Brookings Institution Webinar on Digital Assets
Brookings Institution
Regulating Digital Assets: The Prudential Perspective
Thursday, October 20, 2022
Topline
- Acting Chairman Gruenberg expressed confidence in digital currency’s reliability and meaningful future applications and public utility within the payment systems and stated the significance of investigating potential risks for the banking industry.
- Various panelists debated the need for prudential regulations of payment stablecoins and agreed that more action is needed by the FDIC and other agencies.
Moderator
- Aaron Klein, Brookings, Miriam K. Carliner Chair of Economic Studies; Center on Regulation and Markets, Senior Fellow
Panelists
- Martin J. Gruenberg, Federal Deposit Insurance Corporation (FDIC), Acting Chairman
- Gordon Liao, Circle Internet Financial, Chief Economist
- Brooke Ybarra, American Bankers Association, SVP, Innovation & Strategy
- Lee Reiners, Duke Financial Economics Center, Policy Director
Opening Statements
In his opening statement, Klein said the transformative movements of digital assets and cryptocurrencies have challenged the existing financial regulatory system and raised the question of how to effectively regulate digital assets to secure the banking industry’s safety, visibility, and efficiency.
In his keynote address, Gruenberg first gave the context of digital assets’ development by discussing banking and innovation. He said it is crucial to incorporate the newest technologies, such as digital assets, to modernize our banking system, adding that hese innovations need to ensure the banks’ accessibility, convenience, efficiency, safety and soundness, and consumer protection. However, he said the use of digital assets in banks brings novel and complex risks that are difficult to fully assess. Gruenberg attributed the difficulty in evaluating the risks to the dynamic nature of crypto assets, the crypto marketplace, and the rapid pace of technological innovation. He urged the Treasury Department to give pause and articulate digital assets’ risks and applications for consumers, investors, and businesses.
Gruenberg provided an overview of the FDIC’s approaches to engaging with banks that consider activities related to crypto assets and discussed how vital it is to recognize that digital assets activities involve investing and trading in crypto assets and the importance of ensuring activities are permissible under applicable laws and regulations in a safe and sound manner. Particularly, Gruenberg emphasized that the FDIC is concerned that the false and misleading statements, direct or implied, by crypto asset entities would confuse consumers, cause them to misunderstand the risks associated with investments in various types of crypto assets, and bring risk to banks. He said the insured institutions need to assess, manage, and control risks arising from third-party relationships, including those with crypto companies.
Lastly, Gruenberg discussed potential benefits, risks, and policy questions regarding payment stablecoins. He began by clarifying that the purpose of payment stablecoins is to develop an alternative currency system that is free of central control and the need for banks and governments. He added that stablecoins have predominately been used as a medium to buy and sell crypto assets for investment and trading purposes. Although there has been no demonstration so far of crypto assets’ value in terms of broader payment systems, he remained confident that digital currencies would have reliable and meaningful applications and public utility within the payment systems. Then, Gruenberg proposed three methods that would make payment stablecoins significantly safer: prudential regulations, the requirement to be backed by cash, and a robust governance and compliance system. Finally, he raised policy considerations regarding nonbanks’ engagement to offer stablecoins and the limitation of the issuance of payment stablecoins to banks and prudentially regulated bank subsidiaries. Gruenberg highlighted the importance of payment stablecoin policies to foster a more inclusive and accessible financial market and provide incentives for greater participation and concluded by emphasizing the necessity for FDIC and other federal banking agencies to manage risks brought by digital assets, ensure their compliance with the law, and build an inclusive real-time payment system with new technologies.
Panel Discussion
Payment Stablecoins
Reiners discussed the importance of achieving and maintaining the consistency and clarity of messaging concerning payment stablecoins amongst prudential regulators.
Liao said stablecoins should be completely backed by cash or cash equivalents, discussed the utility value of payment stablecoins, and said the remittance costs should be decreased to increase the utility value of digital assets for the public. He also said unbundling payment functions from banking and giving nonbanks access to the Fed to regulate payment stablecoins could reduce overall risk to the financial system.
Ybarra said digital asset and blockchain technology are going to be the next innovations that support future banking and financial services, but further experiments and research are required to assess the risks and evaluate their real-life applications.
Prudential Regulations
Ybarra said to support banks to move into the era of digital currencies, the prudential regulators, instead of solely offering guidance, should properly limit banks’ ability to participate. She said the Securities and Exchange Commission’s (SEC) staff accounting bulletin that implicitly impacts the banks’ ability to provide custody service serves as a good example.
Reiners said he would like to see clear guidance from the banking agencies on holding crypto assets on balance sheets. He said the Financial Stability Oversight Council (FSOC) should consider if firms specialized in crypto custody should be designated as systemically important financial market utilities. He also encouraged banking agencies to give guidance regarding deposits and stablecoins reserves.
Liao said crypto assets would be significantly useful and meaningful for banks and enhance monetary policy transmissions. He emphasized that the prudential regulations of payment stablecoins and cooperation with technology firms would help facilitate stability to safeguard physical money and offer transparency.
Roles of Regulators
Ybarra discussed the ambiguity that stablecoins may be seen as a deposit substitute or a deposit that would encourage a new banking framework. She regarded the payment stablecoins more like a deposit than a money market mutual fund and acknowledged various possibilities for their future development.
Reiners questioned the necessity of implementing prudential regulations for payment stablecoins under the status quo. He said payment stablecoins are a net importer of stability and bringing payment stablecoins under prudential regulations would fuel DeFi and drain liquidity from the current financial system. Instead, he suggested more disclosure similar to those of money market mutual funds.
Liao affirmed the payment stablecoins’ emerging value, although they have not been fully developed, and he insisted that prudential regulations are necessary. He said it is important to invest resources at every agency to have the data and information to understand the effective regulations and applications of the new innovations.
Financial Inclusion
Ybarra said while cryptocurrencies are reported to be a financial inclusion contributor, there is no demonstration of their effectiveness so far.
Reiners said it is important for the regulators to consider how to encourage the participation of people of various identities. He suggested that education and more disclosure requirements would help.
Liao acknowledged the usefulness of the programmability of smart contracts and money. He said the decision-makers could expand financial inclusion by opening the existing data silos and the transaction silos.
Financial Crisis
Liao said regulations would safeguard the financial market by ensuring that digital currencies are backed up by cash or cash-like equivalents.
Reiners said it is important for policymakers to keep a minor interconnection between the traditional financial system and the crypto market to avoid chain reactions that would lead to a destructive financial crisis.
For more information on this hearing, please click here.
For an archive of past SIFMA hearing coverage, please click here.