Central Banker Decrypts Crypto

Federal Reserve Bank of St. Louis, MO — David Andolfatto is not your typical PhD economist. He refrains from focusing on abstract theories like those in the ivory towers. Rather, Dr. Andolfatto has emerged as a thought leader on the live experiment of cryptocurrencies and blockchain technology.

By and large central bankers have been reluctant to express their views on the disruptive potential of digital currency to traditional financial systems. But David has been front and centered in public forums before Bitcoin was in vogue. Though cryptocurrency markets have shifted dramatically since those early years, David has been a constant intellectual force from the Fed’s marble halls to Twitter feeds.

He has held several Fed community dialogues about the foundation of blockchain technology. There he shares his thoughts on the role of central bank-issued digital currency and the impact it could have on our current payment system and on the global economy.

Listen to our interview with David on (iTunes, Spotify, Google Play, Stitcher).

Highlights below:

David Andolfatto, VP Research Economist, St. Louis Fed
What does the technology, as it evolves, permit in the way of redesigning institutions in the economy to promote various degrees of cooperation? I think that’s the research question economists will find interesting. — David Andolfatto

A Bit Cryptic: Finextra, a financial technology newswire, wrote that: “central banks apathy for blockchain is waning,” citing several major research and development efforts at the European Central Bank, the Bank of Japan, and the Bank of Canada.

In its Global Blockchain Benchmarking Study, the Cambridge Centre for Alternative Finance reported that more central banks are actively testing blockchain technology in various use cases from payments to regulatory compliance.

Do you think central banks are now more interested in this technology?


I detect there’s growing genuine interest in the community. I’ve been a little skeptical about the applications of central bank digital currencies. For example, the Bank of Canada has experimented with Project Jasper at limited scale with some financial institutions on a distributed wholesale payment system. From what I gather, the outcome was a little disappointing.

That’s not to say future innovations won’t work. I think the most promising areas will occur outside the realm of central bank digital currencies. We may see central bank digital currencies, but that’s not to say it will be powered by blockchain. I see the potential applications lying elsewhere.

A Bit Cryptic: what is the state of the public’s understanding and adoption of cryptocurrencies? A Coinbase study shows roughly one-fifth of US university students own cryptocurrency and 42 percent of the world’s top 50 universities now offer at least one course on crypto or blockchain.


The average person may not know the details but sense this notion that blockchain is different than the traditional institutions in place and that something is changing and will be disrupted. We see the prices visibly rising rapidly. Even if we don’t understand what’s going on, it’s interesting. Bitcoin critics predicted several years ago that since it’s an unbacked digital currency so it’ll go to zero. Bitcoin is still here.

Blockchain is a philosophy of a decentralized communal record-keeping process. It’s very different than conventional models today where we delegate record-keeping to trusted intermediaries.

This notion that we can bypass traditional intermediaries, manage things on our own is interesting to people.

A Bit Cryptic: How do you feel about your colleagues — Paul Krugman, Joe Stiglitz, Bob Shiller, all Nobel laureates and thought leaders, who have expressed a lot of skepticism about crypto, especially Bitcoin — suggesting it will die, is a bubble, or something short of a scam even. Do they have valid concerns?


We have to be aware and educated. Local currencies exist today. There are many provincial currencies that are co-existing with digital currencies. It’s not entirely new. But it’s taking on this new digital form. It’s our job as policymakers and economists to understand. It’s hard to combat [scams]. People get interested and can fall for scams. It’s those bad elements that attract these economists to make negative comments.

They wouldn’t have such negative comments if they view the endeavor from my perspective, which is this is a database management system that’s rooted in a new communal consensus protocol rather than the traditional way of delegating that responsibility to a trusted intermediary. At the same time we can appreciate that agents on the side line are taking advantage of the system. But bad actors are always there. There are bad actors in the stock market, but we shouldn’t shut down the stock market.

A Bit Cryptic: you mentioned that there are novel aspects about blockchain but other aspects are not so new. Please elaborate.


There’s a historical monetary phenomenon. Anthropologists and economists have noted for a long time that primitive economies don’t really have to use anything that resembles monetary exchange. They may use it outside the community or tribe. But within the community, no.

