Michelle Neal: Advances in digital currency experimentation
Remarks by Ms Michelle Neal, Executive Vice President and Head of Markets of the
Federal Reserve Bank of New York, at the Singapore FinTech Festival 2022,
Singapore, 4 November 2022.
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As prepared for delivery
Good afternoon. It is a pleasure to be here with you at the Singapore Fintech Festival. It
is exciting to be a part of this gathering of industry professionals, policy leaders, and
investors to discuss key developments in the fintech industry. Digital innovation has the
potential to benefit the financial system writ large by reducing transaction costs,
increasing competition, and broadening access to a wider range of participants.
However, harnessing the full potential of financial innovation and related technologies -
especially regarding cross-border settlements and payments - will require collaboration
across a range of international partners. In my remarks today I will discuss the
landscape of digital assets and some of the ways that the Federal Reserve System is
engaging in research and experimentation that support ongoing innovation. As always,
the views I express today are my own, and do not necessarily reflect those of the
Federal Reserve Bank of New York or the Federal Reserve System.
Digital Assets and the Federal Reserve
We are all experiencing the incredible pace of growth and change within the digital
asset domain, which encompasses a range of opportunities and risks. The market
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capitalization of digital assets reached $3 trillion in November 2021. The rapid growth
of digital assets presents opportunities to both reinforce the role of central banks and
regulatory bodies in stewardship of the global financial system and be positioned at the
technological frontier. However, this growth is not without risks: in May, the crash of
Terra, an unbacked algorithmic stablecoin, and the subsequent wave of insolvencies,
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wiped out over $600 billion of investor and consumer funds. , Currently, the total
cryptoasset market capitalization rests around $1 trillion, a 66 percent decline from its
November 2021 peak.
When I consider the ways in which digital assets impact the mission of the Federal
Reserve, I see several channels - including monetary policy and the provision of an
elastic currency, the preservation of financial stability, and the smooth operation of the
payments system. Regarding monetary policy and currency, in January, the Federal
Reserve released a discussion paper that considers a future where digital assets may
play a large role in our financial system, and in particular, establishes some broad
principles and outlines some of the pros and cons of a central bank digital currency, or
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CBDC. While at present the Federal Reserve has neither issued a CBDC nor plans to
do so imminently, ongoing research improves our understanding of the risks and
opportunities inherent to a CBDC. Central bank money - a liability of the Federal
Reserve - is the bedrock of the U.S. financial system. It is held by depository
institutions as bank reserves or by individuals in the form of paper currency. Demand
for central bank money is driven by many fundamental factors, including the settlement
of both retail and wholesale transactions and its role as a store of value. In addition to
these factors, which are likely familiar to any of you who have studied monetary
economics, demand for the U.S. dollar is also driven by international factors owing to
the role of the dollar in the global economy. In fact, while precise estimates are
challenging to come by, available data suggests that more than half of all dollars in
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circulation may be held outside the United States. As a result, innovation related to
money provided by the Federal Reserve will have impacts that extend far beyond U.S.
borders.
A U.S. CBDC - a digital form of the U.S. dollar that is a direct liability of the Federal
Reserve- has the potential to offer significant benefits. It could enable a payment
system that is more efficient, provide a foundation for further technological innovation,
and facilitate faster cross-border transactions. It could promote financial inclusion and
equity by enabling access for a broad set of consumers and foster economic growth
and stability. In order to fully realize benefits such as these, a digital dollar would need
to be thoughtfully designed and implemented. A CBDC would need to protect against
cyber and operational risks, safeguard the privacy of sensitive data, and minimize risks
of illicit financial transactions. Additionally, one of the most important aspects in our
deliberations is that any form of a CBDC in the future would need to be intermediated.
This means that the private sector would need to act as intermediaries in that system,
and a direct account approach would not be contemplated.
While the Federal Reserve has made no decision on whether or how to issue a CBDC,
we are actively conducting technical investigations into both retail and wholesale CBDC
design. Project Hamilton, which is a partnership between the Federal Reserve Bank of
Boston and MIT, has experimented with potential approaches to a digital dollar, with
work focused on retail uses and payment channels. In the use case they explored, the
Hamilton team was able to demonstrate the potential for usage at scale, which would
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be a key design element of a retail CBDC. As a complement, and in line with the New
York Fed's unique role in the Federal Reserve System with wholesale payments in both
domestic payments and foreign exchange, the New York Innovation Center is
researching technical aspects related to wholesale CBDCs.
In addition to CBDC, the broader digital assets landscape, which includes stablecoins -
cryptoassets that are backed by assets such as U.S. Treasury securities to stabilize
their value - and unbacked cryptoassets, has grown significantly in recent years, and
continues to evolve quickly. While many digital-asset-related activities fall within existing
U.S. laws and regulations, the rapid evolution and adoption of digital assets highlight
unique risks that warrant a more comprehensive and aligned approach by agencies
across the U.S. government with different regulatory remits. The Federal Reserve, as
an independent central bank, is only one part of the puzzle. Many of these other
stakeholders across the U.S. government, such as the Treasury Department, market
regulators, and federal banking supervisors, will be involved in providing guidance and
guardrails to the financial system as the universe of digital assets continues to evolve.7
In the current environment of rapid technological change, it is crucial that innovation
proceeds responsibly in order to safeguard the stability of the financial system. To that
end, on March 9 of this year, President Biden issued an Executive Order on Ensuring
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Responsible Development of Digital Assets. This executive order outlined the first
whole-of-government approach to addressing the risks and harnessing the potential
benefits of digital assets and their underlying technology. In response, over the past six
months, agencies across the government have worked together to develop frameworks
and policy recommendations that advance the six key priorities identified in the
executive order: consumer and investor protection; promoting financial stability;
countering illicit finance; U.S. leadership in the global financial system and economic
competitiveness; financial inclusion; and responsible innovation. The executive order
will be a catalyst to increased coordination among U.S. regulators. Last month, as part
of the approach outlined in the executive order, the Financial Stability Oversight
Council, or FSOC, released a report that considers the financial stability risks of crypto
assets. In the report, the FSOC noted that financial stability risks of crypto assets are
drawn mainly from interconnections with the traditional financial system. The report
identified vulnerabilities unique to crypto assets and recommended approaches to
regulation and supervision in the future, highlighting the importance of ongoing research
to improve our understanding of risks and opportunities, and planning to ensure we can
continue to achieve our mission including supporting safety and stability in this evolving
domain. The Fed also collaborates with other U.S. regulators on the topic of stability
risks arising from digital assets, and coordinates with international authorities through
forums including the Bank for International Settlements (BIS) and the Financial Stability
Board.
