Bitcoin payments worry the Fed, but volatility not so much...yet

Rising bitcoin transaction volumes could worry the Fed's payments czar, Jerome Powell, who's incidentally the central bank's likely next chair. Yet he's signaled openness to crypto-currency innovations. As an asset class, a punitive capital requirement determination, more than money-laundering concerns, could crush bitcoin's future.

1. Bitcoin's Low Transaction Volume Belies High Price
Even as blockchain's value explodes from an influx of new users, transaction volume pales in comparison with payments networks like Visa or Mastercard. Bitcoin hacks, outages, opacity and cyber vulnerability don't mesh with the Fed's vision for a reliable payments network. Transactions spiked to nearly 450,000 a day, but Bitcoin's network limits volume by design. Compare that with Visa, which processed 65,000 transaction messages a second worth more than $10 trillion in the 12 months ended June 30.

2. Bitcoin would see sting from 1,250% risk weight treatment
The Federal Reserve could choose to assign a punitive 1,250% risk weight to bitcoin and other cryptocurrencies, which would require Fed-regulated banks to hold almost dollar-for-dollar capital to own bitcoin. Bank adoption is crucial to the future of the asset class and derivatives trading, since bitcoin isn't an efficient retail payment system. Without banks, institutional traders will struggle to access leverage, enter derivatives contracts and make risk-free arbitrage bets that aid in price discovery.

3. Jerome Powell, the Fed's Payments Guy, Is Open to Crypto Cash
President Donald Trump's nominee to run the Fed, Jerome Powell, won't support extremes like abdicating control of the U.S. money supply to a decentralized network, but he may be surprisingly open to new ways of moving FDIC-insured deposits through the banking system. Powell spent his first five years at the Fed working on developing real-time payments, which remain a priority. Bitcoin as an asset class doesn't concern him yet, but he will be on the lookout for clearinghouse risk and bank exposure to a frothy asset.

4. Bitcoin could force Fed to embrace payments innovation
The Fed is unlikely to issue its own digital token like bitcoin, but could consider electronic alternatives. One possibility, dubbed "Fedcoin" by academics, would use a Fed-controlled ledger to issue a digital token redeemable at par with U.S. dollars. Fedcoin's supply would be controlled, but transactions would be decentralized. The Fed has shown no interest yet as Fedcoin would threaten the U.S. commercial banking model. Commercial bank deposits could run in favor of risk-free central bank reserves in a crisis.

Source: Bloomberg Pro Terminal

Jr Trader Alexander Kumanov

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