There’s a fair bit of noise about crypto these days. About a year ago, advertising from crypto exchanges and various sh*t-coins really ramped up, and it really hasn’t ceased. Fortunately, the cringe-worthy tie-up between Matt Damon and crypto.com has been received about as well as anyone outside the crypto bubble would expect, but I’ve been doing a lot of thinking about crypto recently as a result. And I’ve been thinking more about about Bitcoin, as, regardless of what you think of crypto in general, Bitcoin is not a shi*t-coin, and is regularly held up as an alternative to the global financial system.
Yet, the markets are currently in free-fall, and one of the main reasons to hold Bitcoin (as a hedge against inflation) hasn’t really panned out – inflation is up, and Bitcoin is down more than the S&P 500. This is not a counterpoint to Bitcoin as a reserve currency though, as the free-fall of Bitcoin is based on its value in fiat. But the fact that we’re still pricing BTC in fiat, more than 10 years since its inception, demonstrates to me that it has failed in this mission.
I think there are many problems with cryptocurrencies and blockchains, but in this essay I’m only going to talk about one aspect of Bitcoin as a currency – the hard limit on supply. I should also add that I am not an expert, just an interested observer. In the early days I thought Bitcoin was an interesting idea, and I have held a little crypto over the years. While I never lost money, I didn’t make a fortune, and these days I am consciously a “no-coiner” – someone that holds no cryptocurrency, and believes they have no value. Or more specifically in my case, that they are a bad solution looking for a problem.
Deflationary by design
One of the arguments in favour of Bitcoin that I keep reading about, is that supply is inherently limited, making it a deflationary currency. This would mean that, hypothetically speaking, if adoption of Bitcoin was universal and stable, the price of goods in Bitcoin would steadily fall over time. This is a gross over-simplification, but the supply of Bitcoin has a hard limit, and thus we can never alleviate upwards pressure on its value by increasing the supply (I.E. debase it), without forking the chain. And of course, as a network participant, you wouldn’t support that if, like most Bitcoiners, you were against debasement in the first place.
Fiat currencies aren’t like this, because they have central banks issuing them, and these banks debase their currencies as a fiscal tool. The effect of this deliberate inflation is that the real value of the cash that people hold (and also their wages) goes down over time.
If the argument is that Bitcoin’s deflationary nature is a good thing, a corollary to this, is that a currency that can be debased is a bad thing.
With me so far? Good. Let’s take a look at that argument.
Tax by stealth?
Bitcoin fundamentalists see deliberate debasement by central banks as a sort of tax by stealth. Even if you are not opposed to taxation, doing it in a non-transparent way isn’t good (so the argument goes). Effectively they are printing money, which increases the supply, thus devaluing your wages (and hence your time), and the cash you hold in your bank account. Right? Well, it’s not quite that simple.
I don’t want to go deeper than I need to here, but essentially, to increase monetary supply, a central bank can buy back its bonds (returning cash to the system), decrease capital requirements for banks (allowing them to hold less in deposits for the same amount of lending), or lower interest rates, which lowers the cost of lending, thus encouraging people to borrow, increasing overall supply. All of these devalue the currency relative to other assets, thus inflating the price of goods in that currency (I.E. causing inflation).
Conversely, central banks can also issue bonds, increase capital requirements, and raise interest rates to decrease monetary supply, thus deflating the price of goods in the currency (or at least providing downward pressure on prices to counter other inflationary pressures).
So back to the Bitcoin argument – that increasing supply is a bad thing, as it’s effectively taking money out of the pockets of the people. Maybe they accept it as reasonable, but are against it because it disadvantages them as individuals. Whether or not it’s bad for any particular individual (I’m not going to argue anyone’s personal circumstances), I believe it is a stupid argument at a macroeconomic level for a few reasons.
1: As a worker, it’s only a problem if your labour is not in demand
Devaluing labour is, on the face of it, far from ideal. I could write an essay on this point alone, but my thinking on the matter boils down to; inflation rewards (or is at least neutral for) more productive workers, as it disincentivises stagnation. Any negative effects of inflation on “less productive” workers (I put that in quotes as lacking market demand doesn’t necessarily mean they are less productive), are better solved with non-fiscal policy – education, unionisation, and a social safety net when all else fails.
