In the summer, US Federal Reserve Chair Jerome Powell announced that the public would be consulted on the possibility of a Central Bank Digital Currency (CBDC). He acknowledged the benefits and the risks of stablecoins, implying that new restrictions are on the way.

That is no surprise, given the increase of USDC, a US-based stablecoin, from $2.9 billion to $18.7 billion in just six months and the soon-to-be-released Diem (previously Libra) dollar stablecoin.

This wasn’t just another press release. To accompany the news, Powell delivered a prepared address to the camera. The takeaway is that these issues are critical.

Despite the Boston Federal Reserve researching with the Massachusetts Institutes of Technology, the Federal Reserve has remained cautious about a digital currency (MIT).

This announcement had a different tone, one that was more pro-innovation. Perhaps a sense of urgency as well?

“Stablecoins aims to employ new technologies in a way that can improve payments efficiency, speed up settlement processes, and lower end-user costs,” Powell added.

However, he pointed out that they are risky since they lack consumer protections and can negatively influence the financial system.

“As the use of stablecoins grows, so must our focus on the right regulatory and supervisory framework,” he concluded. This includes paying attention to private-sector payment innovators who are not currently regulated like banks, investment firms, and other financial intermediaries.”

Stablecoins are used to quote many cryptocurrency trading pairings. The USDC in the United States has increased tremendously due to the cryptocurrency boom, from a market capitalization of $2.9 billion six months ago to $18.7 billion today.

Grant Thornton audits the reserves that underpin the stablecoin every month, with a two-month delay.

There is a significant risk if stable coins are abruptly redeemed in large numbers. A portion of the reserves held by banks could result in massive withdrawals from bank accounts. Some resources are in “authorized investments,” while others are in deposits.

Central banks are also concerned about potential market distortions resulting from a sharp increase in demand for treasuries or money market funds as stablecoin reserves.

The Facebook-linked stable coin Diem poses a much greater risk to central banks. How quickly could Diem become enormous if USDC can see this exponential growth without a user base like Facebook?

 

Why is the Federal Reserve considering a central bank digital currency (#CBDC) now?

For more:
– https://t.co/rHdiRba8qM
– https://t.co/TaUy7mNKMc pic.twitter.com/dfnhFhvMH9

— Richmond Fed (@RichmondFed) April 27, 2022

Diem announced a transfer to the United States and an agreement with Silvergate Bank to create a US stable coin just a week ago.

Is CBDC now Grave?

So the question is if Diem and the quick expansion of stablecoins have caused a shift in the urgency of a CBDC.

“We believe any prospective CBDC must serve as a supplement to, rather than a replacement for, cash and current private-sector digital forms of the dollar, such as commercial bank deposits,” Powell said.

“As part of this process, we will seek public input on payment, financial inclusion, data privacy, and information security issues.”

There’s something of a domino effect going on here. As Diem prepares to launch, the Fed may decide to create a CBDC sooner rather than later.

Canada, our next-door neighbor, has already stated that it plans a CBDC to combat dollarization from a global stablecoin or US CBDC. As a result, Canada’s operations may now be accelerated.

Alternatively, the central bank could impose laws to prevent the floodgates from opening.

This could cause the stablecoin sector to be delayed while central banks try to catch up.