Bitcoin Forum

Dear all,

I'm an academic macroeconomist (with a doctorate, university post etc. for what it's worth). As such, BitCoin and the various other crypto-currencies hold a great deal of interest for me. However, there's something I'd like to discuss with the community, possibly with the ultimate goal of collaborating on a new crypto-currency.

While I have very few doubts that a crypto-currency will come to dominate in the long run, I am somewhat sceptical that it will be any of the current crop, despite Bitcoin's substantial first mover advantage.

Given the constant proliferation of alternate crypto-currencies, it seems likely that in the long-run there will be a range of crypto-currencies all of which use an algorithm without obvious flaws, but which differ in the degree of inflation/deflation and/or price volatility they generate. In such a circumstance, which currency would people pick? Well, the answer to this depends on what the main costs of inflation/deflation are for them.

In standard macro-models today, there are two main costs. Firstly, people face costs due to the necessity of holding cash. If you have to hold cash to make purchases, and that cash is subject to inflation, then the contents of your wallet are constantly losing value -- you are effectively paying a tax to the people creating ("mining") new currency. Secondly, people face costs due to constantly adjusting prices and/or contract terms. For buyers, these costs include search costs, information costs, etc. etc. (If a loaf of bread always costs $1.00 in your normal supermarket, then when you see a loaf of bread on sale for $0.90, you know it's a good deal. If the cost of that loaf of bread is wildly fluctuating in your normal supermarket, then you face a much harder job assessing whether another store's price is a good deal or not.) For sellers, these costs include the cost of going round and physically changing prices in a store, and again various information costs.

Depending on which of these two sets of costs dominate, the exact optimal policy prescription varies, but never by so much. If the former cost dominates, then nominal interest rates should be set to 0 (so steady-state deflation is equal to the real interest rate), meaning there is no opportunity cost of holding cash rather than having your money in a bank. (This is the "Friedman-rule", not to be confused with the "Friedman K% rule", which is not optimal in any standard model.) If the latter cost dominates, then inflation rates should be set to 0.

Directly targeting an inflation rate of 0 to fix the second cost would be very hard with a crypto-currency. Yes, the supply could be controlled to ensure a constant exchange rate to some (basket of) currency(ies), but this would mean putting your trust in the maintenance of the value of the crypto-currency back with national central banks, rather defeating the purpose of using such a crypto-currency in the first place. Even monitoring the relevant inflation rate for a crypto-currency would be difficult, because at present much of their use (if I understand correctly) is in the purchasing of goods where one or both parties don't want it made public that the transaction took place (e.g. because the good is illegal), making it very hard to build a price index.

What about the first cost? Well, first note that with any electronic currency there's no need to set the nominal interest rate to 0 in order to remove the opportunity cost of holding cash. Instead, one can directly pay interest on the currency. With a crypto-currency, this can be done via Peercoin style "proof-of-stake" payments, where the payment rate is tied to the observed risk free nominal interest rate on the crypto-currency (appropriately smoothed). To get this risk free nominal interest rate, the creator of the crypto-currency would create a (ideally, decentralised) platform for the exchange of repurchase agreements denominated in the new currency, using "old" currencies as collateral (though in the long-run, other assets could come to fulfil this role). Although using repurchase agreements rather than unsecured loans removes much of the risk, it may still be desirable to construct a simple reputation system, so that the repo rate for high reputation parties is truly a risk-free rate.

If this is all one did, the interest rate and the inflation rate could be unstable. However, with a crypto-currency one has a second instrument, namely the release of new coins via the "proof-of-work" mechanism. With this one could ensure that the nominal interest rate remained at least (say) 4%, which is approximately the long run real interest rate, meaning that prices would be roughly stable (thus minimising the second cost), and is high enough that any problems stemming from the zero lower bound on nominal interest rates are avoided. In the unlikely scenario in which interest rates actually exceeded 4%, then Peercoin style transaction costs could be applied, though this is to be avoided if at all possible since transaction costs reduce allocative efficiency, having a big welfare cost (and meaning consumers won't be persuaded to use your currency).

Happy to discuss this further if anyone's interested. And if anyone's seriously interested in creating this crypto-currency and wants help, PM me. Another possibility would be open development which seems the best way of avoiding the stink of scammery...

Best regards,

ZeroNominal

Interest read,hopefully some more informed guys come along and give some input
I can say that I think Devcoin releases coins to keep inflation in check,you might want to go over to the thread and have a chat about how it's set up

Good luck!

Hi,

very interesting.  You may want to have a look at emunie ( http://forum.emunie.com/ ), which has a built-in mechanism to stabilize the value of the currency.

And I think this assumption is wrong:


IMO the current problem is that at this time the value of coins is mostly due to speculation. Very few currencies have a real world use, like buying goods. And even for those that have it, the merchants have to adjust their prices due to the volatility created by speculators.

Emunie sounds like it's made some interesting technical innovations. (Described here for the benefit of others: http://forum.emunie.com/index.php/topic/139-emunie-latest-technical-and-feature-set-ramblings-29th-june-2013/ ). The "hatcher" mechanism is an interesting new supply mechanism for one, and the multiple chains sound like a good idea.

But it's naive to expect to be able to stabilise the value of the currency via reacting to base money demand. The theory, if I understand correctly, is that if you know the elastic supply schedule (because you're in charge of that supply), then you can back out demand fluctuations from movements in price. The natural price for a currency is the nominal interest rate denominated in it, but there's no mention of a bond market in the eMunie proposal. Nor are they responding to an exchange rate, it seems (not that that's ideal either). Instead, it seems from the second post in that thread that they're proposing to respond to the price of generating the currency, which there's no reason to suppose is in any way related to the currency's value.

There's an even greater problem with this proposal, in that controlling the supply of base money is not the same as controlling the money supply. Central banks around the world tried this approach in the 80s, inspired by Friedman, and the result was massive volatility in inflation. Fractional reserve banking means the money supply exceeds the monetary base. And hoarding of money as an asset implies the supply may be lower than the base. In any case, true money supply is not observable, so the controller's of the currency couldn't distinguish between demand and supply fluctuations, leading to unstable value.

The author's of that proposal also seem somewhat confused about what is and what is not inflationary. Paying interest on the currency is inflationary. (Money creation is money creation.)

So, it's a step in the right direction, but still doesn't seem like something that could challenge traditional currencies in the long run. Perhaps everything that is wrong with the proposal is contained in this sentence:

"The result is a reliable, predictable real world value increase, which when rising ultimately results in ... profit for for the stake holder."

This is pretty much the definition of a ponzi scheme. Holding an asset just because you'll be able to sell it for more later, even in the absence of any fundamental value. (And no, unless you can consume solutions to cryptographic puzzles, "mining" doesn't count as value generation.) The true value of a currency comes from its use in transactions, and a necessary condition for being useful in transactions is roughly stabilising the price level.

Thanks for the post. Glad to see a more serious economic analysis by academics of the cryptocurrency phenomenon. However, given the nature of this forum, I doubt there will be a serious economic discussion.

