Based on the recent release of our Web3 Cyber Incident Database, we continue with our brief survey of crypto and digital currency initiatives from around the globe, all of which are officially sanctioned to enhance national competitive advantage (in the event crypto overtakes the US dollar as the global reserve currency). It is the cumulative adoption rate of state-sanctioned crypto and digital currency legalization and regulation that will propel this innovative system for value exchange as a global currency standard.

In previous posts, we provided an analysis of crypto and digital currency initiatives in El Salvador, Panama, Ukraine, India, Argentina, and Russia. Today we provide an analysis of the major central bank digital currency (CBDC) initiative in the U.S., Project Hamilton, which is a technical collaboration between the Federal Reserve Bank of Boston and The MIT Digital Currency Initiative.

As OODA CEO Matt Devost noted in his recent post, Is Bitcoin a National Security Risk?, “the Biden Administration is set to release an Execute Order (EO) articulating national security concerns associated with Bitcoin and other cryptocurrencies.” Project Hamilton is a major applied basic research project which will inform some of the actionable and directional components of the EO when released.

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NOTE: As of this writing, the EO has not been made publicly available. Please reach out to us if you hear otherwise. We are assuming a delay in the release of the EO due to the recent demands of the war in Europe.

Project Hamilton

Last month, Lael Brainard, a member of the Federal Reserve Board of Governors, presented a framework for a secure, central bank-backed digital currency that would be the unit of transaction and stored value in a more efficient payment system and includes the expansion of services to “unbanked” Americans that the traditional financial systems underserved.

In the major policy speech on February 18, entitled Preparing for the Financial System of the Future, Governor Brainard described Project Hamilton this way:

“In parallel with the Board’s public consultation on CBDC, the Federal Reserve Bank of Boston, in collaboration with the Massachusetts Institute of Technology, has developed a theoretical high-performance transaction processor for CBDC. They recently published the resulting software under an open-source license as a way of engaging with the broader technical community and promoting transparency and verifiability.”

In a recently published white paper from the project, “A High-Performance Payment Processing System Designed for Central Bank Digital Currencies“, the co-authors describe the structure of the research and technical collaboration:

“The Federal Reserve Bank of Boston (Boston Fed) and the Massachusetts Institute of Technology’s Digital Currency Initiative (MIT DCI) are collaborating on a multi-year exploratory research project, known as Project Hamilton, to gain a hands-on understanding of a CBDC’s technical challenges and opportunities. This paper presents the first phase of Project Hamilton’s research and describes the technical design of Hamilton, a research transaction processing system flexible enough to support experimentation with multiple CBDC models. Hamilton is the first contribution to OpenCBDC, a place for collaboration on technical research and development for CBDC.

Central banks are increasingly investigating general-purpose central bank digital currency (CBDC), defined
as a currency that is electronic, a liability of the central bank denoted in the national unit of account, broadly
available, and used for retail and person-to-person payments…Researchers have proposed that a CBDC could help address public policy objectives such as ensuring public access to central bank money, fostering
payment competitiveness and resilience, supporting financial inclusion, and offering a privacy-preserving digital payment method.”

And we know the OODA Loop membership would enjoy footnote #1 from this initial Project Hamilton white paper: “This project is named in tribute to two Hamiltons: Margaret, an MIT computer scientist who led the software development for the Apollo Program’s guidance system at NASA, and Alexander, who laid the foundation for a U.S. central bank.”

Governor Brainard also pointed out other mechanisms for how the board studies innovations, “such as distributed ledger technology…this work includes experimentation with stablecoin interoperability and testing of retail payments across multiple distributed payment ledger systems. The Federal Reserve Bank of New York recently established an Innovation Center, focused on validating, designing, building, and launching new financial technology products and services for the central bank community”.

Additional Key Takeaways from the Fed Policy Speech

The Evolving Digitalization and Decentralization of Finance

20X Growth in Five Years: The market capitalization of cryptocurrencies grew from less than $100 billion five years ago to a high of almost $3 trillion in November 2021 and is currently around $2 trillion.

Stable Coins: The growth in the crypto finance ecosystem is fueling demand for stable coins—digital assets that are intended to maintain stable value relative to reference assets, such as the U.S. dollar. Stablecoin supply grew nearly sixfold in 2021, from roughly $29 billion in January 2021 to $165 billion in January 2022.

