Cryptocurrency

A Rebuttal to a Misguided Income Inequality Narrative


Income inequality is often talked about in today’s political climate and consequently also within the Bitcoin community. To be more specific, Anthony “Pomp” Pompliano recently wrote a short article that surmised that Bitcoin has the best chance out of anything to close the inequality gap for the poorest of our global citizens. Since the nature of my article is as a rebuttal piece I will use and repeat the very same definitions so that the pre-conditions being used are identical to one another. This will allow me, and also you as the reader, to examine every argument through the same objective lens.

The first important definition used per Investopedia was that, “ income inequality is defined as an extreme concentration of wealth or income in the hands of a small percentage of a population which is usually referred to as the top 1%.”

The second definition, which comes from Wikipedia, is for inflation. The quote states, “Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money — a loss of real value in the medium of exchange and unit of account within the economy.”

Now that we have presented the definitions we can move on to critiquing the examples and arguments used throughout the piece.

Sally’s Relationship with Inflation

In the beginning his article he talks about the inflationary design of the dollar and how shares a causal relationship with income inequality. This is partially true but a nuanced argument would have stated that the main purpose of fiat is not necessarily to enrich the wealthy or to thrust the poor further into poverty but rather to allow the federal government to spend unchecked without having to make compromises or setting a budget. This then makes the income inequality really only a byproduct of the real problem which is an unchecked government that can spend as it wishes until the wheels fall off and there is an inevitable currency and credit reset. To go further, this is done primarily because of political incentives that exist in most of the governmental systems around the world. Generally, politicians promise benefits to their voters or campaign supporters and in return the politician can get elected to office almost in perpetuity. Unfortunately, this pattern has repeated itself from a time period spanning all the way back from ancient Rome to the present day.

Sally, although being affected by inflation, has made numerous critical errors in regards to her career, financial planning, and overall decision making. First, Sally should not necessarily be averse to working nights, weekends, going to night school, and or generally working more than a standard 40 hour work week if the opportunity is available. Essentially, Sally should want to take the extra steps it takes to stand out among her peers so that she can gain leverage in negotiations for raises and promotions. This would have a personal butterfly effect in that she would be giving up free time for the opportunity to increase her earnings, savings, and potential to invest in the stock market or other financial assets which would then dramatically outperform the average yearly rate of inflation. By not doing any of these things, Sally is making what is called an economic trade off. Essentially, Sally values her free time or some other thing more than she values getting ahead of her peers at work. This is not necessarily a bad thing but simply a decision that has definitive economic consequences.

Inflation, Elites, and Bitcoin

Later, inflation and its profound impact on the elites is discussed in a very brief account. He correctly surmises that inflation is a factor which drives up the prices of assets that only the wealthy can easily afford. The line in the sand that is drawn is the moment that Nixon announced the U.S was leaving the Gold standard. However, as you can see below the United States, U.K, and the Netherlands have had periods of inequality that far surpassed or equaled today even though all parties involved were indeed on an asset back currency most commonly called the gold standard which is currently still the most proven and time tested financial system to date.

For those who don’t know, the Gini coefficient is a statistic that is used that represents the income distribution within a group of individuals or a nation state. The higher the coefficient the higher the income inequality and the opposite would indicate a lower level of income inequality. Below, is the rich list for Bitcoin which will allow us to compute a rough estimate for the Gini coefficient of Bitcoin.

By taking the numbers from the current Bitcoin rich list, I computed the Gini coefficient of Bitcoin which is shown in the excel spreadsheet above. To put it simply, Bitcoin’s distribution of wealth is actually worse than any nation or other population on earth. I know the counter argument is going to be that the top addresses are various exchanges cold and hot wallets which comprise of a lot of users individual funds. However, to counter this sort of thinking, a particular user can and most likely does have multiple addresses which would actually increase the Gini coefficient even more. Additionally, going by the standard logic in the space, if you do not have the private keys to the address that is holding your funds then you do not own the Bitcoin within them which means the coefficient above is as close of a representation of a distribution as you are going to get in relation to Bitcoin.

To compound on the poor distribution experienced in Bitcoin today, there are also numerous forward factors to think about. Many Bitcoin proponents believe that Bitcoin will naturally become more stable as adoption occurs and this belief is not entirely unfounded. To this point in time, Bitcoin has indeed become more stable with every cycle and it has also garnered some degree of increasing levels of adoption. However, as Roger’s Diffusion of Innovation suggests, there are indeed things that can interrupt adoption the mainstream. Bitcoin’s major issues are stability in purchasing power, scaling, high fees, network congestion, a poor network distribution, and tech that is increasingly coming in behind its peers. Bitcoin has the clear and inherent “network effect” advantage but how long this will be the case remain more muddy today than ever in its young history.

