8 ms·

Bitcoin Deflation and Economic Activity

55 points by exogen 13y ago

sciguy77 13y ago
This is a fantastic article, and it highlights some of my worries as a Bitcoin lover. It would seem the only times one would use Bitcoin over USD is if a Bitcoin-specific benefit (for instance, anonymity when buying illegal goods) outweighs the cost of using BTC over USD. In a deflationary economy I can't fathom why someone would spend BTC over USD buying a legal good, except maybe for the kick of having spent Bitcoin.
- mike_esspe 13y ago
  2% less fee, than credit card. It's enough to take over the payment world. And it's only one of the advantages.
  - dragontamer 13y ago
    The 0.0001 BTC Transaction fee tacked on to every BTC exchange is only going to get worse and worse as BTCs's exchange rate goes up btw. What used to be a rounding-error that happened on every BTC transaction is now a $0.10 tax on every BTC transaction. If BTC continues to deflate, the transaction fees on BTC are going to become quite sizable.
    - marcell 13y ago
      This is a known issue. The current design around smart fees is described here: https://gist.github.com/gavinandresen/6548612 https://gist.github.com/gavinandresen/6548612 The high level idea is to introduce market mechanics to bitcoin fees, with the expectation that competition will drive prices down.
- lukifer 13y ago
  If the deflation ever becomes stable(ish), the increase of value can be accounted for in the price, as sellers will have a reason to prefer BTC and offer discounts (not to mention eliminating all those 2.9% credit card fees). We already buy all sorts of optional goods, even if those goods will depreciate compared to letting money sit in a bank account and accrue interest.
  - dragontamer 13y ago
    Bingo, we have a winner. What is important is NOT deflation vs inflation, but to keep that value _stable_. USD inflates at a rate of 3% year over year, so we can compare investment vehicles against the rate of inflation and see whether or not they are good deals. But since BTC is extremely volatile, its impossible to use it as a unit of value. Until it settles down and becomes predictable, it will become impossible to form a "BTC Economy".
    - lukifer 13y ago
      I think of it as owning shares of stock in a DAC (Distributed Autonomous Corporation). At some point, those shares of stock might become worthwhile as a day-to-day currency. As is, though, I think it's already more stable than local currencies for some parts of the world (though perhaps still not more so than the dollar).
      - dragontamer 13y ago
        It isn't a stock however, and never will be. The reason why people invest in companies is to make more money. Companies may not offer dividends today, but eventually they will. (IE: Even Apple, once allergic to the idea of dividends, offers a regular one to its investors). Any company that churns a profit will eventually share those profits with its investors. "Owning" BTCs is not about churning profits eventually, its 100% about speculating about its future value. Building BTC Mining equipment is where the real "value" of owning BTCs is in, since that puts you in control over a number of BTC transactions. The BTCs themselves can NOT be compared to stocks. Stocks mean you actually own the company, you eventually partake in that company's profits... and even partake in choosing the board of directors. (who then in turn... choose the CEO). A BTC on the other hand, is like speculating on Oil, Gold, or Timber. Its a commodity, not a "share".
        lukifer 13y ago
        I suppose the proof-of-stake coins act a little like stock, in that one gets to contribute to the 51% that writes the rules of the network, but I take your point. Ultimately, crypto-coins are a new type of financial instrument that don't fit cleanly into either currency or commodity (given that they're not exchangeable for something tangible). Owning BTC is subjectively stock-like, in the sense that its present value is based primarily on network effects, and its future value is highly uncertain.
marcell 13y ago
A few thoughts: 1) Conversely, why would I want to keep my wealth denominated in a currency that loses 2% value every year? 2) Supposing 90% annual deflation forever, as this article does, is disingenuous. Bitcoin is currently a 5 year old technology, and of course it will have periods of significant volatility. In the long run, bitcoin will stabilize, and deflation will be on the rate of global economic growth, currently estimated at around 2% [1] 3) In the long run, people could keep their wealth denominated in bitcoin, and spend dollars. There you have the best of both worlds: your wealth storage is deflationary, and your spending currency is inflationary. edit: 4) Perhaps most significantly, remember that bitcoins and dollars are exchangeable at any point in time. Any dollar you spend on goods/services is a dollar you could have spent on bitcoin. Have bitcoin enthusiasts completely stopped spending dollars on goods/services? [1] http://www.wolframalpha.com/input/?i=global+gdp+growth http://www.wolframalpha.com/input/?i=global+gdp+growth
- dragontamer 13y ago
  Because losing 2% to 3% every year is actually quite stable. Its so stable that the typical person doesn't notice it. Deflation at the rate of 100% over two weeks on the other hand (ie: BTC's current rate of change), is absolutely and utterly ridiculous.
- brownbat 13y ago
  > In the long run, bitcoin will stabilize, Why would this be true? Gold and silver have been around a long time, but both are still relatively volatile. I mean, I hope you're right, I'm just curious where you think volatility ends up and why you think so.
