[USD 2.0 – WOULDN’T THAT BE GREAT?]

Here are our thoughts on Fedcoin.

The full text is also below.

USD 2.0 – WOULDN’T THAT BE GREAT?

The world desperately needs technologies like Fedcoin.  Money has fallen far behind advances in technology.  We endure levels of monetary friction that predate the information age.  Half of the world’s adult population, 2.5 billion people are unbanked, yet desperately need access to modern financial services.  These billions remain unbanked because it’s too expensive to give them accounts, and despite the best efforts of extremely well funded organizations and the smartest individuals in the world, nothing seems to change.   This situation is entirely caused by an arranged marriage between our monetary systems and outdated sets of rules that trace their origins to the days when we knew the earth was flat.  Most of the rules we follow in 2015 were created before people used computers, yet we seem surprised that an international money transfer costs the poorest people 8-10%.  You can email someone halfway around the world in seconds for free, but a wire will cost you $50 and take 3-5 days.  We are living in the dark ages of money.

RULES?  IT’S ALL ABOUT FOLLOWING THE RULES.

The rules different Governments apply to monetary systems are so demanding that only well funded financial institutions can afford to follow them.  End users of the currency must open “accounts” with these institutions in order to participate, and there is no universal standard for transmitting money between these financial institutions globally.  Standards in the same Country vary widely.  This complicated global regulatory framework is why we suffer from unacceptably high fees when sending money overseas or between banks.   A Fedcoin technology could, if properly designed, eliminate this friction entirely and allow anyone interested to essentially “download a bank”.  That said, it’s difficult to not be a skeptic.  There are three major issues standing in the way of mass adoption of a Fedcoin like technology.

ISSUE 1: FEDCOIN REGULATORY INCOMPATIBILITY

The first major issue with Fedcoin has to do with regulatory incompatibility.  The Bank Secrecy Act and similar regulation require anyone moving money to comply with strict sets of record keeping and monitoring requirements.  These requirements exist to ensure that money is not transmitted to individuals or entities that are on sanctions or other lists or for reasons considered illegal or otherwise prohibited.  These rules and the institutions that enforce them will never allow the download of an application that lets users send and receive US dollars anonymously.  There will be a requirement for users of the software to be identified first, creating a network of ID verified individuals who are allowed to transmit funds.  This alone introduces cost and friction, as some entity, likely a company or companies, must positively identify users of the software.  There will need to be processes to revoke licenses for users that are added to lists of unapproved users.  Identity thieves will create false users, and the same arms race that exists today between banks and organized criminal identity thieves will continue as it does in today’s system.  So while we may see a consistent system for money transmission, we will still see the same hurdles around identity management that exist today.  These requirements around ID will also make it economically nonviable to let the poorest people use the Fedcoin software.  Half of the world’s adult population, 2.5b people are unbanked today, and without a consistent standard for individual ID, Fedcoin with ID requirements won’t be able to help these people.  Today banks and other financial institutions exist because they are able to comply with these rules cost effectively.  Fedcoin as proposed fails to automate all of the complicated and often inconsistent rules that apply to financial institutions, which means that these same institutions would still need to exist to ensure compliance, regardless of whether Fedcoin software is used to transmit money or not.

ISSUE 2: FEDCOIN CENTRALIZATION AND HUMAN NATURE

The second major issue with Fedcoin relates to monetary policy and the nature of the technology.  While decentralized cryptocurrencies issue new currency units based on predictable math based rules and prevent counterfeiting though economic incentives offered to miners, Fedcoin would be directly connected to US monetary policy and those controlling it.  While many see this as a positive, as the US dollar presently experiences lower volatility than bitcoin and similar cryptocurrencies, it fundamentally changes one of the key beneficial properties of decentralized cryptocurrency, a predictable and transparent monetary policy that is not subject to human error.  The average lifespan for fiat currency is 27 years.  The Great British Pound is the longest lived currency today, surviving well over 300 years, yet when it was conceived, the GBP was fixed in value to one pound of sterling silver, and has lost well over 99% of its value in those 300+ years through inflationary monetary policy.  The US dollar enjoys status as the world’s reserve currency today and is typically the unit of account for trading oil, but this status is closely tied to geopolitical power.  This is not to say that the US dollar will not continue to enjoy its status as the most widely used currency in the world, but history indicates that the lifespan of even the greatest currencies comes to an end.  In 2008 we came right to the edge of a serious global currency crisis that was narrowly averted.  This pattern of financial crisis is predictable and happens roughly every 10 years or so.  When studied, there is a common theme behind them.  Human decision making typically caused by greed created financial imbalances that built upon themselves resulting in a crash.  Compare this history with bitcoin or other cryptocurrency with math based monetary policy where inflation is predictable and limited.  These rules are not based on human decision making and value is tied to its effectiveness as a medium of exchange, not the backing of a sovereign government of elected or appointed individuals.  This makes bitcoin much like digital gold, another form of currency accepted across borders and cultures universally for thousands of years.  Bitcoin has survived for over 6 years and has yet to be hacked or compromised.  It looks increasingly likely that issues around scale will be overcome as computer storage costs drop.  This makes bitcoin an ideal “neutral ground” for money transfer across powers that may or may not see eye to eye.  This is the other side of the coin in terms of the volatility argument against bitcoin, it has superior properties as money and a built in neutrality that insulates itself from politics.  The coin has been flipped and time will tell if its heads or tails.