Going back to the main topic at hand, early adopters have reaped all of the reward and have immense amounts of interest in pushing adoption to the masses. Due to the block halving schedule and the total supply cap, these early adopters would have wealth that makes Jeff Bezos seem poor in comparison if the world were to adopt it. This isn’t inherently unfair per se because all individuals had a somewhat fair chance of being one of these early adopters. In such a future, these early adopters would have all of the worlds wealth and they probably could not spend that vast sum of wealth in a thousand lifetimes even should they attempt to do so. All of these early adopters, due to the block halving schedule, also have nearly zero incentive to spend any of their Bitcoin which mean the velocity is low and the status quo will indeed remain the same. Lastly, to make a comparison the top 1% in Bitcoin have somewhere in the range of 90% of the Bitcoin while in fiat the top 1% have around 50% of the wealth. This would mean that Bitcoin actually would exacerbate the problem in a comparative sense instead of alleviating it.

Flat Block Reward with no Supply Cap

Now that I have pointed out some of the problems with Bitcoin, it wouldn’t make for much of an article if I stopped there with it. It seems proper to offer up a few potential solutions of my own. The simplest solution is to have a flat block reward that does not halve and then to coincide that with having no total supply cap. This would mean that there would technically be no limit on the number of coins that could be mined but it also changes the incentives from hoarding to actually using it as a currency. The monetary policy would still be extremely predictable, could better absorb demand shifts that increase volatility, provide continued incentive to mine, and also lead to a far better distribution by removing the incentive to hoard.

This idea is somewhat unpopular within the community largely because the narrative is firmly controlled by the minority that holds steady to a knee jerk reaction from the damaging and unpredictable ways of government backed fiat. The main issue with fiat is not that there is some level of nominal inflation but rather that they do not have the ability to even maintain that level of inflation. Eventually, debt and inflation spiral out of control due to inborn political incentives and then a collapse is in order. Conversely, the a major benefit of this policy is that it provides increased stability up front as seen in Ethereum prior to 2017 when they had a flat block reward. Ethereum was more stable in its first years in dollar denominated value than Bitcoin was in the corresponding years after launch. Additionally, Grin, a new project is also experimenting with this monetary policy.

My Solution: A Partially Dynamic Block Reward

The first step to developing a more stable block reward algorithm would be to first get rid of the block halving schedule and the total supply cap. The total supply cap and block halving schedule are static but demand fluctuates wildly. The demand shifts seen in Bitcoin are relatively uncommon in the fiat world because demand is largely fixed via government decree with legal tender laws. This means that federal banks largely only need to worry about interest rates and supply. To offset the fluctuation in demand, the block reward algorithm should be somewhat dynamic in nature. However, doing this properly is easier said than done and many projects along the way have failed trying to go the dynamic route.

First, you need to find a measure of demand that is endogenous in nature so that you avoid any glaring security flaws. Once you have picked an endogenous metric that has a high correlation to price while not being prone to manipulation, you will need to adjust the block reward at given intervals based on where that metric moves. For example, if demand goes up by ten percent, as measured by your metric of choice, then supply also goes up by ten percent to offset that price increase. In addition to that, you also need to set a constant benchmark that the block reward moves up and down from. For example the standard block reward is set to 50 and if demand went down seven percent in a given period then the block reward will also decrease by seven percent. To be successful it would have to use hashrate as a measurement of demand and then also factor out Moore’s Law per Vitalik’s suggestion. This type of block reward should prevent the irrational exuberance that we saw in 2017 and subsequently the meteoric fall that we experienced in the early parts of 2018. My solution would also balance rewards for early adopters and later adopters which would mean for a much better distribution of wealth than seen in Bitcoin. That being said, this is an extremely simplistic way of looking at the solution and it also has some inherent weaknesses and potential risks as well that can be discussed in a later article.

Conclusion

It may seem that I am exceedingly negative about Bitcoin and cryptocurrency in general but I assure you all that this is not the case. I believe that Bitcoin opened the path to a better future in which we are not subject to the whims of centralized authorities. Additionally, Bitcoin does indeed do many things well and checks some of the boxes that would make for a good currency. That being said, Bitcoin does not and will not in the future ever fix income inequality that is mostly natural but also exacerbated by a variety of factors. It is my opinion that the project that will garner mass adoption and truly provide freedom to the masses is both unknown to us and probably has not been created as of yet.



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