  - dragontamer 13y ago
    The volatility of Gold and Silver is approximately 20% / year. There was a MASSIVE Gold sell off earlier this year, which caused a temporary spike of Gold Volatility to 60%. In comparison, the volatility of BTC is approximately 6000% / year. The magnitude of volatility is straight up ridiculous. The behavior of BTC is more like a penny-stock than any commodity on the market
zcarter 13y ago
The 'depreciating currency is a problem' argument is true for the existence of any asset having a higher yield than your widget factory. Why wouldn't you invest in that high yield asset instead of your widget factory? In this way, you can view _any_ appreciating asset as a reference unit of account. It is just as easy to see your egg and milk purchases as units of the high yield asset and delay your purchases for the same reason outlined in the article. So, it's a nonsense argument. If you have a strong prior that stocks are going to be worth 100% more tomorrow than they are today, why would you buy milk and eggs with your spacebux today? You could invest your spacebux in stocks, sell them tomorrow, and buy milk and eggs tomorrow! Therefore, no one will buy milk and eggs today if stocks are expected to rise in price.
- dllthomas 13y ago
  I'm not sure whether this winds up being meaningful, but a difference is that more hops means more transaction costs.
- john_b 13y ago
  The critical difference is that Bitcoin is intended to be a currency and not an asset. People use assets to store (and hopefully appreciate) value over time. People use currencies to conduct business and as mediums of exchange. If you think of or use Bitcoin as an asset, you immediately nullify any comparisons with currencies because the two serve different purposes. You could, in principle, buy a house with, say, 10 cars. But that is not done in practice because the market for asset-to-asset transactions (bartering) is small and illiquid. If you are willing to ignore Bitcoin's purpose as a currency and only use it as an asset, you need to consider what will drive its value in the long term. For most things, that value is just a function of the supply and the demand. While the supply of Bitcoins is fixed and the demand for items that can be bought in BTC is increasing, what will happen when everyone realizes that BTC is a better asset than currency and stops using it for transactions? It will become illiquid, and illiquid assets only have their tangible value. Since Bitcoin isn't tangible like a house or a car, its tangible value is zero. For the record, I think Bitcoin has potential, but not with the present economic dynamics.
  - 13y ago
brownbat 13y ago
I heard Krebs in a radio interview say that many criminals who are practical experts in the actual use of experimental currencies require something like Liberty Dollars for price stability. Could a cryptocurrency build price stability in as a feature? I know this is anathema to one of Bitcoin's founding principles, but what if the payout for each round of mining was adjusted based on the average transaction size in the last few blocks? If transaction sizes are going up, you're getting deflation, so the algorithm would increase the rate at which money is being printed. Not sure how to control for the opposite, for inflation. Maybe some small percentage of the transaction fees each round would get destroyed by the system, instead of paid out to the miners (it'd have to be a small percentage so you could keep people mining). Maybe better just leaving anti-inflation out of the design, since it isn't yet a demonstrable problem, might not ever be. You could fiddle with how aggressively the system fights for price stability, trading off against the reliability of profitable mining.
lumberjack 13y ago
Don't we the customers and the capitalists already have the same situation with dollars? I could either buy a PS4 or I could buy some penny stocks. I could either try my luck with a startup or I could put that seed money into a CD or a fairly low risk index fund. So it all depends on the actual realistic rate of deflation if Bitcoin ever reaches widespread use.
- john_b 13y ago
  Except that Bitcoin's intended purpose is as a currency, so to make meaningful comparisons you would need to look at other currencies or currency substitutes (gold/silver/jewelry/etc). Assuming that it reaches widespread use ignores the chicken and egg problem that producers of goods will not want to use it if the depreciation is too high. Currently you can spend bitcoins mainly through intermediaries and various online purchases that quickly convert the BTC to some fiat currency. I.e. pay a company for server space, they quickly turn it into dollars or euros to pay their electricity and employees. But to be a legitimate, full fledged currency it will need to both be a reliable store of value (low volatility) and be useful for producers (minimal depreciation). It has neither right now, and I personally don't see a path from the present state to that ideal equilibrium.
unreal37 13y ago
"There is a limited supply of bitcoins". Not really true. Bitcoin is infinitely divisible (unlike a dollar). Having only 21 million is not an issue, because pretty soon we will be talking about micro bitcoins as the base unit of transactions. And then there will be another Bitcoin competitor (Litecoin). And another. And another. We will never run out of bitcoin and equivalent products. Stabilizing the price is definitely an issue. Can it be stabilized?
jwallaceparker 13y ago