Hey, good to see someone serious about economics around here. I'm somewhat of an amateur economist. I follow a lot of econ blogs (my favorite being Scott Sumner's), did some econ in undergrad, and read parts of econ texts in my spare time.

It sounds like the first cost you refer to would not be an issue in the case of Bitcoin, assuming its use as a % of the overall economy eventually reached a stable state. The value of the currency would be expected to rise roughly at the rate of GDP (assuming 100% of its value at that point was determined by its use in transactions).


Doesn't this depend on whether having a positive inflation rate encourages investment, and whether encouraging more investment than is ideal in the 0 inflation case has positive externalities for society?

Speaking of encouraging vs. discouraging investment, a lot of people here will argue that people hoarding bitcoins rather than investing them doesn't actually lead to more idling of productive resources, because it just increases the value of non-hoarded bitcoins, so whenever any non-hoarded bitcoins are invested, their value will be high enough to compensate for the hoarded bitcoins. What are your thoughts on that?


This should be no worse than things are now right? Unless you expect the black market share of the economy to grow with Bitcoin adoption. We will still have grocery stores, department stores, car dealerships, etc, who will all need to be transparent with the government and will have to report sales accurately, even if the relevant data couldn't be harvested directly from the block chain.


I'm not sure I fully understand this, but it seems fairly complex. In the situation you're imagining, when the interest rate being paid on the currency is set/changed, the code running on the network is just hooked up to this decentralized exchange and uses the prices there to set the new rate in a 100% automated way?

Is this complexity really worth avoiding a ~2-3% expected annual deflation?


Is the idea that the stability would come from less people wanting to hold the currency for speculation/investment, because they would know there would be expected 4% inflation?

Btw, my idea for solving the price stability problem is to simply have the government or some trusted private institution publish a price index, which could be NGDP-targeted. All prices, wages, and contracts could refer to units of this index (maybe the government would give favorable tax treatment to businesses which do this). So even though the underlying value of Bitcoin might be fluctuating wildly, people can get stability of they want it. Banks can offer checking accounts denominated in this new unit, giving less risk to the consumer in exchange for keeping the bulk of the value gained from the expected deflation.









 

I'd like to hear your response to this idea, it's a theory that I've kept in mind while developing a crypto-currency (I've had to assume quite a lot to keep it short).  The only rational measure of economic calculation is profit and loss, there is no accurate way to calculate the "real" value created by an activity, but the use of money allows individuals to rationally calculate the production of "real" value in an economy and thereby reward activities with wealth by using a common unit of account, money, as a rough approximation of a measure of value.  Because economic calculation can only be measured through profit and loss, and profit and loss uses as its measure of value money, the way to make the calculation of profit and loss an exact science, such as physics, would be to use a stable unit of value, just as Physics uses stable units of measurement.  However, because value cannot be measured, all monies released on the market are simply approximations of a unit of value (some are closer than others). 

Monies chosen on the free-market, notably gold and silver have an inherent price mechanism that works to stabilize their value.  If the value of gold rises, then gold mining becomes more profitable, thus more resources are allocated toward gold mining capital equipment, thereby increasing the supply of gold to offset the increased demand.  If the price of gold drops, resources are directed away from gold mining capital equipment therefore causing the supply to rise at levels in tandem with the slowing demand for gold.  Historical records indicate relatively stable prices of gold over centuries, from the Greeks to the Romans and up to the beginning of Central Banking, which is an empirical proof that the ideal money has stable value.

The rate of growth of an economy is determined by the rate at which individuals prefer present satisfactions over future satisfactions which decides the rate at which they allocate present resources towards present consumption and investment for greater future consumption.  As an economy grows the satisfactions gained from present consumption grow in direct proportion to the satisfactions gained by future consumption so the rate of growth can only change by a species wide change in values, which is highly unlikely (although at the individual level the rates of present to future consumption are always changing).  Therefore, the way to achieve long-run price stability is to simply create a create a crypto-currency with a long-term stable ratio of coin production, although it is not evidently clear what this ratio would be. 

Finally, any money that has  long-term changes in value will inevitably cause errors in the calculation of profit and loss in "real" terms because money is simply the unit of measurement for economic production (if Physics used units of measurement whose values changed then all calculations of moving bodies would inevitably contain errors).  Therefore, an economy that uses a money that has 0% inflation will be more productive than the same economy using a money that either inflates or deflates.

Let me know what you think, I've been waiting for someone like you to talk to on this topic and I would like to delve much deeper into it. 

Except Bitcoins are fungible so the rise in value of Bitcoins is shared between the hoarders of bitcoins and the invested Bitcoins, so yes there will be some compensation, but this is still less than ideal.  Also the rate of price increase is entirely dependent on how many goods are being traded with that currency, so in the short-run it may fluctuate wildly, but there is nothing you can do about that.  Furthermore, GDP does not contain total wealth of an economy, just what has been produced during the year, so the rate that will keep a currency at 0% price inflation is equal to the rate at which total wealth increases, not GDP.  

Think of it this way, say the total wealth of an economy grows at 3%.  Any business that grows at less than 3%, will be experiencing a monetary loss when calculated in terms of Bitcoin.  Furthermore, hoarding Bitcoins has become profitable thus increasing the opportunity costs of all productive activities further dropping production levels.  This is hugely significant because the majority of wealth is owned by business owners, who want the best return on investment, so if they would see higher returns on a coin with stable price levels you can bet your ass they are going to use it instead.


Value and inter-good price levels can't be measured in a scientific sense, although you can make basic observations about them.  All prices are ratios, for example you may go to a McDonald's and see that the prices of $1 per McDouble and $3 per Big Mac.  If you try adding ratios they must have common denominators meaning in order to add these you must go through the following process  ($1/McDouble)+($3/Big Mac) = ($1/McDouble)*(Big Mac/Big Mac) + ($3/Big Mac) *(McDouble/McDouble) = ($1*Big Mac + $3*McDouble)/(McDouble*Big Mac) = ?????  Also your scheme doesn't seem to fit into Bitcoin's architecture, as it creates a new currency which is kind of redundant given that Bitcoin, or any other crypto-currency, can already function as a unit of account.

I'll take these messages in turn, since it appears I missed one a long time ago. (Sorry!)


The currency would need to gain value at the real interest rate. There's no reason at all to expect this to happen, without explicitly targeting a zero nominal interest rate.


Investment only responds to real interest rates. While the presence of dollar nominal rigidities may mean that high nominal interest rates lead to higher real interest rates, it seems highly unlikely that this channel would work for bitcoins, at least given the current flexibility of bitcoin denominated prices. You are right that there are models in which positive inflation rates lead to higher investment shares and possibly even higher growth rates, but these are usually second order effects, and there are equally many second order effects that go in the opposite direction. The benefits of price stability in the absence of zero lower bound problems is a pretty consensual view in the profession. It is only because nominal interest rates are bounded below by zero due to the difficulty of demurrage on physical currencies that the profession agrees on the value of positive steady-state inflation.

