Janet Yellen, Secretary of the Treasury and former Chair of the Federal Reserve, gave a speech on digital asset policy, innovation and regulation late last week. His remarks focused on President Biden’s March Executive Order on Ensuring Responsible Development of Digital Assets (Executive Order) and the broader development of U.S. regulation of digital assets, including cryptocurrency, stablecoin and central bank digital currency (CBDC).
Secretary Yellen’s remarks included the following five major structural themes. First, the US financial system benefits from responsible innovation. Second, when regulation fails to keep pace with innovation, it is often the vulnerable who suffer the most. Third, regulation should be risk- and activity-based, not technology-specific. Fourth, sovereign currency is central to a well-functioning financial system, and the United States benefits from the central role that the dollar and US financial institutions play in global finance. Fifth and finally, we must work together to ensure responsible innovation. These five themes provide an informative sense of how the Treasury views the regulation of digital assets and the development of frameworks to deal with digital assets. Additionally, Secretary Yellen’s remarks provided a more detailed look at the risks and rewards that come to the fore, as well as insights into how the Treasury might shape the regulation of digital assets in the future. Three key takeaways from the remarks are discussed below.
1. Reduce risk through regulation
As the Secretary noted, “digital assets have experienced explosive growth, reaching a market capitalization of $3 trillion last November, up from $14 billion five years prior.” This meteoric rise has generated a range of new financial “opportunities and risks”. Throughout her remarks, the Secretary discussed various types of risks regarding digital assets, including systemic risk (which can contribute to economic instability), illicit financial risk (fraud, theft, breach of privacy and data, and unfair and abusive practices) and national security. risk (tax evasion, money laundering and avoidance of sanctions). As Secretary Yellen noted, these types of risks are not specific to digital assets and are inherent in many types of financial transactions. For example, the secretary alluded to the global financial crisis where “shadow banks [and] subprime mortgage-backed securities[ies]has allowed dangerous levels of risk to accumulate, resulting in significant economic distress. In short, while the technology driving digital assets may be new, many of today’s digital asset issues are not, and existing regulatory frameworks can serve to guide the development of the digital asset space.
The Secretary explained that the prices of “cryptocurrencies have been quite volatile, which has inhibited their widespread use in payments” and that “the adoption of cryptocurrencies for payments may be further inhibited by high fees and slower processing times than those associated with other forms of payment.” Stablecoins (a type of cryptocurrency tied to a stable source of value) can also be susceptible to instability, especially during times of economic crisis. For example, the Secretary noted that “a stablecoin run occurred in June 2021, when a sharp decline in the price of assets used to back a stablecoin triggered a negative feedback loop of stablecoin redemptions. and further price reductions”.
Although the secretary’s comments might seem negative at first glance, her overall tone was rather pragmatic. She acknowledged that “the growth of digital services has opened up a world of possibilities” and said that “digital assets may be new, but many of the problems they present are not.” For example, she pointed out that although “inconsistent and fragmented oversight” currently hampers stablecoins, federal agencies and Congress are already working to “advance legislation to help ensure that stablecoins are resilient to the risks that could endanger consumers or the wider financial system. In short, the takeaway is that digital assets, like financial innovations more broadly, require regulatory frameworks “designed to support responsible innovation while managing risk.”
2. The importance of the US dollar and the complex considerations surrounding the potential development of a US CBDC
The US dollar is the reserve currency and the “most widely used currency for global trade and finance”. The Secretary explained that the importance of the US dollar has grown through a “dynamic process that has unfolded over centuries” and “is strongly supported by US institutions and policies; US economic performance; open, deep and liquid financial markets; rule of law; and a commitment to a floating currency. In addition, the Secretary noted that US citizens “derive significant economic and national security benefits from the unique role that the dollar and US financial institutions play in the global financial system.” Given the importance of the U.S. dollar and its inherent advantages, the secretary stressed that considerations for a CBDC must be seen “in the context of the central role the dollar plays in the global economy.”
President Biden’s executive order requires agencies, including the Treasury, to consider “the potential implications of a CBDC in the United States,” including “design and deployment options” and “assessments of benefits and possible risks to consumers, investors and businesses; financial stability and systemic risk; payment systems; national security; the ability to exercise human rights; financial inclusion and equity; and the actions required to launch a CBDC in the United States if deemed to be in the national interest. In her remarks, the secretary said she didn’t yet know what conclusions they would reach regarding a possible CBDC. That said, the secretary noted that in her view, “issuing a CBDC would likely present a major design and engineering challenge that would require years of development, not months.”
3. Technology neutrality regarding the benefits and risks of digital assets
“Tech neutrality” has been a watchword adopted by federal agencies tasked with regulating digital assets. In her remarks, the Secretary said that “to the extent possible, regulation should be ‘technology neutral’. The basic concept of ‘technology neutral’, in this context, is that many types of risks and benefits can be regulated in the same way, regardless of the technology used. As Secretary Yellen explained by way of example, “the principle of technological neutrality is […] applicable to concerns related to tax evasion, illicit financing and national security – topics of particular relevance in today’s world. It is illegal to evade taxes, launder money or avoid penalties. It doesn’t matter if you use checks, transfers or cryptocurrency. The secretary also pointed out that the federal government is already in the process of “updating [its] rules and guidance to clarify the application of our anti-money laundering and anti-terrorist financing framework to the digital asset ecosystem.
Given the diversity of different types of digital assets, greater regulatory clarity regarding “tech neutrality” will be needed from federal agencies, Congress, and the federal government more broadly. The Treasury appears set to keep technology neutrality front and center as it strives to shape the regulation of digital assets.
Secretary Yellen’s remarks reflect a pragmatic and measured approach to digital asset regulation. As she states, “In my view, the role of government should be to ensure responsible innovation – innovation that works for all Americans, protects our national security interests and our planet, and contributes to our competitiveness and our economic growth”. Secretary Yellen explains that there are differing views when it comes to digital assets, where “some proponents talk as if technology is so radically and beneficially transformative that the government should completely step back and let innovation follow.” its course” and others “see limited, if any, value in this technology and associated products and argue for the Government to take a much more restrictive approach. The Secretary’s remarks suggest that the Treasury appears to be taking a more intermediary when it comes to digital assets, advancing the development of regulatory frameworks “designed to support responsible innovation while managing risk.”
The Treasury is just one of many bodies that will play a key role in the development of digital asset regulation. Others include the SEC, FTC, CFTC, Federal Reserve, FDIC, and OCC. That said, leveraging existing regulatory frameworks to help address the risks and rewards of digital assets, addressing risks without unnecessarily limiting innovation, and promoting technological neutrality are surfacing as common themes in digital asset regulation, and it will be interesting to see the role they play as agencies and Congress continue to address and regulate this developing field.