Cryptocurrency is a recent invention that dates to the release of the original Bitcoin white paper and protocol by the enigmatic Satoshi Nakamoto in 2008. However, in the years since, Bitcoin has steadily expanded from a niche interest into a multi-billion-dollar industry and spawned thousands of new digital currencies along the way.
Today, an increasing number of consumers and businesses seek to use cryptocurrencies for payments or digital asset investments. Yet as the industry matures and intersects with a banking and payments industry developing new faster payment technology, questions remain about what will come next for cryptocurrency and how its evolution will impact, and possibly disrupt, community banks and even national economies. Will stablecoins bring greater stability or create new consequences for banks, governments, and consumers alike?
The Bank for International Settlements defines a stablecoin as a “cryptocurrency that aims to maintain a stable value relative to a specified asset, or pool or basket of assets.”
Stablecoins seek to address and overcome many of the challenges associated with cryptocurrencies, particularly their instability, to create systems that can provide platforms for payments and potentially enable a new generation of “programmable money” that self-executes transactions using smart contracts.
There are a few different ways in which stablecoins attempt to maintain a stable value, including pegs to stable national currencies (e.g., U.S. dollar) or backing by real-world commodities like gold or oil reserves.
Several different types of stablecoins exist, such as Tether and USDC, and the market is expanding rapidly. Total transaction volume exceeded $360 billion for the first time in February 2021, and Tether reached a new market capitalization of approximately $30 billion.
However, one stablecoin project that has caught the attention of regulators and central bankers worldwide is Diem, formerly known as Libra.
Diem is a stablecoin project in development by a collection of companies, including Facebook and Coinbase, that aims to establish multiple single-currency stablecoins in an effort to “enable a simple global payment system and financial infrastructure.”
After the project was first announced, central bankers, such as Governor Lael Brainard, cautioned that global stablecoins “could disintermediate the role of banks in payments” and “have implications for the role of central banks and monetary policy.” Additionally, due to their goal of providing cross-border payments, Governor Brainard also stated that “[Diem]’s intended global reach would likely necessitate a consistent global anti-money-laundering framework in order to reduce the risk of illicit transactions.”
Stablecoins may offer new payment capabilities in the future, but those capabilities should not come at the expense of community banks’ vital role in delivering financial services to Americans. ICBA urges policymakers to ensure that stablecoin issuers employ rigorous AML/KYC programs to prevent financial crimes and guard against potential systemic threats to the wider payment and banking systems.
Cryptocurrency and Financial Crime
Policymakers, regulators, and law enforcement authorities have significant concerns about the use of cryptocurrencies for illicit activities, including money-laundering, sanctions evasion, and ransomware.
Calculating the total dollar amount of crypto-related crimes is difficult, but FinCEN reported in December 2020 that it received “approximately $119 billion in suspicious activity reporting associated with [cryptocurrency] activity taking place wholly or in substantial part in the United States” in 2019. Moreover, FinCEN indicates that this amount equaled almost 12 percent of all cryptocurrency transactions “being relevant to a possible violation of law or regulation.”
Additionally, consumers and businesses are frequent targets of a variety of scams and other financial crimes, such as ransomware and hacks of cryptocurrency exchanges.
Consumers have an acute risk from crypto-related scams and crimes because cryptocurrencies lack protections afforded under U.S. laws and regulations. For example, cryptocurrencies are not covered by Regulation E, the primary regulation that establishes processes to dispute unauthorized transactions and for financial institutions to resolve those claims. Unfortunately, if a criminal can access a consumer’s cryptocurrency, the funds will likely be stolen and there is little to no recourse to recover the stolen assets.
State and federal regulators and policymakers have recently taken actions to establish more oversight for crypto-related companies and highlight the myriad risks to consumers.
In March 2021, New York Attorney General Letitia James issued an alert advising consumers to “extreme caution when investing in virtual currencies.” The alert warned consumers that digital asset investors may be exposed to risks such as “wild price swings, conflicts of interest among trading platform operators, and increased chances of market manipulation.” These statements followed legal actions by her office to protect consumers with lawsuits against illegal cryptocurrency exchanges.
Community banks and cryptocurrency
Some community banks are starting to explore offering custodial services for digital assets; however, many remain cautious about adopting these services due to a variety of risk mitigation and regulatory concerns.
Early adopters are pursuing a range of crypto-related services, such as custody of digital assets or debit card bitcoin rewards programs. It remains to be seen whether and how quickly other community banks will offer similar services. Nonetheless, there appears to be a growing interest among consumers in not only cryptocurrencies but also greater participation from their banks.
