cryptocurrencies

Fed Economists Say Bitcoin Can't Compete in World of Trust

Bitcoin: What’s Coming in the Year Ahead

Bitcoin and other cryptocurrencies solve the problem of making payments in an environment where trust is broken -- but it’s unclear whether that’s a dilemma that needs to be solved, Federal Reserve of New York economists wrote in a blog post.

Consumers trust institutions and the value of their currencies, at least in the U.S. and the rest of the developed world, so cryptocurrencies will have trouble competing with established payment methods like cash, checks, debit and credit cards, PayPal and others, wrote Antoine Martin, a senior vice president in the bank’s Research and Statistics Group.

“If we lived in a dystopian world without trust, Bitcoin might dominate existing payment methods,” 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.”

Solving the issue of trust comes at the expense of convenience and scalability, as the process of picking random validators so that the network can verify transactions instead of financial institutions, “takes time, is expensive, and consumes tremendous amounts of energy,” Martin said. Another issue is extreme volatility, which also makes them less useful as currencies, he said.

While Bitcoin is often criticized because it’s not backed by a physical commodity, that’s not an issue for Michael Lee, an economist in the New York Fed’s Research and Statistics Group, who says that neither is the dollar and most modern currencies.

“It’s trust that the ‘worthless’ piece of paper is actually worth something to other people that makes it an acceptable medium of exchange,” Lee said. “As a result, the price of bitcoin fluctuates with news that vendors or firms accept or decline bitcoin as a mode of payment."

Read more on how criminals may be turning to other cryptocurrencies

One group that’s probably using Bitcoin are criminals as cryptocurrencies are ideal for circumventing legal or regulatory authorities, because they aren’t governed by any, said Lee. The Drug Enforcement Administration reports a sharp decline in bulk cash smuggling in 2016, which is the traditional payment method for drug shipments, and suggests that payments may have shifted toward cryptocurrencies, according to Lee.

Still, 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,” Martin wrote. “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.”

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