WASHINGTON — Federal Reserve Vice Chairman for Supervision Randal Quarles warned Thursday that widespread adoption of cryptocurrencies could undermine financial stability in the event of an economic downturn.

“While these digital currencies may not pose major concerns at their current levels of use, more serious financial stability issues may result if they achieve wide-scale usage,” Quarles said in his first formal speech since being sworn in in October. “Risk management can act as a mitigant, but if the central asset in a payment system cannot be predictably redeemed for the U.S. dollar at a stable exchange rate in times of adversity, the resulting price risk and potential liquidity and credit risk pose a large challenge for the system.”

Randal Quarles, Fed vice chair of banking supervision
Federal Reserve Vice Chair for Supervision Randal Quarles said that while cryptocurrencies do not yet pose a threat to financial stability, "more serious financial stability issues may result if they achieve wide-scale usage." Bloomberg News

Quarles, speaking at a fintech conference sponsored by the Office of Financial Research and the Federal Reserve Bank of Cleveland, and held at the U.S. Treasury, said that digital currencies do hold the potential for innovation, particularly in the area of modernizing the payments system. But those considerations have to be tempered by an even more heightened need for the financial system to remain secure and resilient.

“It is appropriate not only to evaluate the potential of innovations to improve on existing services, but also to judge their ramifications for the safety and soundness of the institutions we supervise and for financial stability,” Quarles said. “Although many of these technologies are still nascent, it is important to have an eye on the potential financial stability implications both in the short- and long-run. Payment systems need to be resilient during adversity. Without that resilience, we could face a sudden loss of public confidence and the seizing up of systems and critical activities.”

Cryptocurrencies, and particularly the distributed ledger — or blockchain — technology underlying them, have grown in adoption as the Fed has engaged in a multiyear evaluation of the national payments system, Quarles said. One of the takeaways from that examination has been that payments changes occur gradually, and can be “measured in decades, not years.”

Quarles added that, while the Fed is examining the possibility of issuing its own blockchain payments product — one that, unlike current cryptocurrencies, does have the backing of the U.S. government — such an innovation is still quite a ways off and requires a resolution to a number of practical considerations, including the implications for cyber threats, money laundering and privacy.

He warned that a central bank-issued digital currency could shift attention away from and even potentially "derail" ongoing efforts to update the existing payments system, as well as potentially threaten commerce by making those existing payments systems unreliable or balkanizing payments methods.

“The effect of all this would significantly divert our focus from work to improve or establish new private-sector retail payment systems based on existing institutions,” Quarles said. “The prospect of a government-sponsored digital currency might even derail private-sector plans to enhance the payment services provided to their customers, thereby significantly disrupting the financial networks that exist today in ways that could create instability.”

Federal Reserve Gov. Jerome Powell, who has been nominated to succeed Janet Yellen as Fed chair, was originally slated to deliver remarks at the conference, but Quarles was made available to deliver the speech. His remarks were in line with comments Powell has made about blockchain in the past.

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