Central Bankers Are Taking Bitcoin More Seriously

In recent years, a growing body of research has emerged from central banks and financial institutions, focusing on Bitcoin and its potential impact on monetary policy.

A Bitcoin change store is seen in Tel Aviv, Israel on December 30, 2022. (Photo by Beata Zawrzel/NurPhoto via ... [ ] Getty Images)

In recent years, a growing body of research has emerged from central banks and financial institutions, focusing on Bitcoin and its potential impact on monetary policy. These studies, issued by organizations such as the Minneapolis Federal Reserve, the European Central Bank (ECB), and the International Monetary Fund (IMF), highlight a key theme: the disruptive nature of Bitcoin and other cryptocurrencies could limit the ability of central banks to perform their traditional role in managing economies. Advocates have argued that Bitcoin could be an alternative to central banking, are central banks finally recognizing Bitcoin as a potential threat?

Can Bitcoin Lead To Inequality?

The European Central Bank’s researchers have published two papers on Bitcoin, both of which offer strikingly different perspectives. The first, published in the wake of the FTX collapse in 2022 while Bitcoin was trading at $16,000 - titled “Bitcoin’s Last Stand” - portrays Bitcoin as being a failed monetary experiment in its final death throes. In 2024, with Bitcoin trading at nearly $70,000, the same authors at the European Central Bank published a paper acknowledging a different reality.

This latter paper argues that Bitcoin’s existence and continued appreciation has a significant impact on wealth distribution. According to the paper, when Bitcoin's price rises, early Bitcoin holders get wealthier. However, since Bitcoin doesn't produce anything or increase economic output, this increased wealth and consumption by early holders must come directly from reduced consumption by everyone else in society.

This means that when early Bitcoin holders spend their profits on goods and services, they are using purchasing power that has been taken from non-holders and people who bought Bitcoin later. This reduction in people’s purchasing power happens even if Bitcoin's price keeps going up forever and even impacts individuals who don’t buy Bitcoin at all.

The key insight is that Bitcoin wealth doesn't create new economic value - it just redistributes existing wealth. Even in the most optimistic scenario where Bitcoin's price keeps rising, it makes early holders richer only by making everyone else poorer in relative terms. The authors argue this is different from gains in stocks or property values, which can reflect and contribute to actual increases in economic productivity and output. With Bitcoin, the gains are purely redistributive since Bitcoin itself doesn't produce anything or increase economic capacity.

This ECB viewpoint mirrors a longstanding critique made by Bitcoin proponents regarding central banks. The Cantillon effect, named after 18th-century economist Richard Cantillon, suggests that central banks, by printing money, disproportionately enrich those who are closest to the money supply (such as banks and wealthy individuals), while the rest of the population sees diminished purchasing power. When new money enters the economy, it doesn't affect all prices simultaneously - instead, the first recipients of the new money (typically financial institutions) can spend it before prices rise, while those furthest from the money supply (typically ordinary citizens) only experience the resulting inflation.

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The redistributive properties of monetary policy have been widely documented and debated. Central banks themselves have investigated whether quantitative easing - where central banks purchase financial assets to boost the economy - has increased wealth inequality. By purchasing assets like government bonds and mortgage-backed securities, quantitative easing tends to drive up asset prices, benefiting those who already own such assets. This creates a similar redistributive effect to what the ECB criticizes in Bitcoin: wealth is transferred from one group to another without necessarily creating new economic value.

Can Bitcoin Jeopardize Monetary Policy ?

A recent working paper from the Minneapolis Fed looks at Bitcoin from a different angle. The paper argues that when people can freely buy and hold Bitcoin (or similar "useless pieces of paper"), it becomes harder for the government to run consistent budget deficits. Normally, the government can spend more than it takes in through taxes by selling government bonds. For this to work, these bonds need to stay valuable. But when Bitcoin exists as an alternative, something tricky happens - no matter what smooth, predictable policies the government tries to use, the government might get forced into a situation where it has to spend only what it collects in taxes. The researchers found only two ways to fix this problem: either completely ban Bitcoin, or put a specific tax on owning it. It's worth noting that this isn't about Bitcoin's price or how many people use it - just its mere existence as something people can buy creates these complications for government deficit spending.

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