How Cryptocurrency is Creating a New Wealth Effect

 

 The confidence boost from additional cash, known as the wealth effect, becomes a significant topic whenever cryptocurrency prices surge. Researchers have sought to measure this impact, discovering that cryptocurrency windfalls in the US are not spent like lottery winnings. So far, the effect on the $28 trillion American economy has been relatively modest. However, if the cryptocurrency market continues to grow, the study provides insights into potential changes in consumer spending habits.

The researchers estimated that over a decade, new wealth from cryptocurrency increased household consumption by about $30 billion, with each dollar of unrealized gains leading to about nine cents of spending. This spending rate is nearly double that of stock-market returns, but it's only about one-third of the spending rate from lottery winnings. Contrary to the lavish spending seen on social media, not all the money was spent on luxury items like Lamborghinis. Some of it was used for home purchases, boosting real estate markets in regions where cryptocurrency is popular.

"If households view crypto like gambling, we would expect them to spend their gains similarly to lottery winners," said Darren Aiello, assistant professor of finance at Brigham Young University's Marriott School of Business and one of the study's authors. 

This topic is likely to draw increased attention from economists, especially after the recent launch of spot-Bitcoin exchange-traded funds, which have expanded the pool of potential crypto investors.

The researchers, who presented their findings to the Federal Deposit Insurance Corp. in March, come from Northwestern University, Emory University, and Imperial College London. They analyzed data from 60 million people between 2010 and 2023, examining millions of bank, credit, and debit card transactions to understand how crypto wealth influences the American economy. They found that 16% of the households studied made deposits to retail cryptocurrency exchanges at some point over the past decade.

Linking spending to crypto investments can be challenging, as some individuals might invest in cryptocurrencies to save for significant purchases rather than deciding to make large purchases only after experiencing a crypto windfall. To address this, the researchers focused on the portion of household crypto gains driven by long-term holding instead of recent investments, directly measuring the causal effects of crypto on spending.

"There is significant debate about the role crypto should play in a household's portfolio due to its high volatility and uncertain fundamentals," said Jason Kotter, an assistant professor of finance at BYU and co-author of the paper, in an interview.

Noelle Acheson, author of the "Crypto Is Macro Now" newsletter, believes that understanding how crypto appeals to different types of investors is more significant than its implications for the broader economy.