Wednesday, October 18, 2023

Crypto adoption in America

Source: America Loves Crypto

You may have recently come across the America Loves Crypto marketing campaign, sponsored by Coinbase, the U.S.'s largest crypto exchange. In an attempt to promote the voting power of crypto owners, the website makes the claim that 52 million American adults currently hold crypto, which constitutes 20% of the U.S. adult population. If true, that's a massive voting block.

As the source for its 20% statistic, Coinbase cites an online survey of 2,202 adults that it commissioned from Morning Consult last February, which among other questions queried respondents for how much crypto they currently hold.

If you've been following other sources for cryptocurrency adoption data, Coinbase's 20% statistic seems... questionable?

To see why, let's dig into U.S. crypto adoption data. What follows is a quick rundown of what the best surveys have had to say about Americans crypto ownership. Later on in the article I'll get into who they are, how much they own, and why they hold it.

1) The granddaddy of all U.S. payments surveys is the Federal Reserve's Survey and Diary of Consumer Payment Choice, or SDCPC. The SDCPC is a long-running data collection effort that tries to paint a comprehensive picture of U.S. consumers' payment preferences and behavior. It fortuitously began to incorporate crypto-related questions way back in 2014, although crypto is just a tiny portion of the incredible amount of data collected by the SDCPC.

The Fed's SDCPC is run through the University of Southern California's Understanding America Study panel. In its 2022 iteration the SDCPC polled more than 4,761 participants. Notably, the SDCPC includes both a survey and a 3-day diary portion. Diaries are more labor intensive to administer than surveys, but provide better information since they minimize recall bias.

The SDCPC found that 9.6% of American adults owned cryptocurrency in 2022, up from 9.1% in 2021, and far higher than the 0.6% it polled back in 2015. However, that's far less than Coinbase's 20% claim. Only one of these numbers can be right. Which one is it?

The SDCPC's historical findings are in the table below.

U.S. cryptocurrency adoptions rates. Source: Federal Reserve's 2022 Survey & Diary of Consumer Payment Choice

2) The Federal Reserve publishes another survey that also sheds light on U.S. crypto adoption. The Fed's annual Survey of Household Economics and Decisionmaking (SHED) examines the financial lives of American adults and their families, and is therefore more general than the Fed's SDCPC, which is focused exclusively on payments.

The Fed's SHED is administered by Ipsos using Ipsos's KnowlegePanel panel. In 2022, 11,667 participants completed the SHED.

The SHED only began to include questions about crypto in 2021. It finds that 10% of Americans used cryptocurrency during 2022, where "using" is defined as buying, holding, or making a payment or transfer with crypto. This amount was down from 12% in 2021 (see table below). The number of Americans who held cryptocurrency as an investment, a narrower definition than "using", fell to 8% in 2022 from 10%.

Source: Federal Reserve's 2022 SHED

The SHED's 8-10% number neatly confirms the SDCPC's 9.6% finding while disaffirming Coinbase's 20% statistic.

3) The next decent source for crypto adoption data is tabulated by a group of four economics and finance researchers using quarterly surveys of the Nielsen Homescan panel, comprised of 80,000 households. With response rates of 20-25% per survey, that represents data from 15,000 to 25,000 respondents.

Weber, Candia, Coibion, and Gorodnichenko (Weber et al) found that at the end of 2022, the fraction of all households owning crypto had risen to 12%. The black dotted line in the chart below shows how ownership rates have changed over time.

Source: Weber et al (2023) using Nielsen Homescan Panel data

4) The fourth in our survey of crypto surveys was conducted by the Pew Research Center using its American Trends Panel. In a March 2023 survey of 10,701 panelists, Pew found that 17% of American adults have "ever invested in, traded, or used" a cryptocurrency. This is a very broad category, and would presumably include someone who casually bought $25 worth of bitcoin back in 2015 and sold it three days later, and has never touched it again.

