Federal Reserve Economist Calls for Government E-Currency to Replace Bitcoin

David Andolfatto, vice president and economist at the Federal Reserve Bank of St. Louis, sees a problem with Bitcoins and views a government issued e-currency as the solution.

He writes:

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... 

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.)

He then offers an alternative---a government alternative:

 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...

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).

And there you have it, the direction the Federal Reserve would like to see e-currencies move in. It's just another reason that e-currencies are dangerous. If the government attempts to takeover the e-currency space, tracking of individuals via their money trails will reach spectacular new levels of intrusion.

Always keep in mind the Swiss proverb: "Gold has no smell." It means it can't be tracked. It is the ultimate libertarian currency (along with silver) and a great alternative to government created money. That's why governments hate it, while being perfectly willing to consider such monies as e-currencies.

  --RW