My Introduction

The paper "The distributional consequences of Bitcoin", written by Ulrich Bindseil and Jurgen Schaaf, makes the following claims about Bitcoin: it has failed as a means of payment except for use by criminals; it has no utility to society; it makes an inefficient and excessive use of energy; in the event that it continues to rise in price, it will cause a transfer of wealth to early adopters, and the rest of society will suffer impoverishment.

Bindseil and Schaaf are employees of the European Central Bank. They wrote the paper independently of the ECB.

We will analyse the claims they make and reveal their errors and biases. But before that, we should take a moment to consider the motivation behind the publication of this paper and whether it is part of a strategy to discredit Bitcoin and counteract its adoption.

The current cycle in bitcoin's price is characterised by its acceptance and adoption by financial institutions. The creation of ETFs is the most signficant event, which has resulted in strong interest by small investors who may not appreciate the value of having custody of bitcoin, or who simply want to add it to their investment portfolio using an instrument that they are familiar with. Investment funds and pension funds are slowly allocating to bitcoin after performing the due diligence that is required of them. ESG funds are also slowly realising that bitcoin mining is not a threat to the environment, as they were led to believe by a biased and ignorant media. Companies are starting to add bitcoin to their balance sheets. These changes that are taking place will provide the main impetus behind the increase in price during this cycle.

But a cloud hangs over the Bitcoin landscape: central banks see growing interest in bitcoin as a threat to their ability to control the money supply, and governments see it as a threat to their ability to issue debt and to tax the people. Governments and central banks will therefore work together (as they always have done) to counter this threat.

That is where Bindseil and Schaaf's paper comes onto the scene. It is one of many publications by central banks and their proxies that aim to create the foundations that will justify the introduction of laws to restrict the people's ability to use bitcoin as a store of value.

This document comments on some of the claims made in this paper. It does so in the order that they appear in the paper. The section titles are those of the paper. Quotes from the paper are displayed in italics.

The paper "Challenging Bias in the ECB's Bitcoin Analysis" (https://www.researchgate.net/publication/385134405_Challenging_Bias_in_the_ECB%27s_Bitcoin_Analysis) provides an excellent rebuttal of many of the claims made in Binseil and Schaaf's paper.

1. Introduction

"... real Bitcoin payments, i.e. effectively “on chain”, are still cumbersome, slow and expensive."

The same can be said of fiat payments at L1, i.e. banks' settlements of central bank money. The fiat system has built multi-tier payment systems such as interbank transfers, credit and debit cards, PayPal etc. This paper deliberately ignores the equivalent payment systems in Bitcoin, such as Lightning and Liquid, to criticise a settlement time of ten minutes while ignoring the fact that interbank settlement times are usually one day.

"... its value is considered too volatile to fulfill the classic functions of money, i.e. unit of account, means of payment, and store of value"

Such volatility is to be expected of a new form of payment and store of value that is introduced into society. It is not an inherent feature of the protocol. Over time its volatility will reduce as more value is transferred to it from fiat and other assets such as gold.

Section 2. The use case of Bitcoin and its valuation

2.1 Bitcoin offers payment services to society: Nakamoto’s original vision of 2008

https://bitcointuesdaymadrid.com/library/the-distributional-consequences-of-bitcoin#OazF0GFS+

"In principle, financial institutions can avoid mediating disputes. Mediation is rather an optional service than a necessity. It is demanded by customers and charged by payment services providers"

This is factually incorrect. A bank has reversed the deposit transaction that paid for the purchase of bitcoin after the seller had sent the bitcoin to the buyer's address; all the buyer had to do was tell the bank that he had been the victim of a scam. The seller did not opt-in to dispute mediation. (From a Bisq2 discussion on Matrix.)

The authors refute Nakamoto's claim that financial institutions mediate disputes using specific examples that do not disprove his claim; they merely show it to not be universal.

The "trusted third party" that the Bitcoin protocol eliminates does more than mediate in the transaction; it decides whether the transaction should be initiated. The degree of interference in the transaction has grown significantly since Nakamoto published his paper. We are often subjected to the "Spanish Inquisition" when wanting to make a transfer. Who hasn't been asked "What is the purpose of this transaction?" when transferring fiat to another person or company? Who hasn't had a transaction blocked when the person making the transaction answers "That's my business. Please respect my privacy."?

