Cryptocurrencies Increase Inequality

Most enthusiasts in the crypto space perceive cryptocurrencies as a revolt against central bank policies that have created wide wealth inequality. There are both right and wrong but it is the latter that is more important.

Central banks have created inequality due to their policies designed to avert a deflation caused by transfer of virtually all manufacturing production to China in a short period of time and the financial crisis this violent economic paradigm change caused in 2008. Central bank quantitative easing benefited directly large corporations and equity investors and only indirectly the general population by increasing the probability they remain employed. This is a form of inequality but central banks want to make sure funds are directed to investments and not solely to consumption because this will cause inflation among other things. It is not central banks who pay people a salary. Everyone will agree wage increases have lagged significantly corporate profit increases but this is not due to central bank policy and corporations should be blamed. But is there another way of boosting the economy without causing inequality?

Crypto enthusiasts want to abolish central banks and even commercial and retail banks and assert a distributed ledger that facilitates transactions in the form of cryptocurrencies but also in general finance (DeFi) will solve these inequality problems. But how will the problems be solved? It’s a promise but the solution has not been offered and it is unlike it will ever be. They think their solution will work without considering the possibility the alternative system they are proposing may make things worse for most people.

As the number of companies accepting cryptocurrencies is increasing, inequality is also increasing rather than decreasing.

Sophisticated economic agents with expensive hardware and advanced software are mining or trading cryptocurrencies using a process only a tiny percentage of the population understands. They can use the digital tokens they mine or trade to buy goods and services. How much cryptocurrency is left for the general population in the case of bitcoin for example after most of it has already been mined and currently in possession? About 85% of bitcoin has been mined already and this means those who were involved early in the game own 85% of the bitcoin wealth. There were about 63 million bitcoin wallet users at the end of 2020. Without taking into account multiple addresses and whales such as Satoshi Nakamoto who owns a million bitcoin, this is an extreme Pareto distribution with less than 0.1% of people owing 85% of bitcoin wealth. In fact, cryptocurrencies like bitcoin have made inequality even more extreme than central bank controlled fiat currency. These crypto schemes do not solve inequality problems but their only effect is to challenge central bank exclusivity in issuing fiat currency. In other words, a system that creates inequality due to policies is replaced by another that has imbedded inequality constraints.

Between imbedded and policy inequality maybe the latter is preferable unless the cryptocurrency enthusiasts come up with a solid concept of how their scheme can reduce inequality. For now, inequality is increasing because those few who have the know-how to mine, trade and invest in cryptocurrencies can use them outside central bank monetary policy control to buy goods and services while the overwhelming majority of the population is using fiat currency. This amounts to helicopter money for cryptocurrency owners but not for the general population. Inequality is rising and there is no solution.

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Quant trader, blogger, trading book author and developer of DLPAL machine learning software. No investment advice. #trading #finance Website