In economic theory, there can be a lot of economic exchanges taking place without money. Some people call it a social credit system. Within your family or network of close friends, what we do is favors for each other. We don’t barter. If a colleague comes by and asks for a favor, it’s not like we barter. You do the favor, even if that person isn’t in a position to reciprocate, so long as your office knows you’re a team player. You’re building your reputation or credit within the group.

I see this community information-sharing as constituting a distributed ledger of human brains. And it replicates among people through gossip. What happens within the group is stored on a distributed ledger located in our brains. It gets updated through communal consensus.

If that sounds familiar, the blockchain philosophy is very ancient, something we use all the time. We have a communal process of record-keeping to track what everybody is doing.

I argued there’s a social function in small communities. The limitations here is that it doesn’t scale very well. It works in small groups but doesn’t work at the city level. Our brain isn't big enough to keep track of what millions of other people are doing. It’s too difficult to achieve consensus through millions of people.

But it’s now feasible since we’re replacing human brains with the Internet, digital systems, along with innovations in game theory, achieving consensus on a larger scale.

What Bitcoin is — is a scale version of this very ancient idea. But the tech is replaced by computers. So people could take a step back and think if blockchain is mysterious, if you view it that way, a communal-based record keeping system, we use this type of system every day throughout history. It’s my hope that we can get through some of this mystery and spirit of this movement.

A Bit Cryptic: the rise of blockchain innovations are attributed to open source collaboration. Cryptocurrencies are programmable money. These are programmable projects that comes as an extension of the digital infrastructure, enabled by the Internet. Now we can iterate through solutions to problems at a much larger and quicker scale.


Imagine doing mass collaboration pre-Internet. These institutions like banks, central banks, other central database repositories are solutions to scaling challenges at city levels even though most of us are strangers to each other. The Internet has brought opportunities of global collaboration, these communal efforts.

Andolfatto speaking at the Fed’s Community Dialogue 2018

A Bit Cryptic: There’s a joke that an economist is someone who, when he finds something that works in practice, wonders if it works in theory. Bitcoin has been running independently for 10 years and has challenged our thinking on computer science, economics, game theory, governance like liquid democracy, and smart contracts.

What can economists or researchers learn from the cryptocurrency and blockchain grand experiment?


I’m an economist. I’m interested in what motivates and sustains this cooperation, especially in terms of trade and more generally. What can affect sustainability is the notion of evil. Not everyone in the group is expected to behave intrinsically cooperatively. Society has to develop institutional structures to combat if members of society can free ride if they have an opportunity. They might want to fabricate information for private gains at the expense of the community.

Economists should look at this as a database management problem — to make it secure and not falsifiable. How to prevent bad actors from causing the system to malfunction. One can view the emergence of monetary exchanges. Researchers could interpret monetary exchanges, central banks and central institutions are a response to scale up this institutional monetary exchange.

What does the technology, as it evolves, permit in the way of redesigning institutions in the economy to promote various degrees of cooperation? I think that’s the research question economists will find interesting.

Mechanism design, game theory, are going to be of interest. How do you achieve consensus in large groups of people? We’re talking about people who are expected to behave non-cooperatively but somehow we need to achieve consensus in a way everyone can agree on the truth. That’s a very difficult problem to solve. These advances in math, game theory, computer science allows us to look at those questions.

Smart contracts (i.e. self-executing contracts) have already been covered in economic theory for a long time. A great deal of effort in economics has been to address self-executing contractual agreements permitted by algorithms. You can google the Arrow-Debreu equilibrium model. It’s a common structure in economics. It assumes a smart contracts structure that’s elaborate and have little issues in self-executing.

Debreu won a Nobel Prize for developing the theory in the 1950s. Economists have struggled with this since the real world has a lot of frictions. A lot of research is devoted to a world where you don’t have this sort of technology. The irony is now the tech has evolved to where smart contracts are becoming more of a reality. If practical applications of smart contracts become hugely successful, economists might have to dig back to the 50s, now that they find that real world to be applicable.

David takes questions from the audience at a town hall

Editor’s note: interview is edited for clarity and brevity.




Interviewer/Editor : Dang Du
Guest: Dr. David Andolfatto

Media Intern: Yidu Wang

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