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The Internet and the U.S. Payment System
Tuesday, February 17, 2015 6:25 AM

The Federal Reserve System said it is actively exploring the idea of using the public infrastructure of the Internet to facilitate the "direct clearing" of transactions between financial institutions.

The basic concept, that banks will use Internet protocols to connect directly with each other, with all of the transactions logged in to a central ledger, reflects the rise of technology developed in connection with Bitcoin and other digital protocols. The Fed concluded that this kind of decentralized system has the potential to cost less than today's mainstream payment system.

Decentralization is only one of the Fed's four options for building a faster, modernized payment system.

In the scenario, banks could use its technology to send money to each other cheaply and in real time. In this hypothetical future, banks can then move these balances across the ledger bilaterally without having to rely on the central bank's server to reconcile and record the payment transfer. The central bank would later reconcile its books with the transactions that had occurred on the real-time payment system.

The Fed raised two concerns about using the Internet as the backbone of a modernized national payment system. First is security, a paramount consideration for the Fed at a time when massive data breaches have become routine.

The Fed's second concern involves, ironically, the decentralized nature of the U.S. banking system. This country has more than 13,000 banks and credit unions, all of which would need to interact with each other directly in this scenario, rather than using the Fed as an intermediary.

Canada already has an electronic payment system in which banks communicate directly, but that nation also has far fewer banks than the U.S. does.

The central bank made clear that it is not interested in building a modern payment system around Bitcoin or any other digital currency, the supplies of which it does not control.

There are lots of reasons to be skeptical that the Fed will ever implement the concept of a decentralized payment system. Its recent paper is conceptual and vague, and a long way from becoming reality. Clearly the U.S. payment system is a dinosaur, but the way forward may turn out to be bottom-up innovations rather than a top-down plan.

 

Source:  Nexis Newswire, 12 February 2015