The market for stablecoins, and cryptocurrencies in general, has grown increasingly competitive over recent years, but there’s one competitor that the market may not stand a chance against: the federal government. While Federal Reserve (Fed) officials seem to think the Fed is just another competitor, there are many reasons to doubt that proposition.

For instance, Fed Vice Chair Lael Brainard argued in a testimony before Congress that there could be a place for stablecoins alongside the Fed’s central bank digital currency (CBDC). In making the case, Brainard stressed the importance of ensuring “a level playing field for competition and innovation across the financial system.” Yet the Fed’s status as a competitor and a regulator means that it is able to play the game, write the rules, and act as the referee. Worse yet, the Fed is also a competitor that does not need to worry about earning a profit—that is, earning revenue above its costs—like its private-sector counterparts. Technically speaking, the Depository Institutions Deregulation and Monetary Control Act of 1980 restricts the Fed from going beyond its means, but the Fed is only required to cover its costs over some unspecified “long run.” Even then, the Fed has ways to circumvent those constraints. Combine those factors with the general condition that the Fed has the full backing of the U.S. government, and we are left with a competitor that does not have to worry about going out of business.

If the Fed is to directly compete with stablecoin issuers, it’s hard to imagine how the very playing field Brainard praised will not be immediately slanted in the Fed’s favor.

The Fed’s Privilege in Practice

Recent history has shown how the Fed’s privileged status can distort markets. For example, the 2019 announcement of FedNow resulted in a temporary halt of private-sector developments in faster payments services. The Fed’s entrance as a regulator of and a competitor to private-sector payments services sent a clear message to the financial industry: despite billions of dollars of investment, years of development, and a network near completion, the future of private-sector payments services would depend on the ability to compete with the Fed.

Now, on the cusp of FedNow going public, it seems that the Fed is readying for its next encroachment on the market with the potential launch of a CBDC.

Competition in Context

One might be tempted to argue that new entrants should be welcomed with open arms considering competition breeds success, and that is largely right. As George Selgin said in a testimony before the Senate in 2019, “As a rule, competition is an effective—if not the most effective—means for encouraging providers of services to price those services equitably, to produce them efficiently, and to improve their quality over time.” However, Selgin noted that there is a condition that comes with this rule: “these outcomes depend on the presence of a level playing field on which all providers compete—that is, they depend on the various providers having roughly equal legal privileges and obligations.”

While the Fed would indeed be a new competitor with the introduction of a CBDC, its legal privileges far exceed that of the private sector. At the same time as it would be competing with the private sector, the Fed would also be setting the rules that that competition takes place under and judging the actions of its competitors. In fact, it was recently made apparent how such a role in the market might go awry when Custodia (a cryptocurrency-focused bank) sued the Federal Reserve because of the 19-month delay over its application for a master account. Put simply, if the Fed is able to deny its competitors access to the fundamental tools of the financial system, it is not competing on a level playing field.

With all of that said, Congress can take steps to level the playing field for currency competition in the United States. To start, cryptocurrencies should be exempt from capital gains taxes, at the very least, where they are used for purchasing goods and services. Congress should also clarify the statute on legal tender so the public can better understand that the law does not force them to choose one currency over another. Both of these steps would help remove overbearing and unnecessary restrictions on the current market.

Yet these steps alone are not enough. If history is any indicator, it may be best to enact these reforms and still prohibit the Fed from issuing a CBDC. But if the Fed is going to move forward, Congress should tighten the constraints in the Monetary Control Act so that the statutes are both effective and credible. And before the Fed can move any further, the Fed should be required to clearly address what problem a CBDC is uniquely designed to solve that is not already being addressed by the private sector.