Cantillon Effects, Crypto and Financial Innovation

Mateusz Siestrzeńcewicz

Richard Cantillon

Richard Cantillon (1680? - 1734??) author of Essai sur la Nature du Commerce en General was a Irish-born 18th-century banker/financial engineer who gave new meaning to the term entrepreneur, possessed deep insights into monetary theory, money markets and merchant finance. An economist of great repute forgotten and rediscovered: see Hayek. Richard Cantillon’s early life is not well documented. Nevertheless, we do know that he was born near Ballyheigue, Co Kerry some time after 1680, and fled to France like many of his rank in Irish Society. His family were dispossessed of their properties as they had fought against the Williamites along side the beleaguered James II in Ireland. This exodus had begun in Elizabethan times and had amplified with the arrival of Cromwell. James II had provided a brief glimmer of hope but this withered as the reality of military defeat became insurmountable. The loss of land and status in early life may also explain why Cantillon took on the heavy risk of relentlessly (and perhaps unwisely) pursuing his debtors, often members of national elites and mortally dangerous adversaries. Cantillon crafted perspectives from a world extending from economic theory deep into finance and banking and possessed insights into the functioning of commerce well before the arrival of the celebrated "Wealth of Nations" later published by Adam Smith. He also more colorfully engineered theories akin to the "invisible hand" by incarnating the concept and language that explained the role of the entrepreneur.

The Quantity Theory of Money and Cantillon Effects

From Cantillon's writings, it is clear he appreciated how Fiat money benefited society but also that money was not a wand that magicked up wealth. In Essai, he examined the neutrality of money but also introduced to the academic debate what we refer to today as Cantillon Effects. Money might be understood to be neutral in a macro sense but at micro level new money produces winners and losers - perhaps somewhat like winners and losers manifest when we consider cryptocurrencies in a contemporary setting. For instance, those cheerleading a particular cryptocurrency - may in fact have a dog in the ring. Any increase in the money supply, (even Bitcoin), will have initially have beneficial effects accruing to those who first receive that new fresh issuance. That means the increase of money changes income distribution in favor of who first receives the new money. Central here is understanding the Quantity Theory and Humphrey (1974) ably describes the evolution of the theory and Cantillon's contribution to it.

"One of the oldest surviving economic doctrines is the quantity theory of money, which in its simplest and crudest form states that changes in the general level of commodity prices are determined primarily by changes in the quantity of money in circulation. This theory dates back at least to the mid-16th century when the French social philosopher Jean Bodin first attributed the price inflation then raging in Western Europe to the abundance of monetary metals imported from the mines of the Spanish colonies in South America. After undergoing considerable refinement, elaboration, amendment, and extension in the late 17th and 18th centuries by John Locke, Richard Cantillon, and David Hume, the quantity theory was integrated into the mainstream of orthodox monetary tradition. Forming the central core of 19th century classical monetary analysis, the quantity theory provided both the dominant conceptual framework for the interpretation of financial events in that century and the chief intellectual foundations of orthodox policy prescriptions designed to preserve the gold standard."

The Classical Gold Standard circa (1870 - 1914), represented an attempted to limit the supply of money because new money must be linked to supply of Gold which for most of history was relatively fixed. In a modern era, Bitcoin is premised also on the notion of limiting the supply of money to the workings of algorithms (see explanation). Below, we investigate the effect of increasing money supply on inflation by scraping data from the FRED database using the pandas reader and appropriate APIs.

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A Proto-Austrian maybe - definitely revered as one

Known by many today as the “Father of Political Economy” his work Essai, published 21 years after his apparent death in 1734 was largely overlooked by a generation who immediately followed. Adam Smith was a rare exception and William Stanley Jevons a century later elevated Cantillon's work to be the "cradle of political economy" to a more English speaking readership. Dr. Mark Thornton has described Cantillon as a proto-Austrian (perhaps a Monetarist not unlike Milton Friedman). But Cantillon, if a monetarist described nuanced rather than mechanical relationships between money and prices. Cantillon criticized John Locke for laying down "as a fundamental maxim that the quantity of commodities and merchandise in proportion to the quantity of money serves as the regulator of market prices .... [H]e has clearly seen that the abundance of money makes everything dear, but he has not considered how it does so. The great difficulty of his research consists in finding out in what way and in what proportion the increase in money raises the prices of things." (Essai p.160) Cantillon stressed that the relationship between money and prices was not the direct one so often assumed by "naive" versions of the quantity theory. This might be usefully integrated into current modelling of asset price inflation. See Thornton (1998). Antoin Murphy has documented many facets of Cantillon's life and it would appear part of the motivation for writing Essai was linked to a need to construct a credible legal defense against a growing number of very determined well positioned antagonists. His economic perspectives were not clouded by a desire to fawn to any regional elite, in fact he seemed to challenge the then hierarchy and views that supported that hierarchy. Not unlike Ricardo and Keynes, Cantillon used his deep understanding of markets to amass fabulous wealth notably during the Mississippi Scheme and South Sea Bubble. Lending to investors in these schemes and then selling their collateral meant Cantillon no doubt made a great many enemies.

