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House FSC Task Force on FinTech CBDC Hearing

House Financial Services Task Force on Financial Technology

Digitizing the Dollar: Investigating the Technological Infrastructure, Privacy, and Financial Inclusion Implications of Central Bank Digital Currencies

Tuesday, June 15, 2021

 

Witnesses

  • Carmelle Cadet, Founder and CEO, EMTECH
  • Jonathan Dharmapalan, Founder and CEO, eCurrency
  • Rohan Grey, Assistant Professor of Law, Willamette University
  • Dr. Neha Narula, Director of the Digital Currency Initiative, MIT Media Lab
  • Dr. Jenny Gesley, Foreign Law Specialist, Library of Congress

Opening Statements
Task Force Chairman Stephen Lynch (D-Mass.)

In his opening statement, Lynch emphasized the decline of cash but also noted its continuing critical role in the financial ecosystem. He added that the U.S. must consider a Central Bank Digital Currency’s (CBDC) effects on financial inclusion, consumer privacy, illicit finance, and business operations. Lynch then posed a series of hypothetical questions to guide the Task Force’s discussion focusing on access, privacy, illicit finance, and development of digital currency technology.

 

Task Force Ranking Member Warren Davidson (R-Ohio)

In his opening statement, Davidson emphasized that we are still in the learning phase of a CBDC and that these hearings are crucial to communicate what is already known about CBDC. Davidson said it is important to be receptive to new ideas for a CBDC and that digital currency should be used to improve the current payment system rather than to replace it. He also pointed out that a CBDC would improve financial stability, consumer protection, and privacy protections. Davidson said the U.S. should preserve cash in the U.S. payment system even with the implementation of a CBDC. Davidson brought up the devaluing of the U.S. dollar and said that to maintain the U.S. dollar’s dominancy as the world reserve currency, it needs to be stable. If the U.S. decides to pursue a CBDC, Davidson believes that the government should steer away from becoming a consumer data collection agency and uphold consumer privacy protections. Davidson advocated for a token based CBDC using a distributed ledger system and preserving anonymity. He stressed the two principles that he hopes will be upheld by a CBDC, “sound money” (stable currency with controlled inflation) and privacy for consumers. Davidson said that the CBDC will help the unbanked and underbanked in the U.S. and warned the Task Force to stay away from discussing other issues in the financial technology industry and stay focused on learning more about the CBDC.

 

Full Committee Chairwoman Maxine Waters (D-Calif.)

In Waters’ opening statement, she mentioned the working group of Democratic members that she organized to look at digital currency issues and that, if properly designed, a CBDC has the potential to harness the positive innovations arising from cryptocurrencies and digitize the U.S. dollar.

 

Full Committee Ranking Member Patrick McHenry (R-N.C.)

In his opening statement, McHenry stated the importance of U.S. lawmakers understanding what a CBDC is and listed the benefits of a CBDC including its potential to make a more efficient payment system and promote financial inclusion. However, he said that a CBDC could limit growth and destabilize the financial market in ways lawmakers have not considered. McHenry concluded by agreeing with Federal Reserve Chairman Jerome Powell that it is important for the U.S. government to get the CBDC right rather than being the first to implement one.

 

Testimony
Carmelle Cadet, Founder and CEO, EMTECH

In her testimony, Cadet highlighted the importance of a CBDC for supporting the unbanked, underserved communities, the unemployed, and the nation’s financial infrastructure. Cadet said that implementing a CBDC will make peer to peer payments and government benefit distribution more efficient and will have the potential to foster economic development while reducing money laundering and cybersecurity threats. She also mentioned that a CBDC can reassert USD as the dominant and trusted global trade currency while decreasing cross-border transaction costs. Cadet stressed that high fees and other indirect costs (i.e., transportation costs) to acquire a bank account have left many low-income communities out of the financial system. Cadet advocated for a “Fed Wallet” system that provides more cash-like benefits and how, from there, other players can provide the user interface for citizens to provide other services. Cadet said that the efficient government benefits disbursement under a CBDC can provide the government with better performance data while reducing fraud and waste. Additionally, she added that a CBDC can help the unbanked get a credit score and access to credit. Cadet emphasized that by using blockchain technology to create a CBDC platform, regulators do not need to approve every transaction but can still guarantee strong consumer protection. Cadet also said that a CBDC can more efficiently connect low-income, small, and medium-sized enterprise borrowers to lenders. Cadet concluded by urging the U.S. government to invest heavily into a blockchain-based CBDC and lead in CBDC research and development.

