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Home , Digital currency, Xapo

Virtual & Technology

CTAGGL May 1 & 2, 2019 The views expressed are those of the presenter only and do not necessarily represent the views of the Federal Reserve Bank of Dallas or the Federal Reserve System

2 What is a “virtual ”?

❑ “A type of stored-value product or digital …issued and usually controlled by its developers, and used and accepted among the members of a virtual community.” (FRB Board)

▪ a.k.a. digital currencies, alternative currencies, , altcoins; decentralized protocols ❑ Not issued by a federal government (not a “fiat currency”) or backed by a

❑ Generally used in electronic, Web-based transactions

3 Virtual Currencies

❑ “Open source”: All rules, algorithms, security scheme, etc., openly available

❑ May involve legal, credit, liquidity, fraud, operational, information security, privacy, law enforcement, and other system risks

4 Potential benefits of VCs

❑ Reduction in transaction costs ▪ Especially for cross-border transactions ▪ Possibly for merchant processing ❑ Useful in countries where: ▪ Social or political climate may lead to distrust of local currencies, and ▪ There is a high degree of Internet connectivity ❑ Opportunities in areas like “smart contracts,” notary services and tracking asset ownership ▪ More on that later…

5

❑ Launched 2009 (“”)

❑ Permits transfer of currency online, directly, anonymously and outside government control

❑ Origins: Fundamentally political; attracted followers among libertarian and anarchist groups

▪ A means of removing the from the hands of government

❑ Subsequently attracted attention from computer developers, venture capitalists, and merchants (alternative to traditional )

6 Bitcoin

❑ All transactions are recorded in the “blockchain” ▪ Searchable public where all transactions are confirmed, in a matter of minutes, by a network of computers working to perform complex algorithms ❑ New are created through “mining” ▪ The first to perform the complicated hash correctly earns bitcoins ▪ When you request a bitcoin transaction, you can increase the incentive for a miner to process it quickly by adding a fee (a.k.a. “tip”) ▪ The average person can’t really be a bitcoin miner, because of the computing power now required

7 Is it money? Or a tulip?

❑ $136b of digital currencies in circulation (CoinMarketCap.com) ▪ 2,086 Cryptocurrencies

Bitcoin – 2017 asset surge, 2018 asset plunge, 2019 ? ❑ Bitcoin: ▪ Dec 17, 2017: ‒ Price = $19,410 ▪ Feb 6, 2018: ‒ Price = $6,852 ▪ Dec 13, 2018: ‒ Price = $3,433 ▪ Jan 7, 2019 – Price = $4,047 Source: bitinfocharts.com

8 Bitcoin and other platforms… A snapshot in time

January 7, 2019 12:38:42 CT Bitcoin Ripple Bitcoin 17,468,417 40,794,121,066 104,247,513 17,540,527 59,932,546 8,558,206 Total: BTC XRP ETH BCH LTC DASH

Price: $4,047.42 $0.37 $154.53 $161.38 $38.16 $83.29

Market $70,701,964,462 $15,081,165,275 $16,109,522,530 $2,830,616,570 $2,287,097,447 $712,795,359 Capitalization:

Average Transaction $13,169 $830.58 $52,454 $12,895 $4,485 Value: Transactions – Avg. number 11,656 1,230 22,567 308 978 839 per hour

Block Time: 9m 40s 15.3s 11m 5s 2m 30s 2m 38s

Source: bitinfocharts.com

9 Double Spends

If the VC is just digital codes, why not copy and paste to make more money? ❑ Timestamp ▪ Each transaction is packaged and publicly recorded in the order it was carried out ❑ Hash ▪ The time-stamped group of transactions are given a unique, algorithmically-derived number ❑ Blockchain ▪ Transactions are recorded in a community-built record of all transactions that acts as a proof-of-work ▪ Computers connected to the network accept the longest chain as accurate

10 Bitcoin & Merchants

❑ Bitcoin does not allow chargebacks ▪ At least theoretically, less protection for consumers ▪ On the flip side, more protection for merchants

❑ Bitcoin transaction costs are generally cheaper than those associated with credit/debit cards ▪ Fees for acceptance average 2-3% ▪ Fee for a like is around 1%

