Two economists from the Federal Reserve have weighed in on the cryptocurrency space, answering a wide range of questions. While some of these questions were simple in nature, others were more deeply involved.
These economists are Michael Lee and Antoine Martin. They are economists in the New York Fed’s Money and Payment Studies function. Let’s go over what they had to say about cryptos.
The utility factor
Many observers of the crypto space have wondered whether cryptos are really filling any specific voids. The economists agreed that cryptocurrencies solve the problem of making payments in a trustless environment possible, but there is a caveat.
Martin said:
“…it is not obvious that this is a problem that needs solving, at least in the United States and other advanced economies. And solving that problem creates others. One is scalability; the process of picking random validators takes time, is expensive, and consumes tremendous amounts of energy. “
The matter of trust is implicit for practically any means of payment, Lee said. Just as trust is key to crypto purchases, such is also the case with traditional payments that we use for everyday purchases.
Lee gave the example of a simple grocery purchase. One may pay with a check, debit card or credit card, but the recipient must trust that payment is good.
“Say I need to buy groceries. If I pay with a personal check, the grocer has to trust that the check isn’t “hot” (that I own the account and it has sufficient funds). Common payment methods, like debit or credit cards, also entail a surprising degree of trust. The grocer and I have to trust the banks that connect us when I swipe, trust the payment system or “plumbing,” whereby funds flow from my account to the grocers.”
What’s so special about cryptos?
As the crypto craze reached a fevered pitch last year, many were curious about what all the rage was about. Then and now, many believe that cash, debit and credit cards will forever be the way to go to make purchases.
Lee explained:
“What’s special about [cryptos] is that they can serve those roles even in environments where trust—or lack of trust—is a problem.”
As far as the question as to what’s the future of cryptos, Martin said:
“It will ultimately depend on how well they compete with other, already established payment methods—cash, checks, debit and credit cards, PayPal, and others.”
What gives if there’s no backing?
Here’s a question that comes up often about what’s supporting cryptos:
If virtual currencies aren't backed by anything real, gold or some other physical commodity, does that mean they all eventually will be worthless?
Lee pointed out that the dollar and most other modern currencies aren’t backed by a physical commodity either. He noted that it’s long been known that currencies that are intrinsically worthless, mere pieces of paper, are recognized as valuable because payments with money are so much easier than the alternative, which is bartering.
The clear problem with bartering is that when everyone trades goods and services directly, the dreaded “double coincidence of wants” becomes an issue.
For example, Lee said:
“If I want to have dinner at my favorite restaurant but the cook is not interested in trading a meal for a bitcoin lecture, I have to keeping searching until I find a restaurant that I like where, coincidentally, the cook can’t hear enough about bitcoin.”
He went on to say that money, even intrinsically worthless paper money, cuts the “double coincidence” problem in half.
“I just need to find someone willing to pay me some of that paper for my lecture, then use that paper to pay for dinner. As long as I trust that someone will accept the paper, I’m willing to accept it in exchange for my lecture. It’s trust that the “worthless” piece of paper is actually worth something to other people that makes it an acceptable medium of exchange.”
At the end of the day…
The pair concluded that cryptocurrencies’ challenges include it being trustworthy and convenient. Martin said people tend to trust financial institutions to handle payments and central banks to maintain the value of money. He saw that as meaning that it is unlikely that Bitcoin could ever be as convenient as existing payment means.
That said, Bitcoin and other cryptocurrencies are trying to improve scalability and convenience so perhaps in the future one of these cryptocurrencies could realistically compete with current payment methods, he admitted.
“But, fundamentally, we wonder whether a payment method designed to function where trust in institutions is completely absent can ever be as convenient as one where trust is required, but also already exists.”