from Liberty Street Economics

— this post authored by Michael Lee and Antoine Martin

Bitcoin and other “cryptocurrencies” have been much in the news lately, in part because of their wild gyrations in value.

Michael Lee and Antoine Martin, economists in the New York Fed’s Money and Payment Studies function, have been following cryptocurrencies and agreed to answer some questions about digital money.

Q: Let’s start simply. What even is cryptocurrency?

Martin: Cryptocurrencies are digital, or virtual, money. Bitcoin, which was created in 2009, is the first and probably the best known cryptocurrency, but many others have followed, such as Ethereum, Ripple, Bitcoin Cash, Litecoin, etc.

Q: Do they have utility that other forms of money lack?

Lee: Like any functioning form of currency, cryptocurrencies facilitate payments between parties and provide a store of value. What’s special about them is that they can serve those roles even in environments where trust – or lack of trust – is a problem.

Trust is implicit for practically any means of payment. Say I need to buy groceries. If I pay with a personal check, the grocer has to trust that the check isn’t “hot” (that I own the account and it has sufficient funds). Common payment methods, like debit or credit cards, also entail a surprising degree of trust. The grocer and I have to trust the banks that connect us when I swipe, trust the payment system or “plumbing,” whereby funds flow from my account to the grocers.

Some of these problems go away with cash because when I hand cash to the grocer, there is no need for trusted intermediaries. But if you think about it, even cash requires some trust. The grocer has to believe that the cash I pay with will retain its value and not be eroded by inflation or confiscatory monetary reforms. So she needs to trust the central bank.

Q: Have cryptocurrencies made progress toward solving the problem of mistrust?