Federal Reserve: "In A Dystopian World, Bitcoin Would Dominate Payment Methods"

Amid a relentless barrage of doom and gloom - and then some more doom for good measure - establishment forecasts about the future of cryptocurrencies, including everyone from Goldman, to the BIS, to the World Bank, all of which have been some iteration on how cryptos have no future, this morning an unexpectedly objective and somber view on the future of bitcoin came from none other than the organization that prints (out of thin air) the nemesis to bitcoin: the Federal Reserve.

While the emphasis of the Q&A with New York Fed economists Michael Lee and Antoine Martin, which we have republished below, is the issue of "trust" and how it defines monetary exchange, there are several things that attracted our attention. 

The first is the Fed's take on what we have been saying since 2015, and the reason behind bitcoin's original surge in 2015/2016, namely its use for illicit purposes:

The Drug Enforcement Administration reports a sharp decline in bulk cash smuggling in 2016, which is the traditional payment method for drug shipments and suggests that payments may have shifted toward cryptocurrencies. Cryptocurrencies are more convenient than cash for many illegal activities that now take place online.

... cryptocurrencies are ideal for circumventing legal or regulatory authorities, because they aren’t governed by any. China, which actively controls capital flow, banned banks from dealing with bitcoin in 2013 (this was relaxed later), because it was thought to be used for money laundering. North Korea is reportedly responsible for state-sponsored hacks to steal cryptocurrencies, which help bypass economic sanctions that are enforced through the cooperation of financial institutions and countries.

This - the ability to hide and store dramatic amount of wealth in a tiny space - is also the reason why according to Goldman cryptocurrencies are really cryptocommodities, as they are not backed by a monetary authority like the Fed. This what Goldman said earlier this week: "Unlike other storage commodities like oil, gold, platinum, diamonds, and even cash, there is no need to hold much physical material to own bitcoin; even a technology as obsolete as the 3½ inch floppy disk can hold almost 30,000 private keys. There is no theoretical upper limit to the value of bitcoins in a wallet, but if we assume each wallet secured by this disk contains as much as the largest wallet today (180,000 BTC), this single disk could “hold” all bitcoins in existence and remain less than 0.5% full. Assuming a bitcoin market cap of roughly $190bn (as of late January), this disk would be the equivalent to either: 95% of the 4,583 tons of gold in Fort Knox, or 1,344 Very Large Crude Carrier supertankers of oil."

Next follows an exchange that many opponents of bitcoin have been leery to engage in, namely why does cryptos have value if they aren't backed by anything. The Fed's response - the admission that the dollar is in the same boat thanks to Nixon - is needless to say , surprising.

Q. If virtual currencies aren't backed by anything real, gold or some other physical commodity, does that mean they all eventually will be worthless?

A. You're right that they are not backed by a physical commodity, but then neither is the dollar and most other modern currencies. It’s long been known that currencies that are intrinsically worthless, mere pieces of paper, are recognized as valuable because payments with money are so much easier than the alternative, barter. The problem with barter, when everyone trades goods and services directly, is the dreaded “double coincidence of wants.” If I want to have dinner at my favorite restaurant but the cook is not interested in trading a meal for a bitcoin lecture, I have to keeping searching until I find a restaurant that I like where, coincidentally, the cook can’t hear enough about bitcoin.

Money, even intrinsically worthless paper money, cuts the “double coincidence” problem in half. I just need to find someone willing to pay me some of that paper for my lecture, then use that paper to pay for dinner. As long as I trust that someone will accept the paper, I’m willing to accept it in exchange for my lecture. It’s trust that the “worthless” piece of paper is actually worth something to other people that makes it an acceptable medium of exchange.

As a result, the price of bitcoin fluctuates with news that vendors or firms accept or decline bitcoin as a mode of payment. Late last year, bitcoin prices jumped after Square, a payments firm, was reported to be testing bitcoin. Wider adoption and acceptance of cryptocurrencies as a payment option naturally increases what they are worth.

All those points are rather spot on, and usually are remiss from the defense arsenal of some of the even staunchest bitcoin advocates.

What was most interesting, however, was the Fed's observation under what conditions cryptos could not only match, but supplant fiat as the dominant currency. The answer: bitcoin would dominate payment methods in a dystopian world, in other words a "decentralized" world, in which there is no more faith - or trust - in central banks.

Which, of course, is the whole point behind cryptocurrencies in the first place: to replace the dollar, and other fiat currencies, once the entire fractional-reserve lending platform, and last 100 years of monetary philosophy are exposed to be a fraud.

"Lunacy" you say? Well, it's a conversation worth having after the next market crash, one which most likely will wipe out what little faith remains in central banks, in fractional reserve lending, in conventional economics and in fiat.

Incidentally, this is precisely what Deutsche Bank's chief credit strategist, Jim Reid, predicted would be the ultimate endgame: the extinction of fiat, and the return to hard, or alternative, currency.

