EB83 – David Andolfatto: Fedcoin And The Implications Of Cryptocurrencies Issued By Central Banks

Transcript

[Music] this episode of epicenter Bitcoin is brought to you by Ledger makers of The Ledger Nano Hardware wallet have piece of Mind in knowing your private keys are protected by industry standard physical security go to ledger wallet.com to learn more and use the offer code eb09 at checkout to get 10% off your first order hello welcome to epicenter Bitcoin the show which talks about the technology projects and startups driving decentralization and the global cryptocurrency Revolution my name is cucho and my name is Brian Fabian crane

uh we're here today with David andul fat he is a he's a professor of Economics at Simon Frasier University in Canada and he's also a VP of research at the St Louis Fed so this is the first time that we are joined by a a proper real life Central banker and um as you know we we talk so much about money and about how money should work and all those things and I think it's it's something that most people in the Bitcoin space don't know that much about how it like sort of works deep underneath so I'm super excited that David is joining us today well it's a great pleasure to be here thank you for inviting me yeah and I guess the the reason why we sort of come to this is because you

written a blog post called fedcoin and then you have also given a few lectures on the topic basically exploring the question what it would be like and how a federal government or a federal bank could issue their own cryptocurrency because it's it's sort of a obvious idea but it's also really interesting to think through all the implications yeah so uh I I guess uh there's uh you know we we have to also kind of uh Define I suppose what we mean by cryptocurrency I mean central banks and and other Banks already issue kind of virtual currencies and and and the the the question really is what sort of

properties do you want to uh you know uh surround that currency with uh in the very extreme I I proposed uh uh uh the idea that I I saw JP coning uh uh present once on a blog post called fedcoin so that the idea was not mine uh but I took it to the Natural limit like suppose uh you know we actually had the the Federal Reserve Bank issuing a cryptocurrency that was uh actually uh where the payments were actually pro pro processed by Bitcoin miners I I entertain that possibility as is kind of an extreme yeah I know I think that's a fascinating one but maybe before we well I I let's let's start with that question

like how long have you been interested in Bitcoin curious about it or do you remember how you first heard about it well um you know I've I've always had an eye on the payment system kind of just from a theoretical uh level as as by way of background I'm I'm an academic I'm a macroeconomist so I I I I actually don't have very much uh uh detailed knowledge of the the actual Plumbing of the way the uh payment system works but I've always you know I've like on the payment system to kind of like the circulatory system is like when it's working fairly well nobody noticed is this you know your circulatory process in your body but I mean when when things screw up that's when you really uh you find out

uh the the potential problems so I guess I I I I I I got a heightened interest in the in the payment system during the financial crisis and at about that time is when Bitcoin kind of came around and I had my eye on it but more of I didn't understand it I I thought it was kind of like a a crazy sort of idea you always see these these kind of crazy ideas out there uh but then uh Marcela Williams who uh was in my department asked me if I would like to uh kind of speak on the subject because uh there seem to be a growing interest in it and uh the Federal Reserve Bank of St Louis has this very very uh I think nice program it's called dialogue with the FED where we give public lectures on topics that

uh that are of public interest and that's about a year when was it March March 31st of 20 14 is when I gave that public lecture so I began to research Bitcoin kind of quite quite intensively at the beginning of 2014 so just over a year ago cool and what were your what were your faults about Bitcoin your first thoughts from a from the perspective of a monetary Economist well I mean it's it's the type of faults are very easy to come by because of just the language that people use to describe things so for example uh mining is is something that kind of confuses

economists I mean you're immediately uh you know Paul Krugman uh famously made the same mistake and it's quite natural because people call a process Mining and it's like you have this vision of actually just this digital gold and you're out there mining it and and as you know I mean mining is not is not an accurate description of what what what is the purpose of of the miners and so you know in in the in the in the classical Theory I mean we know there's these well-known theorems of the inefficiency of commodity money the inefficiency of mining I mean why why do we exert effort into extracting yellow metal from the ground or or silver metal and and just to store it again

underground say in Fort Knox I mean it's just doesn't make sense and and it's very very easy to get kind of if you don't if you don't kind of read up uh on it it's very easy to be uh to be let astray and to have some miscon misconceptions touching on bitcoin I I I believe that it's your opinion that Bitcoin doesn't actually make good store of value uh it does have a good uh an interesting payment system but the store of value in your opinion um necessarily isn't there uh can you talk about what are um what makes good money and yeah so I I think it's I wouldn't go so far as to say that Bitcoin is not a good store of value um I I think that it could

potentially be a good long run store of value um so I I I make a distinction uh and I think a lot of monetary theorists do as well on the short run rate of return versus the long run rate of return of an asset and uh of course it's desirable if you could to have high long run rate of return and a high stable short run rate of return but life is full of tradeoff so my view would be more of yeah you know I think as a store of value if I mean if people wanted to put aside some some uh Bitcoin in their wealth portfolios you know not not too much of it that it might perform kind of in similar ways to say gold or something like that and uh that would be okay but uh there there there is a fixed supply

of the stuff and and you know you could imagine uh with with demand growing that over the long run it might be a good store a decent store of value but uh the to be a good money you know a good money needs more than just that I mean it's good if it has a long run good long run uh store of value but what's what's even uh what's also important is that uh it has a good short run rate of return that in other words that its purchasing power doesn't fluctuate too dramatically in the short run or um or even if it if it does remain stable for a while that it isn't subject to Wild swings and its purchasing power and um I think it's a property of of these types of monetary