The Mississippi and South Sea

These episodes of financial upheaval largely played out at the same time. Cantillon, as one of Law's banker recruits, was never too far from policy circles where many of these considerations were necessarily ventilated by senior officials, as John Law and his sycophants monetized the huge French debt. Cantillon lent money to the powerful and well positioned in French society who got caught up in the mania of get-rich(er)-quick(er). He demanded in return from debtors their Mississippi Scheme shares as collateral. (This manoeuvre was not unlike the margining afforded to traders in a more contemporary market setting. We explore this a little later.) Cantillon cleverly (perhaps unethically) used this collateral to engineer a massive short position - a market trading position which implies you can make money as the market drops. This conceivably amounts to predatory lending. The "Big Short" provides a modern parallel tale as to how Cantillon engineered massive profits at the expense of his borrowers. This strategy of selling collateral ensured that Cantillon had always funding available at his bank. It also implied he too had skin in the game which perhaps should temper a bit our accusations that he acted immorally. See Taleb (2018) definition of fairness. Cantillon also understood the virtues and limits of paper money and his actions contributed to dismantling the grand schemes of the Mississippi and South Sea. This would have put the Kerryman in the line of fire in a fashion not dissimilar to George Soros when the latter scuppered Britain's adherence to the Exchange Rate Mechanism almost three centuries later. Both men are/were figures of admiration and hate. Both men went to great lengths to justify canonically why their actions were not mischievous or reckless but were based on sounder principles of commerce. Both men devoted a significant part of their later careers to scholarly activities, wrote books and George Soros engaged in significant University philanthropy and sponsorship.

Mississippi and South Sea: a parable for Bitcoin and Libra.

Cantillon hugely benefited from speculating against the introduction of Fiat money in France in his own time. This did not mean Cantillon did not engage with Financial Innovation or understand it or in any sense repudiate same. In fact, the contrary. Cantillon had a deep understanding of monetary theory and banking practices across Europe and understood many subtleties of the quantity theory of money that had eclipsed many contemporary monetarists who adhere to a very mechanistic quantity theory. Cantillon, for instance, understood how nonneutral effects might arise and explained in a scientific/methodical fashion, the disproportionate gains/losses obtained by some groups when new money is printed. Policy makers might benefit a bit from perusing Essai, especially when we consider who controls the supply of money be it: the central bank, bitcoin miners or data company launching/designing the architecture of new digital currencies. In a gone by era, free banking would have enabled some actors other than government to print money and this resonates with current developments with Bitcoin, Libra, Ethereum. Cantillon noted that any increase in the money supply will have initially beneficial effects accruing to those who first receive that new fresh issuance. That means the increase of money changes income distribution in favor of who first receives the new money. Then, depending on the predilections of those who first receive the new print, some products will experience an increase in demand, while other goods might experience a relative decrease. Cantillon observed that if the new money comes into the hands of savers, that the interest rate would fall, but if it comes to consumers, the interest rate would increase, as entrepreneurs would need to borrow more to meet the increased demand for goods. Cantillon wrote with the direct experience of the doomed John Law schemes to print money with abandon producing absolute winners and losers. We might note Cantillon understood key nuances to the Mississippi debacle - the promise of a new project with ostensibly endless bounty. He no doubt understood the limits of printing money but also the opportunities that exuberance presents to speculators. The Cantillon Effect would also suggest that those who control the printing press also gain significant control over the spoils. In that sense, Bitcoin, Libra, Ethereum would all appear to be modern day manifestations of the John Law scheme and the hustle on Quinquepoix, Paris. A new discovery with boundless promise is often the catalyst combined with new charismatic actor like Law or Musk will inevitably produce Cantillon effects (winners and losers). More fundamentally of course resides the real power of who controls the money supply akin to precepts of free banking or wildcat banking. The most valuable license a government can grant is license to print money. That can come in many forms. Issuing mortgage mortgage backed securities might be viewed as printing money, issuing debt or derivative products linked to debt, or entrusting the regulation of those activities to ISDA, a self policing body is form of printing money in a free or near free banking architecture.