Here is the Fed:

Q: So are cryptocurrencies the future of money?

Martin: It will ultimately depend on how well they compete with other, already established payment methods—cash, checks, debit and credit cards, PayPal, and others. Cryptocurrencies arguably solve the problem of making payments in a trustless environment, but it is not obvious that this is a problem that needs solving, at least in the United States and other advanced economies. And solving that problem creates others. One is scalability; the process of picking random validators takes time, is expensive, and consumes tremendous amounts of energy.

Another issue lately is extreme volatility in the value of cryptocurrencies which makes them less useful as currencies. This volatility is an inherent feature by design. Since there is no central bank that adjusts the supply of bitcoin to accommodate changes in demand, bitcoin's value can swing sharply with demand. In a world where all things were priced in bitcoin, this would likely translate into massive swings in inflation and economic activity. In contrast, providing an “elastic” currency to promote financial and price stability is a goal shared by the Federal Reserve System, the European Central Bank, the Bank of Japan, and many other central banks.

The trust-proofing provided by cryptocurrencies also comes at the expense of another key feature of a payment method: convenience. If we lived in a dystopian world without trust, bitcoin might dominate existing payment methods. But in this world, where people do tend to trust financial institutions to handle payments and central banks to maintain the value of money it seems unlikely that bitcoin could ever be as convenient as existing payment means.

That said, bitcoin and other cryptocurrencies are trying to improve scalability and convenience so perhaps in the future one of these cryptocurrencies could realistically compete with current payment methods. But, fundamentally, we wonder whether a payment method designed to function where trust in institutions is completely absent can ever be as convenient as one where trust is required, but also already exists.

The punchline, again:

If we lived in a dystopian world without trust, bitcoin might dominate existing payment methods. But in this world, where people do tend to trust financial institutions to handle payments and central banks to maintain the value of money it seems unlikely that bitcoin could ever be as convenient as existing payment means.

Which begs the question: what happens when the "trust" dies? The answer, of course, is the very existence of cryptos: to create a world in which not one network is reliant on "trust" and the presence of a master node.

Here the Fed truly hits it on the head: in an environment of "trust" fiat is perfectly viable. It is what happens after, when the trust ends - in financial institutions, in central and commercial banks, in contract relationships - whether the result of a global monetary collapse, a systemic market crash, or something else, that will see the replacement of fiat with cryptocurrencies.

Full note below (link)

Bitcoin and other “cryptocurrencies” have been much in the news lately, in part because of their wild gyrations in value. Michael Lee and Antoine Martin, economists in the New York Fed’s Money and Payment Studies function, have been following cryptocurrencies and agreed to answer some questions about digital money.

Q: Let’s start simply. What even is cryptocurrency?

Martin: Cryptocurrencies are digital, or virtual, money. Bitcoin, which was created in 2009, is the first and probably the best known cryptocurrency, but many others have followed, such as Ethereum, Ripple, Bitcoin Cash, Litecoin, etc.

Q: Do they have utility that other forms of money lack?

Lee: Like any functioning form of currency, cryptocurrencies facilitate payments between parties and provide a store of value. What’s special about them is that they can serve those roles even in environments where trust—or lack of trust—is a problem.

Trust is implicit for practically any means of payment. Say I need to buy groceries. If I pay with a personal check, the grocer has to trust that the check isn’t “hot” (that I own the account and it has sufficient funds). Common payment methods, like debit or credit cards, also entail a surprising degree of trust. The grocer and I have to trust the banks that connect us when I swipe, trust the payment system or “plumbing,” whereby funds flow from my account to the grocers.

Some of these problems go away with cash because when I hand cash to the grocer, there is no need for trusted intermediaries. But if you think about it, even cash requires some trust. The grocer has to believe that the cash I pay with will retain its value and not be eroded by inflation or confiscatory monetary reforms. So she needs to trust the central bank.

Q: Have cryptocurrencies made progress toward solving the problem of mistrust?

Martin: One important element in any payment system is “validation,” determining which transactions can proceed through the system and which should be refused as invalid. For example, a validator could check if there are sufficient funds in the account of the person who wants to make a payment. If there is, the payment will go through. But if there isn’t, the payment will be refused. If you recall the last time you swiped your credit or debit card, the few seconds you had to wait was that validation. But if the merchant doesn’t trust the validator, and doubts she will ultimately be paid, she’s unlikely to accept your card.

With bitcoin there isn’t one designated validator. Instead, everybody in the bitcoin network could be picked, essentially at random, to validate recent transactions. The details are a bit technical and more details can be found in a recent St. Louis Fed paper on cryptocurrencies.

Q: Aren’t cryptocurrencies sometimes associated with illicit activities?

