At Expensivity, Bernard Fickser, who has explained how to sell non-fungible tokens (NFTs) now offers “The Truth About Cryptocurrencies: A Clearheaded Guide to the Crypto World.” (January 15, 2022) For your convenience, we are serializing his work, which can be read in whole here. Here’s Part 5 (of 5):
5 The Centralization of Crypto Wealth
Decentralization is a watchword of crypto. One of the things said to commend cryptocurrencies is that the blockchain-based peer-to-peer networks that run them are decentralized, residing outside the control of any single authority. This claim that cryptocurrencies are decentralized in their organizational structure is overstated because the peer-to-peer networks that run them can themselves act as central authorities.
True, these peer-to-peer networks feel freer and easier than the usual authorities and trusted third parties of conventional finance, such as banks. But that’s because peer-to-peer networks are run like democracies rather than monarchies, and for now these democracies have behaved themselves reasonably well. But in democracies, it’s majority rule, and the majority can do anything it pleases, especially at the expense of the minority. We’ve seen this already with crypto’s hard forks, such as the one that split off Ethereum Classic (ETC) from Ethereum (ETH).
It’s common to picture decentralization as a graph in which many interconnected nodes all happily exchange information along communication channels, the nodes all being roughly equal in status. That picture is grossly mistaken when it comes to the peer-to-peer distributed networks that run crypto’s blockchains. Invariably, there are major nodes that control much of the network, whether directly (as with Bitcoin’s mining pools that generate most of the newly minted bitcoins) or indirectly in coordinating consensus.
But suppose we grant that cryptocurrencies are decentralized in their organizational structure. And suppose further we grant that cryptocurrencies can avoid the surveillance, lack of anonymity, and risk of confiscation that are endemic to the “trusted third parties” that for now still run most of the financial world. Even then, there’s something disconcerting about the way the actual coins that make up cryptocurrencies are distributed among crypto users. Crypto wealth is concentrated in the hands of the very very few.
In consequence, even if crypto networks are organizationally decentralized, the distribution of crypto wealth within those networks is anything but decentralized, showing even more inequality than the distribution of fiat currency among the populace at large (and that in an age of ever increasing inequality in conventional wealth!).
The problem is so stark that one has to wonder if the constant drumbeat of decentralization among crypto’s leading lights is in fact a distraction from the centralization of money and power that has become typical of cryptocurrencies. Think back to the days before music streaming. Steve Jobs and his iPod were going to make music much more accessible and defang those money-grubbing record labels. Instead, iTunes, Spotify, and YouTube have now essentially become the record labels, rerouting most of the income from music into their own pockets. As a result, musicians are hard pressed to earn a living from recordings and instead now increasingly need to make their money by doing live shows (which technology has yet to replicate).
Cryptocurrency founders and early investors have come to seem like politicians who arrive in Washington as thoroughly middle class, but then somehow during their time in office become so financially astute that they leave office as millionaires. Only with the cryptocurrency leaders, they tend to become billionaires rather than millionaires. We already noted that Bitcoin’s founder Satoshi Nakamoto, based on the number of bitcoins that he mined, is worth tens of billions of dollars in bitcoins. Ethereum founder Vitalik Buterin cashed in much more modestly on ether, owning only about 325,000 ETH, and thus at the present price of ether is worth only in the single billions of dollars (still nothing to sneeze at).
The creation of cryptocurrencies in more recent days takes the form of initial coin offerings in which the creators tend to be a consortium of software geeks and venture capitalists. They will set up a blockchain-based cryptocurrency infrastructure, assign to themselves a certain percentage of the total coins, and then make some coins available for sale, often leaving the creation of other coins for the future. This is why, for instance, if you go to Coin Market Cap, you’ll see for every cryptocurrency listed there both the “circulating supply” (total number currently in circulation) and the “max supply” (total number that can ever exist).
