‘We Welcome Anonymous Cryptocurrencies’ : U.S. Fed Studies Bitcoin in New Research

The Federal Reserve Bank of St Louis, one of 12 regional Reserve Banks that make up the United States’ central bank, has conducted a study asking some of the biggest questions in cryptocurrency today – and they may have found some real answers.

Their researchers investigated the control structure of various currencies and looked into whether central banks will adopt cryptocurrencies as a form of payment.

Commodity, Cash, or Digital?

In an effort to assign Bitcoin one of the above monetary categories, the researchers concluded that Bitcoin actually defied traditional categorization – it’s none of the above, as shown in the chart below.

There are a number of dimensions used by the bank to categorize money.

The first is representation: Is the currency represented physically or virtually?

The second is transaction handling: Are transactions handled in centralized or decentralized payments?

The third is money creation: Is the production of the currency competitive or monopolized?

These dimensions make it easy to distinguish between commodities like gold, physical currencies like fiat cash, and so on. However, Bitcoin proved elusive when analyzed in the traditional manner.

The researchers pointed out that gold has decentralized transaction handling, a competitive creation process wherein anyone can mine it, and a finite supply – all traits which are shared by Bitcoin. However, it also has an inherent value as a commodity, unlike fiat currency which represents the value of a commodity (like gold, silver, etc). Gold is not a low-liquidity form of money, but it doesn’t require extensive bookkeeping or proof of ownership.

Much like fiat cash, simply being in possession of the gold at the time of transaction is enough to prove ownership. Cash is totally decentralized in this sense, with no oversight or bookkeeping required for it to be spent in most cases. The creation, however, is centralized and monopolized. Electronic cash is also monopolized with an infinite supply.

Commercial bank deposits and central bank electronic money are considered virtual money because they don’t have any physical representation – they exist as records only. On the other hand, physical forms of money like gold and cash often don’t even need a record in order to function in the market.

Which category fits Bitcoin?

The answer, of course, is none of them. Bitcoin takes on traits of all three categories and brings some brand new characteristics as well, making it a unique currency.

Bitcoin is the first virtual money for which ownership rights to the various monetary units are managed in a decentralized network. There is no central authority, no boss, and no management. And yet it still works.

The Bitcoin blockchain is the decentralized accounting system, and the so-called miners are the bookkeepers […] decentralized management of ownership of digital assets is a fundamental innovation. It has the potential to disrupt the current payment infrastructure and the financial system. In general, it could affect all businesses and government agencies that are involved in recordkeeping.

The researchers went on to point out the recognisable traits that Bitcoin does have, before moving on to whether bank-issued virtual money even has a purpose at all.

The special feature of cryptocurrencies is that they combine the transactional advantages of virtual money with the systemic independence of decentralized transaction processing. Furthermore, as with gold, the creation of new Bitcoin units is competitive. Anyone can engage in the creation of new Bitcoin units by downloading the respective software and contributing to the system.

In practice, however, a few large miners dominate the mining process. The reason is that competition has become fierce and only large mining farms with highly specialized hardware and access to cheap electricity can still make a profit from mining.

The Case for Central Bank Electronic Money

The researchers made one of their most important points here, and one that is often overlooked by the die-hard supporters of fiat over Bitcoin, or the reverse.

“Each form of money has its benefits and drawbacks. This is why many forms of money coexist.”

Cash is permissionless and anonymous, with no account and no record needed. There’s no one point of attack (like a payment processing server) that can disrupt the cash system of payment, making it a robust and decentralized system in terms of payment…

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