> why buy something today if it will be cheaper tomorrow? Because you want it today. The "fear of deflation" argument is now pervasive among monetary theorists. The argument goes that if people know that prices will fall, they will indefinitely delay all economic activity. This ignores the time preference aspect of economic decision making. For example, I will buy my cup of coffee today rather than wait a day or week to save 1% because I WANT IT TODAY. We've seen periods of significant economic growth coupled with falling prices. Before going fiat, we had slowly falling prices in our nation's period of largest economic growth, the late 1800's. "Wholesale prices dropped 47 percent from 1879 to 1900 and economic growth averaged nearly four percent per year." - Ron Paul http://dailyreckoning.com/the-mythical-merits-of-paper-money/ http://dailyreckoning.com/the-mythical-merits-of-paper-money...
- deleted 13y ago
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- atmosx 13y ago
  Your analogy is flawed and completely unrealistic. BitCoin's fluctuations are insane, we're talking about ~ 15 times compared to last year. Would you seriously use a bitcoin to buy a cup of coffee today ?
  - zcarter 13y ago
    Right, "Price Stability" is a different thing with real merits.
  - jwallaceparker 13y ago
    I don't use Bitcoin at all. I'm just talking about the general idea of inflation. I'm not arguing the merits of Bitcoin.
- tokenizer 13y ago
  What's your opinion on inflation as an economic driver? I'm also a fan of deflation (as I want to save my money) but the Federal Reserve and other central banks (Japan being a notable example) are advocating for higher inflation, which begs another question: Are they right and both deflation and inflation can supply economic growth? If so, does that mean another factor is the main proponent for growth?
Anderkent 13y ago
The 'why buy something today if it will be cheaper tomorrow?' was never very convincing to me. There are many markets, look for example at computer hardware, where delaying a couple months can get you huge savings. And yet people buy new hardware, all the time.
badinker 13y ago
Deflation, where your money actually goes up in value, real bad. Ok got it. http://tinypic.com/r/2d102dj/5 http://tinypic.com/r/2d102dj/5
- atmosx 13y ago
  Real bad for a currency (if you are the FED), very good for an asset :-)
skizm 13y ago
What would happen if bit coins were produced at a steady rate indefinitely? Maybe not linearly but at some predictable growth rate. The amount of bitcoins in circulation would always go up and therefore decrease the value of each in circulation? Obviously I don't know much about economics but I can't see why this wouldn't work. Why does bitcoin have a hard limit on the total number of bitcoins produced?
nardi 13y ago
After some careful calculation, you determine that it will cost you 1 BTC to produce, market, and sell a single widget, and that it is only worth your effort if you can sell each widget for 2 BTC, a handsome 100% margin. I stopped reading right here.
deleted 13y ago
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mpg33 13y ago
This is trying fit a deflationary currency into a debt/consumption driven economy. Who says the best way to drive the economy is by taking on debt to consume good and services? I would argue that debt counteracts a lot of the gains set by consumption. The falling wages argument seems irrelevant...what's the difference between wages increasing 2% to keep up with 2% inflation and decreasing wages 2% to keep up with 2% deflation. Don't confuse numbers with value. I would argue however that the RATE of deflation is important. 90% is brutal...2% not so bad. Theoretically the rate of deflation of bitcoin's should decrease as time goes on.
- Ashendar 13y ago
  Even in a non-debt driven economy debt plays a useful role at a micro level in terms of financing productive investment, not just discretionary consumption. Deflation will increase the real value of debt, making it increasingly difficult to service the debt over time (since your wages would probably be falling), whereas inflation reduces the real value of debt over time.
knowitall 13y ago
I think the "deflation can't work" people are making the same mistake as the "interest can't work because one penny will eventually be worth as much as the weight of the earth in gold" crowd ("Joseph's Pfenning"). They interpolate incorrectly. In the case of interest, some borrowers go bankrupt (which is fine, because the world needs risk taking). In the case of deflation, presumably at some point people will want to buy things. They can not hold on spending forever because they might starve. In any case it seems obvious that the price of one Bitcoin can not go to infinity, because there is nothing of value "infinity" on earth. From that it follows that the deflationary dread scenario has to come to an end at some point, just like Joseph's penny can not accumulate interest long enough to be worth the earth in gold because all his lenders will go bankrupt before that.
bigiain 13y ago