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Cantillon and Financial Innovation

Interestingly, Cantillon deployed option strategies during this psycho-drama to leverage additional gains from understanding the euphoria and then inevitable flight to quality often associated with bubble mania. He also speculated against the French currency in a manner not unlike George Soros in another epoch. It would seem the Irishman was willing to use every tool available to eviscerate those prepared to gamble. Antoin Murphy, in his book Richard Cantillon Entrepreneur and Economist , p.183, noted that the Irish banker extensively employed option strategies with dutch traders. (Option trading may have expanded in Holland with establishment of VOC or East India Company). Cantillon was not unique in this regard. John Law induced investors to purchase call options for the Mississippi Scheme. Option trading is generally time-stamped in text books as beginning with the setting up of the CBOE in 1973. And true - in terms of scale nothing compares to the growth in derivatives trading that occurred post 1973. All the same, it is worth pointing out that De la Vega had a complete understanding of put-call parity as early as 1688 although in a modern literature this relationship is generally attributed to Stoll (1969). It is well documented that as early as the Tulipmania of 1636-37, the trading of futures and options on bulbs in Haarlem was well established. (For an interesting Podcast mapping out the economics and historical context for Tulipmania that entertainingly connects up the dots, please follow link). Cantillon's speculative machinations also provides a glimpse of how options were used by contemporaries and perhaps also reveals trading/gambling practices of the time.

Amsterdam and Financial Innovation

Historically, Amsterdam has been an epicentre for institutional innovation. The foundation of the Dutch East India Company (VOC) is generally viewed as marking the setting up of the world's first publicly listed company in 1602. The VOC was the first company to be listed on the Amsterdam Stock Exchange (the first of its kind) which issued stock and bonds to the general public. The establishment of the Amsterdam Stock Exchange (Beurs van Hendrick de Keyser) by the VOC, is generally recognized as the genesis of secondary market trading in the securities issued by firms. This exemplified greater sophistication than peer republics in Italy who at the time had already demonstrated quite an amount of innovation in banking and government bond issuance. The Dutch pioneered stock futures, stock options, short selling, debt-equity swaps. Joseph de la Vega's Confusion of Confusions (1688) was the earliest book about stock and option trading. These innovations accompanied innovations occurring in paper money and bank money. The establishment in 1609 of the Bank of Amsterdam (Amsterdamsche Wisselbank), is sometimes considered to be the first central bank. The Riksbank established in 1668 may perhaps conform more to our modern conception of a central bank. Nevertheless, the setting up of the Amsterdamsche Wisselbank led to the introduction of bank money and the underlying principles culminating in the introduction of the first ever international reserve currency, the bank guilder. The success of the Wisselbank more than likely spawned the establishment of the Riksbank (1668) and more formal central bank arrangements. The Bank of England was established in (1694) and coincided with the arrival in London of William of Orange. In his entourage, no doubt, came financiers who may have helped usher into England much by way of financial innovation and perhaps the where-with-all to military conquest against the hapless James II. It worth noting that despite the shortcomings of many actors in the process of spearheading financial innovation - John Law not being an insignificant figure - those innovations like paper money or VOC stock equity and no doubt blockchain technology, tend to survive and become essentail to our financial infrastructure. See below images from the Rijksmuseum.

The relevance Cantillon Effects in the Crypto era

Framing cryptocurrency in terms of Cantillon Effects is quite useful in examining incentives of politicians, regulators and private agents. This involves examining how changes in the issuance, distribution, or adoption of cryptocurrencies impact relative prices, wealth distribution, and resource allocation within the crypto ecosystem and the broader economy. It also helps us understand how key stakeholders are likely to act - the Mississippi Bubble and South Sea Bubbles give us a clue and allow us to understand the motivation and incentive structures when financial innovation is introduced. There will be likely significant enthusiasm from early adopters and some significant wealth amassed which can act as a trigger. Unfortunately, some of this gain will come the expense of late adopters. Cantillon's behaviour as a banker (puffer with a short position) during the Mississippi bubble is instructive.

