For bitcoin and other cryptocurrencies to become a viable money option of the future, they need to address two major shortcomings: convenience and volatility.
That’s according to economists Michael Lee and Antoine Martin from the New York division of the US Federal Reserve, who discussed cryptos in an interview published on the New York Fed’s Liberty Street Economics blog.
Granted, cryptocurrency advocates are likely to express some scepticism about a central bank taking an anti-crypto stance.
And some have argued cryptocurrency is a more efficient — and perhaps even a replacement — alternative for the current system based on fiat currency backed by central banks.
Still, questions remain about how the logistics of cryptocurrency stack up from an economic perspective.
One of the issues raised by the two Fed economists — volatility — was also highlighted by Deutsche Bank analysts last month, who noted that as long as the price of bitcoin continues to surge (or fall) in value, it will face inherent limitations as a currency.
Here’s how Lee and Martin summarised the problem:
This volatility is an inherent feature by design. Since there is no central bank that adjusts the supply of bitcoin to accommodate changes in demand, bitcoin’s value can swing sharply with demand. In a world where all things were priced in bitcoin, this would likely translate into massive swings in inflation and economic activity.
In contrast, providing an “elastic” currency to promote financial and price stability is a goal shared by the Federal Reserve System, the European Central Bank, the Bank of Japan, and many other central banks.
On the topic of convenience, Lee and Martin said one of the core value propositions of cryptocurrency — making payments in a trustless environment — is addressing a problem that doesn’t necessarily need to be solved.
In other words, the current system — based on flexible fiat currencies backed by central banks and subject to relevant tax laws — actually works pretty well.
And a system of trustless payments gives rise to another dilemma — scalability.
While the bitcoin development community continues to work on improving transaction speed, the process of verifying each transaction on the blockchain has so far proven to be far slower than traditional payment networks.
“If we lived in a dystopian world without trust, Bitcoin might dominate existing payment methods,” Lee and Martin said.
“But in this world, where people do tend to trust financial institutions to handle payments and central banks to maintain the value of money it seems unlikely that Bitcoin could ever be as convenient as existing payment means.”
Lee and Martin didn’t rule the possibility that issues around cryptocurrency scalability may be solved in future — but they remain unconvinced that the new technology offers a better value proposition than the currenty system.
“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.”
You can read the whole interview on the New York Fed’s Liberty Street Economics blog here.