For Bitcoiners, A Crash Course on Negative Interest Rates

By Kyle Torpey


Bitcoin’s key value proposition is that it removes the third parties that have plagued digital currency systems for the entire history of their existence. Bitcoin users have complete control over their own funds, which means that money cannot be inflated away by a central bank, easily seized by law enforcement, or censored in terms of who is allowed to send or receive specific types of payments.

In the current state of the global economy, a key topic that is mentioned frequently in the context of Bitcoin is negative interest rate policy (NIRP). While negative interest rates are often discussed by pundits in the financial media, it’s not something that every Bitcoin user completely understands.

So, what are negative interest rates? How do they work? And can Bitcoin help guard against them? Let’s take a closer look.

What is NIRP?

Central banks have been using unconventional, unprecedented forms of monetary policy since the start of The Great Recession back in 2008. Quantitative easing (QE) has become increasingly well known over the past ten years. But more recently, negative interest rates have become another key tool used by the central banks of Europe, Japan, and other major economies in an effort to increase economic activity and hit their inflation targets.

Negative interest rate policy is a tool by which central banks set target interest rates below zero. This means that depositors at the central bank or even private banks will be charged a fee on their deposits, rather than earning interest.

The basic goal of NIRP is to get money moving around the economy as much as possible in an effort to avoid deflation, which is viewed by some mainstream economists as a great evil. In their view, falling prices will lead to the hoarding of savings rather than spending or investment, which leads to a further slowdown of the economy, more unemployment, and eventually a deflationary spiral. This school of thought is known as Keynesian economics, as it is mostly based on the work of the economist John Maynard Keynes. 

While the World Bank referred to the proliferation of negative interest rates throughout Europe in a time of non-crisis as “unprecedented” back in a 2015 report, half of the top 10 global economies are now following a negative interest rate policy through their central banks.

Problems Popping Up for Banks

UniCredit CEO Jean-Pierre Mustier has made the case that bankers should rejoice in negative interest rates, because without them the economy would be in much worse shape, which means even lower profits for banks. But as one can imagine, increasing expenditures for banks has not been good for business.

“Banks are now finding themselves between a rock and a hard place having to make bold decisions on either charging their clients on their deposits and risk them leaving, or bear the brunt of excess reserve charges, further squeezing profitability,” explains a recent CoinShares report.

According to Bloomberg, bank profits in Denmark have plunged as a result of the country’s negative interest rate policy. Denmark’s NIRP is a result of the Danish krona’s peg to the euro, as the European Central Bank (ECB) implemented negative rates back in 2014.

Barron’s reports that the CEOs of Germany’s two largest banks have referred to the ECB’s continued negative interest rate policy as unsustainable and noted that it will have serious side effects on the banking system and overall economy.

An ex-CEO of Credit Suisse and UBS, which are the two largest banks in Switzerland, recently took things a step further by simply referring to NIRP as “crazy.” 

In terms of the effect of NIRP on the average Joe, the key issues are threefold: (1) potential loss of savings through additional fees charged by banks, (2) a potential further loss of savings through inflation if NIRP is used for an extended period of time, and (3) a generally more volatile economy, as explained by Austrian business cycle theory.

Bitcoin Fixes This

With Bitcoin, the monetary policy is set in the consensus rules that are run by every node on the network. While it would be technically possible to implement something similar to NIRP in a cryptocurrency system (Freicoin did this in the past), it would be extremely unlikely for such a change to gain consensus among the nodes on the network. Without network consensus, it could not be implemented.

As illustrated by the years-long block size debate, it’s extremely difficult to change Bitcoin’s consensus rules. Changing Bitcoin’s monetary policy or implementing an effective tax on Bitcoin holders would be an extremely controversial change, and it would likely only happen in a situation where transaction fees had proven unable to take the place of the block subsidy over time as the key incentive for miners is to secure the network. Even then, there are other potential solutions that could be used, as pointed out in a recent research paper.

Much like gold, Bitcoin is hard money. While having a third party moderate the supply of a currency can have its benefits in terms of short term price stability, there is an implicit tradeoff in terms of political pressure that can be applied to the central bank. This could lead to policies that may not be in the best interest of the fiat currency’s users. Notably, U.S. President Donald Trump has been pushing the U.S. Federal Reserve to lower interest rates for quite some time now.

Bitcoiners don’t have to worry about this kind of thing. Bitcoin is often criticized for its wild price fluctuations, but there’s simply no way to achieve its key features, such as an uncontrolled monetary policy, without removing the ability for someone to regulate the supply of money. In a decentralized system like Bitcoin, there is no one to set the price of the money other than the free market.

Bitcoin has also been criticized by mainstream economists, such as Paul Krugman, due to the deflationary effect the digital cash system would have on the global economy if it became a widely-adopted form of money. With no central banker around to artificially lower interest rates, the cost of borrowing Bitcoin would also be left to float on a free market basis, likely climbing to levels much higher than they are today due to Bitcoin’s inherently deflationary issuance schedule. This embrace of deflation and higher savings rates is basically a mainstream economist’s worst nightmare.

Economists can debate over whether a deflationary economy would be a net negative for society, but Bitcoin adoption is left up to the market, not bureaucrats. If the incentive structures around Bitcoin lead to further adoption of the cryptocurrency, then those who think deflation is bad won’t be able to do much of anything about it.

Many financial pundits have suggested that the “digital gold” meme, in the context of policies such as negative interest rates gaining traction around the world, has been behind Bitcoin’s positive price movements in 2019. A “perfect storm” could be brewing for 2020, as monetary and economic policies that aren’t kind to savers are combined with Bitcoin’s next halving event. If the Bitcoin bulls are right, this could eventually take the price to $100,000 by the end of 2021.

Of course, it’s also possible that Bitcoin could simply act as a sort of added competition that was needed to get governments to improve the value proposition of their local currencies. This is a theory that has been posited by the likes of The Bitcoin Standard author Saifedean Ammous and applied cryptography consultant Peter Todd.

When central banks are forced to compete with a truly free market money in Bitcoin, the idea of punishing savers through NIRP may not seem like such a viable idea.

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