The authors misinterpret Nakamoto's "trusted third party" as the party entrusted to provide the escrow service in the case of the purchase of a good. The "trusted third party" is in fact the financial institutions that execute the transaction on behalf of the buyer and seller. The Bitcoin protocol eliminates them and their associated costs and controls.

https://bitcointuesdaymadrid.com/library/the-distributional-consequences-of-bitcoin#6XOdffed+

"... it is unfortunately also true that proof-of-work is highly impractical itself as it is costly and inefficient compared to alternative ways to secure the safety and prevent double-spending of a payment instrument. The problem of double-spending is hardly an issue in payments (because it is generally solved without particular difficulties, and certainly with far less social cost than those incurred in the solution offered by Bitcoin)."

The authors consider POW to be inefficient compared to alternative ways to prevent double-spending. They blithely say it can be solved without particular difficulties, without mentioning them. One "minor" difficulty they probably refer to is the presence of a trusted middleman - the financial institution. This is not such a minor issue, as it reduces the privacy of the transaction and in oppressive countries can result in the counterparties being sanctioned or worse. Canada and Holland are examples of oppressive countries in so-called free societies.

The authors may also be alluding to POS as an alternative way to prevent double-spending, but they prefer to leave the possibilities to the reader to guess at, or to just blindly accept that they must exist. As we all know, POS cannot provide the same resilience against the double-spend problem; all it would take is a confederation of large holders of Bitcoin - e.g. ETF providers such as BlackRock, Fidelity, exchanges, governments and companies like Microstrategy - to control over 50% of the Bitcoin supply and collude to double-spend. POW on the other hand would require over 50% of all miners to collude. Given the ease with which new miners can go online and their geographic diversity, such a threat is greatly reduced to the point of being insignificant.

The authors repeatedly state that POW is an inefficient use of energy resources. They do not mention the positive benefits it brings to energy producers: its on-demand consumption stabilises the grid, reducing prices for consumers; it makes otherwise unviable green enery production viable; it uses stranded energy that is located far from the grid; it reduces greenhouse gas by burning landfill methane gas emissions. They do not mention that about 56% of the energy consumed is renewable energy, which is higher than that consumed by any other industry.

https://bitcointuesdaymadrid.com/library/the-distributional-consequences-of-bitcoin#2eQPLgBm+

"Overall, Nakamoto's (2008) understanding of retail payments was inaccurate. It is therefore doubtful whether his invention effectively addressed the problems he perceived in e-commerce and it is therefore also hardly surprising that Bitcoin was never significantly used in legal e-commerce."

The authors attribute the lack of adoption of Bitcoin in e-commerce to Nakamoto's lack of understanding of payments. They deliberately ignore the fact that it is used widely in developing countries as a means of payment (see Gladstein). Many people use Bitcoin to transfer fiat money between different countries (e.g. Strike). The authors ignore this because they are targetting an audience of uninformed people in developed countries in order to dissuade their adoption of Bitcoin.

The authors ignore the real reasons that the adoption of Bitcoin as a means of payment in developed countries is not yet widespread. The existing electronic point-of-sale payment systems are convenient for users; most people have not had their accounts blocked by their bank or government for expressing their political views (as has happened to some in Canada and Holland), or do not know of those who have; the volatility of the price of Bitcoin is high enough that a subsequent transfer into fiat is necessary in order to spend the funds in the base currency of the holder.

The authors use the term "legal e-commerce" to imply that Bitcoin is widely used in illegal e-commerce. This is not true; only about 0.3% of illegal e-commerce is transacted using Bitcoin (Daniel Batten).

https://bitcointuesdaymadrid.com/library/the-distributional-consequences-of-bitcoin#loFoau1R+

2.2 The fair value of Bitcoin

The authors seem unable to decide if Bitcoin is like an equity asset, a commodity or a digital version of gold (which is also considered to be a commodity, but whose properties are more akin to a store of value and means of payment). They therefore try and fail to assign a fair value to Bitcoin. They look for a relationship between its price and various market-related variables. They apply DCF as if it were the stock of a company providing goods or services. They discredit S2F as a price predictor, which, as they rightly say, is a regression on only one variable, but in fact has been a good predictor of the overall exponential growth trend in its price. They omit this observation, instead focussing on its failure to predict the recent price drop in 2022. They don't propose an analytical model that has predicted any price drop of the stock market, the bond market, the commodities market or the gold market.

