Originally posted in: Cryptonomics
A central bank backed blockchain payments network for a national currency like the USD is a neat idea. It would, first of all, put digital cash on the map for good. And digital cash that trades at parity with an economy’s well-established unit of account is a far more useful medium of exchange than a volatile cryptocurrency like bitcoin. Andolfatto:
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).
So the idea is that the supply of Fedcoin expands and contracts perfectly with changes in Fedcoin demand, as the Fed would issue and redeem Fedcoins for USD deposits at parity.
Exactly what sort of blockchain protocol would be appropriate for this scheme is an open question. It certainly cannot be a proof-of-work protocol. Maybe it wouldn’t be a blockchain protocol at all. This is what I wrote about the idea on that email list:
forget nakomoto-consensus for a moment and assume Fedcoin is just a 1990’s implementation of digital cash, Fed-run servers, chaumian blinding, etc. Assume it’s executed well, so we’ve got something with all the properties of cash with the added benefit of cheap electronic payments. That’s actually a pretty evocative idea on its own, even though we had everything in place to do it 20 years ago and it has nothing to do with blockchains.
So what’s innovative about Fedcoin–whatever its technical implementation may be–isn’t blockchain tech. It’s rather the monetary implications of central bank sponsored digital cash. And those implications are IMO more profound than what both Koning and Andolfatto suggest. Andolfatto says:
Of course, just because Fedcoin is feasible does not mean it is desirable. First, from the perspective of the Fed, because Fedcoin can be viewed as just another denomination of currency, its existence in no way inhibits the conduct of monetary policy (which is concerned with managing the total supply of money and not its composition). In fact, Fedcoin gives the Fed an added tool: the ability to conveniently pay interest on currency.
In his theoretical work, Andolfatto has advocated the interest-bearing money concept as a way of increasing the efficiency of money holdings: the economic efficiency of the Friedman rule without the deflationary implications. So I can see why Andolfatto is interested in digital cash.
Indeed, Fedcoin could pay interest (at t
he IOER rate?). In fact, if Fedcoin were to displace the use of greenbacks, this could remove the last remaining impediment to negative nominal interest rates, so perhaps that is one aspect of Fedcoin that would actually expand rather than inhibit the conduct of monetary policy.
Just another dollar denomination?
But I think that Andolfatto and Koning are seriously underestimating the implications of Fedcoin. This is what I wrote:
But I’m not interested blockchains here, it’s the economic implications, which are radical: it would cause the demise of fractional reserve banking. A central bank that went down this path would effectively bring about something dubbed the “Chicago Plan“, an early 20th century proposal that banks hold 100% reserves and the CB compensate for the destruction of privately-created “endogenous money” with a dramatic expansion of base money (monetising in a non-inflationary way much of the national debt as a side-effect).
So the problem (or opportunity, depending upon your perspective) with Fedcoin is that it will compete with bank deposits in a big way. Unlike your bank deposit, which is an unsecured loan to a highly leveraged deposit-taking institution, Fedcoin is central bank money. It cannot default, by definition. Fedcoin would be better than credit than US Treasury Bills. Why would anyone use bank depo (and it’s creaky array of payment systems like ACH and SWIFT) given such an alternative?
The only reason why we are accustomed to thinking that cash and bank deposits are the same thing, exchangeable 1-for-1, is because for 80-odd years bank depo has been buttressed by the central bank’s Lender-of-Last-Resort (LLR) facilities, government-backed deposit insurance, and a bank debt credit market built around expectations that banks are Too-Big-To-Fail (TBTF).
Fedcoin would be immensely popular. Not just among individuals, but institutions, which could finally own large balances of the unit-of-account without having to assume the credit risk of a >30x leveraged balance sheet with a big duration miss-match between its assets and liabilities.