Drilling in further, of the 17% who have ever owned or used crypto, 69% report that they currently hold some, which works out to a 2023 ownership rate of 11-12% among American adults. That's not too far off the two Fed surveys and Weber et al, but significantly different from the Coinbase result.

5) A fifth source of data comes from Canada, which serves as a decent cross-check against U.S. data given that both countries are quite similar in terms of culture and geography. Of the two key Canadian surveys, the first is the Bank of Canada's long-running Bitcoin Omnibus Survey (BTCOS), administered by Ipsos, which amalgamates participants from three different panels.

The 2022 BTCOS polled 1,997 Canadians and found an ownership rate of 10%, down from 13% the year before (see chart below). This constitutes a lower bound to ownership rates since it only includes bitcoin owners. The 2022 BTCOS also finds that 3.5% of Canadians own dogecoin and 4% own ether. However, it's not possible to add these amounts to the 10% bitcoin ownership number since many respondents own multiple types of crypto. 

Source: Bank of Canada 2022 Bitcoin Omnibus Survey

The second Canadian survey of note was carried out by the Ontario Securities Commission in 2022 to explore Canadian attitudes towards crypto assets. Conducted with Ipsos, the survey polled 2,360 Canadians in early 2022. It found that 13% of Canadians currently own any type of cryptocurrency, including crypto ETFs, which are legal in Canada but illegal in the US.


So there you have it. The two Federal Reserve surveys put crypto ownership at 9.6% and 8-10% respectively in 2022, while Weber et al peg it at 12% using Nielsen Homescan data. Pew has American crypto ownership at 11-12% by early 2023. And in Canada, the Bank of Canada calculates bitcoin ownership to be at 10% by the end of 2022, while the Ontario Securities Commission pegs total crypto ownership at 13% in early 2022, before much of crypto imploded.

Given this range of data, the 20% adoption rate that Coinbase's Morning Consult survey trots out is a glaring outlier and probably deserves to be thrown out. The American crypto owner is a potentially sizeable voting group, but not as big as Coinbase would like us to believe.

For what it's worth, I've found a few other odd things with Coinbase's Morning Consult survey that further adds to my skepticism. Morning Consult reports that 8% of respondents currently own a cryptocurrency called USDC, down from 10% the quarter before (see here for more). The survey also says that 5% currently own Tether. USDC and Tether are stablecoins. To anyone who follows crypto closely, the idea that 1 in 10 Americans own any particular stablecoin is absurd. Given that Morning Consult has surely got this wrong, perhaps through a sampling error, that makes you wonder about the quality of their overall work.

However, even if we ignore Coinbase's Morning Consult survey, the 9.6% adoption rate found in the bellwether SDCPC is still breathtakingly high. In just fifteen years, crypto has gone from a strange niche product to something that is being held by tens of millions of Americans.

What additional facts do we know about America's crypto owners?

Size of holdings

Going through the SDCPC data, the majority of Americans who own crypto only have a little bit of the stuff. Out of all U.S. crypto owners surveyed, 45% owned just $0-200 worth of crypto in 2022. This is illustrated in the chart below. The median quantity of crypto held was $312. Given such small amounts, I doubt that these crypto owners qualify as durable crypto adopters, as opposed to folks who've jumped on the bandwagon when they saw a Superbowl ad from Coinbase, bought some dogecoin, and have since stopped paying any attention.

The SDCPC data suggests that 1 in 4 crypto owners are what I call crypto fundamentalists, holding more than $2,000 worth of crypto. Given that 90% of Americans don't hold any crypto at all, two in every 100 Americans qualifies as a crypto fundamentalist.

This skewed distribution of crypto ownership is confirmed by survey results from Weber et al and the Nielsen Homescan panel. An outlier group of hard-core owners, representing around 8% of all crypto owners, allocates their entire portfolio to crypto (see chart below). By far the largest group of crypto owners is comprised of small dabblers who put just 0-5% of their portfolios into crypto.