Because keeping up with inflation is easy if your skills are in demand – you simply ask for the market rate, and if you don’t get it, move to a company that will pay you a fair wage. It helps reduce waste in the economy by incentivising moves to more productive endeavours.
To be clear, I have not looked for research to either support or refute this idea. But the idea that inflation would put put upwards pressure on pay and mobility for productive workers, at the expense of less productive ones, is quite intuitive.
2: As an investor, it’s only a problem if you hold cash
Currencies are supposed to be a medium of exchange, not an investment.
The simple way to avoid debasement of cash is to not hold your net worth in cash. Invest it in markets, buy a house, or start a business. All of these involve taking on varying levels of risk, but some governments offer inflation-linked bonds, which are effectively zero gain for zero risk. And if stagnation isn’t your thing, whole-market index funds offer liquid, diversified and accessible exposure to the stock market at low costs.
An obvious counter-point to this argument is that poorer people hold a higher proportion of their net worth in cash, as they may not have the financial knowledge to invest, or no surplus to invest at all. Thus the argument goes, debasement would disproportionally affect poorer people.
This could be a problem for some, but consider also that poorer people hold proportionally more debt as well, and that inflation reduces the real value of that debt. Inflation can be a problem for poor people if wages are stagnant, but that’s a separate problem not specific to fiat money. Again, I have no research to back this up, but intuitively you could argue it’s neutral – anyone highly leveraged with debt certainly wins (if you could call it that), while anyone without debt that spends all their earnings on living costs, and doesn’t invest, would lose if they couldn’t secure a wage rise.
But what if you just want to preserve your wealth in liquid form? There are already ways to do that, that don’t cede the power to set fiscal policy to private miners, or consume the electricity of a nation state. And in any case, Bitcoin has so far proven a very risky investment (not to mention an exceptionally poor medium of exchange).
But what if it was the worlds reserve currency? Then it would be less volatile, and you would be able to hold it without the evil government stealing your wealth, while the finite supply ensured price deflation in BTC!
Well, to be frank, f*** that deflationary nightmare and f*** anyone that wants it, because:
3: No one has a right to financial gain without taking on risk
A deflating currency rewards holders of that currency, while disincentivising spending, because whatever you buy today will effectively cost less tomorrow. In such a situation, wealthy hoarders are rewarded, while those that must spend their income to survive are royally screwed. And it’s not hard to see how the economy grinds to a halt as a result – the lack of money supply means wealthy holders get a free ride at the expense of everyone else. Even a zero-inflation scenario is bad, because then there would be no incentive for those that have their needs comfortably met to deploy their wealth in a productive way. Many would be quite content to hold cash.
So in a way, debasement is a form of tax on wealth. But only unproductive wealth.
Even in an extremist libertarian
utopia dystopia with no state police, you would have to pay private mercenaries to secure your stash of assets, and there would still be a risk of theft, not least from the private mercenaries themselves. So it is right that a wealthy person pays to secure their wealth, or assumes some risk by deploying it to productive uses.
Bitcoin as extreme economic libertarianism
And that’s the crux of my argument. Unless you’re a wealthy right-wing libertarian you should oppose Bitcoin as a currency, because it would principally benefit the already-rich, and doesn’t align with any other political ideology.
It is anti-capitalist, because persistent deflation makes a capitalist economy unworkable. It’s anti-socialist, because it removes fiscal power from the state, and puts it in the hands of private miners (or holders in proof-of-stake situations). It’s anti-conservative because… well actually it’s really just extreme economic individualism. Maybe that’s not really anti-conservative, but even as a left-leaning thinker I don’t believe many conservatives are Bitcoin fundamentalists.
I suspect that most Bitcoin enthusiasts are in it for the money though, I.E. as a speculative asset to earn fiat, rather than to replace their fiat as a medium of exchange. But unless you’re a wealthy f***-you-I got-mine hoarder, that would sooner build your own island fortress than fund state police or a social safety net, I believe Bitcoin is something you should vehemently oppose. That may be an extreme representation, but I’m yet to hear a compelling argument for something more moderate.
25th Jan – Revised the deflationary by design section