policies like the gold standard and and and also Bitcoin that uh in times of in in times of heightened um demand for for uh money like during a financial crisis you see these uh these these very large increases in the demand for money that if if the supply of money is fixed that what's naturally going to happen is is that the purchasing power of that money is just going to Skyrocket which is is to say it'll create a huge deflationary event and and um we know that these unexpected deflationary events are are very harmful because because you know most people organize their their payments in terms

of like nominal debt contracts I mean you pay the rent in in so many dollars per month I mean you're paying your employees a certain amount of wage and and if if if firms see the product prices plummeting in a big deflation they're going to have difficulty meeting these uh these nominal obligations and they're going to have to lay off workers Rene on their debts and you know this is this is why um this type of uh Bitcoin the monetary policy is not necessarily a good monetary policy from the you know relative to a well-designed kind of U uh elastic monetary policy that would increase the supply of money uh during a crisis to alleviate the the pressure that there is

on the demand for the money and in doing so you're you're able to kind of smooth out the price level effect and and kind of avoid the worst consequences of these unexpected deflationary events that's basically no I mean I think that makes complete sense right also there are some of these perhaps rather unlikely scenarios but one can one can imagine that right let's say Bitcoin was adopted by the world became a new world currency or something you know it might happen uh and and of course the consequence would be there would be an incredible increase in the value of a Bitcoin and there will be incredible uh change in wealth distrib like shift in how the wealth is

distributed and all those things and and it's pretty obvious that those would be incredibly disruptive Events maybe some good consequences and some bad consequences but in any case like really really disruptive so I mean I think it makes sense that you know when you say that that this inability which I guess in Bitcoin case is also a feature right but to adjust the money supply is um you know has its downsides in some scenarios yeah the disruptiveness of of these events though as as as you know in in the in the best case scenario for Bitcoin Advocates as it becomes uh widely adopted I mean it'll be disruptive but uh you know the key thing is it's it's not not

necessarily going to be uh something that just happens overnight I mean these that sort of disruption can be kind of more or less forecast and and and people can adapt to it the type of disruption I'm talking about is uh you know a Great Depression yeah so suppose Bitcoin does become the the the the the new you know the the numer rare the the unit of account suppose that it is the base money uh that that that money supply uh as as in kind of like the goal centers is basically fixed and uh that's that's that's not best practice when it comes to uh to to the conduct of monetary policy at least according to a you know a wide body of uh of theory now some have proposed uh I mean it's something

talked about that we would have uh some fork in Bitcoin at some point some modification in Bitcoin where we would integrate some monetary policy as uh as an automated part of how Bitcoin Works um do you feel that do you think that at some point it would be possible in the current sort of given the current state of Bitcoin you know a decentralized currency with no Central Bank Etc do you think it's possible to have monetary policies integrated um without uh oversight by Central Bank essentially an automated monetary policy that that's an excellent question you know and and uh the thought had occurred to me um and and uh I I have seen people

kind of kind of think about that idea uh and I I haven't thought it through as much as I would have liked unfortunately but here's the issue I mean my own feeling is uh yeah I think that that that's possible and it'd be interesting right if if such a forkward do occur uh and then and then of course these two these two types of currencies could coexist and we could kind of see you know there'd be a competition uh just as there would be a competition between the US dollar and Bitcoin there's a competition about uh which type of monetary policy is kind of a a dominant um there is the question of you know how we could automate it I mean how you it'd have to be like a you'd have to uh you know write something into the

program um I think the challenge is I mean it would be very easy to write into the program uh a rule that for example during a crisis U you know that could be measured by some publicly observable event to say the the price level or something like that I mean you typically see the price level begins to plummet uh uh in in a in a crisis of deflation you could program uh you know a a a state contingent policy in the Bitcoin protocol to actually inject new Bitcoins into the system conditional on that event that that would be very easy I mean it would just say you know if the price level Falls below this level I

mean we're going to inject you know U one everybody's Bitcoin uh balances are going to increase by 1% something like that I mean you could you could build that into the protocol very easily injecting the the uh the cash would be easy um I think that the the the problem uh the more challenging uh uh issue would be how do you withdraw that money after the crisis has passed Yeah well yeah I mean it's it's interesting to bring up because we actually did a podcast episode on on with Robert Sams on his paper senior chairs and he he developed exactly a model to do that okay so uh I mean we'll have to link the show notes but I can very very briefly

sort of recate the idea like he had there would be I mean the idea was that you have a stable uh a stable currency right so that in case people more people want the currency more coins get issued right and if if fewer people want the currency then the coins get coins get destroyed so the question is how do coins get destroyed is in particular and uh he would have there would be coin holders and sort of shareholders so shareholders you could think of like the owners of the the system and uh in the case of uh where you need to destroy coins essentially um the the shareholders can buy those and um or no

the the coin holders can destroy the coins and in turn they get the shares right so in a way you have to is the sort of equilibrium that's between the two uh the two coins that I see so so like I said I mean uh so I had I didn't think through that part of it very carefully and it wouldn't surprise me that smart people like Robert for example and other people might come up with solutions to the problem the the interesting part is suppose you you we do come up with a solution like that and there's a fork it'd be a very interesting experiment to see uh just to see how how it performs I mean I don't think there's much chance that that's going to happen

with Bitcoin but maybe someone else is going to do a another currency and it's it's it's not without its complexity let's take a short great to talk about sponsor Ledger Ledger are the makers of The Ledger Nano Hardware wallet a small beautiful simple device that lets you keep your Bitcoin safe without buying a Swiss bunker without digging a hole in the basement without uh buying a data center defended by autonomous autonomous robots none of these you need all you need is a small device lets you plug it into any computer whether it's safe or not and your private Keys remain

