Former Federal Reserve Bank of Atlanta Vice President Gerald Dwyer critiques recent papers from the European Central Bank and the Minneapolis Federal Reserve Bank, highlighting where their arguments about Bitcoin fall short.
Two recent working papers have started with the premise that Bitcoin is useless, and conclude that Bitcoin should be banned because of detrimental effects. One is a working paper written by two European Central Bank (ECB) economists, Ulrich Bindseil and Jürgen Schaaf, and the other is a Federal Reserve Bank of Minneapolis working paper by Amol Amol and Erzo G. J. Luttmer.
Ulrich Bindseil and Jürgen Schaaf’s claim is straightforward:
“[S]ince Bitcoin does not increase the productive potential of the economy, the consequences of … [an] assumed continued increase in value are essentially redistributive, i.e. the wealth effects on consumption of early Bitcoin holders can only come at the expense of consumption of the rest of society, which is impoverished.”
Bindseil and Schaaf underscore that early buyers of this “useless” asset have higher consumption of goods and services because they buy at a low price, near zero, and sell at a higher price. The higher consumption of these early buyers when they sell the “useless” asset is at the expense of lower consumption by later buyers who buy at a higher price. They view this redistribution of consumption negatively because they believe this results in later buyers becoming “impoverished.”
Amol Amol and Erzo G. J. Luttmer claim that “useless” bitcoin is an impediment to a desirable policy of running a permanent primary deficit, in which government spending is greater than tax revenue in perpetuity. “A legal prohibition against bitcoin” or a tax that eliminates it is necessary to maintain that primary deficit. There is much about their model that is non-standard, including the absence of money, the lack of a tie between returns to capital and the interest rate, as well as savings that do not depend on the interest rate. Amol and Luttmer note that a permanent primary deficit is suboptimal in their model compared to consumption taxes large enough to pay for the spending. In the absence of such taxes, though, a permanent primary deficit can be a way of financing the spending (Amol and Luttner 2024, p. 5). Bitcoin makes the suboptimal permanent primary deficit impossible because it provides an alternative investment vehicle to government securities. As Amol and Luttmer note, the useless asset that they call “bitcoin” could as well be called “fiat money.”
Both of these papers are premised on the belief that Bitcoin is useless. But is bitcoin useless? The conclusions of both papers fail if any use case is found for Bitcoin. We outline several below.
While the authors presumably do not consider illegal activity a good reason for Bitcoin to exist, they would likely concede that it is one use case for Bitcoin. The argument for banning Bitcoin based on illegal activity, though, applies equally well to $100 bills. The U.S. government produces substantial numbers of $100 bills and makes them readily available, including for export. One estimate suggests that more than a third of cash is used for illegal activities and tax evasion, and the Fed itself reports that 80 percent of $100 bills now reside overseas. Dollars are also used by foreigners as a way of avoiding lost purchasing power due to inflation in their local currencies. These dollar bills often are not only imported illegally to avoid capital controls, but are also held illegally as countries with rapidly depreciating currencies commonly make it illegal to possess dollar bills. If Bitcoin should be banned due to its possible use in illegal activity, this argument applies equally well to $100 bills. Yet no one seems to be arguing for banning $100 bills. Maybe the argument is not as strong as it seems.
Bitcoin is quite useful for people in countries with high inflation. Similar to U.S. dollars, bitcoin provides value to residents of inflation-plagued countries such as Zimbabwe and Venezuela. An impression of the inflation in these countries is given by the available data on the Venezuelan bolivar which indicate that prices rose 54,000,000% from 2016 to 2019. While the governments in these countries try to force citizens to hold the government’s rapidly depreciating currency by making it illegal to hold alternative assets such as dollars and bitcoin, people have an incentive to avoid impoverishment due to hyperinflation. Governments also try to restrict imports of substitutes for their currencies, such as dollars, by instituting capital controls. While using bitcoin to circumvent capital controls can be characterized as illegal activity, it is an activity of value to many people who are trying to avoid becoming impoverished by their governments. While central-bank economists may not approve, and International Monetary Fund policymakers certainly would not approve, those evading capital controls have an understandable reason for holding assets other than their country’s currency and they typically are not otherwise criminals.
Bitcoin is also becoming increasingly important in global remittances. Chainalysis provides a summary of trends around the world. Remittances using cryptocurrencies – in particular stablecoins – are important and increasing in Latin America and sub-Saharan Africa. By construction, stablecoins are not included in the analyses by either Amol and Luttner or Bindseil and Schaaf because these coins have a redemption value. But transactions in bitcoin and other cryptocurrencies also are increasing. While it is challenging to come by precise numbers on bitcoin’s use in transactions, it is increasing.
There is a very large financial literature examining the use of bitcoin in a portfolio, with the consensus that bitcoin can, in fact, play a positive role as a diversification asset to hedge against risk, e.g. Matt Hougan and David Lawant. As Hougan and Lawant show, portfolios rebalanced to keep a reasonably constant fraction of bitcoin in the portfolio can be an effective way of increasing a portfolio’s expected return without unduly increasing the portfolio’s risk.
Bindseil and Schaaf and Amol and Luttmer focus on what they perceive to be the current state of Bitcoin. This is short-sighted. Ken Olsen, President of Digital Equipment Corporation, a maker of mini-computers, famously said in 1977, “I see no reason why anyone would want a computer in their home.” That was a fair statement about computers at the time. Today though, many people around the world hold smart phones that are about 75 times faster than supercomputers were at the time that Olsen made that statement. The digital asset world is developing rapidly. Whether smart contracts, decentralized autonomous organizations, decentralized finance, or some currently unknown innovation will make a major difference in people’s lives remains to be seen. Neither Bindseil and Schaaf nor Amal and Luttmer nor I can credibly say that digital assets are a dead end.
Innovations are accompanied by volatility. There were many high-flying personal-computer stocks that subsequently crashed. The owners of some personal-computer stocks were big losers, and the owners of other stocks were big winners. Regardless, almost everyone is better off than if a law had been passed to confine computers to mainframes in computer facilities. The same will likely be true for digital assets; no one can reliably predict the benefits digital assets will bring in the future.
In closing, are Bitcoin and similar cryptocurrencies useless? The answer today is “no” and the answer is likely to become more emphatically “no” in the future. Certainly, it would be imprudent to ban Bitcoin and other digital assets because some think the world would be a better place without them.
