Randal K. Quarles, a Trump administration appointee to the Federal Reserve Board of Governors and Vice Chair for bank supervision, has given a lengthy speech (“Thoughts on Prudent Innovation in the Payment System”) that directly targets Bitcoin as a danger to the monetary and financial system.
To reiterate, an official speaking for the nation's central bank that manages the global reserve currency – the institution that has long bragged about its power to bail out the entire world with the magic powers of the alchemist – has put down Bitcoin for being untrustworthy, unbacked, and unsound.
The timing here seems about right. Nine years ago, Bitcoin was born, but only a small group of developers were really paying attention. Today, there are lines forming at Bitcoin ATMs around the country as people scramble to convert cash to digital money even at absurdly high premiums.
With one unit of Bitcoin now worth 10,000 times the US dollar, it makes sense that the Fed would begin to feel a bit defensive. Indeed, the speech comes to the defense of the central bank, the existing money, and payment system networks, and calls for the pace of innovation to be controlled by regulators in the interest of “prudence.”
His summary criticism of Bitcoin is that:
The "currency" or asset at the center of some of these systems is not backed by other secure assets, has no intrinsic value, is not the liability of a regulated banking institution, and in leading cases, is not the liability of any institution at all. Indeed, how to treat and define this new asset is complicated.
That a Fed official would denounce cryptocurrency as unbacked strikes me as the height of irony. The dollar was once “backed” by the secure asset of gold, but that system was finally abolished by Richard Nixon’s Fed in 1971, lighting up inflationary fires that lasted a full decade. Since then, the banking system has moved from crisis to crisis, from the S&L debacle of the late 1980s to the near-death experience of the entire financial system of 2008.
This is not an excellent track record.
It is not a coincidence that Satoshi Nakamoto released his White Paper on Bitcoin in October 2008. It became very clear that we needed a new system of sound money that could not be manipulated by the very regulators and central banks that unleashed the crisis. Bitcoin was proposed as a sound money solution.
As for backing, Bitcoin is backed by the use value of the distributed ledger in the underlying technology of the Blockchain. What’s more, that backing has been tested. The march of BTC value from $0 to $10,000 in nine years reflects a market judgment, not anyone’s imposition, dictate, or regulatory plan.
Stability and Instability
And yet Quarles raises questions about Bitcoin’s soundness and suitability to serve as a kind of mainstream infrastructure for money, banking, and credit. Because cryptocurrency is privately produced and managed, he compares it to the banking system that existed before the Fed.
Earlier in our history, the United States frequently witnessed bank runs that severely disrupted financial and economic activity, an example of what can happen when people lose faith in a payment system. In response, Congress ultimately introduced both a central bank and deposit insurance programs to help regulate fluctuations in the supply of liquidity in order to keep prices stable. Without the backing of a central bank asset and institutional support, it is not clear how a private digital currency at the center of a large-scale payment system would behave, or whether the payment system would be able to function, in times of stress.
But, again, the entire story of cryptocurrency is that it was a response to a loss of faith in the system that the regulators have overseen. The banking system did not perform well at all in this time of stress and needed trillions of dollars in fiat subsidies to maintain confidence.
Quarles also seems confused about the structure of Bitcoin itself. It deals in settled payments, not faith and credit. The entire point was to create a system that does not rely on trust; it runs on proof. The same cannot be said about the banking system before the Fed, which lived on leverage, risk, and dealing in government debt.
It is, however, true that the existing Bitcoin network today cannot scale to become a mainstream payment system, and there is strong evidence that it was never intended to. But this is also why there is continued innovation in the sector, with new payment methods, alternative tokens, side networks, and other scaling solutions. The beauty there is that cryptocurrency doesn’t have to wait for a crisis to be tested; it is stress-tested in real time all over the world every second of the day.
Many people have wondered if the Fed and other central banks would seek to compete with private-sector cryptos. Quarles strongly rejects that idea:
Some have argued that central banks should begin to issue their own digital currency as a 21st century analogue to paper currency. I would urge caution, particularly for countries like the United States with highly developed banking systems and ongoing robust demand for physical cash.
As a practical matter, I believe that consideration of a central-bank-issued digital currency to the general public would require extensive reviews and consultations about legal issues, as well as a long list of risk issues, including the potential deployment of unproven technology, money laundering, cybersecurity, and privacy to name a few. I am particularly concerned that a central-bank-issued digital currency that's held widely around the globe could be the subject of serious cyberattacks and could be widely used in money laundering and terrorist financing.
Instead, he says, we should look to the existing banking system to continue to improve, citing here such “innovations” as banks with websites and mobile applications.
The alternative to privately issued digital currency is not necessarily a publicly issued digital currency. Instead, the near-term alternative is to build on the trusted foundations of the existing payment system and work to improve private-sector payment services. Importantly, this means looking to the banking system, which holds the bulk of the transaction deposits in this country, to improve services.
But this begs the question: If the existing analog system, made available only to people the government knows and tracks, is so trusted, why is the competition doing so well? And why is he so against it if consumers seem so ready to embrace it with such vigor?
Still, he assures us that if we just give the Fed a chance (ok, it’s been 100 years now), it will get better. It really will.
The Federal Reserve has been working with the banking industry and a wide range of other payment system stakeholders to better understand the consequences of this state of affairs and support efforts to expand the available options through our payment system improvement initiative. For example, based on recommendations from the industry, the Federal Reserve is currently studying potential improvements in its settlement services – a traditional core function of a central bank – that could address the future needs of a ubiquitous real-time retail payments environment.
This “potential improvement in settlement services” has a name: blockchain. I say to the Fed: you didn’t create that.
The entire rationale behind the Fed relies fundamentally on monopoly. End that and you end it entirely. This is what Quarles knows. And so do crypto holders, who together now control $350 billion of wealth. It’s just the beginning.