Balancing Risks and Benefits – Analysis – Eurasia Review

What makes Bitcoin a gold-like commodity is its perfect decentralization and high cost of production, both qualities lacking in every other cryptocurrency. As gold can be found in physical nature, Bitcoin can be found in digital nature, by anyone with electricity, internet and some hardware.

‘By Sambuddha Mitra Mustafi

Introduction

Those who lack access to basic financial services such as banking, credit and insurance are considered economically excluded. The World Bank estimates that around 24 percent of the world’s adult population did not have access to regulated banking services in 2021, with about half of them living in just seven economies including India (Figure 1).

There is also a significant population that may have access to basic banking services but suffers from low financial resilience – they are deeply in debt and have low savings or irregular income. They are particularly vulnerable to financial shocks due to the lack of quality assets, whose earnings can cushion the shock. They are not necessarily poor—many are middle- and lower-middle-class—but being priced out of assets by events like COVID-19 and the ensuing spiral of inflation is pushing them close to poverty. In the United Kingdom (UK), over 25 percent of the adult population was left with low economic resilience in the wake of the pandemic; globally, between 75 million and 95 million people may fall into extreme poverty.

IN Assets for the Poor: The Benefits of Diversifying Assets, sociologist Thomas M Shapiro points out that wealth has been a “neglected dimension” of social science’s concern for the economically weak. “We have been much more comfortable describing and analyzing occupational, educational and income distributions,” he writes, “than examining the economic bedrock of a capitalist society, private property.”

In the current era of high inflation and rapid currency depreciation, the poor – those who save only in cash or in a simple savings account – are vulnerable to a crushing devaluation of their wealth. To decode this systemic weakening of the poor (and Bitcoin’s structural intervention), we need to delve into an economic phenomenon called the Cantillon effect.

The Cantillon effect

Richard Cantillon, an 18^th20th century banker, economist and author, observed that when new money is injected into the economy, those closest to the source of the money benefit first (and most), while it trickles down much later (and less) to those further downstream. In other words, the distribution of new money is not neutral: It favors the creditworthy over the credit-poor who have no collateral, even though it is the latter who need the stimulus in a crisis. And inequality gets worse over time because the entire population has to pay higher prices caused by the increase in the money supply.

While Adam Smith is widely regarded as the intellectual father of modern capitalism, Cantillon had some prominent supporters of that title – Joseph Schumpeter, Friedrich Hayek and Murray Rothbard among them. Hayek called Cantillon’s work “the first attempt … to trace the actual chain of cause and effect between the quantity of money and prices”. Now though, like unprecedented money printing by central banks (Figure 3), combined with supply shocks, wreaking havoc with consumer prices globally, Cantillon’s work on the uneven (and sometimes unpredictable) effects of monetary stimulus comes from Adam Smith’s long shadow.

Seeking to engineer a quick economic turnaround from COVID-19, United States (US) Federal Reserve policy increased the dollar’s supply by an astonishing 40 percent since 2020, while keeping interest rates close to zero. Other central banks followed suit with their own large liquidity pumps, at a time when the world economy had ground to a halt with low productivity. As excess liquidity pushed up demand, broken supply chains couldn’t keep up; and with the war between Russia and Ukraine putting further pressure on food and energy prices, we were thrown into the worst inflationary spiral the world has seen in 40 years. Now, as central banks rush to raise interest rates to reduce liquidity and get a handle on inflation, we may be on the brink of a recession, which we initially tried to avoid.

So who are the winners and losers of this Cantillon cycle? The winners are the asset-rich: Those who owned real estate, high-growth stocks or Bitcoin before early 2020 saw asymmetric returns on their wealth, helped by the monetary stimulus. The losers are the poor, whose small savings were brutally devalued through a combination of high inflation and low interest rates. Worse, quality assets are now further out of their reach, and they may face unemployment in a recession.

In sum, the post-pandemic monetary stimulus, although politically packaged to help the vulnerable and restart the economy, ended up in the hands of higher income groups who have a propensity to invest in financial assets that overconsume in the real economy. Overconsumption starts a productive cycle, this created a frothy asset bubble, risk of stagflation and increased wealth inequality.

Bitcoin disrupts the domestic Cantillon cycle by limiting and decentralizing access to new money; it also provides nations with an escape hatch from the global boom-and-bust cycles (the international Cantillon effect) triggered by the US Federal Reserve, which supplies the premier currency for international trade. Since the Cantillon business cycle disproportionately hurts poor people (with weak assets) and poor countries (with weak currencies), Bitcoin’s disruption of this cycle is a prominent breakthrough in financial inclusion and equitable global development.

