10 ms·

Bitcoin is Deflationary, and That's OK

36 points by bdr 13y ago

dnautics 13y ago
It shines a light on the problem with inflationary currencies - one, costs of real goods tend to go down as technology advances, this is the "rising tide that lifts all boats", and is supposed to bring the lower economic classes to enjoy luxuries only available to the riches in eras long ago. Why are we trying to raise the prices on these goods? Secondly, why are we urging the economy to have exponentially increasing production to maintain nominal value, when we have limited resources on this planet?
- chii 13y ago
  There are several parties in the game - the "normal plebians", and the upper eschlons. Guess who benefits the most from inflation? Guess who decides monetary policy that leads to inflation?
yyqux 13y ago
I found this remarkably unconvincing: none of the arguments really seem to address the actual concerns with deflationary currencies, but seem to be directed at some (vaguely implied) strawman. I mean, why is the fact that there is a liquid market for bitcoins relevant at all? I don't think that has any bearing on whether a deflationary currency is bad or not. One failure mode for a currency is that it's completely illiquid, but that's not the most likely problem. E.g. there was always a liquid market for gold but it's probably the main example of a deflationary currency in practice.
- lingben 13y ago
  Agreed. The author is beset by muddled thinking. None of the arguments he brings forward are relevant to the question at hand. The most important consequence of bitcoin is watching programmers and other tech oriented people play armchair economist. They certainly seem to be having lots of fun but they are playing a game no economist recognizes.
  - bdr 13y ago
    > None of the arguments he brings forward are relevant to the question at hand. That's an unfair criticism, since the arguments I address are exactly those raised by everyone else who has written on the subject.
    - thecage411 13y ago
      I have to agree with the posters above. What is the question at hand? I'd assume from the title you would be explaining why bitcoin is deflationary and why that is okay. (What is okay?) What you actually seem to be addressing is whether the statement "Bitcoin cannot work as a medium of exchange" is true.
    - stevesaldana 13y ago
      Your third point is good and one that I personally think is the most impactful. At the end of the day, everyone has their "price". You can't take BTC to the grave with you, so at some exchange rate, you are a seller. For some people this amount is $130, or $500, or $5000. But at every new BTCUSD high, it introduces a new group of sellers and eventually all hoarders will get shaken out. I'm not sold on your second point "someone who sells a Bitcoin for X would have been equally happy to spend it on something they value at X." Using daily volume on Gox as an example, just because $2M changed hands yesterday, it doesn't necessarily imply that these folks would have happily exchange their coins for a good or service. A lot of this volume could represent traders getting in and out of a position, not someone ready to empty their account. However, your general point is that liquidity is a positive reinforcing signal, and I can agree with that. If liquidity is increasing because more merchants need to swap out, this is a direct indication that spenders are willing to transact.
- bdr 13y ago
  > directed at some (vaguely implied) strawman The Felix Salmon piece linked at the top, and every other article on the subject. If there's a good one, I haven't seen it. > I don't think that has any bearing on whether a deflationary currency is bad or not. Of course it does. Read the "supposedly relevant" link.
jstalin 13y ago
Expect lots and lots of arguments against bitcoin because of its deflationary nature. Nearly the entire universe of modern academic economics rests on the Keynesian and/or Monetarist foundation that increasing money supply (thus inflation) is a good thing. Most people don't connect the fact that their money is worth less year after year with the fact that it is the government itself devaluing their money. Heck, most people don't even realize their money is losing value. Only savers, especially in our current zero interest rate policy environment, come close to understanding what is going on. Nothing illustrates better what has happened to our money than the current market value of US coins made before 1965. For instance, a 1964 dime (nominally worth 10 cents) is actually worth $1.64 in silver content. That's somewhere around a 95% devaluation in just the last 50 years!
- Guvante 13y ago
