Will Cryptocurrencies Trash Cash? ‘Fedcoin’ Could Do It

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The cryptocurrency hype train obviously has no brakes. But could it eventually replace cash in the US? According to the thinking of economists cited by the Bank for International Settlements, it just might. And to the chagrin of the anti-establishment types that fueled bitcoin’s early rise, it will likely be run by the Federal Reserve.

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Alternatives, such as the US dollar and gold bullion, have faded in stature as prices have fallen all year while bitcoin has pushed near $6,000 over the past week. Both China and Russia are exploring the use of blockchain technology to create their own, state-backed cryptocurrencies. A recent Bank of America Merrill Lynch fund manager survey showed "long bitcoin" as one of the most popular trades on Wall Street right now.

Initial coin offering activity is red hot, an area we have covered at length recently in light of intense VC interest in blockchain startups. Many show promise, like Tezos, which is trying to decentralize the governance process behind the blockchain. Or Tether, which is trying to refocus interest on cryptos as an actual medium of exchange (vs. the current obsession with speculating for fast gains) by tethering it via a peg to the US dollar and other national currencies.

But many more stretch the limits of reasonableness. Paris Hilton and Floyd Mayweather have promoted ICOs on Twitter, for example. Others don't really need any further explanation: Dogecoin, PotCoin, TrumpCoin, PonziCoin, and Jesus Coin. Not a bubble, clearly.

While sentiment has likely come too far too fast, the underlying technology shows great promise. I guess that makes my position similar to JPMorgan Chase CEO Jamie Dimon, who attracted a lot of attention for calling bitcoin a "fraud" while his bank rolled out a blockchain-based system to expedite cross-border payments. This is also motivating the efforts by China and Russia to create a central bank-backed cryptocurrency using distributed ledger technology—all while regulators squeeze out private-market competitors.

Economist Ed Yardeni of Yardeni Research asks the obvious question: Why would central banks—which derive their power as the centralized gatekeepers of fiat currency creation, check clearing and payment processing—embrace a movement that's primary motivation has been to usurp this power in a decentralized way?

Part of that, according to St. Louis Federal Reserve president James Bullard, is recognition that the technology has achieved critical mass. Thus, there's a fear of being left behind as the very foundations of banking and monetary policy—intermediation, funds transfers, transactions—rapidly change, not unlike the way the creation of mortgage-backed securities and credit default swaps changed housing finance in the mid-2000s.

There's another, more self-serving purpose: Central banks could use their own cryptos to put the squeeze on paper currency. Why? To facilitate the use of negative interest rate policy, which has been deployed in Europe and Japan in recent years in half-baked forms. Currently, in Switzerland, short-term interest rates are at -0.75%.

When another recession hits, especially if one comes soon, a dive to even deeper rates of negative interest would be hampered by the hoarding of cash since banks would charge for deposits (vs. absorbing the cost of negative rates themselves, as they're doing now). This is known by the economics cognoscenti as the "zero lower bound" in that interest rates cannot go much below negative before the traditional functions of deposits, loans and fractional money creation break down. Mattress stuffing ensues en masse.

The Fed is clearly thinking about it. In testimony to Congress last year, Fed chairman Janet Yellen admitted policymakers "expect to have less scope for interest-rate cuts than we have had historically," adding she would not completely rule out the use of negative interest rates.

If this sounds crazy, remember that the "dollar" already largely exists as a digital construct moved electronically between the Fed, reserve banks and commercial banks. Bill pay and ACH wire transfer services use electronic settlement. The current share of the money supply that's in paper currency form is only about 11%.

Fedcoin, or whatever they decide to call it, would enable widespread digital peer-to-peer payments and money transfers. Properly structured, it provides a best of both worlds: A level of anonymity and widespread acceptance that cash provides with the efficiency and security of blockchain. Negative interest rates could be built into the blockchain's ledger, slowly eroding the Fedcoin's value, encouraging the frantic spending the Fed desires while penalizing savings.

This potentially eliminates the need for large paper bills, potentially giving the kiss of death to the $100 and maybe the $50; not unlike the $1,000 and higher denominations killed by the Fed back in the 1960s. Anyone remember the $10,000 bill with Chief Justice Chase? Last year, the European Central Bank announced it would phase out the €500 note, ostensibly to combat illicit activities like drug dealing but perhaps sounding the death knell for cash money.

All of this is catalyzing change.

Sweden's Riksbank is studying the viability of an e-krona for retail payments amid a steady decline in demand for cash over the past decade amid the rise of Swish, a mobile payments app developed by Nordic banks. Ecuador has dinero electrónico. Russia is launching the CryptoRuble. The United Kingdom's Home Office told Her Majesty's Treasury that there are benefits to issuing a state-backed digital currency. Estonia is looking at launching the estcoin.

Digital retail money transfer systems already exist but aren't yet prolific in the US. Zelle is like Swish, backed by more than 30 US banks and both Visa and Mastercard. Tech giants like Apple and Facebook have unveiled peer-to-peer money transfer services. Venmo, run by PayPal, is another. All of those depend on closed ecosystems to work, are centralized, and thus increase the risk of a bank-run-type event or security breach. Mt. Gox anyone?

Paper and coins are archaic, inefficient and oh so analog. The future of money is coming. My bet is that even if it's in an ethereal, digital form, it will have "Federal Reserve Note" somewhere on it 1s and 0s.

Check out some of our recent featured coverage on cryptocurrency:

How governments worldwide are responding to the ICO invasion [infographic]

Would venture capitalists be better off buying bitcoin?

Can VCs keep pace with the ICO market?

Wall Street skeptical as bitcoin soars

Article by Anthony Mirhaydari, PitchBook

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