Lee: Definitely, and this is likely related to trust also. Criminals, who typically use cash for the anonymity and security it provides, may be moving to cryptocurrencies. The Drug Enforcement Administration reports a sharp decline in bulk cash smuggling in 2016, which is the traditional payment method for drug shipments and suggests that payments may have shifted toward cryptocurrencies. Cryptocurrencies are more convenient than cash for many illegal activities that now take place online. In 2013, following a government crackdown on Silk Road—an online marketplace that was used to trade illegal goods—bitcoin prices plunged. And for good reason too.

More broadly, cryptocurrencies are ideal for circumventing legal or regulatory authorities, because they aren’t governed by any. China, which actively controls capital flow, banned banks from dealing with bitcoin in 2013 (this was relaxed later), because it was thought to be used for money laundering. North Korea is reportedly responsible for state-sponsored hacks to steal cryptocurrencies, which help bypass economic sanctions that are enforced through the cooperation of financial institutions and countries.

Earlier, we talked about how a currency requires people to trust in its value. When Greece fell deeper into financial distress in 2015, Greek interests and trading in bitcoin rose quickly amidst fears of capital controls and the possibility of exiting the eurozone. Bitcoin became attractive as trust eroded.

Q: If virtual currencies aren't backed by anything real, gold or some other physical commodity, does that mean they all eventually will be worthless?

Lee: You're right that they are not backed by a physical commodity, but then neither is the dollar and most other modern currencies. It’s long been known that currencies that are intrinsically worthless, mere pieces of paper, are recognized as valuable because payments with money are so much easier than the alternative, barter. The problem with barter, when everyone trades goods and services directly, is the dreaded “double coincidence of wants.” If I want to have dinner at my favorite restaurant but the cook is not interested in trading a meal for a bitcoin lecture, I have to keeping searching until I find a restaurant that I like where, coincidentally, the cook can’t hear enough about bitcoin.

Money, even intrinsically worthless paper money, cuts the “double coincidence” problem in half. I just need to find someone willing to pay me some of that paper for my lecture, then use that paper to pay for dinner. As long as I trust that someone will accept the paper, I’m willing to accept it in exchange for my lecture. It’s trust that the “worthless” piece of paper is actually worth something to other people that makes it an acceptable medium of exchange.

As a result, the price of bitcoin fluctuates with news that vendors or firms accept or decline bitcoin as a mode of payment. Late last year, bitcoin prices jumped after Square, a payments firm, was reported to be testing bitcoin. Wider adoption and acceptance of cryptocurrencies as a payment option naturally increases what they are worth.

Q: So are cryptocurrencies the future of money?

Martin: It will ultimately depend on how well they compete with other, already established payment methods—cash, checks, debit and credit cards, PayPal, and others. Cryptocurrencies arguably solve the problem of making payments in a trustless environment, but it is not obvious that this is a problem that needs solving, at least in the United States and other advanced economies. And solving that problem creates others. One is scalability; the process of picking random validators takes time, is expensive, and consumes tremendous amounts of energy.

Another issue lately is extreme volatility in the value of cryptocurrencies which makes them less useful as currencies. This volatility is an inherent feature by design. Since there is no central bank that adjusts the supply of bitcoin to accommodate changes in demand, bitcoin's value can swing sharply with demand. In a world where all things were priced in bitcoin, this would likely translate into massive swings in inflation and economic activity. In contrast, providing an “elastic” currency to promote financial and price stability is a goal shared by the Federal Reserve System, the European Central Bank, the Bank of Japan, and many other central banks.

The trust-proofing provided by cryptocurrencies also comes at the expense of another key feature of a payment method: convenience. If we lived in a dystopian world without trust, bitcoin might dominate existing payment methods. But in this world, where people do tend to trust financial institutions to handle payments and central banks to maintain the value of money it seems unlikely that bitcoin could ever be as convenient as existing payment means.

That said, bitcoin and other cryptocurrencies are trying to improve scalability and convenience so perhaps in the future one of these cryptocurrencies could realistically compete with current payment methods. But, fundamentally, we wonder whether a payment method designed to function where trust in institutions is completely absent can ever be as convenient as one where trust is required, but also already exists.

 

Comments

nope-1004 DavidFL Fri, 02/09/2018 - 11:43 Permalink

Ya enlighten him that WE ABSOLUTELY ARE IN A DYSTOPIAN WORLD, YOU ASSHAT!!!!!!

This is just another media lie, planting the underlying notion in the comment first that trust in Central Banks exists.  This is how the evil control freaks do it:  They outright lie by making a statement that, in and of itself, presupposes its own conclusion.  They've learned to be propaganda masters.

Fuck YOU banker shill.  Don't tell me how to think.

In reply to by DavidFL

marysimmons Dsyno Fri, 02/09/2018 - 12:23 Permalink

The Fed hates BTC but regulators and politicians are starting to embrace it.