Initial Distribution of Cryptocurrency
Early adopters of a cryptocurrency often acquire it at a lower price or through mining when the cost of acquisition is low. As adoption grows, the value of the cryptocurrency increases, disproportionately benefiting early adopters while late entrants purchase at much higher prices. This mirrors the Cantillon Effect, where those closest to the issuance of "new money" gain the most.
Mining Rewards and Staking Yields
In proof-of-work systems, miners who validate transactions and secure the network receive block rewards. These miners are the "first recipients" of new cryptocurrency issuance. In proof-of-stake systems, validators earn staking rewards, often benefiting those with significant holdings, reinforcing wealth concentration. Miners or validators can reinvest their rewards early, potentially influencing the ecosystem before the broader market adjusts.
Tokenomics and Pre-mines
In many projects, developers or venture capitalists receive a significant share of tokens before the public. This early access mirrors the Cantillon Effect, as they can influence markets and allocate resources before general adoption or inflation of token supply. Early holders may sell their tokens at inflated prices during bull markets, leading to wealth redistribution similar to traditional monetary systems.
Decentralized Finance (DeFi)
In DeFi protocols, early liquidity providers earn rewards in the form of native tokens, giving them an advantage in accumulating wealth. These rewards often lead to capital flowing disproportionately into high-yield projects, potentially distorting the allocation of resources within the DeFi space.
Inflationary and Deflationary Models
Some cryptocurrencies have inflationary supply models, while others are deflationary. In inflationary systems, Cantillon Effects may arise if the new tokens are distributed unevenly, benefiting those who receive them first. Deflationary systems may favor early adopters, as the scarcity of tokens increases their relative wealth over time.
Cryptocurrency Adoption Across Regions
Cryptocurrencies often gain traction in specific regions or among certain demographics first. These groups may benefit from increased purchasing power or financial inclusion before others catch on.
Speculative Bubbles and Resource Misallocation
Cantillon Effects could explain the boom-and-bust cycles in crypto markets, where large inflows of capital into speculative projects distort resource allocation, leading to bubbles. When these bubbles burst, it highlights how initial recipients of capital benefited disproportionately compared to late investors who bear the losses.
Political First-Mover Advantage
Politicians may also seek to exploit Cantillon Effects in the cryptocurrency space by positioning themselves or their allies to benefit from early adoption and regulatory influence. For instance, former President Donald Trump’s pivot toward crypto, including the issuance of NFTs and softened rhetoric, highlights how political actors can gain from first-mover advantages. Additionally, a likely downsizing in enforcement by the SEC and CFTC under certain administrations could reduce fines and regulatory scrutiny, creating a favorable environment for large players in the crypto industry. This dynamic allows politically connected entities to amass wealth and influence before stricter regulatory measures are reinstated, mirroring the early distribution advantages seen in Cantillon Effects. This would augur poorly also for Gary Gensler who adopted a tough stance on crypto.

Understanding the basic technology of Blockchain

Blockchain technology represents a candidate future source of financial innovation. It creates an architecture to immutably record transactions which are accessible to all participants in a dedicated network. A blockchain database is comprised of a number of blocks linked/chained together through a reference hash in each block to the previous block. Each block records one or more transactions, which reflect changes in the listed owner and their claims to assets. New blocks on the chain are produced through a consensus mechanism. Members of the blockchain network must confirm transactions are valid. The blockchain is fully peer to peer, with no centralised trusted third party. The operation of the blockchain can operate independently of a government agency and in the absence of a co-ordinating financial institution. Importantly for a crypto to work properly - it needs to be scarce. The bitcoin implementation of blockchain represents the largest implementation to date of the technology. For a relatively deep but brief overview please see below the 3Blue1Brown explanation.

For a deeper dive that considers the design of Bitcoin and other cryptocurrencies and how they function in practice, focusing on cryptography, game theory, and network architecture - please see here:

Other Blockchains and emergence of Smart Contracts in financial markets

Barclays Bank, based in the UK, have been investigating 2017 ways to trade derivatives using so-called “smart contracts” and blockchain. Derivatives provide a useful archetypal smart contract because essentially they bed in contingency payments. Blockchain technology like Ethereum provides scope for smart contracts to be recorded in an immutable and secure way. Regulators and other stakeholders would have an immutable chain record of transactions taking place. This could obviate somewhat the heavy administrative cost of lawyers and bankers engaged constantly in monitoring derivative positions. To validate a transaction, all parties would submit their ISDA style contracts. When all parties agree on the contracts, then the transaction – in the case of Barclays’ experiment, a derivative – would be traded.