❑ Most merchants contract with a service (e.g., Coinbase), which converts consumers’ bitcoins into dollars and transfers dollars to the merchant

11 Bringing Bitcoin payments to the masses?

Coinbase reports 47,000 merchant clients accepting Bitcoin payments

12 Where to spend my Bitcoins?

❑ Bitcoin as a ▪ More than 100,000 merchants worldwide accept Bitcoin (Source: Spendbitcoins.com) ❑ Sept. 2017: Aliant Payment Systems Inc. announced it will be first ISO to enlist merchants for Bitcoin acceptance ▪ Will recruit merchants for Atlanta-based BitPay (exchange) ▪ Some retailers of high-end merchandise are now accepting Bitcoin payments as some investors look to spend their newfound wealth ‒ E.g., Old Road Harley-Davidson (CA), Lamborghini dealer (CA)

13 Barriers to Payments

❑ Volatility: +1,700% increase in Bitcoin price in 2017

❑ Slow transactions: Increased traffic on blockchain has slowed transaction times, leading to rising fees for users ▪ Bitcoin can process ~3 transactions/sec.; Visa: 24,000/sec.

❑ High costs: Miners charge fees to give priority to payments

“If you’re sending a $10 transaction right now, you may see a miner fee of $3 or $4. It’s a big problem for people who want to move smaller payments.” —BitPay spokesperson

14 Volatility: Up and Down We Go!

❑ Is this the bottom? ▪ Feb 2018: “stunning collapse” ▪ Analysts: Too soon to tell – watching the 100-day average

❑ Are we there yet? ▪ Jun 2018: “could post new 2018 lows” – June 28: BTC closed below $6k for the first time since Nov 12, 2017 ▪ Jan 2019: BTC back above $4,000 – its highest price in over 2 weeks

Source: coinbase.com

15 Volatile transaction fees

Source: bitinfocharts.com Other cryptocurrencies are also seeing volatility, just not as dramatic

16 Bitcoin & Consumers

❑ Many consumers want to earn points/miles ❑ Miner fees/high transaction costs ▪ Especially for small-dollar payments ❑ See also ‘IRS’ slide… ❑ Result: low consumer adoption ▪ Dish Network began accepting bitcoin in 2014 ▪ Less than 1% of total payments are made in Bitcoin ❑ The volume of payment transactions using Bitcoin fell from $427m in Dec 2017 to $96m in Sep 2018, according to data from Chainalysis

SOURCE: Digital Transactions News, Nov. 20, 2018

17 VCs: [Not] Everywhere You Want to Be…

❑ Jan 2018: Visa CEO Al Kelly: Visa will not process cryptocurrency transactions (CNBC interview at the Natl. Retail Federation conference) ▪ Cryptocurrencies are not a “ player” ▪ Visa will accept only fiat currency transactions

❑ 2018: Capital One, BofA, JPMC, Citi and Wells Fargo no longer allow their cardholders to use credit cards to buy VCs through Coinbase and other companies ▪ Some issuers charging cash advance fees

18 High costs are even squeezing criminals!

❑ 2018: Message posted on Carder’s Paradise (Dark Web marketplace): …“If the Bitcoin price continues increasing, this business is not going to be profitable for us anymore because all our revenue is going to be spent on the Bitcoin fees.” “We urge you to start using Litecoin as much as possible. Litecoin is a very fast and cheap way of depositing funds into the store. We are not going to charge any additional fees if you deposit Litecoins.”

19 A “Regulatory Platypus”

❑ VCs are a “regulatory platypus”; they don’t neatly fit under any of the familiar asset categories.—Marco Santori, partner/head of the blockchain practice, Cooley (NY law firm)

20 Regulating VCs: CFTC

❑ CFTC: Bitcoin is a commodity; therefore…

❑ CFTC oversees bitcoin derivatives (e.g., futures contracts listed on CBOE Global Markets and CME Group)

21 Regulating VCs: IRS

❑ IRS: Bitcoin is property, not currency ❑ Advantage for investors: Bitcoin is treated like stocks, a capital asset subject to a more favorable long-term capital gains rate ❑ Disadvantage for consumers: ALL Bitcoin transactions are technically taxable events, whose gains or losses must be individually tabulated ▪ Contrast this with more streamlined rules regarding foreign-currency holdings ❑ Nov 2016: IRS served a summons against Coinbase, seeking details about customers who traded VCs from 2013 to 2015