  Are you saying there is something wrong with nominal inflation? 2% a year is scary when you talk big numbers like that, but the only time that money spans that large of time spans is retirement, which is invested at well over inflation even if you choose something like government guaranteed bonds. To my knowledge the only way to lose money to inflation is to sit on cash (stupid for other reasons), have it in short term treasury bonds (which are bought by companies that have nothing to do with their flex cash), or have a bad savings account.
  - Filligree 13y ago
    > short term treasury bonds Hold on. If those are worse than even savings accounts.. why would said companies not put their money in a normal savings account?
    - Guvante 13y ago
      I do not run the fiscal policy of a huge company, so I am speculating, but here goes: Savings accounts are considered perfectly safe due to FDIC. If you have $10 million for six months you can't do anything with but don't want to invest, Treasury Bonds are zero risk and have some kind of return. In contrast there is a minor risk that a bank could go under. Especially when you consider that you have several accounts with a bank, and you have say $20 million in your accounts total, why add to that?
johnrob 13y ago
I would think a large majority of bitcoins would end up in the hands of people living somewhere with low interest rates - instead of parking their money in banks, they'll park it in bitcoins. The demand for investing - which applies across all currencies - could easily be greater than the demand to spend bitcoins. Investment demand has caused deflationary problems in other areas too, specifically food prices when a lot of investment was made in certain agricultural futures.
- johnrob 13y ago
  Replying to my own comment, deflation isn't the worst thing that can happen to bitcoin IMO - unstable prices could be a bigger challenge. Since the market for bitcoins is not regulated, it could end up subject to all manor of tricks to create panics or booms. If the price fluctuates rapidly then timing the market becomes a burden of using the currency.
YokoZar 13y ago
The article hits on an entire class of silly arguments I've seen against bitcoin from the start: people claim that bitcoins will be worthless because they will be too valuable to trade. The language used for "too valuable" may vary (scarcity! illiquid! deflation!) But, as the author notes, that's not at all what matters -- all that's necessary is that they're tradeable and people have different values for a bitcoin at a particular time.
bdr 13y ago
Hm, HN traffic has grown. The server will be back up in a couple minutes. Edit: All good, I think. This post has been in the draft folder for a while, but I decided to just run it. A better title would be "Common Flaws in the 'Bitcoin is Deflationary' Argument". There might actually be a convincing "Bitcoin is Deflationary" argument to be made, it's just that no one has made it yet.
Xcelerate 13y ago
A lot of these arguments against the future of Bitcoin rest on the ill-founded assumption that the Bitcoin protocol is static and unchanging. This isn't necessarily true; there's already reactionary plans should SHA-2 or secp256k1 become comprised. It seems fair to reason that a community consensus would alter the protocol should deflation ever really become a problem.
- wyager 13y ago
  Replacing the underlying crypto is 1000x simpler than replacing the coin production mechanism, for both political and practical reasons.
  - tlrobinson 13y ago
    I think miners who have invested in farms of (very application specific) ASICs would disagree. Then again, in theory it's the "economic majority", not that miners, that matter: https://en.bitcoin.it/wiki/Economic_majority https://en.bitcoin.it/wiki/Economic_majority
    - wyager 13y ago
      You can replace RIPE or ECDSA or even SHA (in the address-generation mechanism) without impacting the miners at all.
- jellicle 13y ago
  Since the entire premise of Bitcoin is a fanatical devotion to the idea that no evil government will ever be able to produce more of the currency, it seems highly, highly unlikely that the deflationary "bug" in the Bitcoin protocol is one that will ever be changed by Bitcoin participants. Any other bug might be fixed. But not that one.
RockyMcNuts 13y ago