safe so the nice thing about The Ledger is is the wallet which is really great to use and by the way there's a companion app also for IOS and Android which allows you to do the second Factor authentication required anytime you do a transaction but you can also use Ledger with coin kite so if you have a coin kite setup uh you can use Ledger as one of the private keys in that setup for so for instance uh if you're uh just you know an individual and you want to secure your Bitcoins you could have a multi signature setup where coin kite would have one key uh and you would have another key and perhaps I don't know maybe like your girlfriend has another key or if you're a company you know you can also uh have it set up so that you all the founders have keys and there's

like an a three out of five um uh Keys required to sign so there's you know the possibilities are endless and uh that's made possible by the p partnership between coin kite and ledger so if you're interested in trying Ledger out you can go to Ledger wallet.com and use the offer code eb09 at checkout and that'll give you 10% off your first order so don't delay in getting a secure setup today and we'd like to thank Ledger for their support of EP Center Bitcoin so talking about fedcoin can you give a brief introduction about what the the big idea is well I mean you know I mean none none of these ideas are kind of original to me I mean I I was just remarking

on you know uh I I gave a talk actually uh in Frankford earlier this year and I actually prefaced my fed it was called fedcoin but I prefaced the discussion on fedcoin with what I called fedwire for all which is is kind of an old idea and the the idea is is basically why why can't everybody you me uh and firms have have direct Accounts at the at the Central Bank uh at the FED um and now there's a number of reasons why we can't but I mean that's all kind of stuff that could in in principle could be changed um and if not direct accounts why not uh segregated Accounts at at at private banks that are basically you know uh

segregated and constitute 100% backed uh cash reserves with these accounts so basically some form of narrow banking proposal which is kind of an old idea uh and I was just going you know I mean the the the present system that we have in place now is a system that's evolved over centuries based on on pre-internet technology you know may maybe there was even a reason or a rationale for why you didn't necessarily want every Tom dickiry to have a personal service account at the fed and why you might want to delegate this responsibility to private Banks um but you know in since the internet which is is still very very uh new I mean there's there's really

there's really no reason why people couldn't have a direct online account with the fed and um and I I I I was surprised to learn that in fact in the United States people are permitted to have Direct online accounts with the US Treasury I so I I can go and open up an account directly online with the US Treasury and and what am I buying there I I I'm buying you know electronic digits in interest bearing electronic digits and uh now the treasury hasn't set up so that I can easily make payments across people within the system but you know that's just a detail that could be very easily accomplished and U and and if the treasury can do it why

can't the FED do it and just let you know just let uh you know uh businesses directly deposit in an account with a fed or or or through some sort of uh uh Private Bank that has a segregated account and um there's some technical legal issues to overcome there but they could be overcome and um they could earn interest on on directly they could earn interest on on on this this money as well I mean they could be just like treasury bills interest bearing uh government money uh they would be uh 100% insured there'd be no no need for uh FDIC or any sort of insurance like that because the FED prints the money I

mean there's there's no issue of of losing it um a lot of businesses today that you know who are are managing their cash uh you know they they they don't feel like they can deposit 50 or100 million do in Banks because the the deposit insurance doesn't cover that much they're so that's why they're they're motivated to go into the shadow banking sector and and into the repo markets and as we know that was the The Shadow banking sector was the source of the of the financial crisis uh in 2007 2008 so so I said why you know in principle kind of ignoring a bunch of details why couldn't everybody just have a direct account with a Fed uh you could trust the FED to do the

bookkeeping we could you know the FED is people say how can you trust you know the FED to do the bookkeeping I mean I mean like I said my response is you don't expect the FED to kind of steal your money I mean if the fed the FED can print all the money it wants it's not going to like mess around with your bookkeeping so you know we have this this big uh spreadsheet you know the the blockchain if you want but it's just managed by the fed and it's very cheap much cheaper than Bitcoin uh if you're willing to delegate the responsibility to a a third party um and and but then the the downsides to all of that of course is is uh you know some you know you'd actually suppose you you didn't

want the FED to be uh uh responsible for processing the payments I mean suppose you know the the FED will likely impose some kyc restrictions on on some purchases they might not process some purchases that you might want to undertake um and so it was at that point that I said well you know we could if we wanted to extend the concept one step further uh I'm not saying that this is ever going to happen but just conceptually you could imagine not fed wire for all but kind of like a fedcoin where what the FED would do is actually just issue these uh you know Bitcoin like

objects but um and and they would enforce a a par exchange rate with the US dollar that would eliminate the exchange rate volatility uh but they could delegate the the clearing of these payments to some third party you know some sort of Ripple like protocol or possibly uhit even Bitcoin I mean we could delegate the responsibility of processing these these electronic you know fedcoin payments to the miners and the idea there would be you know because uh we can't really expect the FED to turn a blind eye to kind of certain types of transactions uh the in fact the FED does turn a blind eye to a lot of type of transactions already uh those would be the type of transactions that are

facilitated by the cash that the FED prints right so the the FED doesn't impose any kyc restrictions on cash payments you know we somehow Society somehow seem to uh manage you know over the centuries to uh to to not not implode because of the availability of cash and and kind of these Anonymous kind of uh payments that leave no Trail so to the extent that the FED would be is is already kind of comfortable or or for lack of a de better word kind of willing to live with the fact that we already live in a world where these fed liabilities are circulating to facilitate uh you know Anonymous or under underground exchanges

