Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Tuesday, February 3, 2015

Fedcoin: On the Desirability of a Government Cryptocurrency


It was J.P. Koning's blog post on Fedcoin that first got me thinking seriously of the potential societal benefits of government-sponsored cryptocurrency. When I was invited to speak at the International Workshop on P2P Financial Systems 2015, I thought that a talk on Fedcoin would be an interesting and provocative way to start the conference. You can view my presentation here, but what I'd like to do in this post is clarify some of the arguments I made there.

As I described in this earlier post, I view a payment system as a protocol (a set of rules) for debiting and crediting accounts, I view money as widely agreed-upon record-keeping device, and I view monetary policy as a protocol designed to manage the supply of money over time.

The cryptocurrency Bitcoin is a payment system with monetary objects called bitcoin and a monetary policy prescribed as deterministic path for the supply of bitcoin converging to a finite upper limit. I view Bitcoin as a potentially promising payment system, saddled with a less-than-ideal money and monetary policy. As the protocol currently stands, bitcoins are potentially a better long-run store of value than non-interest-bearing USD. But if long-run store of value is what you are looking for, we already have a set of income-generating assets that do a pretty good job at that (stocks, bonds, real estate, etc.). [For a comparison of the rates of return on stocks vs. gold, look here.]

Let's set aside Bitcoin's monetary policy for now and concentrate on the bitcoin monetary object. What is the main problem with bitcoin as a monetary instrument in an economy like the U.S.? It is the same problem we face using any foreign currency in domestic transactions--the exchange rate is volatile and unpredictable. (And our experience with floating exchange rates tells us that this volatility will never go away.) Bill Gates hits the nail on the head in his Reddit AMA:
Bitcoin is an exciting new technology. For our Foundation work we are doing digital currency to help the poor get banking services. We don't use bitcoin specifically for two reasons. One is that the poor shouldn't have a currency whose value goes up and down a lot compared to their local currency. 
For better or worse, like it or not, the USD is the U.S. economy's unit of account--the numeraire--the common benchmark relative to which the value of various goods and services are measured and contractual terms stipulated. With a floating exchange rate, managing cash flow becomes problematic when (say) revenue is in BTC and obligations are in USD. Intermediaries like Bitreserve can mitigate some this risk but, of course, at an added expense. Hedging foreign exchange risk is costly--a cost that is absent when the exchange rate is fixed.

And so, here is where the idea of Fedcoin comes in. Imagine that the Fed, as the core developer, makes available an open-source Bitcoin-like protocol (suitably modified) called Fedcoin. The key point is this: the Fed is in the unique position to credibly fix the exchange rate between Fedcoin and the USD (the exchange rate could be anything, but let's assume par).

What justifies my claim that the Fed has a comparative advantage over some private enterprise that issues (say) BTC backed by USD at a fixed exchange rate? The problem with such an enterprise is precisely the problem faced by countries that try to peg their currency unilaterally to some other currency. Unilateral fixed exchange rate systems are inherently unstable because the agency fixing the BTC/USD exchange rate cannot credibly commit not to run out of USD reserves to meet redemption waves of all possible sizes. In fact, the structure invites a speculative attack.

In contrast, the issue of running out of USD or Fedcoin to maintain a fixed exchange rate poses absolutely no problem for the Fed because it can issue as many of these two objects as is needed to defend the peg (this would obviously call for a modification in the Bitcoin protocol in terms of what parameters govern the issuance of Fedcoin). Ask yourself this: what determines the following fixed-exchange rate system:


Do you ever worry that your Lincoln might trade at a discount relative to (say) Washingtons? If someone ever offered you only 4 Washingtons for your 1 Lincoln, you have the option of approaching the Fed and asking for a 5:1 exchange rate--the exchange rate you are used to. Understanding this, people will generally not try to violate the prevailing fixed exchange rate system. The system is credible because the Fed issues each of these "currencies." Now, just think of Fedcoin as another denomination (with an exchange rate fixed at par).

Now, I'm not sure if Fedcoin should be a variant of Bitcoin or some other protocol (like Ripple). In particular, I have some serious reservations about the efficiency of proof-of-work mechanisms. But let's set these concerns aside for the moment and ask how this program might be implemented in general terms.

First, the Fedcoin protocol could be made open source, primarily for the purpose of transparency. The Fed should only honor the fixed exchange rate for the version of the software it prefers. People can download free wallet applications, just as they do now for Bitcoin. Banks or ATMs can serve as exchanges where people can load up their Fedcoin wallets in exchange for USD cash or bank deposits. There is a question of how much to reward miners and whether the Fed itself should contribute hashing power for the purpose of mining. These are details. The point is that it could be done.

Of course, just because Fedcoin is feasible does not mean it is desirable. First, from the perspective of the Fed, because Fedcoin can be viewed as just another denomination of currency, its existence in no way inhibits the conduct of monetary policy (which is concerned with managing the total supply of money and not its composition). In fact, Fedcoin gives the Fed an added tool: the ability to conveniently pay interest on currency. In addition, Koning argues that Fedcoin is likely to displace paper money and, to the extent it does, will lower the cost of maintaining a paper money supply as part of the payment system.

What about consumers and businesses? They will have all the benefits of Bitcoin--low cost, P2P transactions to anyone in the world with the appropriate wallet software and access to the internet. Moreover, domestics will be spared of exchange rate volatility. Because Fedcoin wallets, like cash wallets, are permissionless and free, even people without proper ID can utilize the product without subjecting themselves to an onerous application process. Finally, because Fedcoin, like cash, is a "push" (rather than "pull") payment system, it affords greater security against fraud (as when someone hacks into your account and pulls money out without your knowledge).