Yes, if everyone was using Bitcoin for everything, forming a price index would be easy. But that isn't the world we're currently living in. However, eMunie now seems to have an inbuilt decentralized marketplace which could be excellent for harvesting price level data, and so perhaps targetting 0% inflation may be possible after all. (I stress again that targetting 0% inflation does not mean holding the money stock constant, as there's no 1 for 1 link between the money stock and inflation.)

Yes, it's a little complicated, but no more so than what say eMunie is doing (they have money creation tied to their marketplace). There's no real problem with expected deflation, the problem is with unexpected inflation/deflation. At the moment the cost of most items denominated in bitcoins fluctuates wildly from day to day, and this leads to various costly distortions to the bitcoin economy.

No, that's not the idea at all. If the mechanism is doing what it ought to, people shouldn't want to hold it for speculation, since that adds additional volatility to the price. Instead, people should just marginally prefer having their money invested to holding it in the cryptocurrency, but the difference should be as close to zero as possible.
The idea, rather, is that with the nominal interest rate fixed at 4%, although the real value of the cryptocurrency may still fluctuate, in the long-run its value should be roughly stable, since 4% is also the long-run real interest rate.

Yes, this is a good idea. The easier it is to access information on the aggregate price level, the easier it is to tie prices to this price level, and so the lower are the welfare costs of fluctuations in it.

I don't have any great solutions, but I've sure been admiring the problem.  

Eliding a whole lot of discussion of economic principles, I want to enumerate the 'levers' I can see that could easily be set (and not easily 'gamed') to try to create a stable cryptocurrency money supply for a healthy economy.

First, we can adjust the block formation subsidies over time.  This is the primary means by which new money now enters cryptocurrency economies.  I think offhand that the "halving every n months" model is the wrong model.  I'd be more confident in a model where each year 5% more is awarded than the previous year.

Second, we could have transaction fees that destroy a small fraction of the money whenever it's transacted.  In "normal" cryptocurrencies transaction fees are simply transferred to the miner - but in principle, they could instead disappear from the economy, or we could have some fraction disappear and some fraction go to the miner instead.   These tx fees are now usually set proportional to the disk space occupied by the transaction, but in principle they could be dependent on some other feature of the transaction or the block the transaction gets into, such as the amount transacted.  

Third, we could have money be created (or destroyed) in proportion to the bitcoin-days destroyed by a transaction -- effectively paying interest or charging demurrage on the interval for which the coins have been held prior to the transaction.  

We could also influence factors such as the velocity of money; for example we could regard as invalid or nonstandard any transaction that did not destroy at least as many coin-days as the number of coins transacted - meaning that the coins could not be spent on average more often than once a day.  Of course, if you have a penny that's four months old, that would mean you could spend a dollar instantly when you get it - it would be a matter of averages, not a requirement on every individual input.  I think of this because I think of the volatility caused by people who spend their money a thousand times a day (robotic twitch-market traders for example) as a bad thing.  

Some combinations of these could be more interesting than they are on their own; for example, a cryptocurrency could charge a tiny transaction fee based on the amount transacted, while simultaneously creating new money for the coin-days destroyed, such that transactions where the inputs were on average more than a week old create more money than the transaction fee (meaning free transactions, or even a bit of extra money back) while transactions where the inputs being spent are less than a week old would mean you had to pay some of the transaction fees out of the inputs.

But anyway, these are the levers we have to work with.  Transaction fees, block formation subsidies, interest/demurrage on the inputs used up in a transaction, and transaction speed limits.  What combination in the opinion of people who've actually studied economics would be worthwhile?  

It is certainly true that calculating real values is non-trivial, but I wouldn't say it is impossible. Where we can observe prices and quantities it's quite easy to derive a measure of real output which ticks most of the boxes one might like such a measure to tick. See https://en.wikipedia.org/wiki/Price_index (https://en.wikipedia.org/wiki/Price_index) for an introduction. (Modern statistical agencies use the Fisher index almost exclusively.)

The idea that "profit and loss" is the source of value is also problematic. We only care about firms profits because they use those profits to pay dividends, which enable us to consume more. So, rather, it is household consumption which is the ultimate arbiter of value in the economy. If a good is not valued by consumers, and is not an input into the production of other goods that are valued by consumers, then it will be worthless.


This is a compelling idea, but it's unfortunately wrong. As you suggest, the way to look at the problem is from the demand and supply sides in turn. Let's write D(p,t,ed) for the demand at a price p at time t given short-run demand fluctuation ed and S(p,t,es) for the supply at a price p at time t given short-run supply fluctuation es. Now its certainly true that if ed is high at some moment in time, then the price will increase, which will increase S. However, with plausible degrees of supply elasticity the result will be both an increase in price, and an increase in quantity, so supply adjustment is not going to perfectly stabilise prices in the short-run. In the long-run, supply adjustment is even more powerless to stabilise prices. Recall that the underlying source of demand for gold stems from its use in jewellery, or in chemistry, or in electronics, or in products manufactured using that chemistry or those electronics etc. So on the demand side, we might see trends coming from population, or from technology. Now higher population will also increase the amount of gold you can extract, as indeed will higher technology, however there's no reason in general why the demand side and the supply side trends should cancel each other out. Just imagine that someone worked out how to use gold to build an incredibly efficient fusion reactors, then the price of gold would sky rocket. In any case, the assertion that the price of gold has been stable just isn't true. See e.g. this graph http://pragcap.com/the-goldwheat-ratio, where the price of wheat may be thought of as a proxy for the world price level (since subsistence crops such as wheat still make up a large chunk of the world consumption basket).

Yes, the discount factor has an impact on the rate of growth in many endogenous growth models, but so do a whole load of other parameters! I also don't see how the conclusion of this paragraph follows from the first few sentences.

Yes, inflation causes real distortions. I think we're in agreement there.

You can get a pretty accurate measure of gdp for the currency in real time from the block chain. Even easier if transaction fees are fixed at a percentage of the value. Can't you use that to give us a formula to fix supply for a stable currency, macro economist.

Since we can see exactly when the currency is used, that's basically the demand for it, surely supply could be fixed to satisfy that demand?

Sounds like a very helpful exercise, especially given I'm not up to date with all the latest developments.


Using transaction fees for money creation/destruction seems like a bad idea to me. Transaction costs distort incentives for trade, meaning gains from trade are left on the table, destroying value. If the transaction costs are compensating for a real externality that that transaction imposes on others (such as disk space), then they may be efficient, but their level should be set in order to exactly counter-balance the externality, preventing their use as an instrument. (They are a kind of Pigouvian tax.)


This I like more...


Very novel idea. But I think it would cause a similar inefficiency to transaction taxes, at least unless the number of transactions allowed per day was reasonably high. You want to encourage people to use the currency as much as possible, so that all mutually beneficial trades are made. And in any case, if you think high frequency trading imposes some negative externality on everyone else, then you should be setting the level of the high frequency trading penalty in order to counter-balance this negative externality. A very nice, accessible, discussion on the pluses and minuses of high frequency trading is here http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.27.2.29 (http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.27.2.29). The author comes to the conclusion that there may be a case for having markets which operate on a discrete clock, with all trades posted in the last (say) minute executing at the end of that minute.

