Earlier this year, the Chairman of the Federal Reserve, Jerome Powell, acknowledged that the central bank of the United States was actively investigating the possibility of creating a central bank digital currency, or “digital dollar.” Without explicitly mentioning cryptocurrency, the Fed was essentially suggesting that it may look to develop its own cryptocurrency. Such a dramatic shift in monetary policy in the United States would undoubtedly have an effect on the financial lives of every American, and is also likely to become a hot-button political issue in the years to come.
Many Americans may be confused about what all the fuss about “crypto-currency” actually means. Here is your primer.
What is cryptocurrency, and why do some people think it could one day replace traditional money?
Currently, government-issued money exists in two forms: cash, and reserves held in financial institutions. The “digital dollar” would be a third possibility, which the Fed describes as utilizing “an electronic record or digital token to represent the digital form of a nation’s currency.” Instead of paper money or a credit card backed by money in a bank, cryptocurrency is a digital form of payment based on a new technology called “blockchain.”
Essentially, blockchain technology creates a digital ledger which verifies transactions across a network and, once they are verified, adds a new data “block” to the chain of verifications (hence the term “blockchain”) thereby creating a permanent and fully verified record of the transaction. Without getting too far into the technical details, blockchains allow transactions using digital currencies to be reliable and guaranteed without any of the parties knowing each other or being required to trust each other—much like cash does today. When you get a $20 bill, you know that it is good as a medium of exchange. In a similar fashion, when you get a Bitcoin, for instance, you can be 100 percent certain it is not fake.
The specifics of how each step of the process works get increasingly complex, and there are plenty of resources online for learning more about it. However, what is important, particularly when it comes to politics and the government’s involvement in the crypto market, is why the technology has grown more popular in recent years.
There are two main appeals of cryptocurrency. First, paying in cryptocurrency eliminates the middleman – namely, banks. You don’t need a bank’s permission to access or move cryptocurrency, and you generally don’t have to worry about a third party accessing your money. You are the only one who has access to your crypto wallet, and you control every transaction. Second, cryptocurrencies are not susceptible to centralized manipulation by institutions like the Federal Reserve, who’s continual “quantitative easing” (money printing) has played an enormous role in the ongoing inflation crisis many are beginning to feel hit their pocketbooks.
Cryptocurrencies, proponents argue, offer everyday people the opportunity to circumvent the traditional financial system, essentially creating a parallel financial system outside government control but just as secure.
Why Central Banks and government leaders are taking notice
Of course, the prospect of a decentralized financial system has many government leaders around the world concerned. Because governments have historically had control over the money supply, they have maintained some degree of control over the economic lives of their citizens—and many (including the United States) have come to rely on a degree of inflation to make their societies function. For authoritarian countries like China, the prospect of such financial independence from the government is unacceptable, which is why the Chinese government banned all crypto transactions in September, citing “illegal activity.”
But the push to assert state control over cryptocurrency hasn’t stopped in Communist China. In recent months, the Biden administration have been signaling its desire to regulate cryptocurrencies through legislation and produce its own fully digital currency. And they aren’t alone. Earlier this year, European Central Bank President Christine Lagarde predicted that the E.U. would have a digital currency within four years and called for the regulation of Bitcoin.
As the crypto market reached a record value of $2 trillion last month, it was reported that the Biden administration was also considering a draft Executive Order that would call for the regulation of cryptocurrencies. The Order would attempt to coordinate the study of cryptocurrencies and a digital dollar across the federal government, and possibly even include the appointment of a White House cryptocurrency czar. Multiple departments would be involved, including Treasury, Commerce, and even various national security agencies.
In the meantime, the price volatility of cryptocurrencies like Bitcoin has led to the development of a form of cryptocurrency called a Stablecoin, which is pegged to a fiat currency like the dollar. These digital coins can theoretically be exchanged one-for-one with actual U.S. dollars. It comes as no surprise, therefore, that the Biden administration has signaled approval for Stablecoins, so long as they can be subject to further regulation. The President’s Working Group on Financial Markets, which has been tasked with studying the issue of cryptocurrency and digital currencies, recommended that Congress pass legislation supporting Stablecoins and limiting their issuance to insured banks—thus incorporating them into the current financial system—whereas many in the crypto space see decoupling from the current system to be the biggest selling point for cryptocurrencies.
Cryptocurrency is not a futuristic pipe dream; it’s a real phenomenon that is quickly taking the financial sector by storm. Although the country is still a long way from paying for gas and groceries with bitcoin, digital markets are reframing how people and governments conceptualize money and payments. A potential switch to digital dollars would undoubtedly bring about unforeseen consequences – some positive, some negative – but being prepared for such changes and understanding the public debate over them will be key in situating Americans for financial security in the long term.
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