In short, Fedcoin is essentially just like digital cash. Except in one important respect. Physical cash is still a superior technology for those who demand anonymity (see A Theory of Transactions Privacy). Cash does not leave a paper trail, but Fedcoin (and Bitcoin) do leave digital trails. In fact, this is an excellent reason for why Fedcoin should be spared any KYC restrictions. First, the government seems able to live with not imposing KYC on physical cash transactions--why should it insist on KYC for digital cash transactions? And second, digital cash leaves an digital trail making it easier for law enforcement to track illicit trades. Understanding this, it is unlikely that Fedcoin will be the preferred vehicle to finance illegal activities.

Finally, the proposal for Fedcoin should in no way be construed as a backdoor attempt to legislate competing cryptocurrencies out of existence. The purpose of Fedcoin is to compete with other cryptocurrencies--to provide a property that no other cryptocurrency can offer (guaranteed exchange rate stability with the USD). Adopting Fedcoin means accepting the monetary policy that supports it. To the extent that people are uncomfortable with Fed monetary policy, they may want to trust their money (if not their wealth) with alternative protocols. People should be (and are) free to do so.

Postscript, February 06, 2015.

A number of people have asked me why we would need a distributed/decentralised consensus architecture to support a FedCoin. In the talk I gave in Frankfurt, I actually made two proposals. The first proposal was called "Fedwire for All." This is basically digital cash maintained on a closed centralized ledger, like Fedwire. It would be extremely cheap and efficient, far more efficient that Bitcoin. But of course, it does not quite replicate the properties of physical cash in two respects. First, as with TreasuryDirect, the Fedwire accounts would not be permissionless. People would have to present IDs, go through an application procedure, etc. Second, the Fed is unlikely to look the other way (as it does with cash) in terms of KYC restrictions. So, to the extent that these two latter properties are desirable, I thought (at the time I wrote this piece) that we needed to move beyond Fedwire-for-All to Fedcoin. There may, of course, be other ways to implement these properties. I'm all ears!

68 comments:

  1. I am attracted to this type of payments system as well.

    If you have not already seen it, you might be interested in George Selgin's proposal for a Fedcoin calibrated to stabilize nominal GDP. Thus, the blockchain technology can perhaps offer a superior payments *and* superior monetary system to our current arrangements.

    http://www.freebanking.org/2014/12/12/free-banking-and-the-dollar/

    ReplyDelete
    Replies
    1. Basil, thanks for the link! I like reading George.

      Delete
  2. "Finally, because Fedcoin, like cash, is a "push" (rather than "pull") payment system, it affords greater security against fraud (as when someone hacks into your account and pulls money out without your knowledge)."

    I'm not sure this is quite right. Bitcoin verifies receivers but not senders, and mostly leaves encryption up to users (public-private key encryption is part of the bitcoin transport protocol, storage security is up to users). So someone can definitely hack into a computer that has a bit-coin and send the coin to themselves. What they can't do is steal your personal information and run up bitcoin debts in your name.

    ReplyDelete
    Replies
    1. Matthew, sure but to me, you hacking into my computer is like you stealing my wallet. Of course if you steal my wallet, you can pull all the cash you want out of it. But maybe this "push-pull" distinction is not as useful as I first thought. Thanks.

      Delete
  3. Good post David.

    1. I don't understand the push vs pull bit.

    2. Couldn't a regular commercial bank also set up its own version? They manage to keep their exchange rates fixed for their chequing account monies most of the time, with deposit insurance and LOLR. I wonder why they haven't already done so?

    ReplyDelete
    Replies
    1. Thanks, Nick.

      On push vs pull, maybe not that useful a distinction to make. Though, read this:http://codinginmysleep.com/push-vs-pull-the-fundamental-flaw-in-modern-payment-processing/

      Yes, commercial banks could do the same with FDIC and LOLR, but with Fedcoin, there'd be no point. Why haven't they done so? Good question. It's still early and the technology is still in beta.

      Delete
  4. I think one of the huge benefits of the idea is that it essentially gives everyone direct access to electronic Fed liabilities. In other words, Fedcoin gives anyone a low cost and secure way to hold an arbitrarily large amount of the medium of exchange, a task that currently poses a problem because of deposit insurance limits and the trouble with safely storing millions of dollars worth of paper currency. For a while it appeared that Money markets did the trick but that sort of blew up in the fall of 2008.

    I’m guessing Nick Rowe has already written about this so I’m going to go check out his blog…

    ReplyDelete
    Replies
    1. Philip: that would be a good topic for a blog post, but I haven't written on it.

      Delete
    2. Philip/Nick: in my Frankfurt talk I actually began with the proposition of "Fedwire for All." The U.S. Treasury has something similar right now (Treasurydirect).

      Nick: the obvious post to write is on the desirability and feasibility of narrow banking in the internet age.

      Delete
    3. That is exactly the blog post I'm imagining. The JME paper this summer by Chari and Phelan pretty much convinced me that the social costs of maturity transformation outweigh the benefits in the internet age.

      Delete
    4. The Fedwire proposal you mentioned in Frankfurt is quite intriguing as it is a perfect example of how to eliminate the necessity for intermediaries through the use of P2P logic. I guess the private sector will not necessarily like it, but the competitive edge of Fedwire and Fedcoin has a lot of appeal when taking a systematic view.

      Delete
  5. Ripple already provides much of the functionality that you describe.

    Banks currently issue USD (and other currencies) into the Ripple ledger. When a bank issues 1 USD on Ripple, that is a liability of the bank, i.e. it is a claim on the bank's assets/deposits. It doesn't need a "peg" to enforce it's value because it's explicitly defined as a $1 claim.

