Cryptocurrency is a recent invention that dates to the release of the original Bitcoin white paper and protocol by the enigmatic Satoshi Nakamoto in 2008. However, in the years since, Bitcoin has steadily expanded from a niche interest into a multi-billion-dollar industry and spawned thousands of new digital currencies along the way.
Today, an increasing number of consumers and businesses seek to use cryptocurrencies for payments or digital asset investments. Yet as the industry matures and intersects with a banking and payments industry developing new faster payment technology, questions remain about what will come next for cryptocurrency and how its evolution will impact, and possibly disrupt, community banks and even national economies. Will stablecoins bring greater stability or create new consequences for banks, governments, and consumers alike?
The Bank for International Settlements defines a stablecoin as a “cryptocurrency that aims to maintain a stable value relative to a specified asset, or pool or basket of assets.”
Stablecoins seek to address and overcome many of the challenges associated with cryptocurrencies, particularly their instability, to create systems that can provide platforms for payments and potentially enable a new generation of “programmable money” that self-executes transactions using smart contracts.
There are a few different ways in which stablecoins attempt to maintain a stable value, including pegs to stable national currencies (e.g., U.S. dollar) or backing by real-world commodities like gold or oil reserves.
Several different types of stablecoins exist, such as Tether and USDC, and the market is expanding rapidly. Total transaction volume exceeded $360 billion for the first time in February 2021, and Tether reached a new market capitalization of approximately $30 billion.
However, one stablecoin project that has caught the attention of regulators and central bankers worldwide is Diem, formerly known as Libra.
Diem is a stablecoin project in development by a collection of companies, including Facebook and Coinbase, that aims to establish multiple single-currency stablecoins in an effort to “enable a simple global payment system and financial infrastructure.”
After the project was first announced, central bankers, such as Governor Lael Brainard, cautioned that global stablecoins “could disintermediate the role of banks in payments” and “have implications for the role of central banks and monetary policy.” Additionally, due to their goal of providing cross-border payments, Governor Brainard also stated that “[Diem]’s intended global reach would likely necessitate a consistent global anti-money-laundering framework in order to reduce the risk of illicit transactions.”
Stablecoins may offer new payment capabilities in the future, but those capabilities should not come at the expense of community banks’ vital role in delivering financial services to Americans. ICBA urges policymakers to ensure that stablecoin issuers employ rigorous AML/KYC programs to prevent financial crimes and guard against potential systemic threats to the wider payment and banking systems.
Cryptocurrency and Financial Crime
Policymakers, regulators, and law enforcement authorities have significant concerns about the use of cryptocurrencies for illicit activities, including money-laundering, sanctions evasion, and ransomware.
Calculating the total dollar amount of crypto-related crimes is difficult, but FinCEN reported in December 2020 that it received “approximately $119 billion in suspicious activity reporting associated with [cryptocurrency] activity taking place wholly or in substantial part in the United States” in 2019. Moreover, FinCEN indicates that this amount equaled almost 12 percent of all cryptocurrency transactions “being relevant to a possible violation of law or regulation.”
Additionally, consumers and businesses are frequent targets of a variety of scams and other financial crimes, such as ransomware and hacks of cryptocurrency exchanges.
Consumers have an acute risk from crypto-related scams and crimes because cryptocurrencies lack protections afforded under U.S. laws and regulations. For example, cryptocurrencies are not covered by Regulation E, the primary regulation that establishes processes to dispute unauthorized transactions and for financial institutions to resolve those claims. Unfortunately, if a criminal can access a consumer’s cryptocurrency, the funds will likely be stolen and there is little to no recourse to recover the stolen assets.
State and federal regulators and policymakers have recently taken actions to establish more oversight for crypto-related companies and highlight the myriad risks to consumers.
In March 2021, New York Attorney General Letitia James issued an alert advising consumers to “extreme caution when investing in virtual currencies.” The alert warned consumers that digital asset investors may be exposed to risks such as “wild price swings, conflicts of interest among trading platform operators, and increased chances of market manipulation.” These statements followed legal actions by her office to protect consumers with lawsuits against illegal cryptocurrency exchanges.
Community banks and cryptocurrency
Some community banks are starting to explore offering custodial services for digital assets; however, many remain cautious about adopting these services due to a variety of risk mitigation and regulatory concerns.
Early adopters are pursuing a range of crypto-related services, such as custody of digital assets or debit card bitcoin rewards programs. It remains to be seen whether and how quickly other community banks will offer similar services. Nonetheless, there appears to be a growing interest among consumers in not only cryptocurrencies but also greater participation from their banks.
A January 2021 survey by NYDIG, a custody service provider, reveals that 80 percent of Bitcoin holders would move their assets to their bank if it provided secure storage. If this sentiment continues to build, more community banks may choose to offer crypto-related services to meet new customer demands and expectations.
Cryptocurrency and Bank Charters
As cryptocurrency adoption expands, the Office of the Comptroller of the Currency (OCC) and several states are exploring special bank charters to help normalize crypto-related financial services and provide avenues for these companies to access the payment system.
Although innovation in financial services can enable new ways for citizens and businesses to engage in transactions and obtain critical services, these innovations should not jeopardize a safe and sound banking and payment system.