22 Regulating VCs: States

❑ New York Division of (NYDFS) ▪ VC firms must obtain “BitLicense” and hold higher levels of capital ▪ 7 BitLicenses have been issued: ‒ Square (June 2018); Coinbase; ; ; Genesis; bitFlyer; and XRP II (Ripple affiliate) ❑ “California Considers Bill Setting VC Guidelines,” AmericanBanker.com, Mar 3, 2015 ▪ “Shelved”

23 OFAC & Virtual Currencies

❑March 2018: Virtual Currencies FAQ published ❑Two important take-a-ways: ▪ OFAC sanctions regulations apply equally to both fiat currency and transactions ▪ OFAC will respond to growing threats posed by bad actors utilizing emerging payment systems by adding addresses that are associated with blocked persons to the SDN list

https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_compliance.aspx#vc_faqs Are the rumors of the death of Bitcoin greatly exaggerated?

Adobe Stock

25 Blockchain/DLT Initiatives

❑ Most new blockchain proposals are looking at: ▪ Limited participant nodes (“permissioned” ledger; only permitted, known participants can validate transactions); ▪ Centralizing all or part of the blockchain ledger; ▪ Paring the blockchain ledger under certain circumstances; ▪ Making blockchain sizes and their analysis more variable; ▪ Incorporating data analytics and probabilities into the verification process

26 Blockchain/DLT Initiatives

❑ IBM-led Linux Foundation Project ▪ Building a blockchain on open-source Hyperledger Fabric ▪ 122 members ▪ Incl. Wells Fargo, BBVA, JPMC, the , FRB , AmEx ❑ Enterprise Ethereum Alliance ▪ Building a blockchain based on the Ethereum protocol ▪ More than 30 financial services and technology members ▪ Incl. JPMC, Intel

27 Blockchain Initiatives: R3

❑ Creating a “blockchain-inspired” called Corda ❑ 84 members, incl. Barclays, BBVA, Commonwealth Bank of Australia, Credit Suisse, RBS, State Street, UBS.

❑ April 2017: JPMC left R3 ▪ JPMC’s “decision to use Ethereum was at odds with R3’s decision not to use that system” ▪ Objections among R3 members to Ethereum included issues around: privacy controls, scalability, immutability of transactions, and consensus mechanisms for validating transactions.

28 Blockchain Initiatives: JPMC’s Quorum

❑ JPMC “also going it alone with a distributed ledger Quorum” ▪ Building in-house

▪ Based on the Go Ethereum client, a software program that supports the Ethereum network ▪ JPMC white paper outlines how its blockchain will handle data and contract privacy and consensus mechanisms (the process by which different computers agree on the order and legitimacy of transactions on the network)

29 Blockchain Initiatives: Walmart

❑ Walmart: Using DLT to manage supply-chain data for mangoes, berries, other products ❑ System built with IBM ❑ Goal: Help trace source of bad food during product recalls ❑ Farmers, packing-house workers and others along the supply chain use a mobile app from Walmart to send details to Walmart’s blockchain ▪ e.g. harvest dates, locations and images of their fruit ❑ Result: Simulated recall using blockchain allowed Walmart to trace the origin of a bag of sliced mangoes in 2.2 seconds. ▪ Using previous methods, same exercise took 6d, 18h, 26 min

30 Blockchain Initiatives: British Airways

❑ 2017: British Airways at Heathrow, Geneva Intl. Airport and Miami Intl. Airport uploaded their flight operations nearly continuously to their blockchain, giving all parties a view of the same information at the same time

❑ Goal: Stop conflicting flight information from appearing at gates, on airport monitors, at airline websites and in customer apps

❑ Result: “one pure, true instance of data”

31 Blockchain Initiatives: Cross-Border

“Protocols like Ripple and Stellar are ‘getting rid of bilateral legacy processes that banks have been using for years to keep money in their pockets.’” —Cheryl Gurz, [formerly] managing director, emerging technology segment, BNY Mellon Treasury Services