    The Fed could similarly issue "Fed-USD" into the Ripple ledger. This would be a $1 liability of the Fed, so for all intents and purposes, it would be viewed as a dollar.

    In order to construct a domestic real-time payments system, the Fed might issue Fed-USD to member banks who hold reserve accounts at the central bank. The number of USD issued would reflect the bank reserves on deposit at the Fed. So if a bank has $1mm in reserves on deposit with the Fed bank, it would receive $1mm in Fed-USD on Ripple.

    Banks could exchange Fed-USD in real-time on the Ripple ledger, which would effectively be a real-time good funds settlement system. (This is a step up from other real-time domestic payment systems which typically use intraday credit to clear transactions in real time, but ultimately perform deferred net settlement at a later time. Ripple's real-time good funds settlement architecture is risk reducing.)

    The legacy central bank ledgering systems could run in parallel to this. When the existing Fed ledger systems spin up at 9am on Monday, they can issue a call into the Ripple ledger to see what transactions occurred over the night/weekend and make changes between reserve accounts in the legacy systems to reflect the activity on Ripple.

    Ripple also has built in compliance tools like the "authorized accounts" feature. The central bank can choose to explicitly authorize every participant who is enabled to hold its issued liabilities. In this way, the Fed could create a closed-loop system in which only member banks could hold and transact in Fed-USD. Retail users could access this by proxy through their financial institutions, as they currently access the payment rails today.

    ReplyDelete
    Replies
    1. Thank you, Phillip. Many people seem to be questioning why we need a distributed ledger at all. Why not just offer digital cash via a centralized ledger? We can trust the Fed to do the accounting, I'm sure.

      Delete
  6. "the issue of running out of USD or Fedcoin to maintain a fixed exchange rate poses absolutely no problem for the Fed because it can issue as many of these two objects as is needed to defend the peg "

    The way you describe it, fedcoin would be backed by the fed's assets. But true crypto currencies have no backing.

    ReplyDelete
    Replies
    1. Mike, no, just think of Fedcoin as another denomination of currency. There's no backing...they're just digits.

      Delete
    2. If it needs mining it's a commodity and needs no backing. I don't have to mine Benjamins so needing to mine fedcoins makes no sense if it's just another denomination. And the whole exchange rate problem is due to the mining required.

      Delete
    3. Tom, the "mining" in Bitcoin is not analogous to "mining for gold." See this: http://andolfatto.blogspot.com/2014/11/bitcoiners-surely-we-can-do-buiter-than.html

      Delete
  7. And then the Treasury could start issuing TreasuryCoin, direct to the public. Right?

    ReplyDelete
    Replies
    1. Phillipe, the Treasury is already very close to doing this, see: http://www.treasurydirect.gov/

      Delete
    2. Then the treasury would be engaging in monetary policy.

      Delete
    3. It does not matter, as long as the Treasury is prescribed to conduct monetary policy in the manner outlined in the Federal Reserve Act.

      Delete
    4. But wouldnt it be a conflict of interest to have the government printing money? There is discretion though. They could lower rates to get reelected, bailouts, etc...

      Delete
  8. That IS what I was thinking. As if the fed started issuing $200 bills. But the $200 bills, like fedcoin, would still be the fed's liability, still backed by the fed's assets. Now, if the fed wanted to issue 21 million fedcoins, with no denomination, and promise never to buy them back with FRN's or anything else, then they'd be crypto.

    ReplyDelete
    Replies
    1. Mike, how is a USD backed? With a US treasury bill? Which is a claim to a future USD? So USDs are backed by future USDs? But a USD is also a claim to a future USD. It's a strange thing when one starts to talk about the "backing" of a fiat currency. Just drop the notion. Fiat is not backed by anything except the expectation that the money supply will be managed responsibly.

      Delete
    2. Wouldn't issuance of central bank e money be better then crypto though? No mining costs. No needing to peg because it is the USD. Commercial banks don't have to peg their deposits to physical cash so why bother with pegging?

      Delete
    3. In my opinion, yes. But the e-version of the USD will probably be subject to KYC restrictions, which is unlike paper cash. To the paper cash feeling, we'd need to let the book-keeping done by disinterested third parties, like Bitcoin miners.

      Delete
    4. This comment has been removed by the author.

      Delete
    5. KYC restrcitions can be lifted for anonymous accounts and maintained for non anonymous it seems.

      Delete
  9. David:
    The USD (FRN's, to be precise) are backed by the fed's assets (gold+ bonds), and since those bonds are backed by the "taxes receivable" of the US govt, then FRN's are backed by taxes receivable. If you think that modern paper currencies are unbacked, then you'd have a hard time explaining why every central bank holds assets.

    Suppose the first $100 of FRN's ever issued were issued in exchange for 100 oz of silver. No problem. The $ is backed by 1 oz of silver. Then the next $200 of FRN's issued are issued in exchange for $200 worth of bonds (denominated in $ this time). That last $200 of FRN's was issued in exchange for $200 of T bills, and it can also be retired in exchange for that same $200 of T bills. That circular backing that you are complaining about, backing a dollar with something denominated in dollars, is not a problem, as long as there are some real assets (100 oz of silver in this case) anchoring things. In the case of FRN's, those real assets include gold plus the govt's real ability to collect resources through taxation.

    ReplyDelete
    Replies
    1. Mike, when was the last time anyone redeemed a USD note for gold?

      Look, I think we agree that the ultimate backing is in the control of the money supply, which means the ability to tax (and transfer). Most economic models we write down do not even reference bonds.