ISSUE 3: CONFLICT OF INTEREST

The third major issue with Fedcoin is that it conflicts with the best interests of banks.  Banks that do not directly profit from the creation of money stand to lose with Fedcoin, as lending activities could easily become obsolete and automated by the software.  Beyond credit, Fedcoin would make money transmission effectively free, which would remove most if not all income from remittance and payments services.  These are other profit centers for banks and financial services companies.  The lobbying against this type of technology will be fierce and unprecedented, the stakes could not be higher, and these institutions are very good at getting their way.  I believe that Fedcoin’s only chance is that if that all incumbents are sufficiently threatened by an even more disruptive technology, such as bitcoin.  I don’t think bitcoin represents an existential threat to these institutions at this time, and as long as taxes must be paid in local currency, it’s unlikely it ever will.

CONCLUSION

These are very early days, but it’s clear that bitcoin and Fedcoin are fundamentally different technologies with very different properties and value to end users.  Bitcoin is a decentralized form of electronic cash that exists without a central authority and is widely used today.  Fedcoin is a derivative idea that represents a standardization of the technology behind transmitting US dollars.  Fedcoin carries the pros and cons of the underlying currency and is more of a transmission standard than a new form of cash.  Fedcoin would be a wonderful improvement over today’s payment systems, but it’s highly unlikely we’ll ever see it in general use.  Banks in the US can’t even agree to modernize the ACH system.  This system is still used as the primary method to move money inside the US, was conceived in 1974, and runs on a batch system that is manila folder friendly.   The backbone of the US financial system is about as fast as the Pony Express because we can’t agree to a defacto real-time settlement system, yet we are going to implement an even more advanced Fedcoin technology and hold hands while singing campfire songs and roasting marshmallows?  Forget it, there are just too many complications and unaligned forces that have a say in the matter for this idea to work.  It will take an existential threat in order to align these forces and create real change.  That threat is not bitcoin.  That threat is destabilization of the system itself.  The root cause of this threat won’t be a new technology, it will be good old fashioned greed.

[About Novauri]

Hello, this is Will from Novauri.  You almost certainly haven't heard of our company before.  We are not planning on releasing it for use until 2015, and we haven't spent a dime on marketing.  Still, our team feels strongly about the emerging BitLicense regulations in New York, and I wanted to share the letter we sent to the DFS with the community today.

We already shared our views within days of the proposal being released here on reddit, but we've had much more time to craft a formal response.  You'll find an abbreviated version below, and a full copy of our letter on our website here.

I know this is a somewhat 'dry' topic, but it's important to the future of bitcoin in the US.  Our thoughts on this topic are below.  Thank you.

About Novauri

Novauri is a virtual currency startup based in Denver, Colorado and San Francisco, California.  Novauri will allow bitcoin users to purchase and sell bitcoin using ACH debits and credits from their bank accounts.  The service will be available initially to US consumers in early 2015.


We are different from our competitors in that Novauri will not control the private keys to our customers’ bitcoin addresses.  Not only will Novauri never have access to customers’ private keys, but our systems are designed so we will never see private keys in unencrypted form. 


We intentionally built this feature into our service as a risk protection measure for our customers.  Novauri cannot suffer from the catastrophic failures and massive internal thefts we’ve witnessed at services that pool customer bitcoin and control their private keys because Novauri never has control of our customers’ funds, bitcoin or US Dollars.  We feel strongly that this feature is both safer for our customers and cheaper for us as a service provider.  Our design requires no expensive security layers around pooled wallets, no insurance for massive, pooled wallets that are vulnerable to insider theft, or regulatory responsibility as a fiduciary holding retail customer deposits like a bank.

Innovation, bitcoin, and concerns about the proposed rules

We believe bitcoin and its underlying blockchain technology is the most significant invention of the century.  Bitcoin allows for unique digital information that can exist safely on the open Internet without the protection of a central authority.  Bitcoin’s unique combination of cryptography and “hashcash”-based proof of work consensus with an integrated economic incentive to participate in the consensus that also creates an automated, and fully predictable monetary policy is something we’ve never dreamed of before 2009. The applications for this technology extend far beyond payment systems, and have the capability to uniquely identify anything digitally; a possibility that becomes exponentially more exciting when it intersects with other emerging technologies, such as the Internet of things, drone applications, or holograph-based UI and peer-to-peer communications.

That being said, we believe the proposed BitLicense regulation falls short in three key areas:

• Redundancy with existing regulation, and creates unfair playing field,
  KYC provisions and ineffective cyber security provisions are dangerous for consumers, and
• Failure to create a risk-based system that scales with the risk of the service.