Consider Zcash, which has dwindled in recent years, but still has a capitalization of over $2B (it’s currently in the top 70 of cryptocurrencies according to Coin Market Cap). Founded in 2016, Zcash was a Bitcoin knock off. Unlike Bitcoin, Zcash’s founders were not content simply to have the advantage of mining their blockchain currency from the get-go on an equal footing with everyone else. Instead, Zcash paid its early adopters 10 percent of all Zcash right up front. As explained on Zcash’s blog: “Zcash’s monetary base will be the same as Bitcoin’s — 21 million Zcash currency units (ZEC, or ⓩ) will be mined over time. 10% of that reward will be distributed to the stakeholders in the Zcash Company — founders, investors, employees, and advisors. We call this the ‘Founders Reward’.”
That was in 2016, and not much has changed since then. The concentration of crypto wealth has remained overwhelmingly in the hands of “founders, investors, employees, and advisors” of the given cryptocurrencies, along with those who made their money outside of crypto and decided to buy big into crypto.
Consider Solana. It represents perhaps the most interesting advance in blockchain technology in recent years. But presumably its founder, Anatoly Yakovenko, along with its venture capitalists, who put up $20M in start-up funds to get Solana off the ground, rewarded themselves generously with SOL. With how much exactly did they reward themselves? The ICO data don’t explain. But with Solana’s market cap at over $50B, presumably Yakovenko and his early investors are billionaires (if not, why not?).
Just to be clear, my purpose in this section is not to fault people who start a cryptocurrency from gaining for themselves a good chunk of its coins. The prime principle of capitalism is that if you create something, you should profit from it. My concern rather is with the concentration of crypto wealth and what seem to be systemic reasons for keeping it concentrated among a crypto elite so that the inequality is greater than anything we’ve come to expect from conventional finance.
Tracking the crypto wealth of particular individuals can be difficult because crypto wealth is located at the addresses of cryptographic wallets, and those addresses give no information about individual owners unless they publicly identify themselves as owners. That said, because crypto wealth occurs on a blockchain, and crypto blockchains are complete immutable ledgers of all transactions that have taken place to date, it’s possible to see how much crypto belongs to each address, and thus form an overall picture of how crypto wealth is distributed.
Bitcoin is emblematic here of the concentration of crypto wealth and its rampant inequality. It’s become popular to use “submarine wildlife” to categorize Bitcoin investors by the number of bitcoins they own. Thus whales are those that own the largest amounts of Bitcoin, shrimp those that own the smallest amounts. Here’s one version of that taxonomy (treating 1 bitcoin as worth $60K):
- BLUE WHALE, over 20,000 BTC, over $1.2B
- HUMPBACK WHALE, over 10,000 BTC, over $600M
- SHARK, over 1,000 BTC, over $60M
- DOLPHIN, over 100 BTC, over $6M
- OCTOPUS, over 10 BTC, over $600K
- SQUID, over 2 BTC, over $120K
- CRAB, over 0.5 BTC, over $30K
- SHRIMP, under 0.5 BTC, under $30K
Note that there are currently just under 19M bitcoins officially in circulation and that 25 percent of these are lost or otherwise inaccessible. Note also that similar taxonomies hold for other cryptocurrencies (for example, Ethereum has its own whales).
So who exactly owns the bitcoins in circulation? It’s possible to identify the Bitcoin holdings of a number of known exchanges, but in general we only know the public addresses of the Bitcoin holders and how many bitcoins are associated with each address. Bitcoin’s blockchain is a public ledger, so we can see exactly how Bitcoin wealth is distributed. BitInfoCharts makes all this data readily available. The most obvious lesson from this data is that Bitcoin wealth (and crypto wealth more generally) is incredibly concentrated, making concerns about income inequality of the US dollar pale by comparison. Consider this chart from BitInfoCharts:
This chart at once overstates and understates the concentration of Bitcoin wealth. It understates it in that the same person or organization may own multiple wallets/addresses (thus suggesting an even greater concentration). It also overstates it in that an exchange with a single wallet can hold Bitcoin for multiple users and thus distribute Bitcoin among a wider user base than is evident from simply looking at addresses (thus suggesting a lesser concentration).