Seems to me the problem pointed out only exists if you view the transactions without taking their larger context into account. Take his "100 Widget @ 1BTC each to produce, sell them later at a different value of BTC." scenario, which he characterises as an 80% loss. Now consider where the widget maker would have got his initial 100BTC from, and what he'll do with the BTC he sold the widgets for. Using his numbers, lets say you sold 50lb of butter to get your initial 100BTC. Several months later, when you've sold all your widgets (for the deflated 0.2BTC price) and you've got 20BTC in your wallet, you convert that back into your original resources, and get 100lbs of butter at the new 0.2/lb rate. All of a sudden the exact same scenario now looks like a 100% profit (50lb of butter becomes 100lb) instead of an 80% loss (100BTC becomes 20BTC). Admittedly, hanging on to the original 100BTC would have allowed the widget maker to sit on his hands for a few months and then buy 500lbs of butter, but looking at just the BTC deflation without the outside context makes things look very much worse than they really are. And ultimately, it's butter (or opamps or widgets) that you need to eat/live and that have "real value" in some sense - those 100BTC could just as easily have turned out to be worthless at the end of the widget production run - and the widgets could still have been sold for USD or traded for butter. The guy with a private key to a magic number proclaiming "100 BTC" might have had _nothing_ Not a problem if you can afford the gamble - not such a great idea if you _need_ that butter to feed yoru family.
- InclinedPlane 13y ago
  You're missing the point entirely. It's about opportunity costs. If you try to use a deflationary currency for any economic activity then you get bitten by deflation, you end up losing money. The fact that the total revenue you get back is still worth the same (in butter or what-have-you) is irrelevant. You still had to buy equipment, you still had to pay people wages, and so forth in that currency to start with. But if you had not invested that money to start with you'd be even wealthier. The major point is that bitcoins or dollars aren't actually worth anything intrinsically. They have no value. Value exists in goods and services. With a deflationary currency people are discouraged from economic activity which produces more goods and services because it causes them to lose money.
  - 13y ago
whyenot 13y ago
There's deflation, and then there is DEFLATION! Five days ago Litecoins were selling for approximately $7/coin on BTC-e. As I am writing this, the price is over $36/coin. If you had bought $100 of Litecoins last Friday, that purchase may now be worth $514. There is almost nothing that you can spend Litecoins on -- with the exception of buying other cryptocurrencies. It reminds me of the height of the dot com bubble, except several times "worse."
InclinedPlane 13y ago
I find many defenses of bitcoin hilarious. A lot of people are pointing out how great it is that bitcoin increases in value over time. Except there are at least two problems with this. One, few people who say such things have any concept of economic theory. Two, nobody seems to care where that value comes from. Somehow they just think it comes from magic, or somehow it has no cost associated with it. All in all it's precisely reminiscent of any and every speculative bubble throughout history. The market will always go up! up! up! Where does the increase in valuation come from? How is it possible for it to be sustained? Who cares?! We're gonna be rich! Yeah, good luck with that. (Edit: all of which is to say, if you want to fly in the face of conventional economic theory, go ahead, but bring some better arguments to the table than "well, it's just been going up the last few years!")
stevedekorte 13y ago
the deflation argument: 1) if value of A increases relative to B, people with A that want B will wait to trade for B Make A money and B some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make B a good and A money. The sellers and buyers are symmetric - when you buy a good with money, you are selling the money for the good. If the deflationary spiral is correct, it is correct both ways, and if it is correct both ways, it isn't correct at all. Any temporary asymmetry in price movements run into time preference barriers that return it to a relative equilibrium.
- dllthomas 13y ago
  If people are waiting to trade A, then there will be a shortage of A, which means (in a marketplace) that people trying to trade B for A will need to trade more B. The pressures are not symmetric just because the action is when we restrict our viewpoint to two participants.
stevedekorte 13y ago
the deflation argument: 1) if value of A increases relative to B, people with A that want B will wait to trade for B Make A money and B some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make B a good and A money. The sellers and buyers are symmetric - when you buy a good with money, you are selling the money for the good. If the deflationary spiral is correct, it is correct both ways, and if it is correct both ways, it isn't correct at all. Any temporary asymmetry in price movements run into time preference barriers that return it to a relative equilibrium.
stevedekorte 13y ago
the deflation argument: 1) if value of A increases relative to B, people with A that want B will wait to trade for B Make A money and B some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make B a good and A money. The sellers and buyers are symmetric - when you buy a good with money, you are selling the money for the good. If the deflationary spiral is correct, it is correct both ways, and if it is correct both ways, it isn't correct at all. Any temporary asymmetry in price movements run into time preference barriers that return it to a relative equilibrium.
stevedekorte 13y ago
The deflation argument: 1) If value of X increases relative to Y, people with X that want Y will wait to trade for X. If we make X money and Y some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make X a good and Y money. What does this suggest about the argument?
n00b101 13y ago
> it will cost you 1 BTC to produce, market, and sell a single widget, and that it is only worth your effort if you can sell each widget for 2 BTC, a handsome 100% margin. That's a 50% profit margin, not 100%. profit margin = 1 - cost/revenue = 1 - 1/2 = 0.5

