Central banks are increasingly studying Bitcoin

In recent years, a growing number of studies have emerged from central banks and financial institutions, focusing on Bitcoin and its potential impact on monetary policy. These studies, released by organizations such as the Minneapolis Federal Reserve, the European Central Bank (ECB) and the International Monetary Fund (IMF), highlight an important theme: the disruptive nature of Bitcoin and other cryptocurrencies could limit the ability of central banks. to fulfill their traditional role in managing economies. Proponents 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?

European Central Bank researchers have published two papers on Bitcoin, both offering strikingly different perspectives. The first, published in the wake of the 2022 FTX collapse while Bitcoin was trading at $16,000 – titled “Bitcoin’s Last Stand” – portrays Bitcoin as a failed monetary experiment that is in its final death throes. In 2024, when Bitcoin was trading at almost $70,000, the same authors published an article at the European Central Bank recognizing a different reality.

This latest article argues that Bitcoin’s existence and continued appreciation plays an important role impact on the distribution of wealth. According to the paper, early Bitcoin holders will become richer as the price of Bitcoin rises. However, because Bitcoin produces nothing and does not increase economic output, this increased wealth and consumption by early holders must come directly from decreased consumption by everyone else in society. This means that when early Bitcoin holders spend their profits on goods and services, they are tapping into purchasing power taken from non-holders and people who bought Bitcoin later. This reduction in people’s purchasing power is happening even if the price of Bitcoin continues to rise forever and even affects individuals who don’t buy Bitcoin at all.

The key insight is that Bitcoin wealth does not create new economic value – it only redistributes existing wealth. Even in the most optimistic scenario where Bitcoin’s price continues to rise, the early holders will only get richer by making everyone else poorer in relative terms. The authors argue that this is different from gains in stock or real estate values, which can reflect and contribute to actual increases in economic productivity and output. With Bitcoin, the profits are purely redistributive, as Bitcoin itself produces nothing and does not increase economic capacity.

This ECB position reflects a long-standing criticism of central banks by Bitcoin proponents. The Cantillon effectnamed after 18th century economist Richard Cantillon, suggests that by printing money, central banks disproportionately enrich those closest to the money supply (such as banks and wealthy individuals), while the rest of the population sees a decline in purchasing power . When new money enters the economy, it does not affect all prices simultaneously; instead, the first recipients of the new money (typically financial institutions) can spend it before prices rise, while those furthest away from the money supply (typically ordinary citizens) can do so on their own. experience the resulting inflation.

The redistributive properties of monetary policy have been extensively documented and discussed. Central banks have done this themselves examined or quantitative easing – where central banks buy financial assets to stimulate the economy – has widened wealth inequality. By buying up assets such as 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 Endanger Monetary Policy?

A recent one working paper of the Minneapolis Fed looks at Bitcoin from a different angle. The paper argues that allowing people to freely buy and hold Bitcoin (or similar ‘useless pieces of paper’) will make it harder for the government to run consistent budget deficits. Normally the government can spend more than it collects through taxes by selling government bonds. For this to work, these bonds must remain valuable. But if Bitcoin exists as an alternative, something tricky happens: No matter what smooth, predictable policies the government tries to implement, the government could end up in a situation where it only has to spend what it collects in taxes. The researchers found only two ways to solve this problem: ban Bitcoin completely, or impose a specific tax on its ownership. It’s worth noting that this isn’t about the price of Bitcoin or how many people use it; its very existence as something people can buy creates these complications with government deficits.

The Minneapolis Fed isn’t the only institution concerned about Bitcoin’s ability to hinder the effectiveness of monetary policy. The IMF’s 2023 policy paper focused on how crypto assets could weaken the effectiveness of monetary policy, especially in emerging markets with unstable currencies and weak monetary frameworks. While skeptical about implementing a blanket ban on Bitcoin and other cryptocurrencies, countries should first focus on strengthening their monetary policy frameworks and institutions. The article suggests that currency substitution (“cryptoization”) is more likely to occur with stablecoins pegged to foreign currencies, as they offer a less volatile alternative to domestic currencies, than with volatile cryptocurrencies such as Bitcoin.

The document specifically recommends against giving crypto assets legal tender status as this would further weaken monetary sovereignty. Instead of anti-crypto programs, the IMF advocates comprehensive regulation alongside robust macroeconomic policies. The key to protecting the effectiveness of monetary policy, according to the IMF, is maintaining credible institutions and sound monetary frameworks – addressing the root causes that may make citizens want to switch to crypto in the first place. This approach reflects the IMF’s current view that while crypto poses risks to the transmission of monetary policy, the solution lies in strengthening traditional monetary and fiscal frameworks rather than focusing primarily on crypto restrictions.

Central bankers are taking Bitcoin more seriously

Research from central banks and the IMF shows that monetary policymakers are taking Bitcoin much more seriously than before. Working papers do not necessarily reflect the thinking of decision makers at central banks, but are nonetheless indicative of how monetary policy is increasingly taking Bitcoin seriously. This goes beyond academic working papers and is also reflected in policy: the IMF’s 2022 bailout for Argentina included several anti-crypto provisions.

The European Central Bank’s arguments against Bitcoin warrant some introspection from the central bankers themselves. If Bitcoin’s redistributive effects are problematic because they transfer purchasing power from late adopters to early adopters, how is this fundamentally different from monetary policy that transfers purchasing power from those far from the money supply to those closest to it? Both mechanisms appear to create winners and losers through the redistribution of purchasing power rather than through productive economic activity. Be that as it may, it should come as no surprise to central bankers if Bitcoin’s increasing adoption becomes an obstacle to central banks’ ability to dictate monetary policy. This has long been a goal of Bitcoin enthusiasts. From its inception, Bitcoin’s self-declared purpose has been to provide an alternative to centrally planned monetary policy.