But there are only a few exchanges, and to the degree that exchanges hold Bitcoin for more and more users, to that degree does the concentration outside the exchanges becomes more stark. Coinbase, for instance, has 73 million users and provides customers with the equivalent of 152 million Bitcoin wallets, though these wallets are internal to Coinbase and thus don’t actually appear on the Bitcoin blockchain. With about 1 million BTC to its name, Coinbase can therefore be thought of as apportioning all these BTC among all these Coinbase wallets, which then, on average, comes to a few hundred dollars per wallet.
So, between understating the concentration of crypto wealth on account of individual users owning multiple addresses and overstating the concentration of crypto wealth because exchanges hold it for multiple users, it’s probably fair to say that the above diagram, simply as it is and without overinterpreting it or qualifying it in terms of types of users (e.g. people vs. exchanges), still gives a reasonable picture of how concentrated Bitcoin wealth is among its users.
However you want to interpret it, the inequality evident in the above chart is, proportionately, much worse than in the US as a whole from the vantage of conventional finance. There are, for instance, 22 million millionaires in the US (12 million if you go by households). With a US population of 333 million, that gives 22,000,000/333,000,000 = 6.6% of the US population that are millionaires. What’s the percentage of Bitcoin millionaries by comparison? From the above chart it is 91,147/34,837,715 = 0.26%. Proportionately, there are over 25 times as many millionaires in the population at large than among Bitcoin owners.
Just how extreme the wealth inequality is for Bitcoin sometimes gets lost in the popular press. An article for Yahoo, for instance, claims in its title “Top 1% of Bitcoin holders own 27% of BTC supply,” and then notes in the article that this is better than for the US as a whole, where the top 1% own half the wealth. But that’s because whoever was writing for Yahoo failed to distinguish 1% from 0.01%. The Wall Street Journal did the math right: “New research shows that just 0.01% of bitcoin holders controls 27% of the currency in circulation.”
From the above chart, 85.66% of all bitcoins are owned by addresses with 10 or more bitcoins, and the number of addresses that own 10 or more bitcoins comes to 147,590. So, given 34,837,715 Bitcoin addresses total, that means that 85.66% of all bitcoins are owned by 147,590/34,837,715 = 0.42%. In consequence, less than half a percent of Bitcoin addresses own more than 85 percent to Bitcoin. By contrast, the top 1% of the US own less than 40% of its wealth.
But maybe the inequality here isn’t really quite so bad. It might be argued that this concentration of wealth among Bitcoin owners is a historical artifact of the way Bitcoin was introduced and subsequently developed within a technologically sophisticated cypherpunk subculture so that early adopters cashed in and that late comers were simply out of luck. But the pattern is repeated across all cryptocurrencies, and the example of Bitcoin concentrating crypto wealth seems unexceptional, if not mild.
As it turns out, other cryptocurrencies concentrate crypto wealth even more savagely than Bitcoin. Ethereum, for instance, in 2020 hit over 50 million addresses, and has more addresses than Bitcoin. Ethereum’s top 100 addresses (or less than 0.0002%) hold just around 40% of all ETH. The top 10,000 addresses (or less than 0.002%) hold just over 80% of all ETH. Solana is as extreme, with the top 0.1% of addresses owning over 90% of all SOL.
It follows that if crypto is going to become widely used in the society at large, the key question we need to be asking is how crypto wealth can be distributed more equitably. It is a question that admits no easy answer. Given existing blockchain technology, there’s no clear path to distributing crypto wealth more evenly.
In fact, it could be argued that crypto’s blockchain technology guarantees that the more sophisticated, educated, technologically savvy users will be the ones to cash in on crypto. By contrast, the majority of the population will be acquiring crypto less out of conviction or knowledge than out of a fear of missing out (FOMO) or on the “hot tip” of those who themselves know next to nothing about crypto. And so a crypto elite would always own way more crypto than the masses.