Source: Weber et al (2023) using Nielsen Homescan Panel data

Reasons for ownership

Why do Americans own cryptocurrency? Despite being labelled as "currencies," cryptocurrencies are not generally used as a medium for making payments. Price appreciation is the dominant motivation for owning them.

When the SDCPC survey queried participants in 2022 for their "primary reason for owning virtual currency," the most popular answer (at 67%) was investment (see chart below, orange rows). The second most popular reason (21%) was "I am interested in new technologies." It was rare for respondents to list any sort of payments-related use case as their primary reason for ownership. As for lack of trust in banks, the government, or the dollar  all of which are common cryptocurrency themes these were rarely mentioned in 2022 as a primary reason for ownership.

Interestingly, Americans crypto owners were not always so obsessed with price appreciation. In 2014, the SDCPC found that American crypto currency owners tended to offer a much broader set of motivations for owning crypto, including lack of trust, cross-border payments, and to make purchases of goods and services (see chart above, blue rows).

The dominance of investment as the motivating reason for owning crypto is echoed in Weber et al's analysis of Nielsen Homescan survey data. Respondents were allowed to give multiple reasons for owning cryptocurrency, the most popular reason (see chart below) being to take advantage of "expected increase in value." The desire to use cryptocurrencies for international transfers was almost nonexistent, as was the desire to be "independent of banks."

The Fed's SHED survey isolates the same pattern as the other two surveys (see table below). Of the 10% of Americans who report using cryptocurrency in 2022, most do so as an investment. One small difference is that the SHED reports that around 2% of all survey participants used crypto to send money to friends of family in 2022. This suggests the transactional motive, while not primary, may be somewhat more prevalent than the previous two surveys suggest.

Source: Federal Reserve's 2022 SHED

Types of cryptocurrency held

What sorts of crypto were popular with Americans? Using Nielsen Homescan data, Weber et al found that of the 11% of survey respondents who are crypto owners, 70% held bitcoin while just over 40% held ether and dogecoin respectively.

This distribution is echoed in the Fed's 2022 SDCPC. Almost 65% of all crypto owners surveyed held bitcoin (the data is here), making it the most popular type of cryptocurrency. Meanwhile, 44.8% held ether and 38% held dogecoin, a coin that was originally created as a joke in 2013. That works out to around 4-5% of all Americans who are in on the joke.

Crypto bros

There's a reason that people throw around the term "crypto bro." Without exception, all of the U.S. surveys find that cryptocurrency owners tend to be young, male, and have a high income. 

The same goes for Canada, where in 2022 there were three male bitcoin owners for every female. The Bank of Canada has also regularly tested bitcoin owners for their degree of financial literacy using the Big Three questions method, and finds that they tend to have lower financial literacy than non-bitcoin owners.

Interestingly, in addition to isolating the crypto bro pattern  the tendency for crypto owners to be young, male, and wealthy  both the Pew survey and the Fed's SHED (see table below) find that U.S. crypto owners are more likely to be Asian, followed by Black and Hispanic, and least likely to be White.

The Fed's SHED survey dug deeper into usage by demographics, and found that while "investment" remains the driving case for owning crypto, and that the rich use the stuff proportionally more than the poor, certain demographic groups tend to rely on it more than others for making transactions. Specifically, the SHED finds that among low income families, 5% report an investment motivation for holding crypto while 4% report a transactional motivation.

Source: Federal Reserve's 2022 SHED

All of this data suggests to me the existence of three American crypto archetypes. 

The most dominant crypto archetype is the young wealthy male crypto dabbler, most likely non-white, who holds a few hundred bucks worth of doge or some other coin in order to gamble on prices going up. Coinbase's America Loves Crypto campaign makes the claim that "the crypto owner is a critical voter," but I suspect this doesn't hold for the dominant dabbler archetype, who probably doesn't have much attachment to their casual $50 bet on doge or litecoin or bitcoin, and thus can't be assembled into a voting block for crypto-related cause.