32 The Fed & VCs

Jerome Powell, Fed Chairman: ❑ March 2017 speech: ▪ Technical issues remain with the technology and “governance and risk management will be critical.” ▪ There are “meaningful” challenges to a central bank cryptocurrency, that privacy issues could be a problem, and private-sector alternatives may do the job ❑ At Senate confirmation hearing: ▪ The volume of cryptocurrencies could at some point “matter” when it comes to monetary policy ▪ “They’re just not big enough” today

33 “FedCoin”

❑ IDEA: The Fed could peg its own VC at a rate of 1-to-1 with the U.S. dollar ❑ This “Fedcoin” would be , just as are ❑ New Fedcoins would be introduced into the economy by swapping them for banknotes—one dollar for one Fedcoin ❑ As demand for Fedcoin fluctuated, the Fed could redeem the public’s banknotes for VC, and vice versa, with the Fedcoin protocol allowing the Fed to dispose of superfluous (much as it destroys old paper notes)

SOURCE: “Cheat Sheet: Radical Visions of Central Bank-Issued Digital Currencies,” by Brian Patrick Eha, AmericanBanker.com, March 14, 2017

34 “FedCoin”

❑ “The idea is a fascinating one, and it looks like the 21st- century analog of paper currency…” ❑ “The Fed is not considering issuing a digital currency…” ❑ “It’s not something we’re looking at doing. We’re not at a place where I think that’s going to happen.”—Gov. Jay Powell ❑ “A digital currency issued by a central bank would be a global target for cyber attacks, cyber counterfeiting, and cyber theft.”— Gov. Powell, in prepared remarks at a conference held at the Yale Law School on payment technology

SOURCES: “Cheat Sheet: Radical Visions of Central Bank-Issued Digital Currencies,” by Brian Patrick Eha, AmericanBanker.com, March 14, 2017; “Fed’s Powell Warns of Digital Currency’s Risks,” , March 3, 2017

35 “The Party Line…”

❑ Remarks by Lael Brainard at Decoding Digital Currencies Conference, May 2018 ▪ “…the still relatively small scale of cryptocurrencies in relation to our broader financial system and relatively limited connections to our banking sector suggest that they do not currently pose a threat to financial stability.”

▪ “Ultimately, a more holistic approach to the security of the broader cryptocurrency ecosystem, along with added layers of security on top of , are likely to be necessary for cryptocurrencies to be widely adopted.”

36 Challenges for a Fed-issued Digital Currency

❑ Technical and operational challenges ▪ “…unless there is the technological capability for effective identity authentication, a central bank digital currency would provide no improvement over physical notes and could be worse than current noncash funds transfer systems”

▪ “…putting a central bank currency in digital form could make it a very attractive target for cyberattacks by giving threat actors a prominent platform on which to focus their efforts.”

37 Challenges for a Fed-issued Digital Currency

❑ Implications for retail banking ▪ “…the parallel coexistence of central bank digital currency with retail banking deposits could raise the risk of runs on the banking system in times of stress and so have adverse implications for financial stability.” ❑ No compelling need ▪ “…a multiplicity of mechanisms are likely to be available for American consumers to make payments electronically in real time. As such, it is not obvious what additional value a Fed- issued digital currency would provide over and above these options.”

38 Wholesale Digital Settlement Tokens

❑ A better possibility? ❑ Potential reduction in time and costs for wholesale financial transactions (interbank payments, securities settlements, cross-border transactions) ▪ “…it is possible at some point in the future that a limited central bank digital instrument that serves as a settlement asset for wholesale payment and settlement activity may hold some promise.”

39 Distributed Ledger Technology

❑ Something to keep an eye on ▪ “Even if cryptocurrencies prove to have a very limited role in the future, the technology behind them is likely to live on and offer improvements in the way we transfer and record more traditional financial assets.” ▪ “…perhaps the biggest potential benefit for payments, clearing, and settlement of distributed ledger technology may be resiliency.” ▪ “I remain optimistic that the financial sector will find valuable ways to employ distributed ledger technology in the area of payments, clearing, and settlement in coming years.”

40 Questions?

Matt Davies, AAP, CTP, CPP Assistant Vice President Federal Reserve Bank of Dallas E-mail: [email protected]