Fed official: Bitcoin poses threat to central banks

Last week, David Andolfatto, St. Louis Federal Reserve Vice President and Director of Research, published an in-depth presentation on the peer-to-peer decentralized currency bitcoin. This is the first time that such a high level central banking official has studied the cryptocurrency and upon his research he has discovered that it could very well pose a threat to the system – but that’s a good thing.

The Business Insider was able to sit down with Andolfatto and talk about the presentation entitled “Bitcoin and Beyond: The Possibilities and Pitfalls of Virtual Currencies,” (PDF) his blog post and bitcoin itself.

He explained that it all began when he attempted to refute that gold is not superior to fiat money, but because bitcoin was in the news he acknowledged that the two share a similarity: there is a fixed money supply. Andolfatto blogged a little bit more and wrote about traditional theories of money.

After this, he was approached by Marcela Williams, the St. Louis Fed’s assistant vice president of strategic communications, to deliver a presentation on bitcoin.

When he first discovered the digital currency, Andolfatto deemed it “silly” and read a blog post by Keynesian economist Paul Krugman and concurred that this was an “intensive effort to mine for gold,” something that the world doesn’t need more of. He performed a little bit more research and then tergiversated.

“I shared in that opinion, but I continued to read about it, and it struck me that that analogy was incorrect — that in fact what these miners were, was mislabeled,” said Andolfatto. “They were performing a communal service, a record-keeping service which is critical to any money system. Mining was a red herring, it’s just one way to reward record keepers for their service, and that protocol could function even with constant supply.”

During his talk, Andolfatto attempted to explain that bitcoin would have immense difficulty competing against the United States dollar because of its fixed money supply. History has shown, says Andolfatto, there is a problem with multiple competing currencies.

“So I asked, how do we think things are going to work out? Do we think merchants are going to accept several different virtual currencies? The relative prices remain stable? Really? What makes you think that? History shows these things are going to fluctuate like crazy.”

He argued that the dollar has remained stable and secure for the past three decades.

In the end, though, bitcoin could be a threat to the establishment, which he argues is a good thing for the Federal Reserve System and other central banks because it prompts these institutions to operate sound policies. If they refrained from doing so then the citizenry would look into another currency.

States have implemented currency controls because it produces demand for a domestic currency – whether it’s in good shape or not – but these days it’s a lot more difficult because everyone has a computer or a smartphone so these regulations make it harder.

“So that’s not gonna happen in the U.S., but to the extent there are other technologies looming out there, that threat might discipline central banks,” said Andolfatto.

What do you think about the Fed official’s remarks about bitcoin? Is it a terrible investment? Will it improve monetary policy at central banks? Sound off in the comment section.

Andrew Moran is a financial journalist who writes for PFHub.com where this article first appeared.