Another archetype is the much rarer crypto fundamentalist, a young male who has committed most of his savings to crypto. I suspect these are the types I encounter on Twitter, who evangelize and debate crypto to anyone who'll listen. This may be a small group, but they are also the most likely to vote for crypto-related causes.

Lastly, there seems to be a very small group of low-income people who are using crypto for actual transactions, the original use-case that Satoshi Nakamoto intended when he introduced the first cryptocurrency back in 2008.

Friday, October 13, 2023

Inflation as a tax

Last week I explored how Henry VIII resorted to coin debasement as a way to raise revenues in order to fight his wars. This provided Henry with the financial firepower to annex the city of Boulogne from the French in 1544, albeit at the price of England experiencing one of its greatest inflations ever.

Zoom forward five hundred years and Rishi Sunak, the Prime Minister of the UK, has ignited a controversy by referring to inflation as a tax, and further suggesting that the "best tax cut I can deliver for the British people is to halve inflation." His BBC interviewer disputed the claim, saying that inflation isn't a tax, a stance that the BBC upholds on its fact checking page.

If you recall, my previous article showed how Henry VIII's debasement functioned very much like a tax, say a new customs duty on wine or a beard tax. It did so by incentivizing people to flock to English mints to have their precious metals turned into coinage, Henry extracting a small fee on each coin. But the 21st century monetary system is very different from that of the middle ages. Is Rishi Sunak right to characterize inflation as a tax?

First, we need to better define our terms.

What do the BBC interviewer and Sunak mean by inflation? In the western world, prices have been rising at a regular pace of 2-3% each year for decades as result of central bank policy, which targets a low and steady inflation rate. Is this the definition they are using? Alternatively, Sunak and his interviewer may be referring to inflation as a *change in the change* in price. Since 2022 or so, that 2-3% rate has leapt to 8-9% all over the western world. Is it this jump that Sunak and his interviewer are talking about?

For the sake of this article, we'll assume that the conversation between Sunak and the BBC refers to the latter, a spike in the rate of inflation.

Secondly, what is meant by the word tax? Sometimes when we say that something is a tax we mean that it causes suffering. That is, inflation is taxing: it makes people's lives harder by increasing the cost of living, with salaries failing to keep up. It creates unfair changes in winners and losers.

Fair enough. But the more precise view I want to broach in this article is that inflation is actually a tax, where we define a tax as a formal charge or levy, set by the political process, that leads to cash flowing from the population to the government.

What does the data show?

Interestingly, a surprise jump in inflation leads to the very same effects as a new tax. All things staying the same, a new tax leads to an increase in government revenues. This improves the government's fiscal balance, or the difference between its revenues and expenses. A recent IMF paper by Daniel Garcia-Macia using data from 1962 to 2019 shows how an inflation shock typically achieves this exact same end result, boosting government revenues and improving its fiscal balance. This effect lasts for a few quarters, even up to two or three years, then recedes.

The IMF's chart below breaks down exactly how an inflation shock tends to improve government finances using quarterly data going back to 1999:

Charts source: IMF

Total tax revenue (the first panel) immediately begins to rise after the inflation shock at about the same rate as inflation.That's because most taxes are set by reference to values or prices, say like the prices of goods and services, or the price of labor, or the value of corporate profits. Since inflation pushes these amounts higher, this gets quickly reflected in tax revenues.

Income taxes and profits taxes (the second panel) rise particularly fast. Inflation is presumably pushing tax payers into higher income tax brackets, a process known as "bracket crreep," and so the government very quickly starts to collect a proportionally-larger amount of income tax.

Meanwhile, the government's total expenditures, the third panel, typically stay flat or only marginally rises in the quarters after the inflation shock hits. Notably, the amount of wages that are paid to government employees and social benefits (panels 4 & 8) tend to fall.

