Has the Federal Reserve Jumped on the Bitcoin Bandwagon?
Note: This article was originally posted here as a member article for the Digital Currency Council on January 30, 2015.
A new Federal Reserve white paper reveals that the agency has taken an increased interest in decentralized digital currencies and has begun to recognize their beneficial characteristics, but stops short of full advocacy due to the technology’s lack of maturity.
The Fed’s “Strategies for Improving the U.S. Payment System,” published January 26, presents a multi-faceted plan for collaborating with payment system stakeholders to enhance the speed, safety and efficiency of the U.S. payment system. These stakeholders include large and small businesses, emerging payments firms, card networks, payment processors, consumers and financial institutions.
“A U.S. payment system that is safe, efficient and broadly accessible is vital to the U.S. economy,” the agency writes. “[T]he Federal Reserve plays an important role in promoting these qualities as a leader, catalyst for change and provider of payment services to financial institutions and the U.S. Treasury.”
The paper proposes five desired outcomes for an improved U.S. payment system: (1) speed, (2) security, (3) efficiency, (4) international, meaning cost-effective and timely cross-border payments, and (5) collaboration among a broad array of payment participants.
The remainder of the paper’s core outlines the strategies and tactics the Fed will pursue, in collaboration with stakeholders, to help the country achieve these outcomes. The agency intends to establish a task force to identify effective approaches for implementing safe, ubiquitous, and faster payment capabilities.
However, an appendix to the plan initiates the conversation by engaging in a “Faster Payments Alternatives Analysis.” In this analysis, the Fed discusses cryptocurrencies under yet another new alias: “Digital Value Transfer Vehicles.” The agency’s definition of that term, “decentralized digital stores of value that can be exchanged,” is almost certainly referring to Bitcoin despite its avoidance of the name.
The analysis reveals that the Fed does not consider existing digital transfer vehicles “a sufficiently mature technology at this time,” but specifically highlights them for “further exploration and monitoring given significant interest in the marketplace.”
While existing digital transfer vehicles remain on the shelf, one of the Fed’s four preferred options selected for further study, “Option 2,” is notable for both its similarities and differences.
Like Bitcoin, Option 2 employs the distributed architecture of the internet to allow for direct communications from “point-to-point,” lowering costs compared to clearing transactions over a hub-and-spoke network architecture.
Unlike Bitcoin, these “points” are assumed to be financial institutions, rather than individual users in a “peer-to-peer” system. In addition, a central authority retains the role of managing the central ledger and setting the rules, standards, and protocols to facilitate efficient “point-to-point” communications.
There are a number of reasons why the Fed may be conservative in its embrace of Bitcoin’s fully decentralized model, but its lack of fit with existing laws and control mechanisms may be at the forefront. The existing legal infrastructure is designed to deal with CEO’s and managers of centralized institutions, while no individual party can be held responsible for the conduct of a fully decentralized digital currency.
The Fed must engage in a delicate balancing act between providing a secure improvement on the existing payment system to large institutions, yet avoid locking out smaller players or failing to serve their needs. Should they fail, the agency may lose its grip on a single dominant payment system, for as the Bitcoin economy rapidly matures, it will only become a more attractive alternative for the underserved.