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Neutrality and the Federal Reserve’s Role in Cryptocurrency

4 mins
Updated by Kyle Baird
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In Brief

  • Federal Reserve Governor Christopher Waller advised against cryptocurrency investments and warns of the risks involved.
  • The Federal Reserve focuses on broader economic and financial conditions and traditionally does not take a stance on specific investments.
  • The benefits of cryptocurrency include decentralization, speed of transactions, and financial inclusion.
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Federal Reserve Governor Christopher Waller recently advised against investing in cryptocurrencies, stating that prices could fall to zero and investors should not expect the government to bail them out.

In a conference at the Global Interdependence Center, Waller emphasized the risks of crypto investing, comparing it to a speculative asset such as a baseball card.

Industry-Wide Problems

Mr. Waller also highlighted industry-wide problems such as the bankruptcy filing of crypto firms and the collapse of crypto exchanges like FTX. He emphasized the need for authorities to address fraud and scams arising from banks and financial institutions engaging in crypto activities and to ensure they follow all KYC and anti-money laundering requirements. Waller failed to mention that the FTX implosion had more to do with garden-variety bank fraud than with any flaws in cryptocurrency.

History of the Federal Reserve

The Federal Reserve, also known as the “Fed,” is the central banking system of the United States. It was established in 1913 with the passage of the Federal Reserve Act. The Fed was created to address financial panics and to establish a more stable and flexible monetary and banking system.

Over the years, the Fed has played a significant role in shaping the US economy by managing monetary policy through adjustments to interest rates and the money supply. The Fed is also responsible for supervising and regulating banks and other financial institutions to ensure stability and prevent systemic risk.

The Rise of Cryptocurrency

Cryptocurrency is a digital or virtual currency that uses cryptography for security. The first decentralized cryptocurrency, Bitcoin, was created in 2009 by an unknown person or group using the pseudonym Satoshi Nakamoto. Since then, hundreds of cryptocurrencies have been created, each with unique features and uses. Some good. Others, not so much.

Yet, the popularity of cryptocurrency has grown rapidly in recent years due to its potential to provide a decentralized, secure, and fast means of payment and investment. 

Crypto Benefits

Despite the cautionary tale from Waller, there are many potential benefits of cryptocurrencies. One of the main advantages is decentralization, which means no central authority controls the currency or transactions. This can provide greater security and privacy compared to traditional financial systems.

Another advantage is the speed of transactions. Cryptocurrency transactions process in mere minutes or seconds, while traditional bank transfers take several days. This can be especially useful for international transactions, where cross-border transfers can take even longer.

Cryptocurrency also has the potential to provide greater financial inclusion, especially in developing countries where access to traditional financial services is limited. With a mobile phone and internet connection, anyone can participate in the crypto economy, regardless of their location or financial history.

Security, Fraud, and Scams

While there are many potential benefits to using cryptocurrency, there are also significant risks. One of the main risks is the volatility of prices, which can be subject to rapid and large fluctuations. This can make it difficult for investors to make informed decisions and can result in significant losses.

Another risk is security. Digital wallets store cryptocurrencies. If those wallets get hacked or the private keys get lost, the funds can become irretrievable. This is a major concern for investors, especially given the lack of consumer protection in the crypto industry.

Finally, there is the risk of fraud and scams. The decentralized and anonymous nature of cryptocurrency can make it a prime target for criminals, and there have been many instances of Ponzi schemes, hacking, and other fraudulent activities in the crypto industry. 

And now we come full circle back to the legacy financial system, fiat currency.

The Fed’s Interest in Defeating Cryptocurrency

Despite protests over keeping consumers “safe” from crypto, the Fed and other central banks have a vested interest in maintaining the current fiat-based financial system. 

Cryptocurrency operates outside the traditional financial system and is not subject to the same regulations and control as fiat currencies.

Central banks have the power to create and control the money supply, set interest rates, and regulate financial institutions. If the cryptocurrency industry were to gain widespread adoption, it could disrupt the central banks’ ability to control the financial system and potentially reduce their power and influence. Things they would not let go of easily.

Misconceptions of Cryptocurrency and Illicit Activities

One of the main concerns raised by central banks and regulators is the potential for cryptocurrency to facilitate illegal activities such as money laundering and tax evasion.

While cryptocurrency’s decentralized and anonymous nature can make it attractive for illicit activities, it is important to acknowledge the use of fiat currency for similar purposes.

The Role of Fiat Currency in Illicit Activities

Illegal activities, such as drug trafficking, arms smuggling, and human trafficking, widely use fiat currency. Unlike cryptocurrency, cash is easily transportable, untraceable, and widely accepted, making it a preferred medium of exchange for criminals.

Illicit activities have implicated traditional financial institutions. Money laundering is just one example of this. The 2008 financial crisis showed the traditional financial system’s vulnerability to corruption and illegal activities.

The Potential for Cryptocurrency to Combat Illicit Activities

Contrary to popular belief, cryptocurrency has the potential to combat illicit activities-providing a transparent and traceable means of payment. Transparency on the blockchain makes hiding criminal activities difficult due to the ease of auditing.

Furthermore, cryptocurrency exchanges are subject to increasingly strict regulations and anti-money laundering (AML) requirements. This reduces the risk of illicit activities and helps ensure the crypto industry operates responsibly and ethically.

The Importance of Neutrality

The Federal Reserve has multiple roles, including implementing monetary policy and regulating banks to promote stability. It can impact asset prices. But it’s not its role to comment on individual assets’ likelihood of falling to zero. Waller’s comments are a clear example of this.

Interpretations could view the Federal Reserve’s comments on a particular investment as taking a stance. Potentially leading to unintended consequences and a loss of market confidence. It is, therefore, important for the Fed to remain neutral and focus on broader economic and financial conditions. Instead, the Federal Reserve generally focuses on broader economic and financial conditions. Market participants make investment decisions based on their own risk tolerance and assessments.

Top crypto platforms in the US | February 2024

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