The net effect is an improvement in the government's fiscal balance. More specifically, for a 1% increase in inflation, the government's overall balance tends to improve by about 0.5% of GDP. And so an inflationary shock ends up at the same endpoint as a new tax: higher revenues and a better budget. That doesn't necessarily mean that inflation is itself a tax. Taxes have a degree of intentionality. They get implemented through a political process that has a certain set of goals in mind. By contrast, the extra revenue that an inflation shock raises is often (though not always) accidental, the result of external forces rather than political decision making.

So while it may not fall under the dictionary definition of a tax, the tax implications of a modern inflation shock resemble that of a new tax.

Everything I've written above applies to an inflation shock, say a rise from a 2-3% to 8-9%. Next I want to show that even constant 2-3% inflation can have the same revenue implication as a tax. Here's how.

Banknotes and seigniorage

Governments usually have a monopoly over the issuance of two key financial instruments: banknotes and settlement balances (also known as reserves). We all know what banknotes are, but what are settlement balances? Commercial banks find it useful to keep a stock of settlement balances on hand to make crucial large-value payments to other banks. The central bank, which the government controls, is the monopoly provider of these balances. (Sometimes banks are required by law to keep a a fixed number of settlement balances on hand, often above and beyond their day-to-day needs, a policy referred to as required reserves.)

Historically, interest rate on both types of central bank-issued money have been set at 0%. At the same time, the rates on short-term credit instruments (Treasury bills, commercial paper, bankers acceptances, etc) are determined by the market, typically hovering at a positive rate ranging between 0.25% to 5% over the last thirty years. These yields are priced to compensate investors for inflation.
The interest rate gap this gives rise to allows central banks to earn a steady stream of revenues, borrowing at an artificially cheap rate of 0% from both the banknote-using public and banks, and reinvesting at, say, 3%. Most of the revenues that the central bank collects from this interest margin flows back to the government. Economists usually refer to these revenue stream as seigniorage.

So seigniorage performs the same function as a consumption tax or an income tax: it takes resources from the public and gives it to the state. Likewise, a reduction in seigniorage would be very much like a tax cut.

If politicians wanted to, they could do away entirely with this form of raising government revenues. They have two ways of going about this. One way would be to have the central bank reduce price inflation to zero. By doing so, the interest rate on short-term credit instruments like Treasury bills would also fall to 0%, or thereabouts, since these instruments no longer need to compensate investors for inflation. And so the gap between the 0% rate at which central bank fund themselves and the rate at which they reinvest would cease to exist, seigniorage effectively shrinking to zero.

Over the last few decades, governments have taken a second route to removing seigniorage: they have begun to pay a market-linked yield on settlement balances. Canada, for instance, adopted this policy in 1999, and the Bank of England did so in 2006. By paying a market-based return, central banks no longer extract seigniorage from banks by forcing them to hold 0% assets. 

However, that still leaves banknotes as a significant source of seigniorage. We can calculate how much the UK government roughly earns from banknote seigniorage. With £95 billion in banknotes outstanding in October, and interest rates at 5.1%, the Bank of England's banknote-related seigniorage comes out to around £5 billion per year, much of which flows back to the government. That sounds like a lot, but it's only a small chunk of the £790 billion in taxes the UK government collected last year.

Banknote seigniorage isn't set in stone. It's a policy choice. If governments wanted to, they could reduce this form of seigniorage by paying interest on banknotes. One way to go about this would be to introduce a banknote serial number lottery. This lottery would offer around £5 billion in cash prizes to holders of winning banknote serial numbers, equating to a 5% interest rate on banknotes. Doing so would be akin to enacting a tax cut on British citizens.

To sum up, the fact that both an inflation shock and steady 2-3% inflation have implications for government revenues suggests that while inflation may not quite qualify as a tax, it is certainly tax-like.

