Exploring a Fedcoin and Other State-Backed Cryptocurrencies

While bitcoin and other cryptocurrencies were built to rival fiat currencies issued by centralized institutions, they have now become more popular as an investment tool rather than a payment method. Recognizing this emerging market, legacy financial institutions are now contemplating taking their first step in the world of cryptocurrencies. Several central banks around the globe, for example, have already expressed a desire to release state-backed cryptocurrencies. While they may violate the promise of decentralization, such widely recognized digital tokens may finally allow the digital payment ecosystem to finally be adopted by the masses.

Sheila Blair Explores a Fed-Backed Cryptocurrency

Former FDIC Director Sheila Blair wrote a guest article for Yahoo Finance where she proposed the idea of a Fed Reserve-backed cryptocurrency. This digital currency would complement the fiat dollar. She explained that there is no need to completely migrate to cryptocurrencies as the new coin would work side by side with the dollar. Another advantage of a central bank backed cryptocurrency would be stability. While cryptocurrencies are currently notorious for their price volatility, a national digital currency would be stable and pegged at a one to one ratio with the U.S. dollar.

For those unaware, Bitcoin was launched by Satoshi Nakamoto as a method of payment and was meant to revolutionize how we pay for goods and services. However, more recently, its development and adoption as a currency have been mired in controversy. Reserve banks have been the most vocal critic of the asset class with a few countries even taking the extreme step of imposing an outright ban on using or investing in cryptocurrencies.

Making a Case for “Fedcoin”

Three researchers at Yale University mooted the idea of a Fedcoin as a cryptocurrency through a research paper in 2017. They proposed the creation of a cryptocurrency based on the proof of work (PoW) consensus algorithm that would be backed by the Federal Reserve. As suggested by the former FDIC Director Sheila Blair, Fedcoin would bring a new era of monetary policy.

During a period of high inflation, the Federal Reserve could hike the interest rate on a hypothetical Fedcoin held by users in their wallets. This would give some space for the financial authority to lower inflation.

Similarly, during a period of deflation, the Fed could lower the interest rate or bring it to zero. This would encourage people to spend more and seek more Fedcoin on credit. Former Fed Governor Kevin Warsh said, “It strikes me that a central bank digital currency might have a role to play.” He told The New York Times, “If the next generation of cryptocurrencies look more like money and less like gold and have less volatility associated with them so they would be not just a speculative asset but could be a reliable unit of account, as a purely defensive matter I wouldn’t want somebody to take that monopoly from me.”

The Curious Case of State Sponsored Cryptocurrencies

Venezuela, a country that struggles with hyperinflation and political unease, was one of the first countries to announce the launch of a national cryptocurrency in December 2017. The nation launched “petro” as the country’s official digital currency in 2018 which was said to have been backed by the country’s natural resources.

The move also had political motives as it was a step in circumventing American trade sanctions. The government even offered a 30 percent discount to India if it paid for crude oil using the petro. The Indian government, which has had a mostly anti-cryptocurrency stance, rejected the proposal.

The Swedish Central Bank may see the launch of an IOTA-based cryptocurrency E-Krona. The IOTA platform was a preferred choice as the backbone of the E-Krona due to its unique blockchain system called Tangle. Estonia has also announced plans to launch its version of their cryptocurrency labeled Estcoin.

Russian president Vladimir Putin has even hinted the creation of a Russian national cryptocurrency named the “Cryptorouble.” Since Russia paid for Venezuelan crude oil in the latter’s cryptocurrency petro, Russian officials likely see the creation of a Cryptorouble as a great way to circumvent American sanctions on the country.

Most state-sponsored cryptocurrencies have been launched for political purposes and have yet to be launched for use by citizens. Although state-backed cryptocurrencies may seem paradoxical, they may be the solution to the problems faced by the cryptocurrency sector.

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