Falling prices and strong growth tend to be mutually exclusive in the real economy. Suppose you’re an investor and an entrepreneur comes to you with a proposal to build a factory, and the business plan shows next year the factory will cost 5% less to build, and the products will sell 5% cheaper. Why build a factory today if you can get 5% a year increase in purchasing power just by hoarding currency? You need much bigger margins than are currently typical outside tech and zero marginal cost products. Incur debt, and even at the zero interest rate bound, you need 5% more real income next year to pay it back. In a modern economy, especially where there's a lot of debt finance, price deflation is death. Anyway, since Bitcoin isn't a currency in the sense of a transaction medium, a stable store of value, and a unit of account, but more akin to a digital pet rock or Beanie Baby, deflation doesn't really matter very much.
- nandemo 13y ago
  Why build a factory today if you can buy your country's bonds and enjoy a risk-free x% a year? Why buy a smart phone today if you can wait 1 year and get a much better one for the same price?
  - deleted 13y ago
    [deleted]
  - RockyMcNuts 13y ago
    The short answer is, you don't. When real interest rates are at 5%, that is not normal and those are not usually good times. Bonds in the US have earned a real 2.3% since 1926. From 1937 to 1981 bonds lost a real -0.72% per year. You don't buy bonds to earn the rate of growth of real GDP or better. If you want to do that, you have to take risk. The last 30 years of declining inflation have been the anomaly. People built businesses instead of buying bonds because bonds looked pretty unattractive, but when inflation kept surprising to the downside, bonds did better than expected.
- clamprecht 13y ago
  re: "since Bitcoin isn't a currency in the sense of a transaction medium" $2M per month of transactions on SilkRoad beg to differ.
jiggy2011 13y ago
The comparison to housing seems a little off to me. For example with the property boom, people didn't want to sell their houses because they were going up in value. Therefor they go up in value some more. Therefor people can't afford to buy them, so we fix that with sub prime mortgages..
- dnautics 13y ago
  Right, whereas, if we didn't create subprime mortgages, if people couldn't afford to buy them, eventually the price would have had to come down, or else you have idle stock. Instead, we inflated the price bubble by enabling risky individuals to make purchases they shouldn't be able to, and so when the prices actually came crashing down, not only did they take down the housing sector, but the defaulted loans exerted magnified, collateral damage across the entire economy.
hristov 13y ago
I think it is not ok, and I think that the deflationary nature of Bitcoin is a wonderful practical example of the problem with deflation. To the best of my knowledge bitcoin does not seem to be used as currency that much. It's explosion in popularity is not matched in explosion in currency usage. And why would it? If you, for example, buy a toaster online with bitcoin and it keeps appreciating, this toaster may end up costing you a $1000 in a year. If bitcoin were to fullfil its promise, a large portion of online transactions should take place with bitcoins. AFAIK, thus far this is only happening for illegal drug transactions, for which there is no other alternative. Thus far bitcoin is something people buy and hold hoping it appreciates. If they are tired of holding it, they sell it back. It is not a currency, it is an object of investment/speculation.
gnoway 13y ago
What stops you from doing business in fractional bitcoins? I'm pretty sure shift is a basic instruction in every architecture.
- jellicle 13y ago
  Dealing in fractional bitcoins doesn't solve deflationary problems in the same way that Zimbabwe printing a $100 trillion dollar banknote didn't solve their inflationary problems.
Steko 13y ago
None of these arguments is at all persuasive. "First of all, the present value of a perpetually appreciating asset is not infinity" Straw man. No one is claiming the present value of anything has to be infinity. And I don't see anyone saying real estate is a good medium of exchange. "Second, there is a liquid market for Bitcoins." Another straw man. No one is saying there will not be any trade in deflationary currencies. The amount of Bitcoins that are not being circulated speaks to exactly what people don't like about deflationary currencies though. "Third, the marginal utility of money is diminishing." A true fact that has no impact on the criticism of Bitcoin because it's deflationary. Red herring.
tlrobinson 13y ago
Deflation may prevent Bitcoin from replacing all government fiat currencies, but I don't think it has much impact on Bitcoin becoming a popular form of payments / transfer / store of wealth. Some Bitcoin proponents would be disappointed by that prospect, but I think it would still be a big win. It likely means several orders of magnitude difference in price, but in either case the price would go up significantly.