we are already living with this reality why don't we just issue a fedcoin and permit it to be cleared through these Miners and it's just kind of like the the equivalent of what's happening with the cash we already we print out yeah I mean this is this is such a novel idea and there's so many there's so many topics that uh that we can cover on this but so the kyc um idea the idea that okay so currently in the Cash System there's no kyc you can make these cash transactions without uh any the government knowing uh where the money is going and what you're doing with the money uh but you know the cash has certain limitations so cash is hard to transport in large quantities over

borders for instance you can't pay uh digitally with cash and it it seems to me that if the fed or if there's some like government issued coin that it it's just so unlikely it's just it would be Preposterous to think that the government would not uh want to impose some sort of kyc on there because know the implications of not having kyc are I mean think about uh Capital controls for instance or being you know being able to send like large amounts of money to countries where there are economic sanctions like just that do do you really think that governments would not impose kyc on on like a proposed fedcoin no I I I think I think that quite you're quite likely right I mean

you know but for that matter you know governments are kind of strange sometimes I mean for example why look at all the $100 bills that the FED prints I never see a $100 bill where are they where do they all go I mean yeah similarly in Europe we have these 20500 Euro bills and I don't know where they go either yeah well as far as I can tell from what I'm reading I mean all these $100 bills are like circulating over in in in in Russia or you know around the world and it's quite clear you know I mean there there's some legitimate uses as well for $100 bills I'm not saying that people who hold $100 bills are necessarily criminals but I'm just saying it's quite clear that uh you

know the fed and the authorities seem to be turning a blind eye to this fact and and in principle um you know uh the other thing though is that you have to keep in mind that um you know even on the blockchain I mean it's possible to you know the IRS or the FBI I mean it's possible to do the forensics and kind of and and kind of Trace where these payments are going ultimately I mean I I know there's all these games being played to kind of anonymize payments and all that but uh that's just the property of the blockchain it's going to be there if it's with fedcoin or with just Bitcoin this blockchain is public information it's living out there you're going to be

able to trace payments one way or the other I mean people are going to uh the authorities are going to design techniques to uh Trace payments somehow the uh uh people in the in in the Bitcoin space will develop ways to get around it there will be kind of this continual arms race um so yeah I so just to come back to what you say yeah I think you're right from a practical point of view I think it's unlikely that uh that the authorities would kind of really turn a blind eye to AML or kyc sort of concerns but I'm just I was just kind of throwing it out there is kind of in principle was kind of possible and that it wouldn't really be that much that much different than kind of what's happening today with cash I mean if if we sort of take the

other perspective so I I mean I agree I think this is a is probably going to be a hard sell right but I mean you could say one of the big political advantages and the reasons why the US is such a strong country is because the US dollar is like the the world's strongest currency right that in many countries that have very weak currencies like you know a lot of Latin American countries and other countries uh you know the dollar is like the factor has a very important role that a lot of economic transactions are done with the dollar and that's despite the dollar being quite a pain to use there because well you only have the cash and and you know if you want to get it across the border

you may get caught and then there's all these things but well if we imagine now a fedco well that that's an entirely different thing right so then you could I I think that would be extremely threatening to to countries that have uh you know terrible monetary policies but on the flip side it might also be really attractive for the US in that it it would solidify potentially its its sort of position as this dominant world currency no I think that's that's absolutely correct cor I mean uh there you know it it would give the US a great

advantage in that sense um there there are some pitfalls associated with with having your currency circulate globally but on net it's probably positive and and and this type of idea this fedcoin idea uh is uh is something that would just enhance the the attractiveness of the US currency abroad and solidify its purchasing power uh I I think um um but of course the the the downside of of the program is of course that the people who use fedcoin or or or fedwire for all uh whatever the the the the case may be are are subjecting themselves to uh us monetary policy and uh you know for the past 30

years one could make the case that the US monetary policy has been run uh responsibly in the sense that inflation is has been low and stable I I know there's all sorts of critics out there about fed policy but uh we could spend all day debating that by and large for the past 30 years inflation has been low and stable uh and but of course just because that's the case uh in recent history doesn't mean it always has to be the case so people who would be using fedcoin of course are subjecting themselves to whatever political uncertainties might afflict the the central banks the usfed or or I mean I think that's that that's

certainly one thing that for example you know it might even be the case right that the you the fedcoin would have a a better monetary policy than Bitcoin right but that's perhaps some an aspect where Bitcoin would have an advantage because it's it's neutral in a way um right but even there I I think you know I mean people use the US Dollars Today right and they are subject to us monetary policy I think you could it could probably still succeed there but where I think if you do have to start imposing kyc that's not going to work right like having kyc on people in other countries and those kind of things um it that you know it will break down I

think at that point you know unless the fed or a hypothetical Central Bank would really be willing to give up that control yeah and I I think that for myself I think that uh I mean if I was in charge I I would give up that control uh especially over small transactions right I mean you could actually con condition the kyc uh specification you could say transactions below $100 or whatever $1,000 whatever whatever the parameter is uh whatever do what you want um but um yeah I I mean I agree with you I mean and for for people who are concerned who just not going to trust

the government currency whatever there's Bitcoin or there's other cryptocurrencies I think that's great I think it's it's fantastic that these Alternatives uh uh coexist and and meet the demands of uh these people who want it may they're willing to live with a day-to-day volatility in the currency they're they're comfortable with the idea over the long run the currency is going to maintain its value uh it's they're not subject to these uh kyc restrictions I mean go for it that's that's fine uh I think there's room for these uh these currencies to coexist so one important Robert Sams wrote a post we we link to it in the show notes as well which I thought was very interesting in response to your post and he he sort of said well you and