A January 2021 survey by NYDIG, a custody service provider, reveals that 80 percent of Bitcoin holders would move their assets to their bank if it provided secure storage. If this sentiment continues to build, more community banks may choose to offer crypto-related services to meet new customer demands and expectations.
Cryptocurrency and Bank Charters
As cryptocurrency adoption expands, the Office of the Comptroller of the Currency (OCC) and several states are exploring special bank charters to help normalize crypto-related financial services and provide avenues for these companies to access the payment system.
Although innovation in financial services can enable new ways for citizens and businesses to engage in transactions and obtain critical services, these innovations should not jeopardize a safe and sound banking and payment system.
These new charters for non-bank companies challenge long-standing principles separating banking and commerce and potentially introduce systemic risk into the payment system.
ICBA urges policymakers and regulators to ensure that cryptocurrency companies fully meet the requirements of federally insured chartered banks before granting any charter or access to the Federal Reserve’s payment system.
Wider adoption of cryptocurrency is altering global digital commerce and the global financial system. ICBA has serious concerns regarding threats posed by cryptocurrency to privacy, consumer protections, and financial stability resulting from increases in money laundering, terrorist financing, and fraudulent activity. Unregulated cryptocurrency threatens to disintermediate community banks and undermine their ability to provide funding to support local economic activity, growth, and development.
ICBA urges policymakers to ensure public trust by fostering collaboration between domestic and international regulatory authorities to mitigate risks as the adoption of cryptocurrency continues to increase.
ICBA supports ongoing efforts by policymakers to harmonize regulations to ensure strong, clear, and consistent oversight of cryptocurrency service providers and establish a path forward with guidelines for permissible activities by banks.
ICBA urges policymakers, regulators, law enforcement, and national security organizations to coordinate their efforts to combat ransomware and prevent bad actors from using cryptocurrencies for illicit activities.
ICBA supports efforts by policymakers to resolve regulatory and legal debates about the classification of digital assets as securities, commodities, or banking products. Regulatory uncertainty inhibits wider adoption and impacts community banks’ ability to compete in a rapidly evolving digital economy.
ICBA encourages regulators to collaborate on a comprehensive approach to prevent the rise of a shadow banking system filled with unregulated, decentralized platforms that pose risks to consumers, the financial system, and U.S. national security. Decentralized finance (DeFi) threatens to disintermediate community banks and exposes consumers to significant risks from hacks, including the complete loss of user assets.
ICBA urges policymakers to bring stablecoins within the regulatory perimeter to address serious risks to financial stability, national security, and consumer protection. Unregulated stablecoins and stablecoin products threaten to disintermediate community banks and heighten risks for disruptions to the wider economy.
ICBA encourages community bankers to educate their staff on cryptocurrencies, follow market and regulatory developments, and evaluate their bank’s exposure to cryptocurrency through customer activities. ICBA also urges regulators to prioritize examiner training on digital assets to ensure fair and accurate assessments during exams and fulfill their oversight responsibilities.
ICBA is strongly opposed to special purpose bank charters being granted to crypto-asset companies that do not fully meet the requirements of federally insured and supervised chartered banks.
Market Evolution Includes Community Banks. Cryptocurrencies are expanding from a niche investment class to function as means of payment and stores of value. Although cryptocurrencies such as bitcoin are not yet widely accepted by merchants, several crypto companies are developing solutions to enable crypto payments for consumers and businesses.
Some community banks are beginning to explore offering cryptocurrency products and services to meet customer demand, such as cryptocurrency debit card rewards programs or custody services for cryptocurrencies. Numerous financial service providers and fintech companies now offer consumers and businesses access to cryptocurrency-related activities, such as investments, lending, and custodial services.
ICBA has encouraged regulators to collaborate on a comprehensive digital assets regulatory framework. The Federal Reserve, FDIC, and OCC released a plan to provide additional guidance on digital assets products and services in 2022.
Stablecoins. Stablecoins are a type of digital asset that attempts to maintain a stable value by being pegged to a national currency or backed by assets, such as commercial paper or commodities. In 2021, the total stablecoin market surged more than 500percent since October 2020; the top three stablecoins have more than $125 billion in circulation as of December 2021.
In response to growing concerns about the rapid growth of stablecoins and the risks they may pose to financial stability and consumer protection, the President’s Working Group on Financial Markets issued several recommendations in November 2021 to bring stablecoins within the regulatory perimeter. ICBA and its members remain committed to work with regulators and policymakers to mitigate the hazards posed by stablecoins.