      Now, we can think of adding frictions to the model that makes the composition of the Fed's balance sheet matter for a variety of reason (e.g., bonds constitute a credible threat of contracting the money supply through asset sales, instead of increasing taxes), but at the end of the day the back comes from the ability to manage the money supply over time.

      It's the same thing with Bitcoin. The monetary policy itself is what forms the backing for its value (along with the fact that it is useful in transactions). Change the monetary protocol in Bitcoin, like increasing the cap, and you will see a dramatic change in its value.

      Delete
    2. The most important element in creating money demand is the competence of issuer and accountability. Competence is largely composed of setting targets and effectiveness of tools used. Accountability assures people hat the monetary system is run in the interests of the public.

      Thats the backing not a metal that if the system collapses you can never redeem anyway.

      What fundamentally backs money in the long run is transactions money demand. Taxes create some demand. Without taxes people would still demand money because of its usefulness in making payments. Taxes can undermine the monetary system if excessive or if fiscal policy is poor.

      Delete
    3. David:
      The value of every financial security (stocks, bonds, etc.) is determined by its backing, not by its mere quantity. Back when FRN's were convertible into gold, you would have agreed that the value of the dollar was determined by the rate at which the fed converted dollars to gold, and that rate, in turn, could only be maintained if the fed's assets were enough to buy back all the FRN's at the pegged rate. But let the fed suspend gold convertibility, and you think that the forces determining the dollar's value change overnight, from "backing sets value" to "quantity sets value". Surely you see that the suspension of gold convertibility is not the same thing as a loss of gold backing, given the obvious fact that the gold is still in the fed's hands.
      Bitcoin is valued like gold, and nobody denies that when mines produce more gold, or more bitcoins, then their price will drop. But when a bank issues 10% more paper dollars, at the same time that it gets 10% more assets, then the value of the dollar stays the same, in spite of the increased quantity of paper dollars. By analogy, consider a firm that issues 10% more shares of stock or bonds, while it also gets 10% more assets as backing for those stocks or bonds. The price of those stocks or bonds will not change, since assets rose in step with liabilities.

      Delete
    4. Mike, let me reply in detail:

      The value of every financial security (stocks, bonds, etc.) is determined by its backing, not by its mere quantity.

      Well, yes and no. We know that securities, like Bitcoin, can trade at above the value of assets backing them (liquidity premia).

      Back when FRN's were convertible into gold, you would have agreed that the value of the dollar was determined by the rate at which the fed converted dollars to gold, and that rate, in turn, could only be maintained if the fed's assets were enough to buy back all the FRN's at the pegged rate.

      Not quite. The peg could have been maintained with zero gold on the balance, but the promise to tax the population for gold to honor the peg in the event it was challenged.

      But let the fed suspend gold convertibility, and you think that the forces determining the dollar's value change overnight, from "backing sets value" to "quantity sets value". Surely you see that the suspension of gold convertibility is not the same thing as a loss of gold backing, given the obvious fact that the gold is still in the fed's hands.

      So if I issue you a promissory note redeemable in my labor, but I then remove the redemption option while keeping possession of my labor, then the value of the promissory note remains unchanged?

      Bitcoin is valued like gold, and nobody denies that when mines produce more gold, or more bitcoins, then their price will drop. But when a bank issues 10% more paper dollars, at the same time that it gets 10% more assets, then the value of the dollar stays the same, in spite of the increased quantity of paper dollars.

      The same would be true if the Fed temporarily injected money in the economy (as a lump sum transfer) and then taxed it back. No assets involved. Same effect. The "backing" of money with assets is not important (unless one introduces special frictions of the type I alluded to earlier).

      By analogy, consider a firm that issues 10% more shares of stock or bonds, while it also gets 10% more assets as backing for those stocks or bonds. The price of those stocks or bonds will not change, since assets rose in step with liabilities.

      I agree with this, but notice that the firm is issuing paper to acquire capital. When the Fed creates paper, it buys claims to fiat paper. Again, what is the "backing" when the collateral is just a fiat object?

      Wish we were having this discussion over a beer! :)

      Delete
    5. Wish we were having this discussion over a beer! :)
      If you’re ever near UCLA, look me up and I’ll buy (within bounds of reason, of course.)
      We know that securities, like Bitcoin, can trade at above the value of assets backing them (liquidity premia).
      I don’t consider bitcoin a security. A security is an asset to its holder but a liability to its issuer. Bitcoin is nobody’s liability. I think bitcoin is more like gold in that way.
      The peg could have been maintained with zero gold on the balance, but the promise to tax the population for gold to honor the peg in the event it was challenged.
      No fair. You’ve just added the government’s assets to the fed’s assets, and claimed that the dollar is backed by both. Maybe the dollar is backed by both, but that’s a confirmation of the backing theory, not a refutation.
      So if I issue you a promissory note redeemable in my labor, but I then remove the redemption option while keeping possession of my labor, then the value of the promissory note remains unchanged?
      It’s more like this: You issue me a promissory note redeemable for 1 oz. worth of your labor, and also redeemable for 1 oz worth of rent on property you own, and also redeemable for an actual oz. of silver from your vault. Then one day your vault runs out of silver, so you suspend direct silver convertibility, while still accepting the note for labor and rent as before. Eventually you stop pegging your notes to silver, and just peg them instead to a CPI basket of goods.

      The same would be true if the Fed temporarily injected money in the economy (as a lump sum transfer) and then taxed it back. No assets involved. Same effect.

