An interest in bitcoin and digital currency makes Federal Reserve Bank of St Louis vice president and research director David Andolfatto something of a rarity among Fed officials. However, while he may see the technology’s big picture, why he believes bitcoin is potentially transformative doesn’t exactly fall in line with the common mantras of the community.
Take, for instance, the claim that bitcoin is part of a long-term trend toward “digital money”, one Andolfatto delights in debunking.
Today, virtually all money used by the private banking sector, and all the money in modern economies, he asserts, is digital.
In a conversation with CoinDesk, Andolfatto went so far as to suggest that the bitcoin network isn’t that much different from the Federal Reserve, and that while ideologically opposed, both are highly similar in their structure and goals. The St Louis Fed is just one of 12 banks that make up the US Federal Reserve System, which supervises state-member banks, bank holding companies and loan holding companies, and provides educational outreach.
Andolfatto said:
“The way I view the Fed, and any institution, is it’s basically a computer program. Just like bitcoin, it’s an open-source computer program. You ask yourself, ‘What is bitcoin?’ It’s a protocol, it’s a computer program, it’s a constitution, it’s a law, it’s a legal code, it’s basically a constitution that governs the supply of its money and that governs the processing of payments.”
Still, Andolfatto does believe bitcoin has one key advantage that he has called its “stroke of genius” in past presentations – its open-source decentralized ledger known as the blockchain.
In contrast to the Federal Reserve Wire Network (Fedwire), the US central bank’s real-time settlement system, Andolfatto believes bitcoin, or a similar blockchain-based system could pose real benefits for centralised financial institutions like the Fed.
The comments come as part of a wide-ranging interview that sought to gather Andolfatto’s opinion on bitcoin as a currency, payment network and financial tool that could grow in relevance to the global economy.
Bitcoin’s competitive edge
With digital money out of the running as the big innovation behind bitcoin, Andolfatto has turned his interest to another often-cited aspect of the technology – its public ledger system, the blockchain.
Still, he questions whether the bitcoin network will prove to be more cost-effective than other available payment systems, and whether another similar system might ultimately solve the key problems he still sees in its design.
“The amount of money and resources you have to pay bitcoin miners is like 3% of all transactions,” he said. “That’s kind of like what Visa charges.”
With these often-cited benefits out of the running, however, Adolfatto is still interested in bitcoin because of one key benefit it has over the current system used by the Federal Reserve.
By using a distributed ledger, he said, every bank in the Federal Reserve system could have a copy of all transactions in the system, thereby guarding against potential problems inherent with a centralized approach.
“What would happen on the distributed ledger is all the books would be kept simultaneously in every one of these member banks, the same way that the blockchain is on everybody’s computer,” he said. “If any one computer goes down, that doesn’t in any way violate the integrity of the blockchain because the records still exist on all these copies of this ledger.”
Andolfatto indicated that such a feature could add a “robustness” to the Fed’s existing system, potentially even allowing the public more transparency during times of economic turmoil.
“You could actually see which bank is sending money to which bank on this ‘Fedcoin blockchain’, so if the Fed was to make an emergency loan to one of these entities you’d be able to observe who is the recipient of the loan and how much,” he theorized.
But if the bitcoin system has advantages, Andolfatto isn’t ready to make the case that they should be embraced by the Fed. Andolfatto cautioned that he doesn’t see the immediate need for financial institutions to migrate to public ledgers.
“To the extent that people would value that transparency – and I have to say that it’s not immediately clear you want that type of transparency – that would be another benefit,” he said.
Bitcoin as a currency
In the past, Andolfatto has been bearish on bitcoin as a currency, arguing that distributed payment systems like Ripple come closest to unlocking the full power of bitcoin’s original ledger.
Unsurprisingly, he indicated that he doesn’t see the uptick in the merchant adoption of bitcoin as payment a sign that this conjecture might be wrong.
“People use all sorts of stuff as currency,” Andolfatto said. “There’s many, many currencies out there and the bitcoin currency is just one.”
Andolfatto countered with the assertion that, rather than a currency, bitcoin is considered by most to be an investment vehicle, a development he suggested might limit its ability to function more broadly as money.
“People see that in the long run the supply of bitcoin is capped and they see it’s demand growing, so in the long run you have to expect that it might be a good investment vehicle,” he said. “You might think the same about gold, but just because something’s a good investment vehicle does not make it a good currency.”
Andolfatto ended by citing the volatile exchange rate between bitcoin and US dollars, a subject that has been the subject of increasing attention in recent weeks.
“What makes a good currency is its ability to hold its value for very, very short periods of time,” he said, adding the caveat that developing markets where money is managed poorly might come to contradict his theory.
He continued, “I think there might be a big scope for cryptocurrencies like bitcoin to replace or at least take a good market share of currency transactions [in these areas].”
Comparisons to Fedwire
Perhaps most surprising was Andolfatto’s assertion that the bitcoin network is similar to the Federal Reserve, but he elaborated at length on the subject and why he believes all money is just a ledger.
In this context, he explained that all money attempts to perform a simple function, debiting an account and crediting another.
“Fedwire uses the US dollar as the currency unit and the Fed serves as the third party that does the accounting,” he said. “The key difference with bitcoin is that there’s no trusted third party to do the accounting. The accounting is done by this community of miners, this decentralized system. It’s a completely different philosophy.”
Still, he sees the Federal Reserve as an evolving system, one that is also “open source” due to its reliance of foundational laws.
“The Fed is a set of rules that evolved over time, much like the open-source bitcoin protocol does. It takes feedback from the community, in this case the community votes, represented by the Congress. Congress is the creator of the Fed, and so there are amendments to the way the fed might operate. As long as this occurs, I see the Fed as an open-source evolving protocol, much like bitcoin,” he said.
More pressing issues
While Andolfatto admits that he has followed the development of the bitcoin ecosystem, it wasn’t an intellectual curiosity that first lead him to speak out as part of his institution’s “Dialogue With the Fed” series. Rather, it was the work of a savvy PR team.
“This is an earlier in [2014] and public interest in the phenomenon was really cresting. It was one of those things our public affairs team identified as something we wanted to know more about,” Andolfatto recalled.
He indicated that, while the darling of the mainstream tech and finance press, most Federal Reserve economists aren’t thinking about bitcoin. Of the 1,000 or more on staff, he said that he is aware of just “pockets of researchers” that have looked at the issue.
“The thing to keep in mind is that there’s a lot on the minds of fed economists these days,” he added.
Still, he said he is encouraged by what he’s seen of the bitcoin ecosystem, particularly the technology’s enthusiastic fan base, which he cites as key to his never-say-never view of developments in the industry.
“My experience with meeting people [in the industry] has been highly, highly positive,” Andolfatto said. “They might not have a good understanding of money, monetary policy and macroeconomics and stuff like that, but they have a very, very good idea of the payment system, of how it works, the plumbing, and moreover and I’ve come away marveling at the energy and the ingenuity that these people have.”
He added: “I mean the entrepreneurs in this space, I am just in awe of.”
Images courtesy of the St Louis Fed