also JP cunning kind of maybe underestimated how just how revolutionary this concept is because in his view it would really undermine the very idea of fr Reserve banking in that it would make you know deposits holding deposits with banks really really unattractive because everybody would want to hold fet coins so it would be a huge issue for well for the existing Financial systems uh what is your view on that well this is this is uh an interesting fascinating uh subject for study and so my views on on this matter are are not set in stone they're they're

continually uh evolving um uh but so I noticed you mentioned fedcoin and not uh Bitcoin is is that what you meant fedcoin yeah yeah yeah I mean I guess Bitcoin could have a similar effect but that's I think a much harder shot because it can't compete well this this is this is an interesting uh you know it it would definitely uh impact to some extent on the on the the the incumbents in the banking sector that's for sure um but it wouldn't take way uh you know their business in the sense of their lending arms what they do I mean uh Banks you know in narrow banking systems you kind of you're separating out the payments from the credit side of the

economy Banks could still go out and lend money they could still make mortgages they could still uh you know Finance uh uh you know uh firms small firms inventory investment or or whatever um so so so you you know um I think that that that part is uh is is going to be very disruptive for for the incumbent banking sector but you know arguably for the benefit of society um but just let me jump in there but wouldn't wouldn't that be the sort of banking system where cuz I can I I don't think in my view it's possible to have a a

fractional Reserve Bitcoin system I mean you can have people can run a a Clos sort of a a closed fractional Reserve like Mount GA is doing apparently right but then you can't use like Mount gaw Bitcoins to pay anywhere else it's a close system and then as soon as people realize it and withdraw off like it breaks breaks apart so wouldn't this work out in a similar way that you know okay maybe there will be banks that do lending but then you know if they had 1 billion in deposits from from depositors well they could only actually lend out 1 billion in loans and not um 50

billion with a fractional Reserve System you don't you think that would be the case so no I've uh I've uh and that's a kind of a provisional no because uh I've actually been corresponding with Robert Sams uh uh by email and we've been discussing uh debating the issue and so I I'm familiar with uh Robert's uh assertion that fractional Reserve banking is impossible essentially under a Bitcoin system um and and I'm not so sure about that uh and and and my my feelings on this follow both from what I think I've seen in history and also from what I I know in type of the theoretical

models I write down uh but the basic argument would be something like this I mean uh you know know um you know I think Robert's one of Robert's arguments is is like look in the old days maybe fractional Reserve banking made sense because what would happen is you'd have these Banks issuing paper Bank notes redeemable in gold and the reason why it was useful to have Bank notes is because gold has some undesirable properties I mean to to move gold from New York to San Francisco you'd have to hire wels Fargo and a stage coach and all the security I mean it's really really difficult to to transport gold to aay gold you know to keep gold secure and for that reason there may have been a role for these uh

intermediaries called Banks to kind of monetize that gold in in the form of paper notes redeemable in the gold um um but um and and Robert might argue one argument he has is you know today Bitcoin is not like it's kind of like gold but it's like digital gold it's like if I want to send uh digital gold from New York to to San Francisco there's there's none of these issues and and so why do we need a bank to kind of intermediate this this this Bitcoin stuff when it's already such a great kind of payment object my argument on that is is well one property of Bitcoin is that it's uh it doesn't earn any interest

right you don't earn interest on your Bitcoin now you might earn some capital gains if the purchasing power goes up and uh you know you might earn some Capital losses as this purchasing power goes down but you don't earn any interest on it so it's a zero interest bearing asset um which is okay but that's just the fact it's a zero interest bearing asset now banks are still going to be motivated I think to go out and say you know the way the banking system works is they could imagine a world where where Bitcoin is kind of the unit of account and the base money Banks could still you know I'll go up to the bank and say can you lend me a a million Bitcoins I've got a business a

restaurant business I want to finance and what the bank does is even if it has just uh 100,000 Bitcoins in its possession it could just issue me those Bitcoins on account I mean that's how demand deposit that's how the banking system work it just in the in the in the uh in the act of making the loan it actually creates uh Bitcoin denominated liabilities uh that are redeemable on demand for the limited amount of Bitcoin reserves it has but are are otherwise constitute uh legal claims against the bank who who would accept those I mean if if I was like now maybe a supplier and I mean I wouldn't give I I certainly wouldn't treat those uh at parody well

suppose I offered you 5% uh return on on on your deposits held with me suppose that suppose that you felt uh you know we're in a period of economic tranquility the economy is kind of moving along humming along you know banks are doing well uh but that's it's a bit like a pyramid scheme no I mean then no not not at all because the what the bank is doing is investing in my business I'm generating 10% profit for the bank the bank takes 5% and pays the depositors in the meantime people are using the bank liabilities as payments you say who would do it my friend we're doing it today we use these Bank this bank money today all the time and and

moreover even even before FDIC I mean people would just use private bank money exactly this but so so you would so the bank would so you would the bank would have 100,000 in in Bitcoins 100,000 Bitcoins and they would give you a million a credit of a million uh correct Bitcoin worth Bitcoin and now you have obviously they're not Bitcoins right like cuz they don't have those so so you have this other I don't know maybe another cryptocurrency another Ledger maybe it's tracked on another Ledger right yeah on the bank's Ledger just like it is on the bank's Ledger and then uh you would want to pay someone else and they would say um