      No fair again. You’ve added the government’s assets (taxes receivable) to the fed’s assets again.
      I agree with this, but notice that the firm is issuing paper to acquire capital. When the Fed creates paper, it buys claims to fiat paper. Again, what is the "backing" when the collateral is just a fiat object?
      It’s not like that. Here’s an analogy: Say GM issues new share of stock, and uses them to buy call options on GM that were issued by Merrill lynch. The new shares get entered on the liability side of GM’s balance sheet while the calls become GM’s asset, even though the calls are denominated in units of GM stock. This transaction would not change the value of GM stock, though it would raise its potential volatility: Say GM’s profits fall, so its stock falls. This would make the calls fall, but the calls are GM’s asset, so the stock falls still more, etc.

      Delete
    6. >>I don’t consider bitcoin a security. A security is an asset to its holder but >>a liability to its issuer. Bitcoin is nobody’s liability. I think bitcoin is more >>like gold in that way.
      >>The peg could have been maintained with zero gold on the balance, but >>the promise to tax the population for gold to honor the peg in the event it >>was challenged.
      >>No fair. You’ve just added the government’s assets to the fed’s assets, >>and claimed that the dollar is backed by both. Maybe the dollar is >>backed by both, but that’s a confirmation of the backing theory, not a >>refutation.

      Yes, bitcoin is not a security. It's a currency. But the whole discussion of whether it is backed or not is pretty meaningless. The value of a currency resides exclusively in the trust of its users that it will maintain its monetary value in the future. If a population starts questioning whether they will be able to use the existing currency in future transactions, then the lifetime of that currency is nearing its end, regardless of what the issuers pretend they have as backing. The idea of a currency backed by another asset class is there for the exclusive reason of creating confidence in the validity of the currency, not to create an actual exchange transaction in the future if someone wanted to exchange his or her currency for the backing asset.

      A coin, a colourfully printed piece of paper or a cash account statement are the physical (or virtual :-) ) representation of the trust the community places in the validity of its exchange medium. It does not have any further qualities and no value other than its continued usability in real-world transactions. That's why Fedcoin does not need any backing from a systematic perspective. It may, however, require an argument of being backed by something to generate the community's trust in its future usability - same as with existing USD.

      Delete
  10. "A security is an asset to its holder but a liability to its issuer. "

    Shares are a security. GM shares arent on liability side, they're on equity side. Equity isnt a liability. There is no specific liability with equity.

    ReplyDelete
    Replies
    1. I apologize for my sloppy use of accounting terminology. But of course there are only two sides to a balance sheet: the asset side and the liability side. Shares get entered on the liability side, because they are a claim to the stuff on the asset side

      Delete
    2. If they are a claim then what is it? A company can issue equity and never pay dividends if it wants. Equity is what's left over after company ceases to exist. Equity just denotes a balance or difference between two items.

      If equity is a liab, how can you have negative equity?

      Delete
  11. Axel:
    " If a population starts questioning whether they will be able to use the existing currency in future transactions, then the lifetime of that currency is nearing its end, regardless of what the issuers pretend they have as backing. "

    If, for example, some superior private currency was invented, and people no longer wanted to use or hold federal reserve notes, then those FRN's would reflux to the fed. At first, every refluxing dollar would be retired in exchange for a dollar's worth of the fed's bonds, and the last few refluxing dollars would be retired in exchange for the fed's last remaining assets, including its gold. An orderly retirement like that would not be possible if the fed had no assets. The fed's assets matter, both for its ultimate unwinding and in its day-to-day-open market operations.

    Virtually all paper moneys started out convertible into something else. They had to have full backing, or else speculators would have started a Thailand-style run on the central bank. You seem to think, like David, that on the day that convertibility was suspended, the principles determining the value of the currency changed overnight, from being valued according to its backing (like every other financial security), to being valued because of a belief that other people will value it. A circular argument if ever there was one.

    ReplyDelete
    Replies
    1. Mike, I understand the argument on the effects of a private currency developing without the existing monetary authority controlling its issuance. Such a tidal change may be the sole instance where the ability to convert your USD to something else might have any real-world validity, although I am not sure what the scenario for the adoption of such a new superior private currency would actually look like. Either I can then exchange my USD for the new private currency (then I don't care whether I could have exchanged them at the FED for some collateral), or I can't, which implies that my existing USD is worthless right that very moment and I can then only re-develop my asset base inside the new money (or be granted the pro rata share of the new money comparable to my share in the existing currency, which is unlikely in a private currency set-up). Either way, my ability to exchange existing currency for some FED-owned collateral is not really what I'd be concerned about.

      On your second paragraph: Not quite. I think that the value of currency is always only extant to the extent that everyone (or almost everyone) in the economy believes it can be used in the future; and that the whole idea of backing a currency (as you say, mostly in the beginning of a new currency) is there for the sole purpose of creating the initial confidence in human beings that the currency will be around for while - or if it isn't, that I can move it backed into another currency (which is the collateral). Take gold as backing as an example. Gold does not have any intrinsic value. The sole reason it has been used first as currency and then as backing of currencies is that most people believe they can use it for future transactions, simply because it's shiny and rare and therefore thought to be interesting to someone I want to transact with in the future. This token backing could have been anything as long as the majority of economic actors believed such a token to be of stable value and future use. So, I share your perception that we are talking about a circularity here, but it is not in my argument but in the nature of money itself.

      Delete
  12. David:
    I wonder--why would a "Fed coin" need any mining at all. The Fed merely does the following:
    1) Debit someone's fed funds account (or receive a treasury bill);
    2) In return the Fed creates the "genesis block" for the coin and digitally signs the transfer of the Fedcoin to the counterparty.

    In a redemption of the "Fedcoin", the counterparty would digitally sign the transfer back to Fed in exchange for securities, Fed funds credits, or paper money.

