As more of everyday life moves to cyberspace, it’s not surprising that cryptocurrencies like bitcoin, a global, borderless currency, have come into being. Now there’s increasing chatter about the possibility of the Federal Reserve getting in on the action with a so-called Fedcoin, digital money that would be exchangeable on par with real dollars that works much like bitcoin. Sounds interesting indeed.
Bitcoin runs on a decentralized, peer-to-peer network, with no human intervention possible. This means there are no banks, no expensive rent, no employees, or international financial organizations at its core, just direct point-to-point transactions from anywhere to anywhere in the world. If you go on bitcoin.com you find what it says is bitcoin’s advantage. "U.S. dollars and other paper currencies are credits issued by a single nation. Their strength lies in the strength of the nation that controls them. Bitcoin’s strength lies in its mathematical design. Its open nature eliminates the need for trust. When nations print more money, their currencies get weaker. In bitcoin, nobody can just decide to increase the amount, including the creator of bitcoin. Bitcoin is more like gold than cash."
So what if Uncle Sam joins the fray?
The case for Fedcoin
"There is a need for widespread adoption of technology like Fedcoin. We have unacceptable levels of monetary friction today because only approved financial institutions are able to transmit money. End users of the currency must open ‘accounts’ with these institutions in order to participate, and there is no universal standard for transmitting money between these financial institutions globally, and even standards in the same country vary widely," says Will Madden, CEO and founder of Novauri, a digital cash purchase and sale service involved in bitcoin since 2010.
These facts, combined with a complicated global regulatory framework, are why we suffer from unacceptably high fees when sending money overseas or between banks, he says.
"Fedcoin technology could, if properly designed, eliminate this friction entirely and allow anyone interested to essentially ‘download a bank’," says Madden.
Fedcoin has advantages says Avra Liakounakos, an associate consultant at Capco a business and technology consultancy. "It eliminates transaction costs, creating a more efficient form of payment. There’s no exchange rate risk, since it would be part of the money supply. There is also less systemic risk in the economy since ownership is not an IOU from a bank (like your bank account balance), and there would be more liquidity in the economy."
Another plus, points out Baseem Mahdi, chief strategist for TechMonegy, a technology consulting firm, is that there would be added security for users of Fedcoin because it is designed for digital use. "Fiat currency was never designed to be cashless, Banks currently use security systems that are inadequate. Fedcoin is based on Push (you must pay someone), not a Pull payment system (where your account can be hacked and money pulled out of it)," says Mahdi.
What are the issues and challenges?
"Regulatory incompatibility. The Bank Secrecy Act and similar regulation require anyone moving money to comply with strict sets of record keeping and monitoring requirements. These requirements exist to ensure that money is not transmitted to individuals or entities that are on sanctions or other lists for reasons considered illegal or otherwise prohibited," says Madden.
He contends that these rules and institutions that enforce them will never allow the download of an application that lets users send and receive U.S. dollars anonymously.
"There will be a requirement for users of the software to be identified first, creating a network of ID verified individuals who are allowed to transmit funds. This alone introduces cost and friction, as some entity likely a company or companies, must positively identify users of the software. There will need to be processes to revoke licenses for users that are added to lists of unapproved users. Identity thieves will create false users, and the same arms race that exists today between banks and organized criminal identity thieves will continue as it does in today’s system," says Madden.
He says the requirements around ID will also make it economically unviable to let the poorest people use the Fedcoin software. "Without a consistent standard for individual ID, Fedcoin with ID requirements won’t help the world’s 2.5 billion unbanked people. Fedcoin, as proposed, fails to automate all of the complicated and often inconsistent rules that apply to financial institutions."
Mahdi says that Fedcoin doesn’t have the economic advantages that independent cryptos have. "Fedcoin is centralized in its control, ownership, issuance and creation (if miners that are independent/non banking are not tasked and rewarded with Fedcoin for transaction validation).
Furthermore, he says that Fedcoin is still subject to volatility relative to currencies (other than the U.S. dollar, which it will be pegged to), and its purchasing power. "It is likely to be subject to devaluation as the U.S. dollar continues its long term inflationary trend." Then there are privacy concerns. "Every transaction made would be permanently recorded on the blockchain," says Liakounakos. She says that ensuring that a Fedcoin is at parity with the U.S. dollar and ensuring that they cannot be hacked, stolen, or replicated are other issues.
Who stands to benefit most from Fedcoin?
"The Fed, because it would incur less costs by keeping track of the physical currency stored/destroyed every year by printing new dollars every year. The IRS, because it would have a much better record regarding people’s transactions. The banks, because they would need less capital to ‘follow the money’ and ensure transactions are safe," says Liakounakos.
Steve Kenneally, the American Bankers Association’s vice president of payments and cybersecurity, says merchants would benefit from lower transaction costs using Fedcoin in lieu of credit cards. They would also benefit from having no chargeback costs if all sales are final.
Is there any chance Fedcoin moves from fiction to reality? Says Kenneally, "Anything is possible, but this not likely in the near term. The Fed is currently working with the industry on a 18 month plan to speed implementation of faster payments in the U.S. at the end of 2016. The Fedcoin may be considered by the group, but there is little chance of a move by the Fed that is both fast and bold in the payments space.