So I'd say use transaction fees and high frequency trading fees to combat any negative externalities related to these, and then use a combination of minting and interest/demurrage to target the desired interest and/or inflation rates.

If possible, this might be a good idea. As far as I'm aware though, the block chain will tell you at most nominal GDP, not real GDP, but NGDP targeting can be close to optimal under certain circumstances. The strongest arguments for NGDP targeting are based on wage rather than price rigidity, but no one that I know of is currently paid a bitcoin wage, so this may be one for the long-run.

If you were to do this, you'd tie the interest/demurrage rate to the deviation between NGDP and an exponential trend (say 2%). So when NGDP was high you'd increase future interest payments more than 1 for 1, for Taylor-principle type reasons.

However, I'm a bit sceptical about the claim that you can get even NGDP from the block chain. In order to arrive at NGDP, you need to know which transactions are associated with the exchange of goods, and which of these exchanges are intermediates for the production of other goods. So, for example if I have two wallets, and I send bitcoins from one to the other, as far as I'm aware, that transaction will appear in the blockchain just the same as one in which I sent someone some bitcoins and they sent me some chocolate. The latter should be counted in NGDP, the former should not. Similarly, if Bob buys cocoa beans with bitcoins from Alice (who harvested them), then Bob uses them to make chocolate, which he sells to Charlie for bitcoins, then if we count both transactions towards NGDP (Alice to Bob, Bob to Charlie), then we are double counting the cocoa beans. True NGDP in this case is just the value of the second transaction.

Thus extracting NGDP from the blockchain seems like an impossible undertaking. But perhaps I'm missing something.

Interesting view, its pretty clear that there is urgent need of this kind of conversation. Personally i would love to read about cryptocurrencies in some of those ecomics journals. I know that people here are mainly tech-people but as for a currency IMO it is mandotory to use macro-ecomic theories when developing a currency. As OP wrote there is many issues related to interest rates.

As far as i know, i havent either saw much of debate how bitcoin and alts will succeed in global financial markets and espacially how the bitcoin deal with in terms of debt and leverage. My language skills are quite weak so i hope that you get my point.

The only real issue I have with transaction fees as normally implemented in cryptocurrencies is that the externality they supposedly compensate for applies to everyone operating a full node, but that the people being paid for that externality are exclusively the much smaller set who have specialized hardware to solve block formation puzzles.   A distortion in the allocation of fees to offset costs seems to me no less certain to lead to economic distortions destroying value than a distortion in the amount.


Interesting.  I came to exactly the same conclusion when I spent some time thinking hard about it, with the added condition that the end of the trading period should be probabilistic (like the end of a block interval) rather than deterministic (like the end of a minute).  Otherwise people would be playing endless games about the last fraction of a second before the end of the period.   But anyway, I'm all in favor of the model where all bids and asks for an interval are matched up and executed in batches where every seller and every buyer get exactly the same price.

It is actually quite hard to target a particular rate of interest or inflation (measured in value) by adjusting the number of units of currency in circulation.   As an altcoin implementor you can influence the latter only.  We tend to assume that in some hypothetical steady state it eventually averages out that the value inflation and the currency inflation track each other in the long run - but is that purely a naive illusion?

I agree with all of this.


The deterministic model is fine as long as people cannot see any buy/sell orders placed within the minute. If this is the case, then you learn nothing by waiting till the last second. If buy/sell orders within the period were visible, then even if periods had random duration, people would still have an incentive to wait a little to learn something at least. It would also lead to random fluctuations in liquidity, which would cause additional fluctuations in price volatility, which is undersirable.


Yes. This is the problem. It is something that central bankers have slowly learnt over the last 50 years, with the focus gradually moving away from targeting measures of the money supply to targeting interest rates and inflation directly. If money growth is 5% per year, then, yes, in the absence of any trends in "velocity", inflation will also be 5% per year in the long-run. The problem is that there are trends in velocity, as new technologies and financial instruments change the need and use of money. For this reason, the velocity of money is something that is almost never mentioned in modern macro. It's so unstable as to be useless. We can expect substantial changes in the velocity of bitcoins as they become ever more tightly entwined in existing financial structures, with e.g. bitcoin banks and loans.

keep in mind that with a cryptocurrency we can directly monitor and instantly respond to any changes in the velocity of money. 

We know exactly how much money is spent every block.  We can apply any kind of deterministic calculation to it to adjust the money supply over subsequent blocks.   Does that help?  I mean, if we observe that the velocity of money is contracting sharply (or expanding sharply) what adjustments ought to be made in upcoming blocks to preserve a stable economy that 'seeks' a particular level of inflation/interest?

Original poster sounds like one the biggest Keynesian, maniac control freaks I've ever witnessed.

Why is gold still worth anything whatsoever and all the currencies in the following chart are worth nothing?  Because gold is the epitome of Occam's Razor, and pretty much everything you typed is the exact opposite.  (ie:  voodoo, witchcraft, or relies on authoritarianism to work at all)

The only logical starting point for a digital currency was to utilize game theory and the gold model combined together.  Central planning always implodes.  Eventually, BTC will be the digital transmission vehicle of gold, while the fiat pairings might become secondary in importance.  Sink your teeth in that watermelon rind, commie.

https://i.imgur.com/l5KmbRC.png

Intuitively, this doesn't sound correct. The true value of a currency surely is a function of supply and demand. Use in transactions represents one type of demand, but there are others. And I think there are a lot of real world examples where volatility in currency values has not inhibited its use in transactions.

^That post is kind of easily debunked by the Peter Schiff paraphrase, "I need this currency to pay taxes so they won't throw me in prison".

Value through coercion.  Keynesians like this guy not only accept it as the norm, but like to see just how far they can expand on the idea.

Velocity is just as hard to measure as NGDP. Indeed, velocity is just NGDP divided by the money stock in question. As I said before, to get to NGDP (and hence velocity) we'd want to prune the list of all transactions of all transfers between wallets, and all intermediate transactions. (In any case, we're only interested in velocity as it enables us to derive NGDP. The original monetarists took velocity as constant in the short-run, so thought they could derive NGDP from the money stock. This assumption has proven to be a bad one.)

The price of a currency is a function of supply and demand. The value is measured in different units ("utils" if you like). You're perhaps thinking of demand stemming from a currency's role as a "store of value", but this is an off-shoot demand from its use in transactions. If you did not expect to be able to use the currency in transactions in future, then it would not function as a store of value.

You're taking out of the picture the central bank role in regulating the price of the currency, that is the existence of the central authority with market-maker capacity. But this is the most prominent distinction between fiat and crypto. In a way traditional macroeconomics money theory cannot be directly applicable to cryptos

Use of currency to pay taxes = use in transactions. It is because I expect that in future someone will give me real goods in exchange for the currency that it has value to me now. (In the case you refer to, the real goods are avoiding whatever consequences non payment of tax has. So, yes, "coercion" if you want.)