36 points by bdr 13y ago

It shines a light on the problem with inflationary currencies - one, costs of real goods tend to go down as technology advances, this is the "rising tide that lifts all boats", and is supposed to bring the lower economic classes to enjoy luxuries only available to the riches in eras long ago. Why are we trying to raise the prices on these goods? Secondly, why are we urging the economy to have exponentially increasing production to maintain nominal value, when we have limited resources on this planet?

chii 13y ago
There are several parties in the game - the "normal plebians", and the upper eschlons. Guess who benefits the most from inflation? Guess who decides monetary policy that leads to inflation?

yyqux 13y ago

I found this remarkably unconvincing: none of the arguments really seem to address the actual concerns with deflationary currencies, but seem to be directed at some (vaguely implied) strawman. I mean, why is the fact that there is a liquid market for bitcoins relevant at all? I don't think that has any bearing on whether a deflationary currency is bad or not. One failure mode for a currency is that it's completely illiquid, but that's not the most likely problem. E.g. there was always a liquid market for gold but it's probably the main example of a deflationary currency in practice.

lingben 13y ago
Agreed. The author is beset by muddled thinking. None of the arguments he brings forward are relevant to the question at hand. The most important consequence of bitcoin is watching programmers and other tech oriented people play armchair economist. They certainly seem to be having lots of fun but they are playing a game no economist recognizes.
- bdr 13y ago
  > None of the arguments he brings forward are relevant to the question at hand. That's an unfair criticism, since the arguments I address are exactly those raised by everyone else who has written on the subject.
  - thecage411 13y ago
    I have to agree with the posters above. What is the question at hand? I'd assume from the title you would be explaining why bitcoin is deflationary and why that is okay. (What is okay?) What you actually seem to be addressing is whether the statement "Bitcoin cannot work as a medium of exchange" is true.
  - stevesaldana 13y ago
    Your third point is good and one that I personally think is the most impactful. At the end of the day, everyone has their "price". You can't take BTC to the grave with you, so at some exchange rate, you are a seller. For some people this amount is $130, or $500, or $5000. But at every new BTCUSD high, it introduces a new group of sellers and eventually all hoarders will get shaken out. I'm not sold on your second point "someone who sells a Bitcoin for X would have been equally happy to spend it on something they value at X." Using daily volume on Gox as an example, just because $2M changed hands yesterday, it doesn't necessarily imply that these folks would have happily exchange their coins for a good or service. A lot of this volume could represent traders getting in and out of a position, not someone ready to empty their account. However, your general point is that liquidity is a positive reinforcing signal, and I can agree with that. If liquidity is increasing because more merchants need to swap out, this is a direct indication that spenders are willing to transact.
bdr 13y ago
> directed at some (vaguely implied) strawman The Felix Salmon piece linked at the top, and every other article on the subject. If there's a good one, I haven't seen it. > I don't think that has any bearing on whether a deflationary currency is bad or not. Of course it does. Read the "supposedly relevant" link.

jstalin 13y ago

Expect lots and lots of arguments against bitcoin because of its deflationary nature. Nearly the entire universe of modern academic economics rests on the Keynesian and/or Monetarist foundation that increasing money supply (thus inflation) is a good thing. Most people don't connect the fact that their money is worth less year after year with the fact that it is the government itself devaluing their money. Heck, most people don't even realize their money is losing value. Only savers, especially in our current zero interest rate policy environment, come close to understanding what is going on. Nothing illustrates better what has happened to our money than the current market value of US coins made before 1965. For instance, a 1964 dime (nominally worth 10 cents) is actually worth $1.64 in silver content. That's somewhere around a 95% devaluation in just the last 50 years!

