The US Federal Reserve in New York said the framework for discussing digital currencies is flawed, in a blog post yesterday. They stated that Bitcoin had “changed” how society thinks of money.
Distinctions on currencies made
Digital currencies, including potential central bank digital currencies (CBDC), have generated a lot of interest over the past decade since the emergence of Bitcoin. The interest has only grown in recent months because of a desire for contactless payment methods, stemming from the coronavirus pandemic, the blog said.
The feds discussed a common distinction made between “token-based” and “account-based” digital currencies. We show that this distinction is problematic because Bitcoin and many other digital currencies satisfy both definitions, they noted.
Bitcoin uses public-key cryptography. Each Bitcoin address has associated with it a pair of keys, one public and one private. Only someone who knows the private key can spend Bitcoins associated with the address to which that key is related. This protects Bitcoin users, as long as they can keep their private key secret, the feds stated.
They noted that Bitcoin fits the definition of an account-based system. The account is a Bitcoin address, and the private key is the proof of identity needed to transact from that account.
Every time a Bitcoin user wants to spend Bitcoin, that user must verify their identity by using their private key, they explained.
It is not relevant whether the system requires users to reveal their true identity. Rather, what matters is whether a user must follow a process the system has developed for verifying the identity that they established within the system, whatever that may be.
Bitcoin Operates Similar to Banks
Analogously, a bank that wants to move funds through the Fedwire Funds Service has to comply with the Reserve Banks’ security procedures, which includes a set of access control features, the blog cited, adding:
“Bitcoin also fits the definition of a token-based system, said the Feds. The current transaction history is used to verify the validity of the “object” being transferred, as other token-based systems also do.”
With Bitcoin, the object is a “UTXO,” which is only valid if it has not already been spent. With cash, the object is a note, which is only valid if it is genuinely issued from the central bank.
Meanwhile, the regulators noted that clinging on to the old definition of money could “slow down progress” when it comes to regulating Bitcoin and other cryptocurrencies. “Perhaps these terms should be retired to avoid further confusion,” they ended.