ICBA urges policymakers to develop a consistent regulatory framework for stablecoins and other digital assets that preserves the separation of banking and commerce, which is threatened by Big Tech firms operating payments systems and industrial loan companies that serve as full-service banks without adequate oversight.
Decentralized Finance (DeFi): DeFi is a term that describes a growing ecosystem of financial applications that run on public blockchains, such as Ethereum. DeFi applications, known as dApps, rely on smart contracts, or automated programming, to execute specific functions in an effort to replicate traditional products and services like payments and lending.
However, DeFi is designed to deliver this variety of financial services without the use of centralized parties, such as banks, insurance companies, or brokerages. DeFi threatens to disintermediate community banks and create a shadow banking system filled with unregulated platforms that pose risks to consumers, the financial system, and U.S. national security. DeFi protocols are also frequent targets of hacks and other malicious activity that result in substantial losses for users.
Risk. Limited regulation and oversight applied to the cryptocurrency marketplace and transactions mean that consumers and investors that use or hold cryptocurrency are exposed to significant risks, including highly volatile fluctuations in value. Cryptocurrencies also present several operational risks and concerns, including flaws in smart contract programming and the loss of cryptographic keys that can jeopardize users’ assets.
Private stablecoins pose substantial threats, including the potential to erode monetary authority and disrupt financial stability. Community banks are at risk of disintermediation if private stablecoins become more widely adopted for payments. A migration of commercial deposits to alternative currencies held in digital wallets could reduce community banks’ source of credit funding, with severe implications for the thousands of communities across our country that depend on their local bank for credit and other financial services.
Money Laundering, Terrorist Financing, and Fraud. Cryptocurrencies have a long history of being used for criminal and illicit activity, undermining law enforcement. Criminals frequently use cryptocurrencies to launder funds, hijack computer systems with malware to surreptitiously mine cryptocurrency, and use cryptocurrencies to facilitate payments for illegal goods and services. Anonymity-enhanced cryptocurrencies, or cryptocurrencies designed to evade scrutiny and cloak users in greater secrecy, are utilized by fraudsters around the world for a variety of criminal actions.
Digital Assets Classification. Unresolved questions about how cryptoassets should be classified and regulated contribute to marketplace confusion and may impede wider adoption. Depending on various attributes and design, digital assets may qualify as securities, commodities, derivatives, or banking products and services. The appropriate classification of digital assets is critical to ensure that issuers and intermediaries adhere to applicable laws and regulations and consumers have adequate protection. ICBA encourages interagency efforts to clarify how existing regulations may apply to cryptocurrencies.
Scope of Regulation. Policymakers are beginning to address the need for greater clarity in cryptocurrency regulations and policies. Any regulatory regime applied to cryptocurrency should be comparable to the multitude of regulations applicable to traditional, functionally similar payments products and services offered by the banking system.
Appropriate regulation of participants in the cryptocurrency industry, such as exchanges, must mitigate significant risks. The scope of regulation should include capital adequacy and reserves; activity restrictions; due diligence; information security and privacy; business resiliency, ownership and control of data; anti-money laundering and anti-terrorist financing; reporting and maintenance of books and records; consumer protections; safeguarding customer information; vendor and third-party management; and ongoing examination. Without such a regime, the lack of parity with the banking industry poses a heightened level of risk to consumer privacy, digital commerce, and the global financial system.
Special Purpose Cryptocurrency Bank Charters. Innovation in financial services offers many benefits to consumers and businesses. However, innovation cannot come at the cost of ensuring a safe and sound banking and payments system. In the past year, several cryptocurrency companies began pursuing bank charters from the Office of the Comptroller of the Currency and from a small, but growing, number of states.
These novel charters for non-banks firms raise a number of regulatory concerns—such as violation of the long-standing principle of the separation of banking and commerce, lack of application of traditional banking statutes and regulations governing safety and soundness and consumer protection, and most significantly, the potential introduction of systemic risk into the payments system. ICBA urges policymakers to ensure that cryptocurrency companies fully meet the requirements of federally insured and supervised chartered banks before granting any charter or access to the Federal Reserve’s payments systems.
Against the backdrop of accelerating interest in digital assets and stablecoins, countries across the globe are assessing the risks and merits of central bank digital currencies (CBDCs). According to the Bank for International Settlements (BIS), 90 percent of central banks are exploring CBDC, and more than half are now developing them or running concrete experiments.
