Tuesday, March 11, 2014

Who benefits if Bitcoin succeeds?

To answer the question who will benefit if Bitcoin is successful it is important to distinguish between two different processes that take place during Bitcoin's road to success:

  1. Bitcoin monetization
  2. Growth of the bitcoin economy

As I will explain below, each of these developments results in different kinds of benefits for different groups of people.

Bitcoin's Monetization
Let's first suppose for the sake of the argument that success for Bitcoin means that bitcoins replace the dollar and/or other currencies [1]. As bitcoins become more and more accepted as a medium of exchange and acquire more and more 'moneyness', their purchasing power will continue to increase. This means that the earlier and fuller that people make the switch from dollars or other currencies to bitcoins, the more they will profit.

Their gains come at the expense of those who make the switch only later, or less fully, or not at all. After all, the closer the economy gets to a Bitcoin economy the less there is to win for those switching from dollars to bitcoins, and there will be some point after which the loss in purchasing power suffered by holders of dollars can no longer be fully compensated by their switching to bitcoins. From that moment on anybody switching from dollars to bitcoins suffers a net loss (compared to their situation before the transitioning began), although the loss is of course still smaller than it would be if they did not make the switch at all and instead just held on to their dollars [2].

So the first way in which people can benefit from Bitcoin's success is through the massive transfer of purchasing power from holders of dollars to holders of bitcoins. 
Growth of the Bitcoin Economy
Let's also suppose that success for Bitcoin means that Bitcoin as the distributed ledger becomes a widely used protocol on top of which applications and other protocols can be built. As such Bitcoin makes all sorts of services that up until now required banks and other financial institutions accessible to all. So people who did not have access to the banking system before will benefit, but everybody else will as well because services traditionally provided by these institutions will now become cheaper and faster. Moreover, all sorts of services that up until then were not possible or had not even been imagined will start to emerge as engineers and entrepreneurs learn new ways in which to use the protocol.

In this process then everybody wins to the extent that they are engaged in transactions that were not possible before the Bitcoin protocol and the applications built on top of it, or that now have lower costs thanks to the protocol and the applications.

Their gains come in part:
  1. At the expense of those invested in pre-Bitcoin but Bitcoin-related technologies & industries (e.g. credit card companies, remittance middlemen, or in general any business that operates anywhere in the ecosystem that may be affected by the new technologies / industries / businesses made possible or made better by the Bitcoin protocol) 
  2. 'Out of nowhere', in the sense that now more and/or better things are produced than before so that there simply is more wealth to go around.


So in short there are two main ways in which people can benefit from Bitcoin's success: the transfer of purchasing power that accompanies Bitcoin's monetization; and the innovation and thus increased productivity made possible by Bitcoin.

Now why is it so important to know that there are these two distinct ways of benefitting from Bitcoin. Let me illustrate this with two examples.

Developing countries
Bitcoin is often promoted as being potentially very beneficial for people in developing countries, as these often have poor or no access to the banking system, and this greatly reduces their possibilities for trade, and their access to financial products such as loans. Moreover, a significant chunk of the money being sent to people in developing countries by their relatives in richer countries goes to the middlemen involved in the remittance industry. Bitcoin can disintermediate that whole industry and drastically lower the costs.

The benefits Bitcoin can deliver in these respects are clear. And they're obviously Type 2 benefits.

At the same time though, to the extent that people in the Western world make the transition from dollars (or other current fiat currencies) to bitcoins sooner than people in developing countries do, people in the West gain at the expense of people in developing countries. This is obviously a Type #1 benefit.

If this is correct, and if Type 1 type benefits are considerable (and it seems obvious that they would be) and if one's goal is for Bitcoin is to benefit people in developing countries, it would be a lousy strategy to want to build up the Bitcoin infrastructure in the West first and only then transfer it to or implement it in developing countries. Now why would one even think of doing such a thing in the first place?

Well, one reason might be the idea that this would mean that people in the West will experiment and take on all the risk and waste involved in research, development and experimentation so that people in developing countries don't have to! Developing countries would receive finished and well-tested products and services based on the Bitcoin protocol, and they wouldn't have to devote resources to research and development [3].

But this kind of strategy would have the unfortunate side-effect of people in developing countries being relatively late in their adoption of bitcoins, and this means that not only would they not profit from being early adopters but they might actually become net losers in the process of Bitcoin monetization. And these losses may very well outweigh the potential gains they receive from new or cheaper and better services made possible by the Bitcoin economy.

A much better strategy, then, would be for people in developing countries to start buying and using bitcoins as early as possible so that they can reap both Type 1 and Type 2 benefits [4].
More Kinds of Opposition
A second example that illustrates why it's important to distinguish between these two types of benefits concerns the possible opposition that Bitcoin faces. Typically when people think about the political and/or economic players who may not be looking forward to Bitcoin's growth they have in mind established businesses in the financial industry who may feel threatened by Bitcoin and the entrepreneurial possibilities it offers to newcomers in the market, and governments who may feel threatened by the prospect of bitcoins partially or fully replacing dollars as this will mean that they will have considerably less room to use the dollar for their own purposes (e.g. monetary and macro-economic policy, creating funds out of thin air, rewarding certain special interests).

But once we take into account that there is a second way in which people can profit from Bitcoin's success, namely through the massive transfer of purchasing power from holders of dollars to holders of bitcoins it becomes clear that the potential opposition to Bitcoin is actually much greater than this: After all, early adopters of Bitcoin will become very very wealthy should Bitcoin succeed and this may very well cause great changes in political, economic and social networks and hierarchies. All kinds of people and institutions who are currently in positions of power or aspire to gain power within the currently existing networks and hierarchies may feel threatened by the upheaval that may result from the massive transfer of purchasing power involved in Bitcoin's monetization. Opposition to Bitcoin may then come not just from established players in the financial industry and government, but from established players in all sectors of society.

Despite this, there may be some reason for optimism for those who would like to see Bitcoin succeed: Perhaps the best and easiest way for people who are currently wealthy and/or powerful to defend themselves against the possible consequences of Bitcoin's success is not to lobby politicians and try to have them work on their behalf, but to just buy bitcoins! The sooner they buy bitcoins the more their interests would be protected in a Bitcoin world. And to the extent that they don't buy bitcoins in a world experiencing that is experiencing Bitcoin monetization, they will suffer financially and thus be less capable of putting up other kinds of resistance to Bitcoin's rise [5].

Of course such a defensive maneuver would not just help those who would otherwise stand to lose in a Bitcoin world but also increase the likelihood that this Bitcoin world will actually come about.


[1] Of course this is a rather ambitious standard and there may very well be ways in which Bitcoin could be successful without bitcoins fully or partially replacing the dollar. In that case the following remarks would not apply.

[2] I have more to say about this process in this post.

[3] I think I heard one of the hosts of the excellent Let's Talk Bitcoin podcast, Adam Levine, describe this kind of plan or vision in one of their podcasts. I'm not sure I'm remembering correctly who it was though, so it may have been one of their guests rather than Levine himself, or I may have even heard it elsewhere instead.

[4] Doing so would also mean more opportunities for entrepreneurship in the Bitcoin economy, and products and services that are better suited for their particular contexts, knowledge and needs than products and services created that were developed in the West and then transferred to developing countries would be.

[5] Of course, throughout this article I am presupposing that Bitcoin will succeed and merely investigating who would win and who would lose in that scenario. But of course chances of Bitcoin actually succeeding are still very small. 

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