Bitcoin restores money as a quality resource

On August 15, 1971, with the US economy under severe stress, President Richard Nixon removed the dollar’s last peg to gold, ushering in the age of fiat currencies – money backed by nothing but trust in the US Treasury. Other national currencies, all of which were linked to gold via the dollar, also came from the gold standard as a default. Since then, the “exorbitant privilege” of the dollar has continued to grow in the absence of a clear competitor; until now, that is. “Nixon’s closing of the gold window marked the end of a commodity-based money order, and the beginning of a new world of fiat currencies,” wrote Princeton historian Harold James, and now “we are moving toward another new money order, based on information.”

But Bitcoin is as much a look back at the past (commodity money) as it is a stab at the future (information money). It is a digital commodity, an energy derivative, accounted for on an immutable ledger of information, secured by military-grade cryptography. As a monetary commodity, it combines and enhances the characteristics of both gold and fiat currencies (Figure 4).

What makes Bitcoin a gold-like commodity is its perfect decentralization and high cost of production, both qualities lacking in every other cryptocurrency. As gold can be found in physical nature, Bitcoin can be found in digital nature, by anyone with electricity, internet and some hardware. And just like gold, Bitcoin has a high cost of extraction (mining) that ensures it is not handed down. Bitcoin goes a step further and mathematically hard limits the supply; in fact, it mimics the absolute scarcity of our time on earth, making it a superior store of our time and value.

As we saw earlier, the core problem with the asset-poor is that our money has ceased to function as a store of value, due to continuous deterioration through inflation. This has led to speculative investment in other assets with limited supply – particularly real estate – driving up prices beyond the reach of ordinary people. When money itself ceases to function as a store of value, the price of virtually all other assets becomes distorted, as they receive a money premium beyond their use value. With its conservative design, Bitcoin corrects this major structural flaw in the fiat economy; it restores money as a high-quality asset with a finite supply, leading to honest price discovery in other assets based on their real utility.

Bitcoin for the Poor: Risks and Benefits

On a theoretical level, Bitcoin has great benefits for the economically weak, but they will only be realized in the medium term, as the market matures with less speculation and volatility, with more adoption and utility. There are already some encouraging signs of bottom-up adoption from different parts of the world: the beach community of El Zonte in El Salvador is the most famous example, which eventually led to Bitcoin becoming legal tender in the country; There will also be inspiring stories from Afghanistan, South Africa, Costa Rica and racial minorities in the United States.

Here are some risks and benefits of early Bitcoin adoption by the financially weak:

Risks:

• Crypto Scams: The abundance of scams in the broader cryptocurrency market, with heavily marketed get-rich-quick schemes, can lure newcomers away from Bitcoin with the promise of higher and faster gains. Once burned by a scam, many investors are likely to avoid the market altogether.
• Regulatory uncertainty: Most small savers tend to be risk-averse with their money. The regulatory uncertainty surrounding Bitcoin is likely to keep the masses away from investing in the best financial asset of our time.
• Volatility: Small savers have to dip into their savings in times of crisis, so they are more sensitive to the short-term volatility of Bitcoin. A prudent investment in Bitcoin should involve a cost averaging strategy with a minimum period of four years.
• Know how to: The Bitcoin user experience (UX) is still evolving, and some aspects like self-storage can feel intimidating, not intuitive. On a comparative timeline, we are still in an age of dial-up internet connections. Further innovations and education are needed before the full range of UX becomes intuitive and ready for mass adoption.

benefits

• Availability: In many countries, smartphone penetration is now greater than the reach of the banking system, making Bitcoin a potentially powerful tool for financial inclusion. Access to the Bitcoin network is permissionless and equal; it is free from human bias against the economically weak, which is inherent in the traditional banking system.
• Remittances: Many economically vulnerable citizens are dependent on foreign remittances from their relatives. Current intermediaries charge high fees, while settlements are not instantaneous. Bitcoin’s Lightning Network enables instant transfers at almost zero fees.
• Easy liquidity: Small savers prefer immediate liquidity with their assets to protect themselves in a crisis. Bitcoin can be redeemed on the network at any time, excluding holidays.
• Long-term, inflation-proof savings: With its supply halving every four years, Bitcoin’s design is the antithesis of fiat currency inflation. Small savers with a long-term view now have immediate access to an asset that protects their purchasing power.
• Financial resilience: All of the above advantages make small savings in Bitcoin a key advance in financial resilience; it gives the poor a chance to withstand with minimal damage the boom-and-bust cycles of the fiat economy.

In conclusion, no nation-state – especially one of India’s size and stature – can afford to ignore the transformative potential of Bitcoin. A hostile or ignorant attitude, towards an unstoppable idea whose time has come, is unlikely to produce any good results. The focus for regulation should therefore be on exploiting Bitcoin’s benefits, while managing the risks in a responsible manner.