FedNow service and blockchain closely linked

Digital-age consumption habits. That's what the Federal Reserve Board is crediting in its decision to install a new round-the-clock payments system, called FedNow, by 2024.

The rapid growth in e-commerce has now impressed upon the Fed a dual mandate. First, the economics of the internet demand a certain level of democratization, as equal access among consumers has become standard in the digital age. Second, the U.S. government needed to find a way to leverage the nonstop nature of internet transactions, to make the irreversible changes to financial behavior work for the national economy as a whole.

Of course, emerging cryptocurrencies have a significant impact on how governments, economists and technologists think about what digital-age economics might look like five to 50 years from now. This is likely the technology the Fed referred to when it announced its FedNow real-time payments system.

“The rapid evolution of technology presents a pivotal opportunity for the Federal Reserve and the payment industry to modernize the nation's payment system and establish a safe and efficient foundation for the future,” the Fed said in a press release on Aug. 5.

But what exactly does that technology enable? And to what extent will policymakers be able to determine the impact of cryptocurrencies on the future?

As the plan stands now, it seems that the Fed will be adopting a consortium decentralized ledger system. In such a system, banks within the Fed’s network will become permissioned nodes capable of entering transactions into a ledger under some centralized board structure.

The key aspect of this kind of distributed ledger technology, or DLT — without the obstacle of public access — will be to record instant transaction finality at a high volume, processed through federated architecture. While many projects claim to be able to handle such a high throughput, only a handful of tested technologies will be able to do so, and an even smaller group would fit the aims of the FedNow service.

The differentiating factor among the possible protocols would center on the consensus mechanism, which is often the engine that makes any DLT run.

Today, one of the most advanced private or consortium consensus mechanisms would be the HotStuff algorithm. The HotStuff consensus algorithm has recently gotten attention because FaceBook’s Libra uses a similar protocol to that of HotStuff. Technology such as this is expected to be more broadly used as it provides faster algorithms than previously assumed.

Another differentiating factor for the FedNow architecture will be the kind of virtual machine it choses for the network to run. Not every smartphone can run a more advanced ethereum virtual machine or execute smart contracts, for example.

The FedNow will require something lightweight, flexible and capable of interacting with legacy systems. This could be a Java virtual machine — a machine that can seamlessly transact with both the devices on the network and the legacy banking systems that operate the network as nodes.

The FedNow service will help integrate the U.S. banking system more fully into the digital age. However, this new system’s responsibilities must exceed the enabling of 24/7 internet consumption.

Beyond instant transaction settlement, it will be crucial that this new system makes room for communication with like-systems of remittances. The internet has enabled transacting at all distanced, and at all times. Bringing the U.S. banking system into the internet age, as FedNow intends, will entail open and instant institutional interactions, as well as individual interactions.

Cryptocurrencies have undeniably reimagined the payments landscape. Leveraging the capacity of robust networks will prove crucial for permissioned activity in the immediate future. The trickier, and perhaps most lasting, innovation will be accounting for interactions across and throughout global internet infrastructures.