55 points by exogen 13y ago

This is a fantastic article, and it highlights some of my worries as a Bitcoin lover. It would seem the only times one would use Bitcoin over USD is if a Bitcoin-specific benefit (for instance, anonymity when buying illegal goods) outweighs the cost of using BTC over USD. In a deflationary economy I can't fathom why someone would spend BTC over USD buying a legal good, except maybe for the kick of having spent Bitcoin.

mike_esspe 13y ago
2% less fee, than credit card. It's enough to take over the payment world. And it's only one of the advantages.
- dragontamer 13y ago
  The 0.0001 BTC Transaction fee tacked on to every BTC exchange is only going to get worse and worse as BTCs's exchange rate goes up btw. What used to be a rounding-error that happened on every BTC transaction is now a $0.10 tax on every BTC transaction. If BTC continues to deflate, the transaction fees on BTC are going to become quite sizable.
  - marcell 13y ago
    This is a known issue. The current design around smart fees is described here: https://gist.github.com/gavinandresen/6548612 https://gist.github.com/gavinandresen/6548612 The high level idea is to introduce market mechanics to bitcoin fees, with the expectation that competition will drive prices down.
lukifer 13y ago
If the deflation ever becomes stable(ish), the increase of value can be accounted for in the price, as sellers will have a reason to prefer BTC and offer discounts (not to mention eliminating all those 2.9% credit card fees). We already buy all sorts of optional goods, even if those goods will depreciate compared to letting money sit in a bank account and accrue interest.
- dragontamer 13y ago
  Bingo, we have a winner. What is important is NOT deflation vs inflation, but to keep that value _stable_. USD inflates at a rate of 3% year over year, so we can compare investment vehicles against the rate of inflation and see whether or not they are good deals. But since BTC is extremely volatile, its impossible to use it as a unit of value. Until it settles down and becomes predictable, it will become impossible to form a "BTC Economy".
  - lukifer 13y ago
    I think of it as owning shares of stock in a DAC (Distributed Autonomous Corporation). At some point, those shares of stock might become worthwhile as a day-to-day currency. As is, though, I think it's already more stable than local currencies for some parts of the world (though perhaps still not more so than the dollar).
    - dragontamer 13y ago
      It isn't a stock however, and never will be. The reason why people invest in companies is to make more money. Companies may not offer dividends today, but eventually they will. (IE: Even Apple, once allergic to the idea of dividends, offers a regular one to its investors). Any company that churns a profit will eventually share those profits with its investors. "Owning" BTCs is not about churning profits eventually, its 100% about speculating about its future value. Building BTC Mining equipment is where the real "value" of owning BTCs is in, since that puts you in control over a number of BTC transactions. The BTCs themselves can NOT be compared to stocks. Stocks mean you actually own the company, you eventually partake in that company's profits... and even partake in choosing the board of directors. (who then in turn... choose the CEO). A BTC on the other hand, is like speculating on Oil, Gold, or Timber. Its a commodity, not a "share".
      - lukifer 13y ago
        I suppose the proof-of-stake coins act a little like stock, in that one gets to contribute to the 51% that writes the rules of the network, but I take your point. Ultimately, crypto-coins are a new type of financial instrument that don't fit cleanly into either currency or commodity (given that they're not exchangeable for something tangible). Owning BTC is subjectively stock-like, in the sense that its present value is based primarily on network effects, and its future value is highly uncertain.

marcell 13y ago

A few thoughts: 1) Conversely, why would I want to keep my wealth denominated in a currency that loses 2% value every year? 2) Supposing 90% annual deflation forever, as this article does, is disingenuous. Bitcoin is currently a 5 year old technology, and of course it will have periods of significant volatility. In the long run, bitcoin will stabilize, and deflation will be on the rate of global economic growth, currently estimated at around 2% [1] 3) In the long run, people could keep their wealth denominated in bitcoin, and spend dollars. There you have the best of both worlds: your wealth storage is deflationary, and your spending currency is inflationary. edit: 4) Perhaps most significantly, remember that bitcoins and dollars are exchangeable at any point in time. Any dollar you spend on goods/services is a dollar you could have spent on bitcoin. Have bitcoin enthusiasts completely stopped spending dollars on goods/services? [1] http://www.wolframalpha.com/input/?i=global+gdp+growth http://www.wolframalpha.com/input/?i=global+gdp+growth