Testimony of CFTC head to Congress - "We owe it to this generation"https://www.youtube.com/watch?v=hBqw1w79b10

Explains HODL to the US Senate:https://www.youtube.com/watch?v=HSPywOS9DWU&t=1s

Twitter reaction:https://twitter.com/giancarloCFTC/status/961612907732783104

Senator Warner (Senate Banking Committee) also bullish on BTC:https://www.youtube.com/watch?v=NjtgObaZLCw

 

Say goodbye to the "government is going to shut down cryptos" FUD propagated for so long by the uninformed.

In reply to by Dsyno

Cloud9.5 Coinista Fri, 02/09/2018 - 12:46 Permalink

Every young man is hopeful for him the horizon seems limitless.  Every old man is doubtful because he has seen too much and the horizon is at his feet.  The real truth is most of us are caught up into a virtual currency.   We all use credit cards.  We use them to buy groceries, rent movies, and pay for gas.   If the banks shuttered their ATM’s this afternoon, how much cash would you have on hand?  Without it, what would you barter for your next tank of gas?  I see bitcoin as another permutation of the debit card system.  Your store of wealth is on some hard drive.  You have no idea where it is or how safe it is.   The same is true for your bank account and your credit card.  Our money system is very fragile.  If marauders come through and crash the system, you can’t dig a hole and burry your wealth in the hopes that you can come back and dig it up when the dust settles.

In reply to by Coinista

Miggy IH8OBAMA Fri, 02/09/2018 - 13:15 Permalink

"Q: If virtual currencies aren't backed by anything real, gold or some other physical commodity, does that mean they all eventually will be worthless?

Lee: You're right"

 

You are correct but that is not the question. The question is timing and what game is being played currently or next.

 

A lot of guys living large that bought pennies of bitcoin a few short years ago. Sadly I am not one of them.

In reply to by IH8OBAMA

ParkAveFlasher hedgeless_horseman Fri, 02/09/2018 - 11:50 Permalink

1) We are in a dystopian world.

2) Complexity is not profundity. 

3) How is complexity even discussed as a viable solution in a dystopian world?  Mad Max's thundering V8 would go no further than the weakest belt in its engine.  A single nail in his tire would render the whole machine useless.  Complexity introduces asymmetric risks.  In this case, bitcoin would sooner harbor a more refined slavery than a more vindicative liberty.  I do believe that's its underlying purpose.

 

In reply to by hedgeless_horseman

TheWholeYearInn hedgeless_horseman Fri, 02/09/2018 - 11:53 Permalink

Exactly ~ BYOB

 

I don't give a crap about BTC as a 'payment method'. I have gold bullion, silver bullion, artwork, antiques & other things of value that I don't use as a 'payment method' either so why can't cryptos act like they do.

 

All I know is that every time I get these FED DOLLARS in my hand, the first thing I want to do is to, yeah, use it as a payment method (so that I can buy things that hopefully will retain their value longer than the little bill with illuminati symbols printed all over it).

In reply to by hedgeless_horseman

daveO hedgeless_horseman Fri, 02/09/2018 - 13:00 Permalink

Interest? You don't say, the author sure didn't. Not one mention of how below market risk pricing(interest rates) created this mess. Crypto's are the new Messiah! They're gonna save the us from the bad ole banksters./sarc Yet, the new Messiah pays no interest just like gold.
Interest is necessary in the grand scheme of money lending, even the hypocritical Muslims charge it in a roundabout way. I predict the FED will raise rates enough to kill the new Messiah just like they stopped gold in 1980, they must to survive.

In reply to by hedgeless_horseman

zebra77a nope-1004 Fri, 02/09/2018 - 11:49 Permalink

In a Dystopian World there would be no infrastructure to support the existence  of a power grid , to support the computers that would then support the existence of a crypto-currency.  Your 3 levels up in the infrastructure before you can even look at supporting the existence of crypto. The greatest problem in the crytposphere today is the falsification of crypto on the exchanges, which are creating fake crypto like fiat. Watery, runny, worthless.  Then they are selling it like it's blockchain crypto, its not. Its a futures representation of it. 

It's like saying we want to bring driverless trucks to the horn of Africa which has no government to tax to support infrastructure or the factory to build the driverless truck, much less the safe community for the AI programmer to go live in. 

Master the basics <then> we can do the space-travel stuff.

In reply to by nope-1004

LawsofPhysics DavidFL Fri, 02/09/2018 - 11:48 Permalink

The common denominator(s) with all that is wrong with the world today;

1) Useless overcompensated paper-pushing middlemen

2) Bad management and bad behavior are actually being rewarded, not punished (i.e. too big to fail etc.)

Trust the banking and  finance sector in a FIAT currency world with "mark to fantasy " accounting rules?  LMFAO!!!!

fuck em, jump you fuckers!

In reply to by DavidFL