writing it is trading around 70 cents.
Importantly, other stablecoins are holding their $1 peg, including DAI, which is tied to Ether, the second largest digital asset. In fact, for the absolute blood bath May has become in crypto markets, stablecoins have proved resilient.
Nonetheless, under the familiar political mantra ‘Never Let a Crisis Go to Waste,’ Treasury Sectary Janet Yellen seized on UST’s troubles to call for stablecoin regulation yesterday in Congressional testimony. Stating the current regulatory regimes, “don’t provide consistent and comprehensive standards for the risks of stablecoins.”
Congress should slow down before blindly jumping into reactive stablecoin lawmaking. First, the President’s Working Group (PWG) released their report on stablecoins last November. It does not even cover algorithmic stablecoins like UST, as Senator Pat Toomey (R-PA) correctly reminded Sectary Yellen. As the PWG report described, these stablecoins are a niche subset that have not gained the importance of what the PWG called “payment stablecoins”—those backed by real-world assets like U.S. dollars and treasuries.
Second even assuming the PWG applied to algorithmic stablecoins, the parade of horribles the report envisions has not occurred. The PWG warned of stablecoin runs turning systemic and even threatening the broader economy:
The prospect of a stablecoin underperforming as expected could result in a “run” on that stablecoin – i.e., a self-reinforcing cycle of redemptions and fire sales of reserve assets. Fire sales of reserve assets could disrupt critical funding markets, depending on the type and volume of reserve assets involved. Runs could spread contagiously from one stablecoin to another, or to other types of financial institutions that are believed to have a similar risk profile. Risks to the broader financial system could rapidly increase as well, especially in the absence of prudential standards.
Terra Luna crash will not harm the larger markets
Third, the entire stablecoin market stands at a relatively miniscule $173 billion. The Fed’s, Financial Stability Report, released on May 9, claims total asset market vulnerable to runs is $19.1 trillion.
Congress should be wary of creating another financial regulatory disaster like Dodd-Frank, as reactive measure to a market correction.
If UST falls, it should be a lesson for traders. Do not back a stablecoin with a relatively unproven reference asset and outlandish yields. Of course, people should be able to bet on riskier assets but their failure should not trigger a Congressional response.
This post originally appeared on the blog of the Competitive Enterprise Institute on May 12, 2022, https://cei.org/blog/terra-troubles-should-not-spur-stablecoin-regulation/
The financial press is again writing crypto’s obituary as a libertarian pipe dream. The Wall Street Journal’s Greg Ip offers as the latest proof, Bitcoin’s recent price drop, stablecoin TerraUSD’s crash, and crypto’s failure to revolutionize finance 13 years in. Mr. Ip then contrasts these failures with the supposed investor protections laden in the 1933 Act registration process.
Mr. Ip’s argument fails both logically and factually.
He first conflates Bitcoin and TerraUSD, as part of the crypto market that has fallen 56 percent since November. Bitcoin is a hackproof digital asset and payment settlement layer secured by 144 TWh of energy, slightly less than Egypt’s annual energy consumption. Together with side chain and above chain applications like Lightning, Liquid, RSK, and Stacks it can settle millions of payments in a single transaction block. TerraUSD was the 2018 brainchild of an ambitious entrepreneur with a flawed product that could not withstand market downturns. That some of the biggest names in crypto venture capital bought in, shows the human penchant for hype and slick marketing over technical capability.
In the long run, crypto will beat Wall Street. Mr. Ip’s reasoning that Bitcoin’s price drop shows the dollar’s strength is inverted. The U.S. government’s money-printing spree boosted Bitcoin’s price along with every other financial instrument in the past few years. Bitcoin may be first but stocks are next. The current four-month drop is the worst since 1939. It will get worse.
Finally, Mr. Ip mocks crypto’s supposed failure to eliminate financial middlemen and offer cheaper alternatives to the masses surmising 13 years is enough to prove its failure. But unless you were privy to obscure computer science list servs at the turn of last decade this isn’t quite right. In fact, Decentralized Finance (DeFi) that allows permissionless, trustless, trading, borrowing, and lending only began in 2018 San Francisco Meetup. Perhaps a little more time is warranted.