okay but I mean for me for example now you have a million Bitcoins uh if I wanted to I I mean I would never be willing for example to accept more than 10% right what if you gave me 110,000 I mean if I went to the bank they wouldn't be able to give it to me that's that's correct but they could just sell off the loan uh to acquire it uh you know then my the they have assets on their balance sheet that constitutes a loan against my business they could sell off that security to some other bank to acquire the Bitcoin they need to to meet the Redemption request the other thing we have to be careful is is um when you say I wouldn't do

this I'm sure that you would but the question is is here's the question if banks were to offer such a product would there be people out there agents or agencies that would be willing to accept these Bank liabilities and treat them at close to par with the actual base money the Bitcoin or the gold or the US dollar and the overwhelming evidence shows us that not only people people are more than willing even for small you know this this is the reach for yield phenomena even for small uh gains and yield they're willing to substitute into these types of liabilities and we saw this in the shadow banking sector we saw this uh you

know people had the option of when they wanted to deposit say $500 million overnight that they could take a US Treasury as collateral for this loan but instead you know they going you know what why should I take this uh this this uh US Treasury I mean maybe this AAA rated trunch of mortgage backs security which earns a slightly higher yield is kind of like a is like a better product or something uh you know you you kind of saw this kind of reach for yield phenomenon in the shadow banking sector and it it it's just kind of a phenomenon that seems unavoidable that that especially during periods of um of uh Tranquility um you know they see that

they go oh you know I i' I've used the bank I've used my bank account uh for the past 5 years it's everything seems to be working well uh now I have the option of holding my money in the form of zero interest bearing Bitcoin or 3% uh 3% uh be interest bearing account at a at a wellestablished and reputable uh Chartered bank which am I going to pick I'm telling you people are people are going to be willing to hold these Bank liabilities and it's going to generate a system of fractional Reserve banking I think so is this so the question is is this desirable I mean you mentioned a few minutes ago that if we were to get rid of fractional Reserve banking that would be for the benefit of humanity would it be desirable to fall

back into this system of uh that can essentially implode at at some point well I have to be careful I did I I actually the the in the theoretical models I work with there there's actually benefits to fractional Reserve banking uh there's kind of costs and benefits so I I wouldn't go so far to say that I'd be in favor of banning it the real issue with fractional Reserve banking or or what we see these behavior in the shad banking sector is this um is this uh you know to to to what extent are the people who partake in these activities to what extent do they have uh are they going to be bailed out by the public that that's the issue okay and um so you know one school of thought says well let fractional Reserve banking

have its way Let It Go just as long as people understand that uh if and when such a system kind of uh uh you know is subject to a run or if if if there's some some sort of losses to be incurred that uh that the depositors will take responsibility on their own for these losses they have to understand the risks and and not be uh and not be uh expecting some sort of government bailout um my view on this is uh is if if if the government could commit not to bail out people or certain groups of people in these types of traumatic events then uh yeah fractional Reserve banking uh or any other type of financial structure I mean Let It Fly I

mean I think that you know these these institutions these structures exist presumably for a reason people are should be free to trade they should be free to contract with each other and if these are the designs that they they find uh uh they find U useful for their own purpose let them go ahead and do it but my my my my more cynical side says we we just the government does not have that ability well to commit not to bail out you know in these events and it's it's that government inability to prevent itself from from bailing out is is kind of what leads to the troubles it certainly can make a very credible claim that it's never going to bail Banks out in the financial crisis right I just

wanted to come back to what we were mentioning a while ago about um the the sort of the strength of the US dollar and the advantage that the us would have if they were to If This fedcoin Were as ever to become a reality Because by the way this is all theoretical this is just thought experiments um so you know let's let's say this the you know there's a fedcoin and it starts being used uh presumably by you know for international trade as well as uh as the currency to trade like oil and commodities and also starts being used in countries where you know the currency is not as strong um could could we then this like and then

okay so for example you know the European commission or the the European Union rather also does their coin and then you have start having these competitions between coins and then can can we assume that in sort of a macroeconomic scenario uh one coin will maybe like one or two coins will become the def facto coins that everybody's using because you know if like Zimbabwe starts doing their coin like who's going to use that if they can use to the US dollar and it's as easy to use as cash well that's right so uh that's a that's a very good question um you know who knows how this uh such a system might evolve I mean my my best guess would you

you'd see I mean I think hi history provides us some guide as to what's likely to happen because you know what you're describing is is not new this phenomenon of currency competition of multiple currencies take a look at the system as it exists today we do have a few dominant currencies around the world right the US dollar the Yen the euro I mean these are dominant uh a lot of international pricing and international trade is is done in in in in US Dollars uh but at the same time even even within the United States we see uh you know what people aren't aware of is we we we see thousands of local currencies coexisting you know the the Ithaca hour in Ithaca New York is kind of a prominent example

uh so uh it is it is conceivable that you'll have this system of of uh where you have a few uh dominant currencies coexisting with a a a a plethora of of of local currencies I mean that's what history suggests is likely to happen I mean I think also one one important thing uh to consider sort of when thinking about this and I think that's something that is really radically changing with crypto currencies is that there is no reason anymore that National boundaries are respect it right because I mean in the past uh and you know still for the most part today but the a

currency is very much like embedded in the financial system and the banks and that's regulated and controllable by the government but when that starts breaking apart well then I think it's extremely hard to to tell how it's going to turn out but I think it will be it will be very interesting and and yeah I guess that idea that of competition between currencies is a that's a very old idea and it will be I guess it's it's never it's never sort of fully come defusion right but it might now yeah and uh in terms of like the uh you know people living in in some jurisdictions like uh actually I

