The Distributional Consequences of Bitcoin

The paper titled “The Distributional Consequences of Bitcoin” by Ulrich Bindseil and Jürgen Schaaf (2024 - https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4985877) critiques the economic impact of Bitcoin, specifically addressing its speculative nature and the redistribution effects associated with its rising prices.

Key Points:?

1.???????? Initial Vision of Bitcoin: Nakamoto’s original vision (2008) was to create a decentralised global payment system. However, the authors argue that Bitcoin has failed to fulfill this promise due to technical limitations and volatility, and it has instead become an investment asset.

2.???????? Bitcoin as a Speculative Asset: The paper highlights that Bitcoin’s increasing value is largely driven by speculative demand rather than any productive economic use. This creates concerns of an economic bubble, with rising prices benefiting early investors (“early birds”) at the expense of latecomers or non-holders.

3.???????? Wealth Redistribution: The central thesis of the paper is that if Bitcoin prices continue to rise, the wealth effects primarily benefit early adopters, who profit from selling their holdings at inflated prices. This wealth transfer occurs at the expense of those who buy Bitcoin later, as well as non-holders, ultimately reducing consumption for the broader population.

4.???????? Long-Term Consequences: Even in a scenario where Bitcoin prices keep increasing, the economic impact is redistributive and impoverishes the rest of society, causing social fragmentation. The authors argue that the continued rise in Bitcoin’s value is a zero-sum game that erodes social stability and democracy.

5.???????? Policy Implications: The authors conclude that governments should carefully consider the implications of Bitcoin’s rise and warn that it could skew political outcomes if pro-Bitcoin policies favour wealth redistribution to early adopters. They call for regulation to prevent Bitcoin’s further rise to avoid worsening economic inequality.?

In summary:

The paper emphasizes the redistributive nature of Bitcoin’s wealth effects, arguing that these effects lead to broader societal impoverishment without contributing to economic productivity. The authors suggest that, even in a Bitcoin-positive scenario, the social damage caused by wealth redistribution outweighs the benefits, posing risks to social cohesion and democracy.

Really? REALLY?

Let’s address these points.

1. Bitcoin’s Role as an Innovation in Financial Technology

Bindseil and Schaaf argue that Bitcoin does not contribute to productive economic potential, implying it is merely a speculative asset with no inherent value. However, this overlooks Bitcoin’s significance as a technological innovation, particularly its role in decentralising finance and democratising access to financial services. Blockchain technology enables secure, low-cost transactions without intermediaries, which holds value beyond mere speculation.

Evidence supporting this argument comes from the rise of decentralised finance (DeFi) and applications built on Bitcoin’s blockchain, which have started transforming financial systems by providing alternatives to traditional banking, particularly in regions with limited financial infrastructure. Studies show that cryptocurrencies like Bitcoin enable financial inclusion in developing countries, providing access to banking services to populations without traditional bank accounts. For example, in countries like Nigeria and Venezuela, Bitcoin has been adopted as a hedge against inflation and a way to move money across borders without the high fees imposed by banks.

2. Bitcoin as a Hedge Against Inflation and Currency Instability

The authors claim that Bitcoin’s value is driven purely by speculation. However, Bitcoin has increasingly been seen as a “store of value,” akin to gold, particularly in regions facing currency instability or high inflation. This perception of Bitcoin as a hedge is based on its fixed supply and decentralised nature, which insulates it from government manipulation.

Countries like Argentina and Turkey, which have suffered from hyperinflation, have seen rising adoption of Bitcoin as a means of protecting wealth from the devaluation of local currencies. Additionally, research shows that Bitcoin tends to perform well during periods of economic uncertainty and market downturns, when traditional assets lose value. Therefore, Bitcoin’s value can be seen as more than just speculative; it serves as a legitimate financial instrument for mitigating the risks associated with volatile fiat currencies.

3. Addressing Wealth Redistribution and Inequality

Bindseil and Schaaf argue that Bitcoin’s rising value results in wealth redistribution that impoverishes latecomers and non-holders. While early adopters certainly benefit from price appreciation, this is not inherently harmful. Early adopters of new technologies or financial innovations (e.g., the internet, Amazon, Tesla) typically receive outsized rewards for assuming higher risks early on. Bitcoin follows the same economic pattern where risk and reward are proportional.

