Cryptocurrencies Present Risk to US Financial System, Will Require New Regulations: Federal Reserve Chair

Federal Reserve Chair Jerome Powell said new forms of digital money such as cryptocurrencies and stablecoins present risks to the US financial system and will require new rules to protect consumers.

Powell, speaking Wednesday on a panel organised by the Bank for International Settlements, a global organisation of central bankers, also said that new technologies will likely make electronic payments cheaper and faster. But they could also destabilise existing financial institutions, he said.

“Our existing regulatory frameworks were not built with a digital world in mind,” he said. “Stablecoins, central bank digital currencies, and digital finance more generally, will require changes to existing laws and regulation or even entirely new rules and frameworks.”

Stablecoins are a type of cryptocurrency usually tied to the dollar or a commodity such as gold. Central bank digital currencies are digital forms of dollars or other currencies, issued by governments. The Fed is researching digital dollars but has not yet made a decision on whether to issue one. It released a study on stablecoins in January.

Powell did not provide any details of what kind of regulations might be needed. He did say that they ought to follow the principle of “same activity, same regulation,” meaning that transactions outside the traditional banking system should be regulated the same as they are when executed by banks.

Earlier this month, President Joe Biden signed an executive order directing the Treasury Department and other federal agencies to study the impact of cryptocurrency on financial stability and national security.

His order came as several Democratic senators, including Elizabeth Warren from Massachusetts, have raised concerns that crypto could be used to evade US sanctions on Russia.

In his remarks, Powell outlined several risks that stem from the growth of digital finance, including to consumers and the broader financial system.

Americans who buy stablecoins or crypto “may not fully understand the extent of their potential losses, or that these investments generally lack the government protections that accompany many of the traditional financial instruments and services that they're used to,” Powell said.

Surveys show that roughly 16 percent of adult Americans — or 40 million people — have invested in cryptocurrencies. And 43 percent of men age 18-29 have put their money into cryptocurrency.

The Fed is also trying to figure out how digital assets like Bitcoin might impact financial markets, particularly during downturns or market crashes.

“We don't know how some digital products will behave in times of market stress, which could lead to large destabilising flows, nor do we know how stresses in crypto markets could potentially spill over into the traditional financial system,” Powell said.

One concern regarding stablecoins is that, while many promise to maintain a value of $1 (roughly Rs. 75), it's not always clear if stablecoin issuers have sufficient cash to redeem each stablecoin they issue for $1 (roughly Rs. 75).

Powell also noted that crypto assets have been used for “illicit activity,” such as money laundering, and “we need to prevent this so that the innovations that do survive and do attract broad adoption are those that provide value over time" for legal uses.

Powell said the Fed has “long supported responsible innovation," though he added that it is difficult to tell which innovations “will have lasting effects and those that will turn out mostly to be hype.”

“And it's never possible in real time to be sure which is which,” he said.