just heard that Ecuador was uh is pegging its its cryptocurrency to the US dollar you know you you look at the look what's happening in Venezuela today as well um um I think that the available uh availability of of a Bitcoin like object uh or or if it was fedcoin or Bitcoin or whatever is is is potentially a great Boon to the uh the people who are living in these jurisdictions because it can free themselves from I mean this this this like Venezuela is what I I would call kind of an example of kind of not a well-managed monetary system and it inflicts a great deal of pain on the on the local population and the the ability to free themselves of this mismanaged uh fiscal and monetary Authority I think

would be a great benefit to uh the people who live in these types of places today's magic word is money m o n y go to let's talk bitcoin.com to sign in enter the magic word and claim your part of the listener [Music] reward can we talk about perhaps some of so more technical aspects of what this would look like so we were discussing this earlier and curious in your idea of how fedcoin would work like would there be mining for instance would it be a fully decentralized system or uh would be be would we be relying on centralized

nodes um I'm sure our listeners will be familiar with Technologies like hyperledger and other um more or Ripple for instance how would that how would that play out yeah so I I'm not an expert in the the technical aspects here but like I I suggested at the very beginning uh you know those are details that could kind of be worked out and it it' be kind of important because um you know at one extreme uh you could just dispense with these uh uh miners alog together and just you know I mean why not just trust the FED to kind of uh do the uh Central database H I didn't hear yeah just a central database right it's it could even be a public Ledger I mean I mean there's nothing that prevents it

from being a public Ledger uh you know and the the identities of people's uh uh of of the them and their accounts may or may not be made public you know I mean there's so many parameters but at the end of the day at one extreme you could just imagine the the FED managing the bookkeeping and and and that system would be extremely cheap really cheap relative to say a Bitcoin protocol which consumes vast quantities of uh electricity for example we know no I agree now but but if we presume that it's a centralized system uh with just a central database like there's so there's some issues with that and so we can look at it from the perspective that we want to have an open system or a more closed

system and if you have a central database then you run into some issues like uh censorship so you know some countries may like all out block uh DNS requests like requests to the central uh database at the fed and making it impossible to use uh that currency in those countries um but then there's also sort of an in between where you could have a semi decentralized system with semi-trusted nodes uh a bit you know all around the world that are operated by the fed and run peer-to peer where you would have you know you trust those nodes because they are run by the FED but you don't have this sort of like one Central server uh that can be um right uh censored by by certain countries

correct right you could have uh the the the Bitcoin uh the F Bitcoin the fedcoin component in my blog post I like in fedcoin as to as as the issuance of just a different denomination of currency I I think it would be conceivable to have that part of the money supply uh exist on a distributed Ledger right so just the way Bitcoin is today the only difference is is that the FED would stand ready to uh enforce a par exchange rate against uh fedcoin and regular US Dollars and and that would have the benefit of eliminating the exchange rate volatility uh and then and then at the Other Extreme you're asking at The Other Extreme you could imagine the FED just

delegating uh the responsibility of uh clearing the fedcoin request using some third party like uh uh like the Bitcoin miners at the at one extreme or or or you can imagine some inmediate system kind of like a ripple Ripple protocol I mean the the the possibilities are endless I mean it'd be I don't know which would be the best way to do it and one one other possibility that the FED could just buy PayPal and start using that as their central payment system and they they've got a a good system in place that's used by a lot of people so why not just do that well well indeed I mean PayPal could actually if if um you know if if the if the federal government we have to be careful right we don't

want to confuse the FED with the federal government a lot of people make that mistake maybe we should like be clear up from the Federal Reserve Bank of the United States States is not the federal government um it's it's the uh it's the central bank that was created out of an act of Congress in 1913 just uh uh so so what was the question so uh the I I lost it there sorry guys um I I lost it in my uh we were talking about the PayPal I was saying pay PayPal at present is is uh you know they're IED from doing a lot of stuff right I mean if PayPal could I suppose that they

would be willing to offer kind of like a pseudonymous Swiss bank you know Swiss style bank accounts for example why could you do something like that I mean they're they're they're prohibited from doing that but I mean you know if if uh so a lot of this technology exists out there already like PayPal could do all this stuff and uh it's just what's what's what's preventing them from doing it is the existing body of legislation obviously yeah no absolutely I think this is um it's very fascinating to think uh where this all can go I think especially and and and that's that's a direction that seems inevitable to me that there will be a lot of currencies competing with

each other with different features different protocols uh and that's that's going to be a very novel World know I mean well like the Bitcoin uh not Bitcoin the Ripple protocol call is actually they they sell it as kind of more of a currency agnostic system so so one does have to make a distinction I think between the currency and actually the payment system you know how you actually affect payment so the the the Bitcoin is both of course Bitcoin is both a money and a payment system it it it has the uh the currency unit it manages the supply of the currency unit and it is a protocol that affects transfers of of of value across accounts uh Ripple is Ripple can can uh can you know in

principle operate without uh its native currency I think I mean it's it's it's it's it's more of a a protocol designed to affect transfers of of value that that don't depend on on on the the actual uh uh management of the supply of a native currency think it's important to distinct make a distinction between the creation and management of a a money supply and the protocol in place for affecting uh uh transfers of the value across accounts yeah absolutely no no we may have just a few or one maybe even a way of transferring value but then there might be all kinds of currencies on top of it um so this is probably going to be

