CBDCs and Parachute Pants
“I have been reflecting recently, and in connection with this speech, on America's centuries-long enthusiasm for novelty… Sometimes the consequences are in hindsight merely puzzling or embarrassing, like that year in the 1980s when millions of Americans suddenly started wearing parachute pants. But the consequences can also be more serious.”
- US Federal Reserve Vice Chair for Supervision, Randal Quarles, from his speech, “Parachute Pants and Central Bank Money”
To which we say to Randal Quarles, what consequences could possibly be more serious than parachute pants?
Jokes aside, it’s pretty important to analyze this entire speech by Quarles on whether calls for a US central bank digital currency (CBDC) are based on hype or a true need. More notably, let’s look at his surprising statement about “the potential benefits of stablecoins, including the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy.” Indeed, he seems to be encouraging a private sector-driven, crypto-based, decentralized financial technology payments and infrastructure platform to co-exist with the US Treasury (shhh… nobody tell Elizabeth Warren).
Is this right and is this possible? Well, from the outset, let’s establish that the driving issue here is NOT the issuance by the PBOC of a Chinese digital yuan. Yes, you read that correctly. While the impending launch of crypto-renminbi plays easily into fear-mongering clickbait, the yuan is not the world’s reserve currency. Putting it into digital form will not suddenly usurp the US dollar’s pre-eminence in a reality where America is the world’s strongest economy with extensive global trade relationships, the deepest financial markets, currency stability, rule of law and property rights.
The issue instead is the exponential growth of crypto-assets and non-bank issued stablecoins and the implications they will have for the status of the US dollar as the global reserve currency.
Starting with a humble whitepaper in 2008, the global crypto market is now $1.5 trillion. But since 2008 until now, users have not been allowed easy, regulated access to cryptocurrency initiatives if they attempt to engage directly with US dollars. This has allowed stablecoins to create a competitive moat and quickly increase their financial influence and scale. Case in point: the popular US Dollar Coin (USDC) has grown from $900M in circulation just one year ago to $25B today. Since inception, USDC’s market cap has grown by a year-to-date CAGR of more than 6,100 percent.
Now the very definition of a stablecoin is that it is a cryptocurrency linked to an asset like a fiat currency that doesn’t change in value. So naturally, stablecoins like USDC, Tether and DAI would go away if we had a US CBDC. But even in the most optimistic of assessments, a US CBDC would be launched in five years, and that includes herding cats, killing sacred cows, and addressing all security and privacy concerns.
Consider what five years means when it comes to crypto system development. Today’s $1.5 trillion crypto markets were just $15B five years ago. Decentralized finance (DeFi), distributed autonomous organizations (DAOs), and non-fungible tokens (NFTs) with digital economies based on gaming, creators, and art have all exploded in the past two years, leading to even more millions of crypto assets with several orders of magnitude more in financial transactions involving those assets.
This parallel crypto financial system has a massive head start with a gap that is only going to widen. Bluntly asking, will a US CBDC even be an accepted and desired admission ticket for a new generation brought up in these digital economies?
This is why we see what we think Quarles also sees: the only way for the Federal Reserve to catch up is to collaborate with the private sector. This could mean the development of public-private-partnerships with companies that have already created US dollar-backed stablecoins like Circle and Coinbase with respect to USDC, or Silvergate Bank and Facebook with respect to Diem (formerly known as Libra). Large financial institutions like JP Morgan are likewise prime potential allies in such an effort. These public-private partnerships could provide the functionality to produce some form of a US CBDC to market much faster.
To underscore, function before form. The purpose of doing something is more important than whatever style it comes in.
Which brings us back to parachute pants, actually. They weren’t just a fashion fad. Early breakdancers used heavy nylon, parachute-like material to construct pants that could simultaneously endure contact with breakdancing surfaces while decreasing friction. The material of these pants enabled the dancers’ complex and lightning-fast spins without them having to worry about tears or wear in their clothing.
So go for it, Fed. Show us your moves.