Finally, a third key dimension through which innovation - both broadly and in digital
assets specifically - impacts the mission of the Federal Reserve is in relation to the
payments system. On a daily basis, roughly $4 trillion of transactions are settled
through FedWire, the real-time gross settlement (RTGS) service offered by the Federal
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Reserve. FedNow, targeted for release in mid-2023, represents a key innovation to
modernize the future of payments. This new cloud-based RTGS system will enable
consumers and businesses to send payments instantly through their depository
institutions on a 24-hour, 365-days-a-year basis.
Of course, payments do not always stay within national borders. The Federal Reserve
is an active participant in international efforts regarding payment systems via the
Committee on Payments and Markets Infrastructures (CPMI) at the BIS. The CMPI
collects best practices and issues recommendations for managing payments, clearing,
and settlement risk across financial market utilities. At present, a high-priority area of
study for the CMPI is coordinating the development of 24/365 RTGS systems - like
FedNow - globally. Innovation in cross-border settlements will reduce liquidity outlays
and settlement risks, leading in turn to cheaper cross-border payments.
The New York Innovation Center and Project Cedar
In the remainder of my remarks, I'd like to focus on an example of ongoing innovation
research that is currently underway at the Federal Reserve Bank of New York. To
further enhance our ability to contribute to financial innovation globally, the New York
Innovation Center, or NYIC, was established in 2021. The NYIC bridges the worlds of
finance, technology, and innovation. Through technical research, experimentation, and
prototyping, our team generates insights into high-value central-bank-related
opportunities, enabling stakeholders and the central bank community to enhance the
functioning of the global financial system.
Project Cedar is the inaugural project of the NYIC and represents the first stage of the
NYIC's research efforts into CBDCs, the NYIC's biggest focus area in 2022. A goal of
the NYIC is to progress CBDC research with an objective of defining a technical design
for a CBDC addressing the wholesale market in the Federal Reserve context.
After taking a close look at the foreign exchange space with economists, traders, and
market analysts, the NYIC team zeroed in on settlement of foreign exchange spot
transactions as a first area of investigation. FX spot transactions are critical in the
context of cross-border payments, and serve as a building block for longer, more
complex transactions. Traditionally, settlement generally takes two days after a
transaction, which leaves some room for improvement. By demonstrating improvements
in settlement of FX spot transactions, the NYIC could address settlement time and risk,
which would have implications to speed and access for the broader cross-border
market. We are not the first to address this topic, of course, but the NYIC wanted to
investigate it from the perspective of the Federal Reserve, through the lens of a
wholesale CBDC.
The NYIC developed a hypothesis that there is a distributed ledger technology solution
for wholesale FX settlement that results in instant and atomic settlement in which a
wholesale CBDC is the settlement asset. NYIC then built a working prototype and
tested it. Results from the experiment indicated that settlement could occur in fewer
than 10 seconds on average and that horizontal scaling was possible. This indicates
that a modular ecosystem of ledgers has the potential for continued scalability, and that
distributed ledger technology could enable settlement times well below the current
industry standard of two days, with the added guarantee of atomic settlement.
Conclusion
Innovations in digital assets have the potential to impact financial markets in many
fundamental ways; it is essential to understand these developments and the impact
they may have on the mission of the Federal Reserve. Through ongoing investment in
research, experimentation, and collaboration, leveraging the full potential of digital
assets is possible. I look forward to building on the successes of Project Cedar and
similar efforts.
1
The White House, Fact Sheet: White House Releases First-Ever Comprehensive
Framework for Responsible Development of Digital Assets , September 16, 2022
2
CNBC, "Terra backers vote to revive luna - but not UST - after $60 billion crypto
collapse ," May 25, 2022
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Vice Chair Lael Brainard, "Crypto-Assets and Decentralized Finance through a
Financial Stability Lens ," remarks at the Bank of England Conference, July 8, 2022
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Board of Governors of the Federal Reserve System, "Money and Payments: The U.S.
Dollar in the Age of Digital Transformation," January 2022
Chicago Fed Letter, " Understanding the Demand for Currency at Home and Abroad ,"
No. 396, 2018
6
Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital
Currency Initiative, Project Hamilton Phase 1 Executive Summary , February 3, 2022
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Vice Chair for Supervision Michael S. Barr, "Managing the Promise and Risk of
Financial Innovation ," remarks at D.C. Fintech Week, October 12, 2022
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The White House, Executive Order on Ensuring Responsible Development of Digital
Assets , March 9, 2022
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Fedwire® Funds Service Volume and Value Statistics , FRBservices.org