a difficult question for you but I'm I'm curious anyway so we've we've been talking a lot about these sort of interesting scenarios for the future and what do you think the probability is or the time frame that maybe the Federal Reserve or some other um Central Bank or government in the world will will do something like that oh so I think that um you know the big big players like the Federal Reserve you know the Emu I mean they're probably going to be relatively slow I think where where you're going to see the the the Innovative attempts occur is kind of like smaller smaller countries smaller jurisdictions and in

fact I I think you're already kind of seeing that in some countries I think I just mentioned Ecuador for example that if if I I didn't read the article uh uh in in depth but it it sounded like in Ecuador for example uh what they're doing is issuing their their own cryptocurrency uh with the property that it's it's going to be uh uh evidently backed by the US dollar uh so you can kind of uh expect I think these types of Innovations to Cur kind of at the fringes these small countries and and these experiments will will take place economists and other people will observe the outcomes and uh you know if something good comes out of it if it's it becomes

an obviously dominant sort of uh institutional Arrangement then at that point you can kind of expect uh you know larger players to kind of develop kind of the best uh policies that uh that have worked out well in these experiments um and at the same time you can expect though it's not like the FED is or the big Banks or the Big Money Services businesses you know MasterCard PayPal um you know Western Union the these agent the they're not standing still in time they they're they're continually innovating as well and um and so it's not going to be clear what how

it's going to all happen I think the only thing I'm really confid ident of is that the trend that we've seen in so far in terms of the uh advancements in in the payment system are going to continue in the future and um you know one one thing that is I think instructive along this dimension for your listeners is to just think about for those of you who are old enough just think about how difficult it was to affect payments even just uh you know in in the 1970s you I so I I I tell a story uh that when when my mother took me to Italy in 1971 uh I was just a a 10-year-old kid at the time but I remember distinctly she had to go and get Travelers checks

right we had to go to the local office we had to find it you know through the Yellow Pages not on the internet you had to go and drive and and and and then you had to pay a fee to get these Travelers checks you had to take the Travelers checks to Italy uh and then you know my uncle would D we'd have to find a local uh office for for American Express I mean we'd have to drive a 100 kilometers to get to that office maybe that office was open maybe it wasn't open then you'd pay another fee to kind of uh converted into the Ala and then you know you'd want to do a big chunk cuz you didn't want to be carrying do it all all the time and uh when I went to Frankford just earlier this year I didn't take any

cash I flew there with my credit card that that was it you know so for for people who are complaining about how the payment system is working today I got you you know I understand we all wish it kind of would work better there's obviously there's room for improvement but we're you know don't don't just take a static view of it I mean we've we've come a long way there's been a lot of innovation a lot of progression and I think what we have to expect is that these Innovations are going to continue into the future absolutely yeah I I I agree and I mean sorry Brian um I agree and I think that in in the next 10 10 20 years we'll see the same sort of innovation in in that in the payment system that we've seen uh

in other sectors uh like like biotech like uh like you know the content business um and that the financial sector is is is now going to see some radical changes and and will'll be disrupted by these Technologies and yeah and and just to just to you know to you know we we were not talking about timeline here but I just want to point out David Johnston uh a well-known uh Bitcoin angel investor I once came on the show and said that if a government isn't integrating blockchain technology within 5 to 10 years not only will they be obsolete but their currencies will be gone so that's just something to perhaps end on and that uh uh say to say that we need to get a move on because we only

have five to 10 years to get this get this right well I have to I have to caution everybody too I mean uh in the following sense I mean uh even in that sort of scenario which I don't think is going to happen but I mean you know a lot a lot of this movement a a significant component of this movement is kind of motivated by you know the Libertarians you know the ones who want to free themselves from the shackles of government uh money manipulation the the one thing you know I want to caution people is that this is not going to even if it even if you eliminated government currencies this is not going to be a solution to that problem of bad governments I mean governments can still tax you know they they could say go

ahead go run your block chain technology awesome uh well we're still going to tax you in fact we might even have to tax you more and uh you know that's just the way it's going to be so I i' I'd be you know careful and saying oh for those people out there who think that somehow this movement to a you know an apolitical currency unit is going to be the end of Oppression um you know it's not so um okay well uh David thanks so much for joining us today it was uh was really interesting talking to you and I think it's a super interesting topic and yeah I guess in a few years maybe we can we can do another episode or maybe before that and see uh see how things have

progressed because I'm sure we'll see a lot of events in this in this area it's going to be fun yeah it's going to be fun yes uh so is there some um Point some place you want to point our listeners to we will link to your blog definitely in the show notes uh is there some other some other resources or well um let's see so I I think Tim Swanson has an excellent blog uh uh so uh yeah yeah you know so we know him yeah we I I'm not I'm not an expert in cryptocurrencies or anything like that I do blog about it once in a while so I I would say if your listeners are kind of uh interested to see a central Banker's

perspective and how his views are evolving over time on the subject I I do intend to post uh something on this notion that we talked about about the possibility of fractional Reserve banking in a Bitcoin like world and and it'll be interested you know if if your listeners would like to go to my blog i' say just monitor my blog and I could potentially Point them to feel feel feel free to email me as well by the way so okay perfect well we'll do that we'll have links to all and also you talks we find in the show us so David thanks so much for coming on was a was a big pleasure thank you very much it was fun yeah yeah and thanks to listener for listening we release episodes of thats Bitcoin every Monday you can get the episodes uh on

iTunes you can get it through your podcast apps on Soundcloud or you can watch the videos on YouTube uh the youtube.com/ Center BTC and uh we will be back next week of course if you appreciate the show you can always give us a tip and we look forward to being back then so until next time [Music] [Music] n