    Transactions could be timestamped either by a group of "certified agents" or the Fed itself who would maintain searchable Blockchain ledgers much like the current Bitcoin system or by a peer to peer system similar to the Bitcoin system.

    In the case of the peer to peer system, the only differences from the current Blockchain system of Bitcoin would be (1) no currency volatility with respect to the dollar, (2) validation costs would be transparently paid by fees (much like Bitcoin once the last coin is minted).

    The "certified agent" validation mechanism should be consume less electricity and avoid the 51% attack problem--which could be a problem during a rollout period where there may be few validators.

    ReplyDelete
    Replies
    1. Well, to keep Fedcoin free of KYC restrictions, we probably don't want the Fed involved in processing these payments. So then, the question turns to who these "certified agents" should be and how they have an incentive to keep the ledger true and secure, and how they should be compensated. I've not heard of the "certified agent" validation mechanism, unless you mean something like Ripple? But I agree with you that the proof-of-work mechanism can likely be improved upon. Thanks!

      Delete
    2. "Certified agent" is not meant to be anything special--just some set of companies that meet high standards (e.g. like banks) so that people could trust the ledgers. The object is rather than have people send their transaction information to 6000 "bitcoin" nodes and have the validation mechanism rest on it being costly to validate one block of transaction, the validation mechanism would rest on being maintained by a reliable agent--just like your bank, register of deeds, etc.

      I'm not sure how one deals with the KYC issues; I would presume if this is insurmountable one would ultimately want to abolish Bitcoin also.

      Alternatively, one could just revamp the current money transfer system so that people could pay directly and instantly from bank accounts using digital signatures and temporary account numbers (to reduce check fraud).

      Delete
  13. Good post, David. Has Janet Yellen given you a call yet?

    ReplyDelete
  14. Great post, David.
    I think Bitcoin is the mirror that all central bankers will (and should) look into from the foreseeable future.
    However, I think that your idea is not taken nearly far enough. And if you take it farther, as you have done to some extent in response to some of the keen comments, the result might be at the same time less radical in appearance but more dramatic in its effects on the economy at large.
    I am going at greater detail in my post (https://claudiomigliore.wordpress.com/2015/02/09/fedcoin-less-revolutionary-more-intriguing)
    where I quote you, but essentially:

    - Once you introduce uncle Sam’s full faith and accounting skills of the Fed, the block chain may be public, but it no longer requires any validators (e.g. miners). That would also mean a dramatic drop in the cost of running Fedcoin.
    - Fedcoin would be just personal accounts at the Fed. It seems to me that the Fed shouldn’t needs a fig leaf to renounce KYC. Just let people open Fed personal as they open any online presence and there you have it. Just add 2(3, 4, n)-factor authentication mechanisms as you see fit.
    - In that scenario, Fedcoin is just one buck, period. Why would it be a problem?
    - The minute Fed accounts come online, I could hear the deafening sucking sound of deposits leaving banks for them. Ironically, if the Fed blockchain is public (good or bad thing?) people and firms might maintain bank accounts only to obscure their balance sheets for privacy or competitive confidentiality reasons!
    - Banks’ business model would change overnight. Bank multiplier would tank to nearly one and the credit intermediation business would become a pure play, taking away systemic risk, dramatically reducing economies of scale and opening up for all kinds of specializations and niche industries. No longer the Fed’s arm for monetary policy and payments system, banks would have a far different position within the business food chain.
    So Fedcoin is at the same time less revolutionary, since there are no byzantine generals, and a lot more far reaching, since implementing it would upend the current financial system. Indeed, I doubt that your proposal could be implemented overnight. At best, bank lobbies permitting, it could crawl in very slowly, to allow bank readjustment. It might make for some interesting experiment.
    Incidentally, Ecuador has floated the same idea. Although I have very little faith in Ecuador’s Central Bank and regulators, it would be interesting to see how the experiment proceeds there if it takes off at all.
    What do you think?

    ReplyDelete
  15. How would Fedcoin be "better enough" than our current digital currency (payroll direct deposit & "web bill pay" via banks & PayPal)?

    ReplyDelete
    Replies
    1. The problem with all of those payment systems is that there's a middleman who demands a cut. Of course, there's a cost of cash transactions (employee time spent balancing cash drawers, getting change from the bank, security, etc), but it's still often less than dealing with the credit card processors, especially for the very small and very large businesses. Not to mention person-to-person transactions like flea markets and the neighborhood kid mowing your lawn. With a currency like Bitcoin, transactions happen through devices like cell phones (QR codes) and P2P exchanges that don't require any third party.

      Delete
    2. Alas, Bitcoin does require a third party, in this case, a community of miners. They have to get paid. The only question is how much.

      Delete
  16. Except the reason why you want Bitcoin over Fedcoin is because the blockchain is finite. There's no advantage to unlimited digital currency, even if the FED says they're only going to create a set amount. That's how the dollar lost 97% of it's value since 1913.

    ReplyDelete
    Replies
    1. Eric, I see that you too suffer from Ron Paul's money illusion.

      http://andolfatto.blogspot.com/2011/03/ron-pauls-money-illusion-sequel.html

      See also:
      http://andolfatto.blogspot.com/2013/04/why-gold-and-bitcoin-make-lousy-money.html

      Delete
    2. http://www.usinflationcalculator.com/

      Delete
  17. You admit in your argument bitcoin is a better store of value than fedcoin when judges in the fundamental attributes. One of the arguments in the linked article is that people aren't that bad at dealing with infation... one of the ways the do it is to buy better stores of value, be it gold, bonds, bitcoin, or productive capital

    ReplyDelete
  18. David,

    To your replies above, True, Bitcoin does require a composite third party, the blockchain miners and True, US inflation last century was minuscule on a human scale.