Thursday, October 5, 2023

Top 13 blog posts

I've been writing on this blog for a while now  over ten years. Many of those posts are now forgotten (by myself included), but some were pretty popular at the time, and a few still get a steady stream of readers. Someone recently asked me for a list of my top ranked posts according to traffic volume, in order to (presumably) get a better taste for my writing.

Well, here they are. Enjoy!

1. Starbucks, monetary superpower (2019)

Starbucks has a gift card program that provides it with fantastic amounts of 0% interest funding. This is by far the most popular thing I've ever written.

2. Bitcoin, 11-years in (2019)

Bitcoin isn't a commodity or a currency, it's a game.

3. Bringing back the Somali shilling (2017)

If the Somali government wants to bring back the official Somali shilling, it'll have to buy back all the counterfeit shillings issued by warlords.

4. One country, two monetary systems (2020)

How the Yemeni rial split into two different rials when war tore the country apart.

5. There are now two types of PayPal dollars, and one is better than the other (2023)

A spotlight on PayPal's new stablecoin and how it reveals America's monetary fragmentation.

6. Ripple, or Bills of Exchange 2.0 (2013)

An analysis of Ripple, back when it was still cool.

7. The gold trick (2017)

The very strange fiscal effects of changing the US's official gold price from $42.22. If you google around you'll see I've written about this in a few other venues. Always popular with the gold bugs.

8. Fedcoin (2014)

First thoughts on a Fed-issued blockchain-based dollar.

9. What happens when a 96 bitcoin ransom payment ends up on Bitfinex (2020)

Shopkeepers get to keep stolen cash. Does the same apply to stolen bitcoins?

10. Kyle Bass's big nickel bet (2019)

In which I try to calculate the storage costs of hoarding 5-cent coins... 44 million of them!

11. Dictionary money (2017)

A very wonky monetary system in which the unit-of-account and medium-of-exchange are separated from each other.

12. Bitcoin is more like ham radio than the early internet (2020)

Searching for a better analogy for bitcoin, landing on ham radio.

13. The siren call of T+0, or real-time settlement (2017)

Instant securities settlement is no panacea, folks.

Tuesday, October 3, 2023

How to debase the coinage in order to pay for wars

Henry VIII, after Hans Holbein the Younger

It's fun to imagine traveling back in time and engaging with the then-prevailing technologies. Would you be able to ride a boneshaker or use a counting board? It's probably harder than you think: kids today can't even use a 1980s rotary phone. In this post I'm going to write about one specific techno-institution, the mint, and a particular function that it sometimes played many centuries ago; funding wars.

If you had to go back to 16th century Europe, and you were asked to operate the mints in a way such that they raised enough revenues so that your patron, the king, could wage war against a neighbouring country, how would you go about that?

I think the general sense that most of us have is that you'd need to somehow "debase" the coinage. The majority of coins back then were made of precious metals. If you could sneakily remove some of the silver and gold from each coin, and replace it with cheaper copper, then you'd be able to amass a hoard for the king (albeit at the expense of the public), and he could use that to hire an army.  

Now, if you went back in time with the above hazy notion of debasement, you wouldn't have much luck, and might even get your head chopped off. There's a grain of truth to it, but much of it won't work.

So before you head off in a time machine, here's what you need to know about the business of minting.

The first thing you need to know is that the King (or Queen) owns the royal mints, which they rent out to private parties to operate. Another important fact is that the public brings their own personal supply of precious metal  raw silver, silver cutlery and dishes, old coins, etc  to the mint, and then after waiting a week or two for the order to be processed, walks out with the final product; newly-minted coins.

But the mint's customers don't leave with as much silver (or gold) as they arrived. For each ounce of precious metals that gets minted into coin, the King collects a fee, known as "seigniorage", usually around 5% in the case of silver. The private individual who runs the mints gets a much smaller cut too, called brassage.  

