Further Recognition! New York Fed: Bitcoin Meets Definitions of Legal Tender and Bank Accounts

The Federal Reserve Bank of New York released a lengthy article on its website on the 12th regarding digital currencies, with a focus on Bitcoin, exploring the pros and cons of cryptocurrencies like Bitcoin in comparison to the current financial system.

In recent years, the popularity of online banking and digital payments has been on the rise. However, when it comes to central bank-issued digital currencies, it is still in its early stages. With the outbreak of the novel coronavirus this year and the apparent progress of China's DCEP, authorities and the public have begun to pay attention to digital currencies and contactless payments.

Tokens vs. Accounts

The New York Federal Reserve distinguishes between "Tokens" and "Accounts" in its discussion, likening their roles in society to physical cash and the banking system. The New York Federal Reserve believes that both systems have their flaws, while Bitcoin and many other cryptocurrencies can simultaneously fulfill both definitions.

A typical use case for the token system is "cash." When individuals use cash for transactions, the only concern for the store is the authenticity of the cash, without needing to know the identity of the consumer or any other information.

A typical use case for the account system is the "U.S. Federal Reserve Funds Transfer System," which provides real-time gross settlement services to the Federal Reserve, all Reserve Banks, the U.S. Treasury, other federal agencies, and financial institutions. The system includes a series of security procedures to effectively prevent fraud possibilities, requiring identity verification in the account system. Use cases for the account system also include the public's bank accounts.

Despite the long history of both systems, the New York Federal Reserve points out that both have their flaws. The token system is susceptible to counterfeiting, with the New York Federal Reserve citing a 2006 report from the U.S. Treasury indicating that around $70 million circulated in the market, potentially reaching as high as $200 million.

Furthermore, the account system is not foolproof either. In 2016, the Bangladesh Bank was hacked, transferring nearly $1 billion from the New York Federal Reserve to the Bangladesh Bank account, successfully withdrawing $101 million.

What Makes Bitcoin Unique?

The New York Federal Reserve believes that Bitcoin and many other cryptocurrencies can simultaneously fulfill the definitions of "Tokens" and "Accounts." The report states:

Bitcoin fits the definition of the account system. Bitcoin addresses serve as bank accounts, and the private key is the identity verification required for transactions within the account. Whenever a Bitcoin holder wants to transact, they must verify their identity with the private key, similar to the security mechanism in bank accounts.

Bitcoin also fits the definition of the token system, as the protocol can verify the validity of transactions through historical transaction records. For Bitcoin, the verification is for Unspent Transaction Outputs (UTXOs); for fiat currencies, it is for authenticity and issuance by central banks.

Note: Bitcoin is based on the UTXO model, which stands for Unspent Transaction Output. Bitcoin does not have the concept of individual account balances, so every transaction verifies all past transaction outputs and inputs to confirm that the address has sufficient "unspent transaction outputs" when initiating a transaction.

The impact of the COVID-19 pandemic on the financial system seems to echo the scenes of the 2008 financial crisis. Governments around the world have implemented quantitative easing policies, printing money on a large scale, paving the way for the existence of Bitcoin. However, Bitcoin has yet to demonstrate its purported hedging properties and still has relevance to the traditional financial markets.

In addition, despite Bitcoin's growing recognition, central banks around the world, including the New York Federal Reserve mentioned in this article, are beginning to pay attention to this emerging asset. The term "Bitcoin" has even surfaced in U.S. Congressional hearings, and a previous ruling by a U.S. federal court stated that Bitcoin is a form of "currency" covered by the District of Columbia's Money Transmitters Act, but its legal status seems to have made little progress in substance.