    Also, IMHO FedCoin would be a great improvement over pure paper + banking money (with the comments I already made above).

    However, I think the comparison FedCoin-Bitcoin, if this is a venue for that, hinges upon whether a decentralized automaton is more efficient than a central authority at transferring and storing value between agents and whether a decentralized automaton (in this case the market pricing mechanisms with up- and down-ward flexibility) is better than a central authority at reaching demand-supply equilibrium.

    ReplyDelete
  19. Replies
    1. I write on these topics at
      https://claudiomigliore.wordpress.com/
      Cheers.

      Delete
  20. with monetary objects called bitcoin and a monetary policy prescribed as deterministic path for the supply of bitcoin converging to a finite upper limit. I view Bitcoin as a potentially promising payment system, this post

    ReplyDelete
  21. David,
    Did you read news around IBM marketing of crypto-factory-ware to central banks?
    https://claudiomigliore.wordpress.com/2015/03/21/fedcoin-helpers/
    http://www.reuters.com/article/2015/03/12/us-bitcoin-ibm-idUSKBN0M82KB20150312
    Cheers.

    ReplyDelete
  22. The primary innovation behind Bitcoin is the consensus that is achieved using the blockchain: If my address 1A38 has 100 currency units in it, and I authorize both a 100 unit transaction to address 1ED4, and another 100 unit transaction to address 1AC2, then which transaction is legitimate, and which one illegitimate? The answer is that the transaction that came first is the legitimate transaction, but how do you prove which transaction was created before the other one?

    Before the blockchain, the answer was to have a trusted third party - the "timekeeper" - who would be attaching signed timestamps to transaction messages, effectively saying "I see at time xxx account 1A38 signed a message authorizing a 100 unit transaction to account 1ED4" and "I see at time yyy that account 1A38 signed a message authorizing a 100 unit transaction to 1AC2". As long as the timekeeper is honest, these signatures by the timekeeper would prove which transaction preceded the other one. The transactions could then be publicly broadcast and validated by any third party.

    The blockchain orders transactions in a particular order without the use of any trusted third party. The chain is constructed through a group-effort computational consensus, which an attacker could compromise in order to effectively re-timestamp and re-order transactions, but only through accumulating more computing power than the rest of the group combined.

    "Fedcoin" requires a trusted third party to control the money supply. You could utilize this same trusted third party as the trusted timekeeper, and eliminate the need for mining entirely. Why waste all that electricity on mining? In any case, if you wanted to let a trusted third party control the money supply, but still use a mined blockchain to order transactions you could certainly do that:

    The definition of a valid transaction in Bitcoin is that (1) the transaction must be signed by the holder of the address's corresponding private key, and (2) the transmitting address must have a transaction history proving sufficient balance. All you need to implement Fedcoin is to define a valid transaction as requiring both (1) and (2), or (3): a transaction is always valid if it is signed by the Federal Reserve's key. In that case, the Fed can increase / decrease the total money supply through injecting or removing currency units to / from any account at will.

    So let's say we want to peg 1 Fedcoin = 1 USD. Initially you and I are the only users of the system, and we each want to store $5,000 in Fedcoins, so we each buy 5,000 of them. There must now be 10,000 fedcoins in existence. And now if two other guys come along and want to store $5,000 of value in Fedcoin, the Federal Reserve needs to come along and create more Fedcoins. Otherwise we have only 10,000 fedcoins in existence in order to store $20,000 of value, which would break the exchange rate. So now we've got 20,000 Fedcoins in existence storing $20,000 of value, which is fine. Fedcoins would be issued from the Federal reserve, in exchange for USD cash. You could deposit cash via bank wire or bills, and get Fedcoins which you can then transfer electronically. You can also convert them back to cash anytime via the Federal Reserve.

    It's a great idea, and effectively this is what PayPal is doing, except instead of calling them "Fedcoins" they call them "dollars," and they fix them at a 1:1 exchange rate with the USD. Since PayPal is already acting as a trusted third-party currency issuer, again why not also utilize them as a trusted third-party timekeeper and forego the expense of mining a blockchain? (They are already doing that too.)

    Regardless of whether PayPal uses a blockchain to order transactions, they could have implemented "push vs pull" or "permissions and free" at any time - those technologies have been around for a while. Unfortunately, doing so would be in violation of anti money-laundering laws.

    ReplyDelete
    Replies
    1. Push vs Pull and Permissionless and Free - While bitcoin does exhibit these characteristics, neither of these things is a recent or bitcoin-related innovation:

      "Push vs pull" is nothing other than a digital signature, which has been a solved problem in computer science for quite some time (decades). With digital signatures, a user generates a public / private keypair - which in bitcoin are the address / private key. The user then uses the private key to create a signed message saying: "I authorize x units of currency to be transferred out of this address" (address = public key). The signed message can only be produced with the private key, which the user keeps to himself. The message can be publicly verified to (1) be associated with the corresponding public key / address, and (2) be authentically generated by the holder of the private key, all without ever revealing the private key. The user gives the public key / address freely to anyone, who can then verify that transactions out of that address have indeed been signed by the unique corresponding private key, which the user keeps to himself.

      "Permissionless and free" also stems from this same digital signature keypair concept. Since a bitcoin address / key are a private / public keypair, then it makes sense that anybody with a computer can generate such a keypair. Just open a terminal on any mac / linux computer and type "ssh-keygen" and you'll get a private / public keypair. You can then use the private key to send signed messages that can be verified using the public key.