These new charters for non-bank companies challenge long-standing principles separating banking and commerce and potentially introduce systemic risk into the payment system.
ICBA urges policymakers and regulators to ensure that cryptocurrency companies fully meet the requirements of federally insured chartered banks before granting any charter or access to the Federal Reserve’s payment system.
In the past year, the cryptocurrency industry has been rocked by high-profile collapses of cryptocurrency lenders and exchanges, notably FTX, as well as the failure of a major algorithmic stablecoin (TerraUSD), and a significant decline in overall market values.
Community bankers are increasingly alarmed by the risks presented by digital assets, including scams and misrepresentations to consumers, and their growing potential to jeopardize the financial stability of the traditional banking sector. Community banks are at risk of disintermediation if stablecoins become widely adopted for payments.
ICBA urges policymakers to develop a consistent regulatory framework for stablecoins that addresses the risks they pose to the wider financial system and preserves the separation of banking and commerce. Likewise, DeFi, a growing ecosystem of financial applications that run on public blockchains, threatens to disintermediate community banks and create a shadow banking system filled with unregulated platforms that pose risks to consumers, the financial system, and U.S. national security. Any regulatory regime applied to cryptocurrency should be comparable to the multitude of regulations applicable to traditional, functionally similar payments products and services offered by the banking system.
Cryptocurrencies also have a long history of being used for illicit activities, including sanctions evasion and money laundering. Broader use of cryptocurrency, without accompanying regulation or oversight, allows financial crimes and threats to national security to proliferate. Therefore, protecting national security and implementing anti-crime measures should be primary drivers of cryptocurrency policymaking and regulation.
Against the backdrop of accelerating interest in digital assets and stablecoins, countries across the globe are assessing the risks and merits of central bank digital currencies (CBDCs). According to the Bank for International Settlements (BIS), 90 percent of central banks are exploring CBDC, and more than half are now developing them or running concrete experiments.
Concerns of potential threats and loss of control over the payment system from privately issued stablecoins, digital currencies and CBDCs issued by foreign nations are accelerating U.S. plans. The Federal Reserve Bank of Boston has partnered with the Massachusetts Institute of Technology (MIT) to jointly build and test a hypothetical digital currency for general purpose use.
The report of the findings of the preliminary phase of Project Hamilton explores the architecture needed for a possible digital version of the U.S. dollar as a medium of exchange. It examines how to support the scale, security, speed, and other factors necessary for such an endeavor.
The Federal Reserve also released several documents designed to catalyze public dialog and feedback. In 2021, it established preconditions needed for a digital dollar that include clear policy objectives, broad stakeholder support, a strong legal framework, robust technology and market readiness. In January 2022, the Federal Reserve released a long-awaited consultation paper entitled Money and Payments: The U.S. Dollar in the Age of Digital Transformation.
This report highlights the opportunities, threats, costs and benefits of creating a CBDC in the U.S. The Fed noted that it was not seeking to promote a specific outcome and issued a request for information. The Fed promised not to move forward “without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.”
ICBA provided comments on the consultation paper, opposing the creation of a U.S. CBDC:
In March 2022, the Biden Administration released an Executive Order which directs the U.S. government to “assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests. The Order also encourages the Federal Reserve to continue its research, development, and assessment efforts for a U.S. CBDC, including development of a plan for broader U.S. Government action in support of their work. This effort prioritizes U.S. participation in multi-country experimentation and ensures U.S. leadership internationally to promote CBDC development that is consistent with U.S. priorities and democratic values.”
A CBDC could fundamentally change the structure of the U.S. financial system, altering the roles and responsibilities of the private sector and the central bank. ICBA has serious concerns with a U.S. CBDC which are described below in our 2022 policy resolution. ICBA looks forward to continued dialogue with the Fed and other policymakers on the question of a U.S. CBDC and other digital asset issues.
The White House, the Federal Reserve, and Treasury are actively exploring the creation of a Central Bank Digital Currency (CBDC), defined as “a digital liability of a central bank that is widely available to the general public.” Policymakers are studying the risks, costs, and benefits a CBDC as well as its implications for economic growth and stability, financial inclusion, and illicit financial activity.
The economics of a CBDC – both direct costs to build and deploy as well as the economic impact– are not well understood. Moreover, policy goals of a CBDC can be achieved by other means. With the impending introduction of FedNow instant payment services and increased Same Day ACH adoption, Americans are enjoying faster transactions clearance and can expect further innovations to be built upon these rails. FedNow must be given a chance to succeed in achieving payments modernization.
A CBDC could destabilize existing banking and payments systems that are the backbone of our economy and markets. The introduction of CBDC could erode the Federal Reserve’s ability to conduct monetary policy and interest rate control by altering the supply of reserves in the banking system and forcing the Fed to balloon its balance sheet. Depositors may prefer CBDC over bank deposits in a crisis even if the CBDC has a less attractive rate of return, introducing the potential for bank runs. The Federal Reserve must preserve the vital role of community banks as economic engines of the U.S. economy.
 Comparing Means of Payment: What Role for a Central Bank Digital Currency?, https://www.federalreserve.gov/econres/notes/feds-notes/comparing-means-of-payment-what-role-for-a-central-bank-digital-currency-20200813.htm.