They also omit the discussion of the meaning of money and its relevance to bitcoin, which claims to be money, not an equity or a commodity or a bond. What is the fair value of money? This is a self-referencing question, as the fair value of money must be expressed as ... money.

Money and Bitcoin are discussed at great length in books such as The Bitcoin Layer (Nik Batia) and Broken Money (Lyn Alden) and need not be reproduced here. Bitcoin, like gold, fulfills the definition of money; however, in the modern age, gold has lost its appeal as a means of exchange for a number of reasons (its prohibition in the US in 1933, the imposition by governments of fiat money and consumer ignorance or acceptance of its shortcomings).

https://bitcointuesdaymadrid.com/library/the-distributional-consequences-of-bitcoin#Hwrxz7qL+

2.3 Bitcoin as a pure investment detached from any use case

The authors provide quotes by investment professionals and celebrities in an attempt to support their argument that Bitcoin's value is only dependent upon the perception that it will continue to increase. However, they ignore a use case that is mentioned in them. That use case is the "store of value". This store of value and its implicit protection against currency debasement is the reason that its price is predicted to grow over the coming years. The authors imply that investors in bitcoin believe that its price will grow indefinitely; the truth is that they believe it will grow to the point that it has captured the wealth that people want to store in this medium. This is what has happened with gold, and why its price in fiat changes in response to the debasement of fiat money and to geopolitical events.

Investors who understand that Bitcoin is a store of value and that its price will increase as society comes to the same conclusion over the coming years will naturally take the opportunity to increase the value of their investment. They do not, as the authors write, believe it to be a "virtuous cycle where its value continuously rises". Early investors in gold, precious metals and successful tech companies such as Apple, Amazon, Microsoft, Google, Tesla and NVidia did not believe this either.

The authors correctly state that a good, or commodity, with no demand has a zero price:

"In the context of Bitcoin with its limited and fix supply the non-economic term “rarity” seems more appropriate. If supply is fixed, the price becomes exclusively dependent on demand. And if the demand were to disappear, the price would be zero."

The same can be said of gold, with the caveat that its price would decrease to a level that reflected its demand for jewellery and manufacturing, and this level would be significantly lower that its current price. Gold's price largely reflects its use as a store of value, as does the price of bitcoin.

2.4 The investment vision of Bitcoin in the political debate

There is not much to comment on in this section; it summarises the political climate surrounding Bitcoin in the run-up to the US elections.

3. The macro-economics of large asset price exuberance

TBD. This section is an economics class that may be too theoretical to comment on.

4. The distributional effects of Bitcoin: an illustration

The authors construct a model that shows a gradual transfer of wealth from one group of people to another group of people during forty years of an exponential growth in the price of bitcoin. These groups are labelled "Early Birds" and "Latecomers". The model concludes that the Early Birds' per capita comsumption grows from 50% to 70% over this period.

The model makes the unrealistic assumption that Latecomers forgo consumption in order to buy bitcoin. They ignore the fact that many store their cash in bitcoin instead of fiat money, choosing to avoid its debasement.

The authors argue that the transfer of wealth from Latecomers to Early Birds is socially unjust, ignoring the fact that it has been common practice in the stock market since its inception. Just ask Warren Buffett.

In past cycles, up to 2–4 million BTC changed hands (Bitcoin Magazine Pro email of 22/11). This is much higher than the w=2% in the authors' model, so the distribution of wealth should me more equal than they predict.(I have to check this statement.)

In Europe and the USA, approximately 70% of the total wealth is owned by the top 10% of earners; the lowest 50% only owned 2.5% of the total wealth.

The authors ignore the fact that the great majority of Early Adopters belong to the 90% of the earners that own 30% of the wealth. The wealth transfer that most concerns the authors is therefore a fraction of the 30% of the wealth. The net effect of such a transfer of wealth will increase the total wealth that 90% of the earners possess, resulting in a fairer distribution of wealth in society.

Now consider the case where most of the Early Adopters belong to the bottom 50% of the earners. The redistribution of wealth from the higher to lower earners would be even greater - a Socialists' dream!

One can only conclude that the authors' model is as simple as the one I have proposed and is not a strong argument to guide government policy relating to Bitcoin.