 

Jonathan Dharmapalan, Founder and CEO, eCurrency

In his testimony, Dharmapalan said that the CBDC is intended to address inefficient payment systems, declining cash use, promotion of payment inclusion, and protection of monetary sovereignty.  Dharmapalan laid out a few key considerations that he recommends regulators to consider: 1) CBDC can promote financial inclusion; 2) CBDC can provide a stable alternative to currently available private digital currency like cryptocurrency and stable coins; 3) privacy protection by avoiding user data collection; and 4) ensuring U.S. leadership in digital and financial technology. Dharmapalan emphasized the importance of a strong legal framework for the implementation of a CBDC to ensure public trust and also said that clear legal authority on the issuance of a CBDC needs to be given to the Federal Reserve to prevent confusion. Dharmapalan added that a CBDC could give the Federal Reserve access to an unprecedented scale of transaction information, so the legal framework for privacy of a CBDC would require specific attention along with a specific anti-money laundering legal framework to avoid use for illicit activities. Dharmapalan recognized the different stakeholders in the implementation of a CBDC and urged Congress to consult with all stakeholders before any attempts to implement a CBDC. To conclude, Dharmapalan asked Congress to address the legal framework of a CBDC, clarify the roles of the Federal Reserve and the Treasury in the creation and issuance of digital currency, and establish clear policy objectives to guide the design of the CBDC.

 

Rohan Grey, Assistant Professor of Law, Willamette University

In his testimony, Grey argued that the Federal Reserve should not be the only entity involved in the implementation of CBDC since other government institutions also administer public payment infrastructure. Given the diverse monetary system of the U.S., Grey recommended involving other key actors in the research and development of a digital currency. Grey opined on token vs. account digital currency and stated that both systems are complimentary and can achieve functionality together. Grey continued to explain the difference between account based and token-based money and explained that account-based money is typically recorded in a common ledger and maintained by central actors while token-based money is a form of transferable “bearer instrument” where legal ownership resides with the person possessing these tokens. Grey recommended that the Treasury Department issue a token-based “eCash” version of digital dollar to complement the Federal Reserve’s account-based FedAccount. According to Grey, transactional anonymity provided by a token-based payment system is a core bedrock of political freedom in a democratic society and should not be hindered. To protect privacy, Grey proposed a principle of “currency neutrality” which treats digital currency as a common utility that processes payments and stores funds as a universal public good. Grey concluded by stressing the importance of using both token and account-based monies, the right to transactional privacy and anonymity, and the need for the Treasury Department to develop and administer an “eCash” system of digital dollar tokens that replicates the features of physical currency.

 

Dr. Neha Narula, Director of the Digital Currency Initiative, MIT Media Lab

In her testimony, Narula mentioned the high costs and limited access of the current transaction system and the benefits of a CBDC, including payment efficiency and financial inclusion. She added that many countries around the world are currently investigating the implementation of a CBDC and that the U.S. should pivot to further developing a U.S. digital dollar to lead innovation in the world. Narula stayed away from the debate on whether central banks should use a distributed ledger technology or a centralized ledger technology to implement a CBDC and urged regulators to first determine how a CBDC should operate. Narula said that one of the benefits of a CBDC is that it can be used by anyone without requiring identification or signing up for an account, and therefore, it benefits low-income households and the unbanked. Narula pointed out that, unlike the private sector, which has an incentive to collect and monetize consumer data, a CBDC should steer away from data collection. Narula discussed seven different architectures for implementation of a CBDC and described their potential to improve the current payment system: 1) expand central bank accounts to more financial institutions to reduce settlement cost and improve competition; 2) expand support for stable coin providers who issue dollar-pegged tokens on public blockchain; 3) “synthetic” CBDC issued by commercial banks that are backed 1:1 by central bank reserves, acknowledging the unclarity around how that architecture can help promote financial inclusion beyond the existing system; 4) “two-tier” CBDC that is only accessible through a commercial bank, noting that this does not address the problem of the unbanked; 5) FedAccounts giving retail users the option to hold an account directly with the Federal Reserve; 6) a digital cash CBDC that is held directly by users without an intermediary commercial bank account; and 7) CBDC that will be issued on an existing blockchain where the central bank can issue the digital currency but would give up all other control of governance. In her conclusion, Narula urged the Federal Reserve and the Treasury Department to invest more in research to fully understand the possibilities, implications, and technology developments of a CBDC.

 

Dr. Jenny Gesley, Foreign Law Specialist, Library of Congress

In her testimony, Gesley said that as digitalization accelerates due to the COVID-19 pandemic, the volatility of cryptocurrencies makes it an unsustainable payment system and that, therefore, a CBDC is needed. Gesley pointed to a poll from the Official Monetary and Financial Institutions Forum (OMFIF) on public trust in monetary institutions and digital currencies in 13 advanced and emerging economies indicating confidence in digital currency issued by the domestic monetary authority but skepticism in digital money issued by a technology or credit card company. Gesley also outlined several considerations for central banks in implementing a CBDC: 1) the legal authority of the central bank/legal tender status of CBDCs and the need to clarify ambiguous central bank laws; 2) compliance with anti-money laundering and counter terrorism financing (AML/CFT) requirements/privacy considerations; 3) capital flight from commercial banks to central banks (“digital run”)/disintermediation of commercial banks; 4) risks to central bank independence; 5) technical solutions and what kind of technology to use to create a CBDC; and 6) financial inclusion.