But the government is not the only body who might be prepared to exchange real goods for currency for you in future. In fact, it's readily easy to write down a model in which a fiat currency such as bitcoin has a value because everyone believes that everyone else will accept it for payment in future. The problem with these models is that they always have at least two equilibria. One in which people coordinate on believing that everyone else will accept the currency for real goods, and so they too are happy to accept the currency for real goods, and another in which no one believes this. Both are fully rational. (They are sub-game perfect Nash equilibria of the dynamic game.)

Macroeconomists have been interested in the role of nominal tax payments not because they're necessarily the fundamental source of a currency's value, but because they provide a way of ruling out the bad equilibrium of the model, in much the same way that gold's use as jewellery ruled out the bad equilibrium in societies in which gold was used as currency. It is interesting to note that there's nothing ruling out the bad equilibrium for bitcoin. However, this is not the case for e.g. namecoin, for which the (apparently) fixed price of a domain name provides a lower bound on value. The bad equilibrium should also be ruled out for coins such as primecoin for which the mining process is productive, since if I value prime chains sufficiently highly I should be prepared to accept primecoins for real goods in order to incentivise others to mine primecoins.

ZeroNominal, have you seen Freicoin?

http://freico.in/

I might have heard it mentioned, but I hadn't seen the details. The problem is the fixed 5% demurrage rate. Having a fixed rate fixes no economic distortions whatsoever, since if (say) the value of a bitcoin grew by a constant 5% a year price setters could costlessly index to this known growth rate. The aim ought to be to use demurrage/interest to remove unpredictable fluctuations, not predictable trends.

The 80% distribution to a foundation also seems troubling.

Algorithms are predictable though so basically you seem to be arguing that you want some kind of central bank or central committee or something.

They have to be unpredictable so the manipulators cannot predict and thus incorporate into their attack/manipulation the actions of the magic fairy dust scatterers who are to scatter fairy dust to make it all magically act how you want it to?

Actually it kind of seems you ultimately are arguing that manipulation is needed thus you want to be the manipulator or to specify the manipulations that are to be done.

-MarkM-

No. I'm not saying what you thought I was saying... Removing predictable components of prices has no effects on welfare. Removing unpredictable components has a beneficial effect. But the unpredictable components can be removed via a very simple, entirely deterministic algorithm. In fact the simpler, more transparent, and less random the algorithm is, the better it is for welfare. For example, in "traditional" economies, central banks can use the Taylor rule https://en.wikipedia.org/wiki/Taylor_rule to stabilise prices.

That rule references target inflation rate without seeming to actually prescribe how that target should be calculated...

-MarkM-

ZeroNominal, we have emailed you.

That's another question... With physical currencies positive target inflation rates may be justified by the zero lower bound on nominal interest rates. But as I said in my original post, that need not be a problem for cryptocurrencies, so 0% inflation would be desirable were it possible.

Zeronominal check this coin, it will use Proof of importance (POI). If you check it, could you shares your views about it. NEM tries to be next big thing in world of cryptos

https://bitcointalk.org/index.php?topic=426303.msg5940057#msg5940057

In the presence of transaction fees, I think we can rule out many sources of 'noise' in measuring the velocity of money.  One can move coins to a different account within a wallet without incurring fees, and if wallets become sophisticated enough for accounting purposes, a natural desire to avoid incurring expenses ought to mean that money hardly ever moves between wallets unless it is genuinely being moved between actors. 

So we should be able to know, instantly, what the velocity of money is.  We can detect how much of the money supply is spent in every ten-minute block and we can react.

How much will it cost someone to move enough coins to cause a reaction they for some reason choose to instigate?

Who gets that cost, is it destroyed thus everyone including the perpetrator gains from it or does it go to miners or something so that who it goes to is compensated somewhat for the cost of the moving?

Is the amount of coin created by a move less than or more than the amount moved, and by how much?

-MarkM-

Cryddit, except that (1) collusion with a miner nullifies those assumptions, (2) when you have the ability to make bets (options) based on the interest rate you've monetized manipulating it, (3) technologies being worked on now like committed transactions and Zerocash encrypt the value amounts so you don't even know how much currency is moving.

We've been looking at this problem since 2010, and I'm confident to say there is no decentralized solution :(

There seem to be two proposals, neither of which seem like particularly good ideas:

1) Proposal for hybrid POS/PON: Non-linear proof of stake rewards. Rewards are effectively per account up to a threshold. Seems ripe for exploitation by botnets.
2) Proposal for POI: Seems to be the Google Page Rank algorithm (i.e. Principal Components) with transactions replacing links between webpages, and the sum of coin ages replacing the content quality measure (i.e. the prior distribution over nodes). Seems equally vulnerable to exploitation by botnets. (Suppose there are N legitimate nodes, all trading, N botnet nodes, not trading, and 1 master node for the botnet. The botnet nodes have arbitrarily old coins so receive substantial weight, despite their lack of any trading except with the master. All of this weight then flows to the 1 master node for the botnet, who must then get the highest "PageRank" in the network.) In any case, rewarding old coins is the opposite of what you want to do. The existence of old coins implies that the currency isn't actually being used! By rewarding old coins you're effectively taxing transactions, which imposes a large efficiency cost.

Not entirely convinced by this. Think of all of the transactions generated by a pool. Given even a tiny bit of concern about the continued existence of the pool, people are prepared to incur the transaction fee in order to remove the risk of the pool disappearing with all of their earnings. And in any case, it's not clear that the distortions generated by transaction fees aren't so high as to remove any benefits from e.g. NGDP targetting.

And in any case, even if we knew all transactions corresponded to an exchange of goods, we still wouldn't know which of these were intermediate transactions and which were final. Only the latter is relevant to the calculation of NGDP and/or velocity. We need to know the value added by each transaction, not the final sale price.

So everyone's financial details should be spied upon in deep detail by Big Brother so that Big Brother can manipulate the currency "properly" ?

-MarkM-

Yes. Their models require 100% accurate information :/

Keynesian economic models also assume that "everything else remains equal" (ceteris paribus). In the real world, however, this never happens.

I'm not sure where any of this is coming from. Certainly not from anything I've written. Suffice to say it's ridiculous to describe what I'm putting forward as Keynesian (I cited Friedman in the first post for god sake) and it's even more ridiculous to ascribe any of the views mentioned in the above quotes to modern Keynesians, who I may not agree with, but who nonetheless manage far more sophistication than is on display from some of the commenters in this thread.

On bitcointalk.org, if you don't believe that the one true monetary system is bitcoin(-based), you are a keynesian. And the only austrians worth discussing are the ones that trumpeted deflation like Mises, or (lol) Lew Rockwell.

NGDP is essentially every unit of x currency spent in an economy. Official GDP figures are only an estimate & there are different ways of estimating that. We can get a very accurate measure for a certain type of NGDP, money supply (probably similar to M1 money supply) & velocity of money from the blockchain. They may be slightly different to typical government stats, but they should at least be more accurate & updated in real time.

So, essentially, we can use these metrics that are easy to generate from the blockchain to determine the demand for the currency. We can control the increase in money supply through controlling the block reward for miners. Transaction fees could be used as a tax to take money out, or maybe there are other ways.

A good argument for targeting NGDP, or velocity (or whatever you want to call it) is that it's pretty simple to measure on a blockchain. Doing that with a traditional currency would be much more prone to error.