Moreover, Bitcoin adoption is not as exclusive as the authors suggest. It is increasingly being adopted by retail investors globally, facilitated by platforms like PayPal and Square, which provide accessible ways to buy, hold, and transact Bitcoin. The broadening base of users suggests that Bitcoin is not only benefiting an elite group of early adopters but also being used by everyday people as part of diversified investment portfolios.

4. Economic Contribution Through Bitcoin Mining and Infrastructure

The authors contend that Bitcoin does not contribute to economic production, but this overlooks the value created through Bitcoin mining, infrastructure, and innovation in related industries. The Bitcoin ecosystem has spurred job creation and technological advancements, especially in sectors like cybersecurity, fintech, and hardware (such as semiconductors for mining). The Bitcoin network itself, through mining, has created a globally distributed infrastructure that supports decentralised financial services and asset transfers.

While Bitcoin mining’s environmental costs are a valid concern, many miners are now shifting towards renewable energy sources to power their operations. For example, mining farms in Iceland and Canada primarily use geothermal and hydroelectric energy, significantly reducing the carbon footprint of mining.

Bitcoin mining operations in countries like Iceland and Canada contribute to local economies by creating jobs, utilising abundant renewable energy, and repurposing waste heat. These regions leverage their geothermal (Iceland) and hydroelectric (Canada) power, making mining more sustainable. A real-world example is Iceland’s Borealis Data Centre, where waste heat from mining is used to warm greenhouses, supporting local agriculture. Similarly, Quebec, Canada, benefits from Bitcoin mining’s use of surplus hydroelectric energy, helping stabilise the grid and contributing to economic activity in the region.

5. Long-Term Value as a Financial Asset

While the paper argues that Bitcoin’s rising prices are unsustainable and speculative, many investors see Bitcoin as part of a long-term diversified investment strategy, providing a hedge against traditional financial markets. For instance, institutional investors such as BlackRock, Fidelity, and Square have invested heavily in Bitcoin as part of broader investment strategies to hedge against market volatility and inflation.

The creation of Bitcoin ETFs (Exchange Traded Funds) and the increasing regulatory recognition of Bitcoin as a legitimate asset class by entities such as the SEC (Securities and Exchange Commission) also signal that Bitcoin is maturing as a financial asset. This regulatory approval demonstrates that Bitcoin’s role in financial markets is stabilising, which is counter to the argument that it is purely speculative.

6. Bitcoin as an Alternative to Traditional Financial Systems

Finally, Bitcoin’s decentralisation and the ability to circumvent traditional financial systems are essential advantages that counter the authors’ argument. Centralised financial systems are often prone to corruption, censorship, and exclusion of marginalised communities. Bitcoin provides an alternative means for people to manage their finances without relying on banks or governments, which is particularly valuable in authoritarian regimes or regions with unstable governance.

Bitcoin also offers transparency through its public ledger, a feature that can reduce fraud and increase accountability in financial transactions, a benefit that is increasingly recognised by businesses and governments worldwide.

Conclusion

While Bindseil and Schaaf emphasise the redistributive and speculative risks of Bitcoin, their argument overlooks Bitcoin’s broader societal and technological contributions. Bitcoin is not merely a speculative bubble but a pioneering innovation in decentralised finance, enabling financial inclusion, acting as a hedge against unstable currencies, and providing an alternative to traditional financial systems. The rising adoption of Bitcoin by individuals, institutions, and governments shows that its utility extends beyond speculation, positioning it as a legitimate financial asset and a driver of economic change.

Furthermore, their core argument that Bitcoin benefits early adopters at the “expense” of non-holders or latecomers is no different from the effect witnessed with any investment asset or technology. Whether it’s the early adoption of stocks, real estate, or emerging technology stocks like Tesla and Amazon, those who assume higher risks earlier tend to see greater rewards. This dynamic is a standard feature of markets, where risk and timing play significant roles in wealth generation. The notion that Bitcoin uniquely redistributes wealth in a harmful way fails to acknowledge that this is a fundamental aspect of investment ecosystems in general.

If the redistribution of wealth through early adoption is indeed such a problem, should we then rally against all forms of investment and demand that they be banned?

Should we dismantle the entire structure of financial markets, real estate, and emerging technologies, simply because early participants benefit?

This argument seems to overlook the very mechanisms that drive innovation, growth, and prosperity in capitalist economies.