Lawmakers and Federal Reserve officials are so concerned about Facebook’s plans to launch a new digital currency that they’re contemplating a novel response — having the central bank create a competitor.Momentum is building for an idea that was once considered outlandish — a U.S. government-run virtual currency that would replace physical cash, a dramatic move that could discourage major companies like Facebook from creating their own digital coins.
The idea of a government-sponsored digital currency has been around for quite some time. See, for example, the unconfirmed rumors reported in a March, 2013 discussion on the Bitcointalk forum titled “Fedcoin: A centrally-issued alternative to peer-to-peer currencies.”
Now U.S. economists are taking it seriously.
On February 3, David Andolfatto, Vice President of the Federal Reserve Bank of St. Louis, wrote a blog post based on a presentation he gave at the International Workshop on P2P Financial Systems 2015. The title of the blog post is “Fedcoin: On the Desirability of a Government Cryptocurrency.”
In a report released earlier this month but which only caught the bitcoin community’s eyes these past two days, the Boston Fed concludes that “the lasting legacy of Bitcoin most likely lies in the technological advances made possible by its protocol for computation and communication.”
Authors J. Christina Wang, a senior economist in the Boston Fed’s research department, and Harvard University economist Stephanie Lo note that this decentralized technology could disrupt a current bank-centric payment system that’s “fragmented” and “inefficient.”
They join St. Louis Fed Chief Economist David Andalfatto, who put out a report on cryptocurrency earlier this year, in specifically acknowledging bitcoin competitor Ripple as a contender for this role. Describing that startup’s network as “essentially a protocol that allows disparate systems to communicate in order to transfer funds and make payments,” the report says Ripple shows that “the development of new technologies for making payments does not need to be accompanied by a new financial claim” – in other words, a new digital currency to compete with traditional currencies. (Ripple has its own native currency, called XRP, but not every transaction requires it and end users typically don’t trade in it, with most transfers passing only momentarily through XRP. The financial service providers that serve as Ripple gateways can distribute and receive payments in sovereign fiat currencies.)
Bitcoin did not miss out on praise. The authors say “it’s conceivable for bitcoin to capture a nonnegligible market share” of e-commerce, noting that despite extreme volatility in its exchange rate, data show that people engaging in bitcoin transactions on average save money over traditional payment methods by avoiding the bigger transaction fees imposed by banks. They especially highlighted bitcoin’s promise in cross-border remittances and while they pointed out thatthis could be held back by underdeveloped personal computing technology and knowledge in developing countries, cellphone technology offers an attractive way around these limitations.
Notably, the report takes a critical look at the mining network, a vital component of the bitcoin infrastructure through which its coins are issued and its transaction ledger is updated. The report describes the competition mechanism that has produced a concentration of mining power as one of bitcoin’s “serious design flaws,” raising concern that reduced profitability for small miners will further concentrate power and could undermine the integrity of the system. The authors even raise the prospect of regulation to manage the mining network – “it suggests the need for enhanced oversight, either by the players themselves or by an independent third party, to guard against the likelihood of collusion or other noncompetitive behavior,” they wrote.
Ms. Wang and Ms. Lo also highlight the fact that more high-powered, independent computers could soon be needed to store the large amounts of data that bitcoin’s blockchain ledger of transactions will contain.
Based on these concerns, they contend that the bitcoin network, “as originally designed, and especially its associated digital currency, will probably not survive in the long run.”