Cantillon Effects and Advent of Cryptocurrency

Financial innovation tends to have very real impacts on the flow of money, payments, patterns of trade and even distribution of wealth. Those who come to control the levers of printing money are not immune from the benefits that the printing press bestows. John Laws dalliances likely influenced Cantillon's appreciation of who are the winners and losers when financial innovation sweeps into a new host. Many economists have considered the effects of monetary systems and their policies on income and wealth inequality. The redistributive impacts of money creation are what we generally understand to be denoted by ‘Cantillon effects' which captures the change in relative prices resulting from a change in the money supply. Cantillon seemed to have realized that those who receive the newly created money first had incomes that continued to increase, while the tail receivers of the newly created money suffered declines in purchasing ability due to an inflation effect. In a modern setting, we might consider the effects of introducing cryptocurrency into a modern economy. Cryptocurrency are typically built on intangible assets created through a competitive and decentralized process called ‘mining’. These digital assets like Bitcoin or Ethereum are designed to work as a medium of exchange that deploy strong cryptography to secure financial transactions. In principle, trust or consensus is built into the financial architecture by setting out protocols to map:

the creation of additional units of currency

the verification process for transferring assets (so as to remove the "Byzantine Generals' Problem")

the decentralization of control (so as to remove effect of stakeholders of with vested interests)

The means by which this architecture works often relies upon distributed ledger technology (referred to as blockchain). The Blockchain obviates the need to depend on centralized control - so no real need to pivot around a conventional central banking system or centralized clearing. An ostensible benefit stemming from this financial architecture conceivably relates to the supposed strong anti-inflation foundations. For instance, Bitcoin’s inflation rate was hardcoded into the software akin to Milton Friedman’s K per cent rule that called for an algorithmic and regulated price stability. This, in principle could eliminate human-error or connivance to manipulate the monetary base for political expediency. The question remains however given the Mississippi and South Sea bubbles: are the protocols strong enough to remove human temptation. Does the John Law scheme to print paper serve to signal how redistributive income/wealth effects will likely pan out in the wake of cryptocurrencies. We might ask how should central banks respond and what scope do they have to establish their own digital currency - perhaps with a Friedman’s K per cent rule? Could a digitalized dollar or euro map out a pathway for central banks to established independence from political electoral calendar?

Antoin Murphy on Cantillon

According to Murphy p. 187 "In summary then, Cantillon, as is quite clear from Chandos's letters, had made a considerable financial killing on his option contract with Pierre Huguetan. Once again he had shown his versatility in choosing the right financial instrument to exact maximum profit. Having made his paper fortune, Cantillon's attention had turned to debt collecting. He was owed considerable sums of money by some of the most prominent traders in the European stock exchanges. His list of debtors was impressive, ranging from the Duke of Chandos, to John and William Law, to Joseph Gage, Lady Mary Herbert, the Duke of Powis, and Pierre Huguetan. He was to discover that debt-collecting was an extremely nasty business." Options are a zero sum game and financial gain inevitably coincided with heavy losses for others and many powerful enemies were made during this period. He was jailed briefly in Paris and spent much of the 1720s engaged in litigation. Essai in part represented a marshaling of ideas that challenged the mores of the early 18th century and amounted to a legal defense of Cantillon's speculation. Essai challenged the hegemony of elites, their grasp over economic levers and their dalliances with printing relentlessly paper money. Cantillon's ideas were radical and perhaps this may explain why Essai circulated as a transcribed manuscript under pseudonym, a sort of charter for modernizing (inventing) economics or treatise rationalizing certain property rights and the limits of paper money. To a modern readership, Cantillon economic insights would not appear to be particularly disruptive or rebellious given the current orthodoxy. His peers however would probably not have shared this perspective. Cantillon ranks highly as a (Schumpeterian) revolutionary and was perhaps even ultimately a martyr for his cause. He understood paper money as a financial technology and the limits of that same technology. He understood money was political and the creation of money produced winners and losers. He also appreciated that exuberance fused with money creation would precipitate an inevitable series of asset price and credit bubbles which he remorselessly exposed through a series of clever bets. His dispassionate scientific approach to economics however has made him possibly a little too amorphous and distant and he has not been to date a figure that has emoted much by way of eulogy in his native land. This of course could change and perhaps given the new generation of revolutionary fintech "entrepreneurs" that hail from the same region perhaps Cantillon's legacy lives on in other ways. Hopefully, the Collison Brothers will have a happier ending in store. The dramatic circumstances surrounding Cantillon's "death" is still a source of intrigue. Here perhaps we should let Antoin Murphy relate that colourful episode. Stripe may also have a happier ending compared to Baltimore Securities.

Just in case we forget: Rijksmuseum

See more images from the Rijksmuseum

Some interesting Podcasts on Blockchain Technology

IEEE Blockchain IEEE Future Directions interviews experts in the field of blockchain across various industries. IEEE Blockchain Podcasts provides you access to the industry’s blockchain innovators, experts and enthusiasts.

Econtalk and Gavin Andresen 2011

Econtalk and Gavin Andresen 2014