Concerns of potential threats and loss of control over the payment system from privately issued stablecoins, digital currencies and CBDCs issued by foreign nations are accelerating U.S. plans. The Federal Reserve Bank of Boston has partnered with the Massachusetts Institute of Technology (MIT) to jointly build and test a hypothetical digital currency for general purpose use.
The report of the findings of the preliminary phase of Project Hamilton explores the architecture needed for a possible digital version of the U.S. dollar as a medium of exchange. It examines how to support the scale, security, speed, and other factors necessary for such an endeavor.
The Federal Reserve also released several documents designed to catalyze public dialog and feedback. In 2021, it established preconditions needed for a digital dollar that include clear policy objectives, broad stakeholder support, a strong legal framework, robust technology and market readiness. In January 2022, the Federal Reserve released a long-awaited consultation paper entitled Money and Payments: The U.S. Dollar in the Age of Digital Transformation.
This report highlights the opportunities, threats, costs and benefits of creating a CBDC in the U.S. The Fed noted that it was not seeking to promote a specific outcome and issued a request for information. The Fed promised not to move forward “without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.”
ICBA provided comments on the consultation paper, opposing the creation of a U.S. CBDC:
In March 2022, the Biden Administration released an Executive Order which directs the U.S. government to “assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests. The Order also encourages the Federal Reserve to continue its research, development, and assessment efforts for a U.S. CBDC, including development of a plan for broader U.S. Government action in support of their work. This effort prioritizes U.S. participation in multi-country experimentation and ensures U.S. leadership internationally to promote CBDC development that is consistent with U.S. priorities and democratic values.”
A CBDC could fundamentally change the structure of the U.S. financial system, altering the roles and responsibilities of the private sector and the central bank. ICBA has serious concerns with a U.S. CBDC which are described below in our 2022 policy resolution. ICBA looks forward to continued dialogue with the Fed and other policymakers on the question of a U.S. CBDC and other digital asset issues.
Expeditiously Assess the Policy Trade-Offs and Rationale of a CBDC
In January 2022, the Federal Reserve released its long-awaited report on a CBDC, beginning a policy dialog around the risks, costs, and benefits of issuing a CBDC in the U.S. The Fed noted that it was not seeking to promote a specific outcome and issued a request for information.
Separately, a Biden administration Executive Order requires the Treasury Department to analyze the implications of a CBDC on economic growth and stability, financial inclusion, and illicit financial activity and to assess whether legislation is required to create a CBDC. Reports are due in September and October 2022.
Any legislation proposed by the Administration would be based on Treasury’s findings and input from the Federal Reserve. It is unclear whether a CBDC would achieve policy goals that cannot be better achieved by other means. The economics of a CBDC – both direct costs to build and deploy as well as the economic impact– are not well understood and are not explained in the Fed consultation paper. A white paper by the Kansas City Fed concluded that, “…it is unlikely that all benefits of a CBDC will be able to co-exist in practice.”
Destabilization Risk to the Existing Banking and Payments Systems
A CBDC could threaten the health of the U.S. financial system by destabilizing existing banking and payments systems that are the backbone of our economy and markets. It would alter the roles and responsibilities of the private sector and the central bank in an unprecedented way.
The introduction of CBDC could also erode the Federal Reserve’s ability to conduct monetary policy and interest rate control by altering the supply of reserves in the banking system and forcing the Fed to balloon its balance sheet. Because a liability of the central bank is riskless, depositors may prefer CBDC over bank deposits in a crisis even if the CBDC has a less attractive rate of return, introducing the potential for bank runs.
Preserve the Critical Role of Community Banks
The Fed defines a CBDC as “a digital liability of a central bank that is widely available to the general public.” While Americans are already accustomed to holding money in digital form as bank deposits recorded as computer entries on commercial bank ledgers, a CBDC differs in that it is not a liability of any commercial bank, but of the Federal Reserve itself.
The Fed’s consultation paper stated, “The substitution effect could reduce the aggregate amount of deposits in the banking system, which could in turn increase bank funding expenses, and reduce credit availability or raise credit costs for households and businesses.” This would have a disastrous effect on the availability of credit, particularly to the small businesses served by community banks.
The Federal Reserve must preserve the vital role of community banks as economic engines of the U.S. economy. Additionally, creation of a CBDC would require significant private sector investment without a clear business case or an expected return on community bank investments.
