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An in-depth look at the key players, challenges and stakes in the effort to modernize the banking system's plumbing, from the editors of American Banker and PaymentsSource.
March 30 -
The financial industry and the Federal Reserve are finally on the same page about the U.S. payment system's need for speed. But achieving consensus about what the new system should look like remains a tall order.
March 30 -
Speedier transactions could make a big difference for a wide range of consumers, from hourly workers to patients waiting for medical insurance claims to clear.
March 30 -
It took a decade and a government mandate for the U.K. banking industry to develop a set of rails to transfer funds from one bank account to another in seconds.
March 30
As more financial transactions move online, cryptocurrencies like Bitcoin have emerged as cutting-edge alternatives to cash. In some ways, these currencies mimic cash: transactions are anonymous and clear quickly. The big difference is that because they are not tethered to a government or central bank, values can fluctuate wildly.
But what if a central bank like the Federal Reserve were to throw its weight behind a cryptocurrency? That currency would gain widespread acceptance, according to Fed researcher David Andolfatto. Unbanked consumers, who are largely restricted from buying goods or paying bills online, would be among the most active users, he suggests.
Andolfatto, the director of research at the Federal Reserve Bank of St. Louis, was inspired to consider the social benefits of a government-backed cryptocurrency after reading a blog post by payments commentator J.P. Koning. Now he's written a couple blog posts of his own and even given a presentation on the idea at the International Workshop on P2P Financial Systems in January.
According to Koning and Andolfatto's vision, the so-called Fedcoin would be a digital currency available for anyone to use. People could download electronic wallets and go to banks or specially designed ATMs similar to Bitcoin ATMs to exchange cash for the digital coins. And since the central bank would fix the exchange rate between Fedcoins and the U.S. dollar, the digital currency would be far less volatile than Bitcoin.
This is an admittedly "pie-in-the-sky" concept, Andolfatto says, given the current technological challenges of implementing such a system and likely opposition from people concerned about security threats. Economist Tyler Cowen dismissed a similar idea in a 2014 blog post, noting that the central bank would be unlikely to take on such an untested idea.
Nonetheless, Andolfatto believes Fedcoin would be useful to people who lack bank accounts. "Poor people often have trouble coming up with the identification" necessary to open bank accounts, Andolfatto says.
But since Fedcoin wouldn't require people to provide identification or go through know-your-customer screening intended to root out money laundering and other criminal activities, they could more easily participate in digital transactions from paying bills online to buying goods on Amazon.
"Many of the unbanked would be able to use digital money instead of cash," Andolfatto wrote in an email. "People would be able to send money peer-to-peer anywhere in the world at a low cost without having a bank account."
Fedcoin also would allow payments to be processed more quickly than many current options, facilitate trade and reduce the costs of maintaining a paper currency as more payments shifted away from cash toward this denomination, he says. Asked whether the Fed would really want to introduce an anonymous currency that risks attracting illicit transactions, Andolfatto responds that the central bank already has one in place. "It's called cash," he says.
While he admits the Fed might not want to expand its current set of hard-to-trace payment options, Andolfatto says that the central bank might actually find Fedcoin preferable to, say, $100 bills. "It's less anonymous than cash," he says.
Since Fedcoin would use a distributed public ledger, federal authorities would have a digital trail with which to trace criminals if needed. And if the Fed preferred to avoid taking responsibility for processing payments without KYC requirements, he suggests that the task could be farmed out to independent Bitcoin miners.
Andolfatto also has a related pitch that he calls "Fedwire for All." The central bank already operates Fedwire, an online, real-time settlement system that clears transactions for about 10,000 banks. Andolfatto suggests the Fed could expand the system to let businesses and consumers open up online accounts directly with the Fed, bypassing banks entirely.
Since the centralized ledger the Fed currently uses for Fedwire could be prone to attack, Andolfatto says the central bank could instead use a distributed ledger similar to that of Ripple Labs' real-time settlement technology. Like Fedcoin, Fedwire for All would not require people to provide identification or go through KYC screening.
Andolfatto says his ideas are already generating a fair amount of interest among his Fed colleagues.
"People are asking questions, like why would we want to use an inefficient system like Bitcoin, which consumes vast quantities of electricity, when a centralized system is more efficient," he says. "But people at the Fed are open to all sorts of weird ideas."
