Fed Analysts Say Authenticating Digital Cash Can Be Difficult

A post from Liberty Street Economics, a research blog of the Federal Reserve Bank of New York, posited that the usual distinction between “token-based” and “account-based” cryptocurrencies are overly simplistic because several popular digital coins, including Bitcoin, could be both.

A token-based system, according to Liberty Street Economics, means a system in which the validation of the object used to pay is needed, while an account-based system verifies the identity of the person paying.

Regular currency, the post stated, is a typical token-based system, wherein people pay for goods or services and all that is needed is to know that the person has enough valid currency to make the payment.

Meanwhile, an account-based system is something like the Fedwire Funds Service, in which a user submits an instruction to transfer funds to someone else. In that case, the system has to verify the person’s identity through the Federal Reserve‘s system to ensure that the request was an authorized one, the blog post stated.

Digital currencies have been increasing in popularity in recent months, expedited by the pandemic. U.S. lawmakers have advocated for “digital dollars” to be created for simpler ways to disburse financial aid.

The post stated both systems have their flaws; a token-based system can be subject to counterfeiting, while an account-based system could run afoul of hacking and sophisticated cybercrime that can appear authentic at first.

The post stated the two are not mutually exclusive and wouldn’t be able to be classified in taxonomic terms. Bitcoin, for example, fits both categories. Like an account-based system, it uses a key to prove one’s account is correct before the Bitcoin is spent. But also, like a token-based system, when Bitcoin is spent, the protocol verifies its validity through its history.

As such, if a cryptocurrency can be both a token- and account-based form of payment, it might become difficult to distinguish between new and existing forms of crypto, and also might slow down progress for understanding the various kinds of digital currencies.