dragontamer 13y ago
Because losing 2% to 3% every year is actually quite stable. Its so stable that the typical person doesn't notice it. Deflation at the rate of 100% over two weeks on the other hand (ie: BTC's current rate of change), is absolutely and utterly ridiculous.
brownbat 13y ago
> In the long run, bitcoin will stabilize, Why would this be true? Gold and silver have been around a long time, but both are still relatively volatile. I mean, I hope you're right, I'm just curious where you think volatility ends up and why you think so.
- dragontamer 13y ago
  The volatility of Gold and Silver is approximately 20% / year. There was a MASSIVE Gold sell off earlier this year, which caused a temporary spike of Gold Volatility to 60%. In comparison, the volatility of BTC is approximately 6000% / year. The magnitude of volatility is straight up ridiculous. The behavior of BTC is more like a penny-stock than any commodity on the market

zcarter 13y ago

The 'depreciating currency is a problem' argument is true for the existence of any asset having a higher yield than your widget factory. Why wouldn't you invest in that high yield asset instead of your widget factory? In this way, you can view _any_ appreciating asset as a reference unit of account. It is just as easy to see your egg and milk purchases as units of the high yield asset and delay your purchases for the same reason outlined in the article. So, it's a nonsense argument. If you have a strong prior that stocks are going to be worth 100% more tomorrow than they are today, why would you buy milk and eggs with your spacebux today? You could invest your spacebux in stocks, sell them tomorrow, and buy milk and eggs tomorrow! Therefore, no one will buy milk and eggs today if stocks are expected to rise in price.

dllthomas 13y ago
I'm not sure whether this winds up being meaningful, but a difference is that more hops means more transaction costs.
john_b 13y ago
The critical difference is that Bitcoin is intended to be a currency and not an asset. People use assets to store (and hopefully appreciate) value over time. People use currencies to conduct business and as mediums of exchange. If you think of or use Bitcoin as an asset, you immediately nullify any comparisons with currencies because the two serve different purposes. You could, in principle, buy a house with, say, 10 cars. But that is not done in practice because the market for asset-to-asset transactions (bartering) is small and illiquid. If you are willing to ignore Bitcoin's purpose as a currency and only use it as an asset, you need to consider what will drive its value in the long term. For most things, that value is just a function of the supply and the demand. While the supply of Bitcoins is fixed and the demand for items that can be bought in BTC is increasing, what will happen when everyone realizes that BTC is a better asset than currency and stops using it for transactions? It will become illiquid, and illiquid assets only have their tangible value. Since Bitcoin isn't tangible like a house or a car, its tangible value is zero. For the record, I think Bitcoin has potential, but not with the present economic dynamics.
- 13y ago

brownbat 13y ago

I heard Krebs in a radio interview say that many criminals who are practical experts in the actual use of experimental currencies require something like Liberty Dollars for price stability. Could a cryptocurrency build price stability in as a feature? I know this is anathema to one of Bitcoin's founding principles, but what if the payout for each round of mining was adjusted based on the average transaction size in the last few blocks? If transaction sizes are going up, you're getting deflation, so the algorithm would increase the rate at which money is being printed. Not sure how to control for the opposite, for inflation. Maybe some small percentage of the transaction fees each round would get destroyed by the system, instead of paid out to the miners (it'd have to be a small percentage so you could keep people mining). Maybe better just leaving anti-inflation out of the design, since it isn't yet a demonstrable problem, might not ever be. You could fiddle with how aggressively the system fights for price stability, trading off against the reliability of profitable mining.

lumberjack 13y ago

Don't we the customers and the capitalists already have the same situation with dollars? I could either buy a PS4 or I could buy some penny stocks. I could either try my luck with a startup or I could put that seed money into a CD or a fairly low risk index fund. So it all depends on the actual realistic rate of deflation if Bitcoin ever reaches widespread use.

john_b 13y ago
Except that Bitcoin's intended purpose is as a currency, so to make meaningful comparisons you would need to look at other currencies or currency substitutes (gold/silver/jewelry/etc). Assuming that it reaches widespread use ignores the chicken and egg problem that producers of goods will not want to use it if the depreciation is too high. Currently you can spend bitcoins mainly through intermediaries and various online purchases that quickly convert the BTC to some fiat currency. I.e. pay a company for server space, they quickly turn it into dollars or euros to pay their electricity and employees. But to be a legitimate, full fledged currency it will need to both be a reliable store of value (low volatility) and be useful for producers (minimal depreciation). It has neither right now, and I personally don't see a path from the present state to that ideal equilibrium.