Perhaps with countries (like El Salvador) and cities (like Miami) officially embracing Bitcoin as money, Bitcoin will diffuse through the population and become more equitably distributed. But that still means it has to get out of the hands of “whales” and come into common use, and how is that going to happen and at what cost to average consumers? One reason crypto keeps reaching unprecedented heights is that investors tend to hold on to it, thinking that it will only go higher, thus reducing the velocity of this form of money. Perhaps these are just growing pains. But perhaps the problem is systemic.
In closing this section, I want to provide a related but separate line of evidence for the stark inequality in wealth distribution that appears common to cryptocurrencies. The Gini coefficient, introduced in the early half of the 20th century, measures the inequality with which wealth is distributed in a population. A Gini coefficient of zero indicates that wealth is perfectly distributed in the sense that everyone in the population has the same amount of wealth. A Gini coeffficient of 100 indicates that wealth is perfectly concentrated in the sense that one member of the population owns all the wealth, and no one else owns any of it.
In the US, according to the Fed, the Gini coefficient throughout the 1970s and 1980s was around 35. In the 1990s it started moving up into the low 40s. Since 1993, it has stood between 40 and 42. The highest Gini coefficients in the world are in Africa, where they can be in the high 50s and go as high as 63. This is the Gini coefficient of South Africa, which currently has the highest Gini coefficient in the world. The one exception could be North Korea, from which it is hard to get reliable data, and whose Gini coefficient has been estimated as high as 86.
What is the Gini coefficient of Bitcoin and other cryptocurrencies? Their Gini coefficients all seem to reside north of 90 (see here and here). Aware of the issue, Vitalik Buterin (the founder of Ethereum and as good an example as there is of someone who embodies Ethereum’s wealth inequality) has tried to pooh-pooh the importance and relevance of the Gini coefficient for cryptocurrencies. But the very fact that he has to address the Gini coefficient indicates that the problem of crypto inequality is real. Moreover, the intuitive measures of inequality given earlier in this section make the same point without the Gini coefficient’s statistical opacity.
It is a fact that crypto wealth is radically centralized. This fact ought to give us pause about the future prospects of crypto, especially in a time of pandemic, when inequality can fuel social unrest.
The whole series in order:
Part 1: Some brute facts about Bitcoin and other cryptos Crypto is transforming money and finance. Like the computer, you don’t need to use one but you’re wise to know the basics. Start here. Crypto functions much like cash, avoiding or minimizing the increasing ability of government or other big institutions to snoop on who you give money to.
Part 2: If you want to stick a toe in Bitcoin’s world … read this first. This short guide offers a quick introduction to the two biggies, Bitcoin and Ethereum. Whether you are investing or just using the system, you need to be very cautious with passwords. It’s not your street corner bank.
Part 3: As money slowly transitions from matter to information… Let’s look at a brief history of cryptocurrencies — which is not quite what we might think. The mysterious Satoshi Nakamoto, founder of Bitcoin, did not invent new concepts in computer science or cryptography; he put them together in a way that worked.
Part 4: How and Why Cryptocurrencies are Revolutionizing Money The trouble is, cryptos are an immature technology at present and that fact may doom many of the current ones. Bernard Fickser looks at the “hard forks” where things went badly wrong. There are problems that decentralization and minimizing the need for trust can’t solve.
Part 5: Is cryptocurrency selling out to centralization? Crypto wealth is radically centralized in the hands of a few, compared to more conventional forms of money. A bit like the politician who goes to Washington to change things and leaves it unchanged — but has become a millionaire in the meantime…
Part 6: Why cryptocurrencies like Bitcoin are not ready for prime time Bernard Fickser at Expensivity — friendly to cryptos in principle — offers an unsparing look at the current problems. Unsolved problems include insane energy consumption, dead coins, and the potential of government subversion, if not suppression.