The Fed report stated that in an “intermediated” model, banks would be expected to provide vital privacy, identity-verification, know-your-customer (KYC), anti-money laundering (AML), and other compliance processes. A CBDC could represent new burdens for community banks with no clear benefit, compensation, or new opportunities.
Legal and Regulatory Framework
The Fed promised in its report not to move forward “without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.” Federal legislation would be required to establish the roles and responsibilities of the various stakeholders—including the Treasury Department, Federal Reserve, and the private sector.
Congress would need to exercise its authority to preclude any actions that would disrupt the stability of the economy and inject safety and soundness risks to the financial system. Critically, any participant of the CBDC ecosystem must be subject to regulations and oversight tailored to the activities and risks they pose and commensurate with those that apply to federally insured banks.
Opposition to FedAccounts and Direct Access by Fintechs
ICBA adamantly opposes the direct provisioning of retail accounts at the Federal Reserve, which have been referred to as FedAccounts. The Federal Reserve has repeatedly said it is not positioned to offer direct accounts to consumers and is not legally permitted to do so.
Consumers are best served by thousands of competing private institutions, which have a duty to ensure their needs are met. ICBA also strongly opposes direct access to Federal Reserve accounts by fintechs and other nonbank providers that sit outside the regulatory perimeter, avoiding the supervisory and regulatory framework that applies to banks while adding risk to the financial system.
Allowing "regulated nonbank financial service providers" to compete in an open market for CBDC wallets, as proposed by the Fed, could introduce regulatory arbitrage risk and unfairly advantage these entities if they are not regulated as stringently as banks.
The Dollar’s Role in the Global Economy
Proponents of a CBCD have argued that it would support the dollar’s role in the global economy. However, the Federal Reserve notes that dollar dominance today is based off the depth and liquidity of U.S. financial markets, the size and openness of the U.S. economy, and international trust in U.S. institutions and rule of law.
They note that competitive CBDCs could add a new dynamic but would not replace these key factors. As noted in a Federal Reserve white paper, "Overall, U.S. dollar dominance has remained stable over the past 20 years...Diminution of the U.S. dollar's status seems unlikely in the near term."
Existing and Emerging Payments System Improvements May Accomplish Policy Goals More Effectively
The additive value of a CBDC is unclear and unproven, particularly given existing efforts by the private and public sectors to modernize the payments system. The U.S. has a diverse and highly competitive payments system today, with significant consumer choice. Safe, efficient Federal Reserve and private-sector interbank payment systems exist now that offer increased transaction speed and reduced costs.
In public comments, Nellie Liang, the Undersecretary for Domestic Finance at the Treasury Department, discussed additional means of addressing unequal access to the financial system. She cited the FedNowSM system, a payments platform being developed by the Federal Reserve, that “will be low cost to users. Because FedNow relies on the banking system, there already are safeguards for consumers and businesses.” With the impending introduction of FedNow instant payment services and increased Same Day ACH adoption, Americans are enjoying faster transactions clearance and can expect further innovations to be built upon these rails.
ICBA urges policymakers to give FedNow a chance to succeed in achieving payments modernization. The launch of a CBDC will be many years away, as pointed out by Treasury Secretary Yellen in a recent speech. A decision at this time to establish a U.S. CBDC would be premature.
Privacy, Security and Operational Concerns
A CBDC would require a public record of all transactions to be maintained by the central bank, significantly undermining the privacy of consumers. Questions remain about how to ensure the appropriate level of surveillance and enforcement without unduly compromising financial privacy or eliminating promised efficiency benefits.
This feature may impede a CBDC’s ability to foster financial inclusion, particularly for those who mistrust institutions and government. In addition, the Federal Reserve’s role as central processor of the CBDC ledger would dramatically increase its profile as a target for hackers, including sophisticated criminal gangs and hostile nations. If a U.S. CBDC were disrupted by hacking, it would undermine confidence in the dollar as a global reserve currency.
ICBA encourages the Federal Reserve to convene a broad group of stakeholders, including community banks and their technology partners, to analyze and explore the merits, opportunities, and challenges of introducing a CBDC in the United States. A CBDC taskforce comprised of a diverse spectrum of stakeholders will help ensure a strategic and inclusive approach that considers the interests of community banks and their customers.
 Comparing Means of Payment: What Role for a Central Bank Digital Currency?, https://www.federalreserve.gov/econres/notes/feds-notes/comparing-means-of-payment-what-role-for-a-central-bank-digital-currency-20200813.htm.