SBC Hearing on Central Bank Digital Currency

Senate Banking, Housing, and Urban Affairs Subcommittee on Economic Policy

Building A Stronger Financial System: Opportunities of a Central Bank Digital Currency

Wednesday, June 9, 2021

 

Witnesses

• Dr. Neha Narula, Director, Digital Currency Initiative, MIT
• Mr. Lev Menand, Academic Fellow and Lecturer in Law, Columbia Law School
• The Honorable J. Christopher Giancarlo, Senior Counsel, Willkie Farr & Gallagher
• Dr. Darrell Duffie, Adams Distinguished Professor of Management and Professor of Finance, Stanford University Graduate School of Business

 

Opening Statements
Chairwoman Elizabeth Warren (D-Mass.)

In her opening statement, Warren drew attention to inaccessibility of banking services for many Americans, what she called the untrustworthiness of the largest banks for their fee practices and how digital currency has been talked about as a solution to the problem. She described cryptocurrency as a fourth-rate alternative to normal currency, unpredictable, and unstable. She also outlined her belief that cryptocurrency is a lousy investment due to its lack of consumer protections and susceptibility to pump and dump schemes. Warren stated that cryptocurrency has become a haven for illegal activity, resulting in the Colonial Pipeline and JBS hacks. She also emphasized cryptocurrency mining’s energy demands and resulting environmental costs. Warren concluded that our current payment system is flawed, and that Central Bank Digital Currency (CBDC) has great promise if well designed and executed.

 

Ranking Member John Kennedy (R-La.)

In his opening statement, Senator Kennedy said the quickest way to get rid of ransomware is to ban cryptocurrency but that this is a difficult and controversial task. Kennedy pointed out that digital currencies have proved to be volatile and subject to market manipulation and that it is important to examine the risks of decentralized cryptocurrencies to Fed monetary policy initiatives. Kennedy highlighted the USD’s position as the world’s primary reserve currency and that as many governments are exploring CBDC, the U.S. should do the same to maintain the USD’s influence around the world. He also explained the necessity of examining who would benefit the most from a CBDC and who will be hurt considering the costs and security risks associated with implementation of CBDC. The government of China, Kennedy pointed out, used  eCNY digital currency to surveil everyday transactions of its citizens and exert control over not only its own economy, but the world economy as well. He emphasized the need for the U.S. to compete with the eCNY in the global market by exploring CBDC without replacing the current banking system’s physical currency. Kennedy concluded by expressing concerns for whether a CBDC will constitute government overreach in the U.S. credit market.

 

Senator Brown (D-Ohio)

Senator Brown provided an opening statement in which he commented on the importance of the U.S. not falling behind other countries in establishing a CDBC. He explained that Americans should not have to pay exorbitant fees to big banks and that a CDBC could help facilitate no fee accounts.

 

Senator Toomey (R-Pa.)

Senator Toomey provided an opening statement asking what problem a CBDC is trying to solve and stating that the U.S. does not need the Fed interfering with the free market system. He emphasized that the federal government would do a terrible job managing a CBDC and that the Fed has no experience in this realm. Toomey commented that concerns over China’s digital currency are not convincing because the eCYN will not replace the dollar. While not convinced we need a CBDC, Toomey stated that we could use a private digital currency, which has the potential to improve access to banking services for all Americans. Toomey concluded by expressing support for private digital currencies.

 

Testimony
Dr. Neha Narula, Director, Digital Currency Initiative, MIT

In her testimony, Narula emphasized the lack of improvements in the current electronic transaction systems, which has in turn resulted in expensive delays. She believes the experimentation of cryptocurrencies has shown the redundancy of financial intermediaries but that this area is still developing and comes with significant risks, prompting central banks to consider digital currency. Narula noted that CBDC is not the only solution to address these problems, but at MIT, they are investigating the possibilities of CBDC as a vehicle for increased financial inclusion and payment efficiency. She explained that the introduction of a digital USD should not be rushed and described CBDC as a digital liability of the central bank. She also stressed the importance of accessibility but warned policymakers to remain vigilant about the use of CBDC in illicit activities. To minimize illicit activity, Narula suggested a “tiers of access” system where users’ transaction volume and balance amounts per month is directly correlated to the levels of identification they provide. Narula also believes that financial data privacy is important and a CBDC should strive to minimize data collection as much as possible. To begin the potential implementation of a CBDC, Narula outlined seven different architectures and described their potential to improve the current payment system: 1) expand CB accounts to more financial institutions to reduce settlement cost and improve competition; 2) expand support for stablecoin 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, however, she noted that it is unclear how exactly this architecture can help promote financial inclusion beyond the existing system; 4) “two-tier” CBDC that is only accessible through a commercial bank, Narula noted that this does not address the problem of the unbanked; 5) FedAccounts which give retail users the option to hold an account directly with the Federal Reserve; 6) digital cash: a 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 to the governance. Narula concluded that CBDC might have many benefits but first requires multidisciplinary research and development.