      Bitcoin Volatility - If there are 1,000 users of Fedcoin storing a total of $1M Fedcoin, and another 1,000 people come along wanting to store another $1M in Fedcoin, then in order to prevent the value of a Fedcoin from doubling, the Federal Reserve needs to double the total Fedcoin money supply; if there are 1million users of Fedcoin storing a total of $1Billion Fedcoin, and another 1,000 people come along wanting to store another $1M in Fedcoin, then the Federal reserve only needs to create a small amount of Fedcoin in proportion to the money supply in order to control volatility.

      By definition Bitcoin is experiencing high volatility because the total amount of money that people want to store in Bitcoin keeps changing; mostly going up over the years, as more people want to use it, where use can be defined as daily transaction volume. The volatility of Bitcoin may reduce considerably over time as this number of people who want to utilize the currency both grows and stabilizes, because each user added / removed from the system would have less of an individual impact versus the total value of the system.


      Serious Question - If Bitcoin did become the dominant form of money, what would interest rates be? 5%? 50%? 0.5%? Why? Since the Fed couldn't control the rates, what free market principles would come into play to drive those rates?

      Delete
    2. Michael, thanks for posting your comment. Highly thought-provoking. Let me ponder.

      Delete
  23. Fedshitcoin will fail..

    1. All commodity/fiat-pegged coins fail for a few fundamental reasons. The first being that the volume of the underlying commodity or fiat currency is UNKNOWN. Due to this fact you cannot credibly valuate a deterministically issued currency by one whose total volume, and rate of issue is "WHOLLY ARBITRARY".

    2. One of the key features of Bitcoin and other successful cryptos is the fact that participation in them is in fact VOLUNTARY. This means people can either mine,.transact, trade Bitcoin, or OTHER crypto-currency I know I won't be transacting fedshitcoin, and I am sure I am not the only one, and #3 is why.

    3. Another of Bitcoin's key features is it's GLOBAL DECENTRALIZED NETWORK of INDEPENDENT NODES AND MINERS. As with many other shitcoins, Fedshitcoin will most likely be pre-mined, and it's protocol closed source. In addition, I strongly doubt Fedshitcoin will in fact have a blockchain either. This means they can wave that same magic wand they make new FRNs with, and make more Fedshitcoin to dump en mass....and all you can do is wait and scream until your next opportunity to sell before it finally crashes to .00000001 SAT....

    ReplyDelete
    Replies
    1. Hi Frank, thank you for sharing your thoughts.

      Here is something for you to consider. The market cap of Bitcoin as of today is about $3.5 billion. Given that the Fed's balance is presently around $4.5 trillion, the Fed could easily buy up all bitcoin with hardly an effect on its balance sheet. Just a thought.

      Delete
    2. Yup....and then 10 minutes later, do you know what would happen? There would be more Bitcoin. and then 10 minutes after that, there would be more Bitcoin, and ten minutes after that, there would be more Bitcoin..... Just sayin

      Delete
    3. David,
      Staying clear of the philosophical debate, I would point out that since more than half the mined bitcoin have never been spent, at current price buying the circulation would be even cheaper.
      One has to wonder however, what a Fed vacuuming action would do XBT/USD. A very modest and plausible twenty-fold increase in the exchange rate would surely make the picture a little different.

      Delete
  24. Nice presentation in los Andes, Bogota. Thank you for your visit. I think digital currency for emergent markets could be interesting. Bitcoin can be a solution but what steps can be done to create a new model, cheaper, simple and regulated?

    ReplyDelete
    Replies
    1. This is as simple as it gets while still being transparent, safe, and the property of the public at large. You don't want regulation, you want security, and reliability. Regulation is the framework by which your wealth is stolen from you under the auspices of protecting you. Fiat markets are "regulated"....do they look "safe" "secure" and "reliable" to you? Have governments managed to prevent businesses from stealing from the public? NO! They just lobbied our government until their thefts from us became LEGITIMATE BUSINESS PRACTICES! Have the governments of the world managed to stop ALL illegal drug and weapons purchases performed with their currencies? Even online? NO! So what makes you think that regulating crypto would make it stop?

      Cryptocurrencies are THE MOST SECURE, TRANSPARENT, and ACCOUNTABLE payment mediums known to man.... And that is exactly why the current money masters are trying to take it away from you, or otherwise prevent your participation in them....

      Delete
  25. Very great post on the subject with good questioning.... Cryptocurrencies are going to get a boost from Denmark's Central Bank that will Stop Printing Money in 2016 in Favour of CryptoCurrencies and Digital Payment. After 2016, Shops will be able to refuse Notes and Coins... I believe this is some kind of test and that it is only a matter of time before every countries adopt the cyptocurrencies...

    Might be good, might be bad, I don't know what to think about it. For more info, I just read this article «Denmark Central Bank to Stop Printing Money in Favour of CryptoCurrencies and Digital Payment : Shops Can Refuse to Accept Notes and Coins» http://www.n3ws.info/2015/05/denmark-central-bank-to-stop-printing.html

    ReplyDelete
  26. It is great that governments will be moving towards public decentralized ledgers. As well, moving towards something like "Fedcoin" will save the Federal Reserve long term on printing costs and fraud prevention technology. Over the last 20 years, they have added holograms, made the artwork more detailed, and added magnetic strips to dollar bills all with the intention of fraud prevention. If they were to switch to digital currency with public decentralized ledgers, it would be beneficial for all parties, including the American people.

    If the government ledgers are made public, it will promote more responsible spending with less room for hiding pork. Even further, the Federal Reserve could look to companies like Amilabs.cc to emulate the Amilabs model of representing a commodity with a digital token. While Bitcoin was purely a ledger, moving towards something like the Amilabs model would be beneficial for all governments.

    ReplyDelete