If you're scrambling for a modern analogy, I suppose you could think of the medieval business of minting as very much like a modern laundromat, where customers bring their clothes, have them processed, and leave with their clothes, paying a small fee to the laundromat owner, who in turn pays a big chunk of this to the franchisor.

Like a laundromat owner, the monarch would have earned a fairly steady stream of revenues from their mints. Coins were more useful and liquid than raw silver, so there was an ever-present demand to convert raw silver into coin for transactional purposes. But remember, the challenge you face isn't just to generate regular profit. The king wants a massive surge in revenue. He's got a war to wage. How are you going to repurpose the mints to provide this gusher?

Your first attempt to raise money for the king might be to boost the minting fee from the low single digits to 20-25%. That might work. And you wouldn't be the first to go this route. For centuries, the English seigniorage rate on silver typically hovered around 5%, as illustrated in the chart below from a paper entitled The Debasement Puzzle, by Rolnick, Velde, and Weber. For gold, the minting fee was typically at 0.5% to 2%. To help fund his war against the Scots and the French, Henry VIII raised the seigniorage on silver to a remarkable 50-60% in the 1540s. Gold fees skyrocketed to 15%.

Source: Rolnick, Velde and Weber [pdf]

Mind you, fee hikes alone aren't going to work. Dissuaded by sky-high costs, many people will stop bringing their silver and gold to the mint to be coined, and the King's seigniorage revenues will dry up. A bothersome coin shortage will probably develop, too. Off with your head! says the King.

After thinking about it some more, you realize that, like a modern laundromat owner keen to make more revenue, you need to dramatically increase the amount of material going through the mint. How to do so?

You've got a few levers to increase throughput. One option is to introduce new products. If you offer new denominations of coins, for instance, people may bring more silver to the mint because those denominations are useful to them.

There's certainly precedent for that. To help pay his armies, Henry VIII brought back the testoon, a coin worth 12 pennies (or a shilling) in the hope that there would be significant demand for them, and that this would boost throughput and thus mint revenues. Testoons complemented Henry's silver halfpennies, pennies, groats (4 penny pieces), and sixpence (six pennies), in addition to a range of high denomination gold coins.

Below is an example of one of Henry's testoons, first minted in 1542. Because they had so much copper in them (more on that later), many of the testoons that exist today have a greenish tinge (due to copper oxidation). In the 1540s, Henry VIII's silver coins still hadn't turned green, but had a reddish tinge, which tended to reveal itself on his nose. Which is why Henry's nickname was Old Coppernose.

English groat (4 pence) issued 1547-49. Source: The British Museum

But introducing new denominations probably isn't going to generate a huge rush to the mints, since a new denomination will to some extent cannibalize existing demand for other denominations. Anyone who orders more testoons is likely to order fewer groats, for example. You'll have to do more.

In addition to introducing new coins, another strategy you might try is to cancel old ones. By having the King demonetize a popular coin, or declare it to be "no longer current," those coins will cease being legal tender or acceptable for taxes. The public will be forced to bring their demonetized coins to the mint to be converted into legal coins, the rush to do so creating a revenue windfall for the King.

And indeed, Henry VIII's successor Edward VI (who continued his father's wars) did this exact same move in 1548, declaring the testoons his father had reintroduced just four years before to be no longer current, as recounted in a paper by C.E. Challis (1967). I've clipped the relevant part below:

The demonetization of testoons is announced. Source: C.E. Challis

But we still haven't broached the main method: debasement. This is where the gusher begins.

Together with the King, you announce to the public that anyone who brings precious metals to the mint will now get more coins than before, for the same weight of precious metal. So for example, if someone used to be able to bring, say, 10 grams of pure silver to the mint and got 100 pennies minted, now they can bring 10 grams and get, say, 200 pennies. Same amount of silver, more coins.

As the operator of the mint, you could enact this change by cutting the weight of each penny by half, or, if you wanted to be more clever, maintain the same weight but reduce its fineness by 50%, by introducing more cheap copper to the mix. Either way, you've just debased the currency.