1) Redundancy with existing regulation, and creates an unfair playing field

Novauri believes that the BitLicense regulation is written in such a way that it will greatly stunt growth and drive innovation to other States or Countries entirely.  The regulation contains provisions that exclude existing banks from the rules entirely. 

Novauri recommends removing the provisions that exempt banks entirely, and replacing the redundant and overreaching language in these areas with a simple statement: The rules and regulations applying to bitcoin at a Federal level (especially from FinCEN) shall apply to all applicable virtual currency businesses with activities in New York State. 

2) KYC provisions and ineffective cyber security provisions are dangerous for consumers

Perhaps the most dangerous aspects of the proposed regulations are the identity verification processes.  We’ve already seen the disasters that the data retention provisions in the Bank Secrecy Act have caused in terms of the ongoing identity theft epidemic.  Every week another bank is hacked, and more and more personal information goes up for sale on the darknet.  We feel that these issues are an unintended consequence of the data retention requirements in the BSA, as well as the decision by certain companies to monetize “big data”.  Novauri feels that these are misguided regulations and business decisions, and is vehemently opposed to corporations storing and selling personal information.  The economic costs of identity theft greatly outweigh any advertising revenue made by these companies, and the cost to taxpayers in reimbursing billions and billions of dollars in stolen tax refunds each year, to say nothing of the stress these unintended consequences cause normal people when they discover their identities have been stolen. 

This issue will be far worse with bitcoin, which features a public ledger.  As soon as personal information is leaked, it can be associated with the blockchain and the entire financial history of individuals will be viewable by anyone.  As written, Novauri feels the proposed KYC provisions in the BitLicense proposal constitute a potential threat to our National security.

Novauri recommends that the NYDFS delay the requirements around KYC until a more elegant solution evolves that doesn’t risk massive identity theft incidents or violations of personal privacy.    We recommend full synchronization with existing regulation, and revision such that an individual’s right to privacy is balanced against the needs of law enforcement.  This synchronization should also include checks and balances that are non-existent today.

Regarding “cyber security”, Novauri believes that the regulations are ineffective, as technologies are continuously evolving.  Novauri recommends that the NYDFS require businesses that act as fiduciaries for customer deposits and maintain control of private keys to hold deposit insurance for 100% of the value of all fiat and virtual currency deposits.  If the business has faulty security, the insurance company can make that determination and increase their premiums.  In the event that the business’s security is unsafe, the insurance companies will not issue insurance at all.  This is a “future proof” way to ensure cyber security without politicizing the topic or risking that rules and regulations become ineffective and anachronistic with time, as they almost certainly will as written.

3) Failure to create a risk-based system that scales with the risk of the service

The proposed regulation doesn’t differentiate between businesses that exchange fiat for bitcoin while taking control of deposits, those that exchange fiat for bitcoin and do not take control of deposits, or even businesses that exchange no currency at all and have no responsibility as a fiduciary. This will effectively kill all small businesses and startups in the State of New York, and if these rules are used as a model in other States, will drive the industry offshore entirely.

Novauri recommends creating at least two types of businesses under the proposed BitLicense regulation:

• Virtual Currency Retail or Investment Banking Provider
• Virtual Currency Retail or Exchange Service Provider

Virtual Currency Retail or Investment Banking Providers would be regulated in a manner similar to banks, but Virtual Currency Retail or Exchange Service Providers would be subject to minimal regulation.   Again, Novauri highly recommends using insurance as a way to “future proof” the areas of cyber security and KYC provisions.

In closing, given the possibilities presented by this emerging technology, Novauri requests that the NYDFS consider revising the rules heavily, adopting a progressive and risk-based approach that uses insurance in lieu of prescriptive measures, removes duplicative rules and regulations, and gives the technology the room it needs to grow and evolve.

Sincerely,

Will Madden
Founder & CEO
Novauri, LLC

For a full version of our comments on the BitLicense proposal, please visit our website here.

[About Novauri]

Novauri is seeking an experienced, full stack developer to create an unparalleled cryptocurrency experience.  This individual will build out our services for closed beta and must thrive working across a wide range of areas.  The developer will work closely with graphic design, marketing, and product to create a highly refined, efficient, stable, safe, and visually stunning user experience.  Remote work is OK for this position, or we have locations in San Francisco, CA and Denver, CO.  The position is critical to our success and is offered at a very early stage; significant equity is available for the right candidate.

About Novauri
Novauri is the safer, cheaper way to buy and sell bitcoin. We aim to make monetary transactions as free and transferable as the Internet and to put people in control of their money.  Novauri makes bitcoin accessible to the everyday consumer while maintaining the integrity of the digital currency's original vision of decentralized digital cash.

What we stand for
Novauri stands for trust, transparency, safety, & consumer-advocacy in the digital currency space. 

How to apply
More information about Novauri is available on the site.  Here is a link to the description for the position:

http://novauri.com/careers/0000010-3/

If you are interested, please send your github commits, examples of work, and resume to careers@novauri.com.

Thank you!