unreal37 13y ago

"There is a limited supply of bitcoins". Not really true. Bitcoin is infinitely divisible (unlike a dollar). Having only 21 million is not an issue, because pretty soon we will be talking about micro bitcoins as the base unit of transactions. And then there will be another Bitcoin competitor (Litecoin). And another. And another. We will never run out of bitcoin and equivalent products. Stabilizing the price is definitely an issue. Can it be stabilized?

jwallaceparker 13y ago

> why buy something today if it will be cheaper tomorrow? Because you want it today. The "fear of deflation" argument is now pervasive among monetary theorists. The argument goes that if people know that prices will fall, they will indefinitely delay all economic activity. This ignores the time preference aspect of economic decision making. For example, I will buy my cup of coffee today rather than wait a day or week to save 1% because I WANT IT TODAY. We've seen periods of significant economic growth coupled with falling prices. Before going fiat, we had slowly falling prices in our nation's period of largest economic growth, the late 1800's. "Wholesale prices dropped 47 percent from 1879 to 1900 and economic growth averaged nearly four percent per year." - Ron Paul http://dailyreckoning.com/the-mythical-merits-of-paper-money/ http://dailyreckoning.com/the-mythical-merits-of-paper-money...

deleted 13y ago
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atmosx 13y ago
Your analogy is flawed and completely unrealistic. BitCoin's fluctuations are insane, we're talking about ~ 15 times compared to last year. Would you seriously use a bitcoin to buy a cup of coffee today ?
- zcarter 13y ago
  Right, "Price Stability" is a different thing with real merits.
- jwallaceparker 13y ago
  I don't use Bitcoin at all. I'm just talking about the general idea of inflation. I'm not arguing the merits of Bitcoin.
tokenizer 13y ago
What's your opinion on inflation as an economic driver? I'm also a fan of deflation (as I want to save my money) but the Federal Reserve and other central banks (Japan being a notable example) are advocating for higher inflation, which begs another question: Are they right and both deflation and inflation can supply economic growth? If so, does that mean another factor is the main proponent for growth?

Anderkent 13y ago

The 'why buy something today if it will be cheaper tomorrow?' was never very convincing to me. There are many markets, look for example at computer hardware, where delaying a couple months can get you huge savings. And yet people buy new hardware, all the time.

badinker 13y ago

Deflation, where your money actually goes up in value, real bad. Ok got it. http://tinypic.com/r/2d102dj/5 http://tinypic.com/r/2d102dj/5

atmosx 13y ago
Real bad for a currency (if you are the FED), very good for an asset :-)

skizm 13y ago

What would happen if bit coins were produced at a steady rate indefinitely? Maybe not linearly but at some predictable growth rate. The amount of bitcoins in circulation would always go up and therefore decrease the value of each in circulation? Obviously I don't know much about economics but I can't see why this wouldn't work. Why does bitcoin have a hard limit on the total number of bitcoins produced?

nardi 13y ago

After some careful calculation, you determine that it will cost you 1 BTC to produce, market, and sell a single widget, and that it is only worth your effort if you can sell each widget for 2 BTC, a handsome 100% margin. I stopped reading right here.

deleted 13y ago

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mpg33 13y ago

This is trying fit a deflationary currency into a debt/consumption driven economy. Who says the best way to drive the economy is by taking on debt to consume good and services? I would argue that debt counteracts a lot of the gains set by consumption. The falling wages argument seems irrelevant...what's the difference between wages increasing 2% to keep up with 2% inflation and decreasing wages 2% to keep up with 2% deflation. Don't confuse numbers with value. I would argue however that the RATE of deflation is important. 90% is brutal...2% not so bad. Theoretically the rate of deflation of bitcoin's should decrease as time goes on.

Ashendar 13y ago
Even in a non-debt driven economy debt plays a useful role at a micro level in terms of financing productive investment, not just discretionary consumption. Deflation will increase the real value of debt, making it increasingly difficult to service the debt over time (since your wages would probably be falling), whereas inflation reduces the real value of debt over time.

knowitall 13y ago

I think the "deflation can't work" people are making the same mistake as the "interest can't work because one penny will eventually be worth as much as the weight of the earth in gold" crowd ("Joseph's Pfenning"). They interpolate incorrectly. In the case of interest, some borrowers go bankrupt (which is fine, because the world needs risk taking). In the case of deflation, presumably at some point people will want to buy things. They can not hold on spending forever because they might starve. In any case it seems obvious that the price of one Bitcoin can not go to infinity, because there is nothing of value "infinity" on earth. From that it follows that the deflationary dread scenario has to come to an end at some point, just like Joseph's penny can not accumulate interest long enough to be worth the earth in gold because all his lenders will go bankrupt before that.