But how exactly does this raise revenues for the King?

Let's think about this change from a merchant's perspective. Say that our merchant owes a supplier 1 pound (a pound is 240 pennies). He's about to pay his debt off with everything he has, 240 pennies, when the debasement is announced. He can now bring his 240 pennies to the mint and have them recoined into 480 pennies. That allows him to pay off his debt, which is still denominated at 1 pound, and still have 240 pennies for himself. What a great opportunity! The merchant heads off to the mint with his silver.

Or imagine our merchant need to buy some property that's priced at 10 pounds, or 2,400 pennies. If he has only 1,200 pennies on hand, he can't afford it. But with the debasement having just been announced, the merchant can now convert those 1,200 pennies into 2,400 pennies and make the purchase.

Congratulations, you've created a revenue gusher! What you've effectively done is offer a short-term arbitrage opportunity to those who are paying attention, most likely the rich and well-connected, at the expense of the not-so-aware. To take advantage of a profitable situation, these enterprising individuals will immediately bring all their silver and gold to the mint. And you'll collect a toll on all that metal as it passes through.

But that arbitrage opportunity won't last forever. Debts will be recalibrated to account for the 50% decline in the penny's silver content. Prices of things like property will eventually double to reflect the new true value of the penny. At that point it will no longer be advantageous to bring one's silver to the mint to be recoined, and the revenue gusher you've created will subside.

You might try announcing debasements every few years or so, thus milking your mint's throughput on a continual basis. Too many debasements, though, and this trick will stop working, since that portion of the population that is the victim of the arbitrage you've created  the less aware  eventually wises up and protects itself by quickly increasing prices whenever a debasement occurs.

A constant series of debasements is exactly what Henry VIII and his son Edward enacted between 1542 and 1551 to keep paying their soldiers. Using data from a paper by John Munro, The Coinages and Monetary Policies of Henry VIII, I've charted out (above) how the penny's silver content changed over that time period. Going into the 1500s, an English penny contained 0.72 grams of pure silver. At the end of the Great Debasement, (the term used for Henry VIII's operations on the coinage) the penny contained just 0.11 grams of silver, constituting an 85% reduction in silver content.

We can further split out how Henry VIII's debasements were distributed between changes in fineness and changes in weight. Going into 1542, the English penny was 92.5% fine. Nine years later its purity stood at just 25% silver, the other 75% being base metal such as copper. As for weight, a penny weighed 0.79 grams in the early 1500s, but only 0.43 grams by 1551. 

These changes are illustrated in the chart below.

Thus it was diminutions in purity, not weight, that drove the biggest chunk of the penny's debasement, although weight did have a role to play.

How successful were these policies in creating a financial gusher for Henry and his son?

The charts below from Rolnick, Velde, and Weber (which I've clipped from  a second paper authored by the trio) show how the combination of mintage policies enacted in the 1540s debasement, new testoons, and a demonetization of the testoon  led to a large influx of silver and gold to the English mints.

Source: Rolnick et al

According to Challis, the combination of these inducements, along with a big boost in fees, resulted in minting profits of £1.3 million for the two kings from 1542 to 1551. This would have paid for a big chunk of the £3.5 million in military expenditures over that same period, much more than actual taxation, which only yielded £976,000.

Of course, the final result of all this was a significant number of deaths, and what one account describes as "an episode of sixteenth-century ethnic cleansing which in its aims and implementation was not dissimilar from ...the former Yugoslavia in the 1990s or, most recently, with the Myanmar government’s actions against the Rohingya." It also caused one of the worst episodes of price inflation that England had ever seen. According to Munro, the English consumer price level rose by 123% between 1541 and 1555.

So there you have it. If you had a time machine, you now know how to go back to medieval Europe and operate the royal mints in order to fund big ticket items like wars. (Whether you should actually do so is another question.)