 

Mr. Lev Menand, Academic Fellow and Lecturer in Law, Columbia Law School

In his testimony, Menand started by describing the two types of money and four shortcomings of the current system. First, he stated that many people do not have a bank account because they either do not trust banks or do not have enough money to open and maintain an account. Second, Menand outlined that the system is costly with banks charging for checks or wires, minimum balance requirements, and monthly account maintenance fees. Third, he explained that deposited checks and wire transfers generally take a long time to settle. Last, he said the banking system is complex with thousands of banks operating different ledgers. Menand also presented what he called the urgent second-order problem: a range of unstable private sector alternatives, like money market mutual funds. With the rise of cryptocurrencies as a retail alternative in transactions, Menand outlined his belief that it will be more difficult for the Federal Reserve to stimulate economic activity through monetary policies and that cryptocurrencies divert limited social resources like energy and the technical skills of computer scientists. Menand said that a CBDC will be able to address all of the first and second order problems by providing the following benefits: 1) it can bring millions of unbanked people into the financial system by eliminating monthly minimum balance; 2) it can speed up payment; 3) it can reduce fees; 4) it can bolster financial stability by offering many businesses with riskless money with a positive yield; 5) it can reduce regulatory complexity as many rules promulgated since 2008 are targeted at deposit substitutes; 6) it can improve monetary policy transmission by offering interest on reserves directly to people on their FedAccount balances; 7) it can generate revenue for the government through “seigniorage” which represent the fiscal revenue from money creation; and 8) it can protect national security by reducing the demand for cryptocurrencies which grows by a perception that the USD is hard to use. Menand concluded that if the government allows our monetary system to become more private, dominated by private sector alternatives, the US is bound to face worse financial crisis and that a form of CBDC will be a part of the solution.

 

The Honorable J. Christopher Giancarlo, Senior Counsel, Willkie Farr & Gallagher

In his testimony, Giancarlo highlighted CBDC’s potential to improve access and inclusion for the financial system. He opined on a new digital currency with a digital wallet and peer-to-peer exchange capability and stated that policymakers are rightly concerned about possible setbacks. Giancarlo then asked a set of hypothetical questions to highlight the potential benefits of a CBDC including more money in the banking sector, expanded access to banking services, decreased energy use relative to bitcoin or physical currency, reduction in settlement times, and expanded economic and small business opportunity. He concluded that a CBDC could protect privacy and provide superior privacy protection compared to many other currencies.

 

Dr. Darrell Duffie, Adams Distinguished Professor of Management and Professor of Finance, Stanford University Graduate School of Business

In his testimony, Duffie said that as the Fed develops a digital dollar, it is also crucial for other agencies to attempt to trigger major improvements in the conventional US payment system, which he characterized as slow and costly. He explained that the use of paper money in US payments declined from 51% in 2010 to an estimated 28% in 2020, as the pace for digitization continues, unbanked Americans will be further isolated from parts of the economy. Therefore, he emphasized that Congress needs to consider the welfare of unbanked Americans when investigating the potentials of a CBDC. However, he explained that the COVID-19 pandemic revealed the big difference that a digital dollar could make for the speed of dissemination of government relief payments to millions of Americans. Duffie recommended the regulators to opt for a decentralized approach to holding and monitoring CBDC personal identity and payment data at the level of banks and fintech firms. He said that another concern is a CBDC operational accident that could impact millions of Americans, so it should be noted that the CBDC should not be deployed for public use until the technology is “bulletproof”. Duffie continued that he does not expect a tightening of credits due to the  introduction of CBDC. Duffie concluded that the US should now begin a significant program for the development of a digital dollar to improve efficiency of payments, privacy, interoperability, financial inclusion, and the ability to monitor payments for compliance.

 

Question & Answer

Risks and Benefits

Warren asked if Bitcoin is stable and reliable. Narula and Menand answered no. Warren also asked if cryptocurrencies offer a safer alternative to the traditional banking system for consumers. Menand answered absolutely not and said that many abuses in the cryptocurrency market that have lost users money, and that it is not a safe place to keep your money or to invest.

 

Kennedy asked Giancarlo and Duffie what other benefits does a CBDC have besides data collection from users. Giancarlo stated six benefits associated with a CBDC: 1) data collection; 2) financial technology modernization; 3) greater financial inclusion for the unbanked and underbanked; 4) monetary policy efficiency for the Feds; 5) geopolitical influence (i.e., Belt and Road initiative by China); and 6) setting standards for digital currencies globally to maintain USD dominancy.

 

Kennedy added on by asking Menand and Duffie if the CBDC can do more than making payment cheaper and more efficient. Menand replied that a cheaper and efficient payment system is the most important and that the CBDC can also help weed out untrustworthy banks and funds from the market to promote financial stability. Duffie said the CBDC can help the Fed better implement their monetary policies and that the U.S can export its digital dollar technology globally as well.