A rare real-life test case emerged recently that allowed observers to contrast government warnings with real world events. Reigning in the crypto markets has become a key priority for Biden administration financial regulators. In March the president signed an executive order seeking “responsible development” of crypto innovation. Last November, a President’s Working Group (PWG) composed of financial regulators released a report warning of dire consequences if a crypto subset known as stablecoins weren’t soon placed under a federal regulatory umbrella. (Stablecoins are digital assets pegged to a stable monetary value, usually the U.S. dollar.).
PWG Predicts Stablecoin Crash
The report came laden with doom and gloom or FUD in crypto speak (Fear Uncertainty and Doubt). One PWG concern was that a stablecoin failure could spark a “run” and a general economic calamity:
Failure of a stablecoin to perform according to expectations would harm users of that stablecoin and could pose systemic risk. The mere prospect of a stablecoin not performing as expected could result in a “run” on that stablecoin – i.e., a self-reinforcing cycle of redemptions and fire sales of reserve assets. Fire sales of reserve assets could disrupt critical funding markets, depending on the type and volume of reserve assets involved. Runs could spread contagiously from one stablecoin to another, or to other types of financial institutions that are believed to have a similar risk profile. Risks to the broader financial system could rapidly increase as well, especially in the absence of prudential standards.
In a recent speech, Securities and Exchange Commission (SEC) Chairman Gary Gensler, a PWG member echoed these concerns. “[S]tablecoins are so integral to the crypto ecosystem that a loss of the peg or a failure of the issuer could imperil one or more trading platforms, and may reverberate across the wider crypto ecosystem.”
Threat Stablecoins Could Crash Opens Door to Regulation
The risks were supposedly so dire, that if Congress demurred, the PWG requested the Financial Stability Oversight Council—an artifact of the Dodd-Frank law—impose regulatory authority sua sponte without input from elected representatives.
As fate would have it, the market produced a test case for the government’s warnings. When stablecoin TerraUSD (UST) spectacularly crashed in May taking down crypto token Terra and $40 billion in the process, all the government’s fears seemed to be coming to fruition.
That UST was an unbacked “algorithmic” stablecoin—a type unaddressed by the PWG report—instead of an asset-backed stablecoin did not seem to matter. Treasury Secretary Janet Yellen testified “[w]e’ve had a real-life demonstration of the risks,” that required the PWG’s suggested “comprehensive framework” to eliminate “gaps in the regulation.”
Asset-Backed Stablecoins are not Crashing
But a funny thing happened on the way to economic collapse: Nothing. Tether, the largest stablecoin did briefly de-peg to 95 cents. And it lost $10 billion in volume as some rushed to convert their Tether dollars into fiat dollars. But amidst the chaos, Tether tweeted reassurance anyone that wished to convert could.
Crisis over. The biggest asset-backed stablecoins all attest to the integrity of their reserves. Today the stablecoin market stands at $159 billion with none in danger.
Academics, journalists, and policy makers will study the Terra ecosystem collapse in the months and years ahead. Clearly, no one has ‘cracked the code’ for sustaining an algorithmic stablecoin under severe market stress.
But that is a market issue not a government issue. A comprehensive federal framework will inhibit not help stablecoin stability.
Everyone except Securities and Exchange Commission (SEC) chair Gary Gensler sees the federal government’s approach to crypto is a mess. Various cohorts, including academics, SEC Commissioners, and lawmakers, have offered alternatives to Mr. Gensler’s “Enforcement Only” approach. Unfortunately, some proffered solutions would worsen the problem.
Paul Watkins and Danielle DuBose recently published an academic article suggesting the states should lead the crypto regulatory charge amid federal intransigence. This approach would fail for several reasons including the lack of motivation for states to cooperate and the hardships it would produce even if they did cooperate. A better solution would be to remove digital assets from the purview of investment-contract analysis and allow private ordering as the most successful security exemption already does.