Guvante 13y ago
Are you saying there is something wrong with nominal inflation? 2% a year is scary when you talk big numbers like that, but the only time that money spans that large of time spans is retirement, which is invested at well over inflation even if you choose something like government guaranteed bonds. To my knowledge the only way to lose money to inflation is to sit on cash (stupid for other reasons), have it in short term treasury bonds (which are bought by companies that have nothing to do with their flex cash), or have a bad savings account.
- Filligree 13y ago
  > short term treasury bonds Hold on. If those are worse than even savings accounts.. why would said companies not put their money in a normal savings account?
  - Guvante 13y ago
    I do not run the fiscal policy of a huge company, so I am speculating, but here goes: Savings accounts are considered perfectly safe due to FDIC. If you have $10 million for six months you can't do anything with but don't want to invest, Treasury Bonds are zero risk and have some kind of return. In contrast there is a minor risk that a bank could go under. Especially when you consider that you have several accounts with a bank, and you have say $20 million in your accounts total, why add to that?

johnrob 13y ago

I would think a large majority of bitcoins would end up in the hands of people living somewhere with low interest rates - instead of parking their money in banks, they'll park it in bitcoins. The demand for investing - which applies across all currencies - could easily be greater than the demand to spend bitcoins. Investment demand has caused deflationary problems in other areas too, specifically food prices when a lot of investment was made in certain agricultural futures.

johnrob 13y ago
Replying to my own comment, deflation isn't the worst thing that can happen to bitcoin IMO - unstable prices could be a bigger challenge. Since the market for bitcoins is not regulated, it could end up subject to all manor of tricks to create panics or booms. If the price fluctuates rapidly then timing the market becomes a burden of using the currency.

YokoZar 13y ago

The article hits on an entire class of silly arguments I've seen against bitcoin from the start: people claim that bitcoins will be worthless because they will be too valuable to trade. The language used for "too valuable" may vary (scarcity! illiquid! deflation!) But, as the author notes, that's not at all what matters -- all that's necessary is that they're tradeable and people have different values for a bitcoin at a particular time.

bdr 13y ago

Hm, HN traffic has grown. The server will be back up in a couple minutes. Edit: All good, I think. This post has been in the draft folder for a while, but I decided to just run it. A better title would be "Common Flaws in the 'Bitcoin is Deflationary' Argument". There might actually be a convincing "Bitcoin is Deflationary" argument to be made, it's just that no one has made it yet.

Xcelerate 13y ago

A lot of these arguments against the future of Bitcoin rest on the ill-founded assumption that the Bitcoin protocol is static and unchanging. This isn't necessarily true; there's already reactionary plans should SHA-2 or secp256k1 become comprised. It seems fair to reason that a community consensus would alter the protocol should deflation ever really become a problem.

wyager 13y ago
Replacing the underlying crypto is 1000x simpler than replacing the coin production mechanism, for both political and practical reasons.
- tlrobinson 13y ago
  I think miners who have invested in farms of (very application specific) ASICs would disagree. Then again, in theory it's the "economic majority", not that miners, that matter: https://en.bitcoin.it/wiki/Economic_majority https://en.bitcoin.it/wiki/Economic_majority
  - wyager 13y ago
    You can replace RIPE or ECDSA or even SHA (in the address-generation mechanism) without impacting the miners at all.
jellicle 13y ago
Since the entire premise of Bitcoin is a fanatical devotion to the idea that no evil government will ever be able to produce more of the currency, it seems highly, highly unlikely that the deflationary "bug" in the Bitcoin protocol is one that will ever be changed by Bitcoin participants. Any other bug might be fixed. But not that one.