Risk Awareness: It is important to have strong frameworks for the quality and sufficiency of reserves and risk management and governance. As noted in a recent report on stablecoins by the President’s Working Group on Financial Markets, it is important to guard against run risk, whereby the prospect of an issuer not being able to promptly and adequately meet redemption requests for the stablecoin at par could result in a sudden surge in redemption demand. It is also important to address settlement risk, whereby funds settlement is not certain and final when expected, and systemic risk, whereby the failure or distress of a stablecoin provider could adversely affect the broader financial system.

Mainstream Adoption: The prominence of crypto advertisements during the Super Bowl highlighted the growing engagement of retail investors in the crypto ecosystem. The past year is any guide, the crypto financial system is likely to continue to grow and evolve in ways that increase interconnectedness with the traditional financial system.

Global Competitive Advantage: Officials in many countries are undertaking efforts to understand and adapt to the transformation of the financial system. Many jurisdictions are making efforts to ensure statutory and regulatory frameworks apply like rules to like risks, and some jurisdictions are issuing or contemplating issuing central bank currency in digital form.

Preparing for the Payment System of the Future

Safety and Security: It is prudent to explore whether there is a role for a CBDC to preserve some of the safe and effective elements of the financial system of the present in a way that is complementary to the private sector innovations transforming the financial landscape of the future.

Four CBDC Design Principles: The Board recently issued a discussion paper that outlines the Federal Reserve’s current thinking on the potential benefits, risks, and policy considerations of a U.S. CBDC. It lays out four CBDC design principles that analysis to date suggests would best serve the needs of the United States if one were created. Those principles are that a potential CBDC:

should be privacy-protected, so consumer data and privacy are safeguarded;
intermediated, such that financial intermediaries rather than the Federal Reserve interface directly with consumers;
widely transferable, so the payment system is not fragmented; and
identity-verified, so law enforcement can continue to combat money laundering and funding of terrorism.

Financial Stability

Future-Proofing: It is also important to contemplate the potential role of a CBDC to promote financial stability in a future financial system in which a growing range of consumer payment and financial transactions would be conducted via digital currencies such as stablecoins.

Bank Liability Would Safeguard Stability: There could be large shifts in desired holdings between these stablecoins and deposits, leading to large-scale redemptions by risk-averse users at times of stress that could prove disruptive to financial stability. In such a future state, the coexistence of CBDC alongside stablecoins and commercial bank money could prove complementary, by providing a safe central bank liability in the digital financial ecosystem, much like cash currently coexists with commercial bank money. It is essential that policymakers, including the Federal Reserve, plan for the future of the payment system and consider the full range of possible options to bring forward the potential benefits of new technologies, while safeguarding stability.

International Considerations

A Federal Reserve-issued CBDC: Decisions by other major jurisdictions to issue CBDCs could bring important changes to global financial markets that may prove more or less disruptive and that could influence the potential risks and benefits of a U.S. CBDC. Thus, it is wise to consider what the future states of global financial markets and transactions would look like both with and without a Federal Reserve-issued CBDC.

Strengthen the Position of the Dollar as the Global Currency Standard: It is prudent to consider how the potential absence or issuance of a U.S. CBDC could affect the use of the dollar in payments globally in future states where one or more major foreign currencies are issued in CBDC form. A U.S. CBDC may be one potential way to ensure that people around the world who use the dollar can continue to rely on the strength and safety of U.S. currency to transact and conduct business in the digital financial system.

U.S. Led Standards and Norms: More broadly, it is important to consider how the United States can continue to play a lead role in the development of standards governing international digital financial transactions involving CBDCs consistent with norms such as privacy and security.

Global Leadership in Research and Policy Development: Given the dollar’s important role as a payment instrument across the world, it is essential that the United States be on the frontier of research and policy development regarding CBDC, as international developments related to CBDC can have implications for the global financial system.

What Next?

We will provide research and analysis of the Executive Order on cryptocurrency and national security as soon as it is available. In the meantime, if the implications of Project Hamilton are of immediate concern for your organization’s business model and value proposition, engage the research and technical resources available below to engage the Project Hamilton research and technical community.