 

Question and Answer

Design and Development Process

Lynch asked Narula about the challenges in designing a CBDC. Narhula replied that there is much research to be done on CBDC policy but that we should not wait on technological advancement before having the policy discussion around what a CBDC should look like. Dharmapalan added that the model for digital currency should be cash and that digital currency must be given the same power as cash. He then explained the history of physical currency and asserted that digital currency should start with similar principles as cash did. Dharmapalan then described the path that digital currency should take, starting with Congress, making the rules, giving the U.S. Treasury Department responsibility to create a digital bearer instrument, moving it to the Federal Reserve, allowing the Federal Reserve to distribute the currency, and ultimately putting the currency into the public stream. He concluded that this process will allow for ultimate inclusion in the digital currency world. Davidson asked Cadet to outline why the blockchain technology is a more appropriate infrastructure for a CBDC as opposed to a centralized data base. Cadet pointed out that by using blockchain technology to develop a CBDC, we will eliminate intermediaries for transactions and allow the CBDC to self-govern, making the system more cost efficient. Rep. Blaine Luetkemeyer (R-Mo.) asked Grey how a CBDC should be designed. Grey responded that different agencies should work together and, in addition to a FedAccount created by the Federal Reserve, the Treasury Department should implement its own eCash. He also added that the government should consult with different stakeholders to get their opinion on a potential form of a U.S. CBDC. Rep. Anthony Gonzalez (R-Ohio) asked Narula whether a digital cash system or a two tiered/FedAccount system is better. Narula said it should be a mix between both systems and that there should also be other institutions outside of banks that are allowed to provide users with digital wallets and other applications.

 

Access and Inclusion

Rep. Al Lawson (D-Fla.) referenced a report highlighting the lack of broadband access for many Americans and asked how to ensure Americans in rural areas are not left behind in the context of a CBDC. Cadet emphasized that financial literacy and education is key to the introduction of a CBDC to the American economy and there is also great value in looking to the Post Office and local physical institutions to provide access to the digital dollar network. Dharmapalan added that, if designed properly, broadband will not be necessary because digital currency should be able to exist in wallets on a smart card. Grey stated that it is critical to take the average person’s access and trust into consideration when developing a CBDC and that infrastructure like the Postal Service will be important as it relates to these items. In response to Rep. Bryan Steil’s (R-Wis.) question regarding the issues solved by a CBDC, Dr. Gesley highlighted the Sand Dollar digital currency in the Bahamas where the country is trying to solve the financial inclusion problem by using a wide range of digital wallet providers and requiring those providers to have an inclusion strategy. She explained that the Bahamas use prepaid cards similar to food stamp cards in the U.S. or some form of pre-loaded card.

 

Tax Evasion and Money Laundering

Rep. Brad Sherman (D-Calif.) asked how the Federal Reserve can ensure that a digital dollar is not used for tax evasion and adhere to know-your-customer (KYC) and anti-money laundering (AML) rules. Dharmapalan responded that the architecture for CDBC should be based on something other than cryptocurrencies and should, instead, be based on the U.S. dollar, which allows for enforcement of KYC and AML regulations. Rep. Tom Emmer (R-Minn.) asked how we can make sure that a cyberattack against the Federal Reserve would not paralyze the financial market if a CBDC was implemented. Gesley said that since central banks normally use commercial banks as intermediaries to issue a CBDC, risk of a cyberattack paralyzing the whole financial market is minimal. She also mentioned that the central bank in Bahamas brought in third party consultants to vet all participating banks’ cyber security to ensure security for consumers.

 

Privacy

Davidson asked Narula to discuss other countries’ CBDC pilot programs and their privacy standards. Narula said central banks are researching to find a balance between data collection and privacy and that she believes it is possible to catch criminal activities without government access to all payment data.

 

Negative Implications of a CBDC

Gonzalez said that one criticism of a CBDC is that the Federal Reserve will replace retail banks and transfer assets directly from banks to the Federal Reserve and asked if that will be an issue. Narula said it is possible to design the CBDC in a way to avoid this but that this should not be a dealbreaker. Rep. French Hill (R-Ark.) asked Narula to lay out the negative effects of individuals directly having accounts with the Federal Reserve. Narula said that the Federal Reserve will not be the only player in the implementation of CBDC and that there is still ongoing work to find a balance between only having accounts with the Federal Reserve versus not giving the Federal Reserve access to any data at all.

 

International

Luetkemeyer asked the witnesses whether they see China’s ability to implement a CBDC as a threat to the U.S. dollar’s status as the world reserve currency or if it would supplement cross-border transactions. Gesley replied that it will be up to other countries to decide whether to make China’s digital currency their reserve currency or not, but she does not think that will be a concern since China’s CBDC has many privacy concerns. Dharmapalan said that as Chinese companies like WeChat Pay and Alipay expand across the world, eCNY might slowly begin taking over mercantile transactions, which is what China wants.

 

Cryptocurrencies

Gonzalez asked whether the digital dollar would compete or coexist with other cryptocurrencies. Narula said that she thinks cryptocurrencies will coexist with the digital dollar and that they will complement each other. She emphasized that many technologies that will be used to develop a CBDC are derived from innovations in cryptocurrencies.

 

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.