RockyMcNuts 13y ago

Falling prices and strong growth tend to be mutually exclusive in the real economy. Suppose you’re an investor and an entrepreneur comes to you with a proposal to build a factory, and the business plan shows next year the factory will cost 5% less to build, and the products will sell 5% cheaper. Why build a factory today if you can get 5% a year increase in purchasing power just by hoarding currency? You need much bigger margins than are currently typical outside tech and zero marginal cost products. Incur debt, and even at the zero interest rate bound, you need 5% more real income next year to pay it back. In a modern economy, especially where there's a lot of debt finance, price deflation is death. Anyway, since Bitcoin isn't a currency in the sense of a transaction medium, a stable store of value, and a unit of account, but more akin to a digital pet rock or Beanie Baby, deflation doesn't really matter very much.

nandemo 13y ago
Why build a factory today if you can buy your country's bonds and enjoy a risk-free x% a year? Why buy a smart phone today if you can wait 1 year and get a much better one for the same price?
- deleted 13y ago
  [deleted]
- RockyMcNuts 13y ago
  The short answer is, you don't. When real interest rates are at 5%, that is not normal and those are not usually good times. Bonds in the US have earned a real 2.3% since 1926. From 1937 to 1981 bonds lost a real -0.72% per year. You don't buy bonds to earn the rate of growth of real GDP or better. If you want to do that, you have to take risk. The last 30 years of declining inflation have been the anomaly. People built businesses instead of buying bonds because bonds looked pretty unattractive, but when inflation kept surprising to the downside, bonds did better than expected.
clamprecht 13y ago
re: "since Bitcoin isn't a currency in the sense of a transaction medium" $2M per month of transactions on SilkRoad beg to differ.

jiggy2011 13y ago

The comparison to housing seems a little off to me. For example with the property boom, people didn't want to sell their houses because they were going up in value. Therefor they go up in value some more. Therefor people can't afford to buy them, so we fix that with sub prime mortgages..

dnautics 13y ago
Right, whereas, if we didn't create subprime mortgages, if people couldn't afford to buy them, eventually the price would have had to come down, or else you have idle stock. Instead, we inflated the price bubble by enabling risky individuals to make purchases they shouldn't be able to, and so when the prices actually came crashing down, not only did they take down the housing sector, but the defaulted loans exerted magnified, collateral damage across the entire economy.

hristov 13y ago

I think it is not ok, and I think that the deflationary nature of Bitcoin is a wonderful practical example of the problem with deflation. To the best of my knowledge bitcoin does not seem to be used as currency that much. It's explosion in popularity is not matched in explosion in currency usage. And why would it? If you, for example, buy a toaster online with bitcoin and it keeps appreciating, this toaster may end up costing you a $1000 in a year. If bitcoin were to fullfil its promise, a large portion of online transactions should take place with bitcoins. AFAIK, thus far this is only happening for illegal drug transactions, for which there is no other alternative. Thus far bitcoin is something people buy and hold hoping it appreciates. If they are tired of holding it, they sell it back. It is not a currency, it is an object of investment/speculation.

gnoway 13y ago

What stops you from doing business in fractional bitcoins? I'm pretty sure shift is a basic instruction in every architecture.

jellicle 13y ago
Dealing in fractional bitcoins doesn't solve deflationary problems in the same way that Zimbabwe printing a $100 trillion dollar banknote didn't solve their inflationary problems.

Steko 13y ago

None of these arguments is at all persuasive. "First of all, the present value of a perpetually appreciating asset is not infinity" Straw man. No one is claiming the present value of anything has to be infinity. And I don't see anyone saying real estate is a good medium of exchange. "Second, there is a liquid market for Bitcoins." Another straw man. No one is saying there will not be any trade in deflationary currencies. The amount of Bitcoins that are not being circulated speaks to exactly what people don't like about deflationary currencies though. "Third, the marginal utility of money is diminishing." A true fact that has no impact on the criticism of Bitcoin because it's deflationary. Red herring.

tlrobinson 13y ago

Deflation may prevent Bitcoin from replacing all government fiat currencies, but I don't think it has much impact on Bitcoin becoming a popular form of payments / transfer / store of wealth. Some Bitcoin proponents would be disappointed by that prospect, but I think it would still be a big win. It likely means several orders of magnitude difference in price, but in either case the price would go up significantly.