bigiain 13y ago

Seems to me the problem pointed out only exists if you view the transactions without taking their larger context into account. Take his "100 Widget @ 1BTC each to produce, sell them later at a different value of BTC." scenario, which he characterises as an 80% loss. Now consider where the widget maker would have got his initial 100BTC from, and what he'll do with the BTC he sold the widgets for. Using his numbers, lets say you sold 50lb of butter to get your initial 100BTC. Several months later, when you've sold all your widgets (for the deflated 0.2BTC price) and you've got 20BTC in your wallet, you convert that back into your original resources, and get 100lbs of butter at the new 0.2/lb rate. All of a sudden the exact same scenario now looks like a 100% profit (50lb of butter becomes 100lb) instead of an 80% loss (100BTC becomes 20BTC). Admittedly, hanging on to the original 100BTC would have allowed the widget maker to sit on his hands for a few months and then buy 500lbs of butter, but looking at just the BTC deflation without the outside context makes things look very much worse than they really are. And ultimately, it's butter (or opamps or widgets) that you need to eat/live and that have "real value" in some sense - those 100BTC could just as easily have turned out to be worthless at the end of the widget production run - and the widgets could still have been sold for USD or traded for butter. The guy with a private key to a magic number proclaiming "100 BTC" might have had _nothing_ Not a problem if you can afford the gamble - not such a great idea if you _need_ that butter to feed yoru family.

InclinedPlane 13y ago
You're missing the point entirely. It's about opportunity costs. If you try to use a deflationary currency for any economic activity then you get bitten by deflation, you end up losing money. The fact that the total revenue you get back is still worth the same (in butter or what-have-you) is irrelevant. You still had to buy equipment, you still had to pay people wages, and so forth in that currency to start with. But if you had not invested that money to start with you'd be even wealthier. The major point is that bitcoins or dollars aren't actually worth anything intrinsically. They have no value. Value exists in goods and services. With a deflationary currency people are discouraged from economic activity which produces more goods and services because it causes them to lose money.
- 13y ago

whyenot 13y ago

There's deflation, and then there is DEFLATION! Five days ago Litecoins were selling for approximately $7/coin on BTC-e. As I am writing this, the price is over $36/coin. If you had bought $100 of Litecoins last Friday, that purchase may now be worth $514. There is almost nothing that you can spend Litecoins on -- with the exception of buying other cryptocurrencies. It reminds me of the height of the dot com bubble, except several times "worse."

InclinedPlane 13y ago

I find many defenses of bitcoin hilarious. A lot of people are pointing out how great it is that bitcoin increases in value over time. Except there are at least two problems with this. One, few people who say such things have any concept of economic theory. Two, nobody seems to care where that value comes from. Somehow they just think it comes from magic, or somehow it has no cost associated with it. All in all it's precisely reminiscent of any and every speculative bubble throughout history. The market will always go up! up! up! Where does the increase in valuation come from? How is it possible for it to be sustained? Who cares?! We're gonna be rich! Yeah, good luck with that. (Edit: all of which is to say, if you want to fly in the face of conventional economic theory, go ahead, but bring some better arguments to the table than "well, it's just been going up the last few years!")

stevedekorte 13y ago

the deflation argument: 1) if value of A increases relative to B, people with A that want B will wait to trade for B Make A money and B some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make B a good and A money. The sellers and buyers are symmetric - when you buy a good with money, you are selling the money for the good. If the deflationary spiral is correct, it is correct both ways, and if it is correct both ways, it isn't correct at all. Any temporary asymmetry in price movements run into time preference barriers that return it to a relative equilibrium.

dllthomas 13y ago
If people are waiting to trade A, then there will be a shortage of A, which means (in a marketplace) that people trying to trade B for A will need to trade more B. The pressures are not symmetric just because the action is when we restrict our viewpoint to two participants.

stevedekorte 13y ago

The deflation argument: 1) If value of X increases relative to Y, people with X that want Y will wait to trade for X. If we make X money and Y some good and you have the deflationary spiral argument. But notice that the structure of the argument is unchanged if we make X a good and Y money. What does this suggest about the argument?

n00b101 13y ago

> it will cost you 1 BTC to produce, market, and sell a single widget, and that it is only worth your effort if you can sell each widget for 2 BTC, a handsome 100% margin. That's a 50% profit margin, not 100%. profit margin = 1 - cost/revenue = 1 - 1/2 = 0.5