Watkins and DuBose propose a two-part state-led solution. First, states should exercise their anti-fraud powers to pursue bad crypto actors. Second, they should provide a two-part safe harbor from state-level securities law and reciprocity between cooperating states. But the states are unlikely to agree to this venture. Some like New York have burdensome and onerous crypto regimes, others seeking crypto investment like Wyoming provide issuer-friendly rules. States with vastly different approaches likely won’t cooperate on standardization. Watkins and DuBose point to state adoption of the Uniform Securities Act while noting Arizona, California, Florida, Illinois, New York, North Dakota, Ohio, Tennessee, and Texas have refused adoption. Some important states are on that list.
States cannot agree on anything
It is even worse for money transmission laws. Peter Van Valkenburgh, Research Director at Coin Center notes only 12 states have adopted the model money transmission law developed almost two decades ago. There would likely be similar reluctance for a crypto safe harbor given the divergent regimes already in existence, the natural competition between states, and the fact many struggle to define crypto’s basic concepts. Issuers would have to comply with each state that declined the safe harbor by either registering with that state or observing its particular exemption—a legal nightmare.
Yet, even in the unlikely scenario all or almost all the states agreed to the proposed framework it would still be unfeasible. The paper proposes two ways crypto issuers could attain the safe harbor. First they could qualify through one of six statutory qualifications. Second issuers could seek an exemption via a government official which through reciprocity other states would accept.
State crypto lead would not preclude federal involvement
The authors specifically designed the safe harbor to survive a federal court challenge rooted in the Howey test and other cases that determine whether a particular instrument is an “investment contract” and thus a security under federal law. “The statutory qualifications and factors for the state official to consider are designed to exempt tokens that do not meet the definition of security under federal law as interpreted by Supreme Court precedent.” Thus, the framework is a federal analysis that doesn’t include or bind federal regulators.
The folly of this approach is shown by the arduous analysis issuers must traverse to qualify for the safe harbor. This is particularly under state-bureaucrat exemption. A nightmare of factors stacked like cordwood each making the existence of a federal security “more likely” or “less likely.”
Particularly bemusing is the strict admonishment against profit, or potential profit seeking and instead the focus on consumption. The authors may rejoin their multifactor analysis is what federal precedent requires. And they are tailoring disclosures to be more germane to crypto issuers than those required under the 1933 Act.
This may be true, but it shows why regulators need new thinking. It is likely. as the authors suggest, their disclosure regime focusing on the token itself, source code, transaction history and other factors better protect investors than disclosures required by traditional registration. But that hardly moves the ball forward.
Private ordering works, not state crypto rules
If their suggested disclosures are important, investors would demand them without the expense and ambiguity of wading through endless factors. This is how Regulation D 506(b) works. The government mandates no disclosures, but Private Placement Memorandums provide what investors consider most important. The success of this exemption—limited essentially to accredited investors—is undeniable. It outpaced the entire public market by itself in 2019.
Congress should remove “investment contract” analysis from the definition of security for digital assets. The Howey test and its progeny have no place in determining assets unfathomable when W.J. Howey, an enterprising salesman, offered orange grove plots to Florida tourists decades ago. The market will demand the information necessary. Some issuers will lie, some offers will be fraudulent. But decades of mandated disclosures have done little to deter scammers as scholars Stuart Cohn and Gregory Yadley lamented in 2007, “[Ex]amination of the securities violations . . . reveals that no amount of technical exemption requirements will hinder the fraud artists from their endeavors. . . . Fraudulent and deceptive schemes have unfortunately continued unabated and independent of formal registration or exemption requirements.” Those still unconvinced can visit the SEC’s website on any given day and view the commission’s ten most recent press releases.
States should lead on fraud prosecutions
States do have a role to play in crypto. It is prosecuting fraudsters. Stiff penalties and jail time are the best deterrent not incompressible new multifactor analyses.
thecrowdfundinglawyers.com founder Paul H. Jossey debated the future of stablecoin regulation with former Commodity Futures Trading Commission chair Timothy Massad.
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