Just need the maths to do that. Should be a fairly simple formula to create a currency who's supply responds to demand to enable even more stable (or slightly inflating) prices than good fiat currencies.

Instead of measuring & targeting price inflation to promote growth, we can measure & target growth with the aim of low price inflation.

No, it's not. It's the total dollar value of final (not intermediate) sales, equivalently, total dollar value added.

You may possibly be right that targeting the total nominal value of all transactions might be an improvement on existing crypto currencies. I really wouldn't like to say, since it depends on the relative variances of various unobserved factors. My hunch is that targeting something sub-optimal like this would not be worth the risk.

Right.  Instead of looking for the stats we can't get, we should be looking at the stats we can get and figuring out how we can use them to make something that works better than if we ignored them.  

So, really, that's what I'm interested in too.  The stats we can get from the block chain aren't exactly the NGDP, or aren't exactly the velocity of money, or whatever,  But they are what we can get, and if we're to do any better than we've done they're what we have to start with.  

I'm no economist, and I don't know what to assume or do about them, but surely they are related to figures that economists have studied?  Maybe not perfectly, but enough for some broad empirical rules under reasonable assumptions about those relationships, about how to respond to them to make things better than they'd be if we simply ignored them?  

'Cause if we can't do better than ignoring them what's this conversation about in the first place?

But there aren't any meaningful stats you can extract out of the block chain. The fact that the block chain exposes who paid how much to whom is a bug, not a feature, and that source of data will be eliminated in the near future. The question will become: how do you control the nominal interest rate without any econometric data whatsoever?

There's a reason Freicoin's demurrage rate is flat: it's not out of laziness or ignorance. It's the best you can do! The only other real option is to track by means of a synthetic asset or prediction market, but that leaves the entire economy vulnerable to collusion and manipulation. But having a fixed demurrage rate doesn't make Freicoin broken - instead of the real nominal interest rate varying between 4-6%, it'll vary between -1% and 1%. This is an improvement. And, sadly, the best that can be done without sacrificing user privacy and/or decentralized control.

Well, my point was that we don't need any of these statistics. We don't need to know velocity, or NGDP. All we need to observe is the interest rate in a repo market denominated in the cryptocurrency, and you'll get big gains in stability. This doesn't seem too hard to me.

On the other hand, it's really not clear what the results of targeting the total value of all transactions would be. It's not even clear to me that it's possible. For example, you might think that you could just increase the interest rate on the currency when you were above the desired trend, since with higher interest rates on the currency, people have an incentive to hold it rather than making transactions. But if some people in the crypto-economy are more patient than others, then an increase in interest rates will lead to the patient people buying the crypto-coins off the impatient ones, generating additional transactions. Without sitting down and doing the maths I'd find it very hard to say what would happen here, and if I find it hard to predict, the chances are other participants in the market would also find it hard to predict, and you'd get more instability not less.

Oh... kay....  I'm game, but still struggling to see how to do it.

First explain carefully what a "repo market" as opposed to, say, a bond exchange or stock exchange or futures market is, or when one or more of the latter counts as a repo market.  Second, exactly how an interest rate relates to such a market.  The only one of those market types where interest rates are directly measurable seems to me to be some kind of futures market. 

If it's a service that we can figure out how to completely decentralize and build into the blockchain itself, then we're cooking with gas. If it's something that would be an external resource, or that would have to be centralized at a website somewhere, then it gets us nothing. 

The basic requirements here for the automatic reaction that we're looking for is that it has to arise in a decentralized p2p service, where the information that's being reacted to is visible to and checkable by literally everybody who can see the blockchain up to the point where the information matters.  Essentially the problem is that if it's an external source of information - if it reflects information not immediately visible to everyone looking at the blockchain - then people will not be able to check the blockchain to see that the response to it was correct at every point.   Being part of the blockchain, in turn, means it has to be a fully decentralized P2P application. 

Now, if it "still doesn't seem too hard" to you, then obviously you have a lot of experience designing fully decentralized P2P applications. 

Okay, if it's not too hard then please reduce this down to practice and show us a detailed design of how this would work.

Or at least maybe check whether something like bitshares or the like, which already claims to plan decentralised markets that do not rely upon outside "oracles", might be able to or would not suffice to provide the required information.

Nice to have an economist active around here again.

Or wait, does a macroeconomist count as an economist or are they rather distinct different disciplines?

-MarkM-

Perhaps I was a bit hasty in my discussion of Freicoin previously. If you could get an interest rate of -1% to 1% then without demurrage that would be an unambiguous improvement, since it represents a lessening of the inflation tax on holding money. However, doing it via demurrage is just replacing the inflation tax on holding money with an explicit demurrage tax. The fact it's explicit makes it marginally preferable, but the economic distortion is still there. People have to hold money to perform transactions, but they're penalised in doing so by the presence of inflation/demurrage.

I started working on a paragraph describing a potential mechanism, but I see there have been several subsequent posts, so I will defer it till my next post.

After some quick research; a repo market is a very specialized type of bond market.    Someone sells a bond (borrows money), then buys it back for slightly more money (or repays the bond plus interest) 24 hours later.  

In the conventional financial world, this is done with government bonds.  The people who need to borrow large amounts for very short periods are almost all banks and brokerages, looking at short-term imbalances in the flow of money among themselves.  

Obviously, there are no government bonds in a cryptocurrency blockchain, so we couldn't do it that way.    It is possible (though some hard work would be involved) to make a decentralized market part of a blockchain.  

However, in the absence of a way to verify and preapprove the identity of the counterparty, it would be completely insane to buy a debt instrument such as a bond on that market.   Picture the buyer, one day later, calling the police: "somebody owes me a million coins, but I don't know who.... " Even if you do have a pretty good idea who, there is still counterparty risk which is effectively absent from repo markets in which the government is the counterparty, and counterparty risk will raise the interest rates in an unpredictable way.

Legal identities are essentially the relationship between people (or businesses) and governments.  When we need to convince people that they can use the government to enforce our agreement on us, we need to give them the legal identity that links that government to us.  So the participants in the repo market must necessarily first publicly register a legal identity and bind it to a key.

And at that point we're no longer talking about a completely decentralized service, because governments are huge pits of information all of which is external to the blockchain.  

ZeroNominal, I would argue that demurrage is more fair.i Maybe this is getting off-topic, but hey it's your thread. When you are using inflation, sticky prices mean that you end up favoring those close to the source of inflation, e.g. investment banks in the fiat economy, miners in the inflatacoin economy. Demurrage on the other hand is felt equally and instantaneously by everybody, pro-rata to their holdings.

When you find a way of creating a crypto-currency without institutional backing (a central bank or other large guarantor of liquidity and value) whose value doesn't trend towards the cost of mining it, please publish your results Satoshi !