 

Sen. Cynthia Lummis (R-Wyo.) asked Menand that since the CBDC can reduce capital collateral during large transactions, would it also reduce financial risks? Menand said it will reduce risks in the financial sector.

 

Privacy and Security

Sens. Kennedy and Mark Warner (D-Va.) asked the panel about the privacy and security risks of CDBC. Narula responded that if the U.S can create a CBDC that is encrypted with blockchain technology, this will better ensure the privacy of users. Narula continued that encryption in the core part of CBDC will help ensure the privacy of users and that her current research is focused on privacy. Menand and Duffie echoed the senators’ privacy concerns, and Duffie stated the need for CDBC to be bullet proof via increased security. Duffie added on that it will be difficult to monitor money laundering and market volatilities if cryptocurrencies become dominant in the payment systems. He concluded that the CBDC represents a way to prevent volatile cryptocurrencies from causing economic crises.

 

In response to Warner’s question about the possible misuse of CBDC, Narula stated that CBDC can serve as a tool for law enforcement, proper guardrails can be built into the system, and that addressing the underlying security concerns can prevent ransomware attacks. Menand said that CBDC offers the ability to hide the trails of criminals. Senator Catherine Cortez-Masto (D-Nev.) asked how the Fed could make a CBDC to reduce the risk of fraud, and Giancarlo asserted that CBDC should have privacy, a secure system, accessibility, and transparency so users know their transactions have been completed.

 

Sen. Steve Daines (R-Mont.) expressed concerns about the recent rise in ransomware attacks that paralyzed company and government networks. He asked Giancarlo, Menand, and Duffie what the government can do to help law enforcement agencies to combat these ransomware attacks. Giancarlo said although Cryptocurrencies can be tracked, it is very difficult to do so. Menand said that even though the FBI and DOJ were able to track down the Bitcoins in the Colonial pipeline attack, the fact that cryptocurrencies are untraceable make them very attractive to criminals. Duffie added that to stop these ransomware attacks, the U.S. needs to coordinate with other countries to make it impossible to convert cryptocurrencies into money across the world, a step that could help prevent criminals from using it.

 

Congressional Oversight

Kennedy asked Giancarlo whether the Fed could introduce a CBDC. Giancarlo said they certainly could research and explore the CBDC as a potential option for a new payment system but would need Congressional approval for any further actions.

 

International

Sen. Jack Reed (D-R.I.) asked about the inevitability of turning to digital currency and if China will use its CBDC to replace U.S. currency. Menand responded that, over time, people will consider digital currency to be necessary and that China will use its CBDC to skirt U.S. sanctions.

 

Sen. Bill Hagerty (R-Tenn.) asked Giancarlo to opine on the biggest risks to the U.S if China was able to dominate the realm of digital currency besides the dwindling power of U.S economic sanctions. Giancarlo said currently all major commodities are priced in USD and China is aiming to change this by investing in their ledger and blockchain technologies. He said if China comes to dominate the realm of digital currency and blockchain technology, USD could lose commodity pricing to RMB.

 

Daines asked Giancarlo and Duffie what the world will look like if China or another country wins the digital fintech race. Giancarlo said that it is inevitable for different digital currency networks to form (i.e., RMB vs. USD) so it will be crucial for the U.S to at least lead the global standard for digital currency. He continued that if the U.S can lead in technology it is secondary for the U.S to implement a CBDC. Duffie agreed with Giancarlo and emphasized the importance for the U.S to invest more into digital currency research order to compete with China globally.

 

Lummis agreed that a CBDC can strengthen the U.S economy and assert USD dominance and asked Giancarlo if the U.S. needs to ensure privacy protection for its CBDC and how that could help the U.S. on the global stage. Giancarlo said since the U.S. has much stronger privacy laws compared to China, if our technology is there, it is possible for our CBDC to dominant the global CBDC market. He added on that the European laws do not protect consumers from government data collection so the U.S CBDC will have great advantages in the global stage.

 

Access to Financial Services

Cortez-Masto asked how CBDC could make it easier to connect to the unbanked and provide financial relief and access to government services. Narula said the key is to remove sources of friction to enable access to CBDC without onerous restrictions. She said we need the right interfaces and a variety of ways to access the currency, assisting those without smart phones for instance. Menand added that if you’re poor, a bank account may not be the most attractive option as the fees associated with typical banking services and financial illiteracy. He concluded that a CBDC could be provided without profitability consideration because the government would not be profit motivated.

 

Warren asked if a well-designed digital currency could serve the those underserved by the current system. Narula answered yes, if it is accessible, open, and frictionless.

 

Environmental

Warren asked if the environmental costs of the energy demand of cryptocurrency’s mining practices are worth it. Narula responded that digital currency could be done without mining and be environmentally friendly. Menand added that the energy demands are not worth it because the environmental costs are so large.

 

Private Currencies

Reed asked if every major company issued digital currency, would private digital currencies still exist and would they be disrupted. Menand said they would still exist and that we need other policy responses to curb the harm of private cryptocurrencies, like taxing and sanctions.

 

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