Use of malicious negative trust to suppress free speech discredits the bitcoin community

A repo market is a collateralised bond market. See e.g. https://en.wikipedia.org/wiki/Repurchase_agreement . It combines elements of futures markets and bond markets to produce one which comes close to capturing the risk free rate. The basic idea is that I sell you an asset (perhaps below market price), and we both sign a contract in which we promise to trade back the asset at some specified price in the future. The specified price may be written as a function of market observables to remove some of the risks associated with fluctuations in the value of the asset. As you point out in a later post, an enforcement method is obviously needed for these contracts, however, if the collateral is appropriate, losses from the other party reneging on the contract may be minimal.


Yes. OK. The details of the bitshares decentralized market seem a bit sketchy in the white paper, but they seem to have much of the required structure. eMunie also seems to have solved the problem, though I understand from Raxe that their solution isn't really decentralized. Finally, Ripple certainly provides a structure on which something like this could be built, with decentralized trust.


I do not pretend to know all the precise implementation details. I was hoping to provide useful guidance on the econ side, but having overused the word "easy" I guess I ought to put my money where my mouth is and conjecture as to how this could be implemented. The version I present here is without any explicit trust mechanism, though perhaps using the Ripple trick for trust would further help. For clarity in the below I call the new currency repocoins.

1) The wallet software would sync both the repocoin block chain, and that of a third party currency (Bitcoin would be the obvious one given its dominance, so I'll call the third party currency bitcoin below).

2)a) You host repocoin-bitcoin exchange orders within the repocoin blockchain, so they're public and verifiable. Each exchange order consists of two quantities: a number of bitcoins, B (possibly negative) and a price in units of repocoins P. The order represents an offer to sell (buy if negative) B bitcoins at the end of the current block at a price of P repocoins per bitcoin.
2)b) At the end of the block, the intersection of the supply and demand schedules are calculated, and the market exchange rate is set at this point. We will call this P* in the below. Since this is a deterministic function of the orders, it may be calculated by all nodes and verified en mass. All sell orders below P* will be executed (to be described), as will all buy orders above P*.
2)c) The repocoins and bitcoins in the orders to be executed are transferred as prescribed, with the bitcoin transactions going through first, and the repocoin ones only happening once the bitcoin ones have been verified en mass. Since the network can enforce the removal of repocoins, but not the removal of bitcoins, this order is required.

3)a) You host repocoin-bitcoin repo orders within the repocoin blockchain, so they're public and verifiable. Each repo order consists of two quantities: a number of bitcoins, B (possibly negative), and a gross interest rate R (e.g. 1.02 representing 2% interest). The order represents an offer to sell (buy if negative) B bitcoins at the end of the current block for a price of P* repocoins per bitcoin and buy (sell) them back at the end of the next block for a price of P*R repocoins per bitcoin. Note: the seller has borrowed BP* repocoins and will pay back BP*R, i.e. R is the gross nominal interest rate on their loan.
3)b) As before, we calculate the market interest rate R* from the intersection of the supply and demand schedules.
3)c) We mark (R*-1)BP* repocoins in the wallet of each seller as locked and untrasferable. This is enforced by consensus.
3)d) At the end of the current block, as before, the repocoins and bitcoins in the orders to be executed are transferred as prescribed, with the bitcoin transactions going through first, and the repocoin one only happening once the bitcoin ones has been verified. If a seller's bitcoin sale transaction fails for some reason then their previously locked repocoins are unlocked.
3)e) At the end of the subsequent block, the reverse transaction has to take place. This only happens if the seller's wallet has the required BP*R* repocoins (including the locked ones). If the seller doesn't have this number of repocoins, then the previously locked repocoins are unlocked and sent to the buyer. This leaves the buyer a total of B bitcoins and (R*-1)BP* repocoins, which are worth BP** + (R*-1)BP* repocoins, where P** is the new exchange rate. Providing the exchange rate fluctuations have not been excessive, this should still represent a moderate gain for the buyer. If the seller does have the required number of repocoins, then, as before, the bitcoins are transferred back first, and then the seller's locked repocoin are unlocked and the required repocoin are sent the other way. If the bitcoin transaction fails (e.g. because they do not have enough), then the seller keeps their repocoins, and the previously locked ones are unlocked. This leaves the seller with BP*R* repocoins, which (given small exchange rate fluctuations) they ought to prefer to B repocoins.
3)f) So, given the locking mechanism, it is only following large exchange rate movements that people will have an incentive to default. At worst then, R* will be the market gross nominal interest rate plus a bit of a risk premium. But fluctuations in the risk premium should be small compared to the fluctuations in the value of e.g. bitcoin, so targeting R* will still result in a stable currency.

4) Once the market rate in the repo market is observable, it's then just a matter of applying sufficient PoS interest on the next block when the repo market rate is below target, and demurrage if its above target. For example, suppose the target is 4%. Then, if the market rate were to be 3%, sellers in the repo market would gain interest on the repocoins they borrowed during the block in which they'd borrowed them, and hence they'd be more inclined to borrow in the first place, pushing up the market interest rate.

Why wouldn't I default every time it's in my favor?

Okay, what I'm reading into this is that in order to borrow 15 coins (sell 15 repocoins worth of bitcoin with an offer to buy the same amount of bitcoin back for ~15.005 repocoins the following day) the borrower must "lock" collateral worth a bit more than 15 repocoins for the duration of the time he's borrowing. 

If this collateral is repocoins, then obviously his borrowing makes no sense because repocoins are fungible.  whatever purpose he has for the repocoins he intended to borrow would be just as well served by the repocoins he's locking up for the duration.  Therefore I conclude that the collateral here must be in some other asset.  But if the collateral is in Bitcoins, then he's locking up the same amount of Bitcoins that he's loaning out, so wouldn't he be charging additional interest because this is tying up twice as much of his assets as are actually appearing on the market?

You would. But, 1) you'd only do this in the movement in exchange rates was larger than the interest rates, which it won't be a lot of the time, and 2) by construction, the loss to the other party from doing this is on the order of (R-1)(P**-P*) i.e. the product of two small things, so the risk premium this adds to interest rates should be small.

Over-collateralization is standard in repo exchanges. The collateral here is mostly bitcoins, plus the small amount of repocoins required to pay the interest.

Your point about the missing interest on the bitcoins is correct though. Just as the buyer is lending the seller repocoins, the seller is effectively lending the buyer bitcoins, and the buyer might legitimately like interest on this, if they didn't expect compensating increases in the purchasing power of bitcoins. The Hotelling model of resource extraction would predict precisely such increasing bitcoin value, which was what I had in the back of my mind. However, it is an undesirable feature of what I presented previously that some of the medium run departures from Hotelling rule growth of repocoins will potentially be reflected in the value of bitcoins. I'll see if this can be remedied.

Modify 3 as follows, changes in red. These changes also ensure that the interest rates are 100% risk free, with the risk now being spread equally over all of the users of the currency, not just those participating in bond markets. I have an idea for further simplifying things by combining 3 and 4, but I'm not sure I have the will power to spend further time arguing here...

3)a) You host repocoin-bitcoin repo orders within the repocoin blockchain, so they're public and verifiable. Each repo order consists of three quantities: a number of bitcoins, B (possibly negative), and two gross interest rates, R_r and R_b (e.g. 1.02 representing 2% interest). The order represents an offer to sell (buy if negative) B bitcoins at the end of the current block for a price of P* repocoins per bitcoin and then buy (sell) R_bB bitcoins back at the end of the next block for a total cost of P*R_rB. Note: the seller has borrowed BP* repocoins and will pay back BP*R_r, i.e. R_r is the gross nominal interest rate on their loan. Meanwhile, the buyer has borrowed B bitcoins and will pay back BR_b bitcoins, so R_b is the gross nominal interest rate on their loan.
3)b) Market interest rates R_r* and R_b* are determined by the following verifiable, deterministic algorithm. First, a list of all of the values R_r takes in orders is created, along with a list of all of the values R_b takes. At any particular value of R_r and R_b we can calculate the total volume of trade that would occur. We take the values which maximise this trade volume as the market rate.
3)c) We mark (R_r*-1)BP* repocoins in the wallet of each seller as locked and untrasferable. We also mark (R_b*-1)BP* repocoins in the wallet of each buyer as locked and untransferable. This locking is enforced by consensus.
3)d) At the end of the current block, as before, the repocoins and bitcoins in the orders to be executed are transferred as prescribed, with the bitcoin transactions going through first, and the repocoin one only happening once the bitcoin ones has been verified. If a seller's bitcoin sale transaction fails for some reason then their previously locked repocoins are unlocked.
3)e) At the end of a specified, later, block, the reverse transaction has to take place. This only happens if the seller's wallet has the required R_r*BP* repocoins (including the locked ones).

If the seller doesn't have this number of repocoins, then the previously locked repocoins are unlocked and sent to the buyer along with any other repocoins left in the wallet. Exchange limit orders are then automatically generated to sell the buyer's B bitcoins if they have them, an any price. This generates BP** repocoins (where P** is the new exchange rate) which are then destroyed, along with the (R_b-1)BP* locked repocoins in the buyer's wallet. Simultaneously, R_rBP*repocoins are generated (from nothing) and transferred to the buyer.  This leaves the buyer with at least the number of repocoins they were promised, despite the seller's default. To disentivise the seller from doing this too many times, after a default they would be excluded from the repo market from then on. And, in the long run, a bitcoin cost of wallet opening would be introduced to counter-balance default losses from people repeatedly opening new wallets.

If the seller does have the required number of repocoins, then, the buyer's B bitcoins are transferred back first, and then the buyer's (R_b-1)BP* locked repocoins are destroyed, and exchange limit orders are automatically generated in order to buy (R_b-1)B bitcoins at any price, using repocoins generated from nothing, with the resulting bitcoins transferred to the seller. Finally, the seller's locked repocoin are unlocked and the required repocoin are sent the other way. If the bitcoin transaction fails (e.g. because they do not have enough), then the buyer's (R_b-1)BP* locked repocoins and the seller's R_rBP* are all destroyed, and exchange limit orders are generated in order to buy R_bB bitcoins at any price, using repocoins generated from nothing. This leaves the seller with the number of bitcoins they expected. As before, the buyer is excluded from future participation in repo markets following default.[/color]
3)f) So, given the locking mechanism, it is only following large exchange rate movements that people will have an incentive to default, and when they do default, losses for the repocoin community will still be minor since they'll be proportional to abs(R_r-R_b)abs(P*-P**) (small).

Freicoin doesn't target 0% price inflation and that's probably impossible for a scarce currency. It targets 0% real interests, since 0% capital yields would mean the lowest profits and thus the lowest possible prices for consumers.
The constant 5% demurrage was recommended by Silvio Gesell based on historical data about real interest rates (https://www.community-exchange.org/docs/Gesell/en/neo/part5/8.htm).
People need to hold money to perform transactions but:

1) They don't need hold big quantities. Thus they don't need to pay high costs.

2) They use 0% interest/0% demurrage mutual credit money like LETS systems or the Swiss WIR.

3) Holding cash-like scarce money (thus without default risks) represents an insurance against uncertainty, a "liquidity premium". Not paying for it is an externality that causes the basic interest and thus higher consumer prices, monetary cycles and encourages less investment.

If you want a 100% stable unit of account, it is completely possible and not hard to implement. Just define it (for example, as a basket of globally traded commodities) and use it as denomination for credit-based currencies. Like Lietaer's Terra but without the backing itself (Thomas Greco agrees that the unit without a scarce currency is better).

As an aside, the primary function of proof of work is not distributing the monetary seigniorage but securing the network!
Something proof of stake doesn't seem to provide so far.

Okay...  After reading, this is all technically feasible and plausible.  Except for the last point.

And the last point is, what benefit does the community at large derive from this activity that makes it reasonable for them to freely choose to act as guarantors?  Why would they not prefer  another cryptocurrency that exposes them to no guarantor risk?

BTW, I am delighted to have someone who actually knows something about financial markets here, and I sincerely want to understand how that knowledge can be used to improve the state of the art in cryptocurrency.   I appreciate your work and knowledge, and sincerely thank you.

I don't intend my responses to be belligerent or argumentative, but instead keep asking questions because much still isn't clear to me.  I don't understand for example the motivations of people who would choose to use an over-collateralized market in debt instruments over the option of using the collateral itself.

The guarantor risk appears to users of the currency as inflation risk, which all cryptocurrencies already expose them to. No movements in their balances would be observed, only (possibly) movements of prices denominated in the good. And, what is more, since this would be the first cryptocurrency which does not impose an "inflation tax" on cash holdings, the costs imposed by this inflation risk would be miniscule to them. Furthermore, as I said in the original post, by pinning the interest target (on both cash and bonds) at the long run real interest rate, prices would be roughly stable in the long run, so any inflation would be short lived rather than persistent.



No need for the thanks or apologies, your discussion has consistently helped me clarify things to myself. I shouldn't have got exasperated...

Bitcoin has many similarities to gold. But societies have persistently chosen to use fiat currencies over gold. Gold however maintains a use as collateral in some real world repos, just as I'm proposing bitcoins would retain a use as collateral here.

A point that puzzles me is how are the miners, following the implied instructions recorded in the blockchain, to manipulate the bitcoins?

Parts of the protocol seem to have the miners sending bitcoins somewhere, or holding bitcoins somewhere, but since the blockchain is the only data upon which to decide which bitcoins to send to where, how are the private keys controlling the bitcoins that are to be moved etc stored?

For example when someone uses bitcoins as collateral and gets a loan, where is the private key of the address used to hold the collateral (those bitcoins) stored?

-MarkM-

Each individual wallet knows it's own bitcoin private key of course, and it is these individual wallets that are responsible for executing the bitcoin transactions they are required to execute for the protocol. A failure to execute these transactions would be detected and would count as default.

Are you sure that any long term equilibrium state of mining power for a given cryptocurrency isn’t >50% control by one entity? If you’re not sure then the specific technicalities are secondary for a decentralised crypto. Perhaps in referring to collateralisation you need to take it a step further. To flip the role of cryptos to simply that of a peer-to-peer clearing mechanism of other currencies/assets, maybe using non-blockchain based coins, and getting the right underlying credit infrastructure in place first. Something like ripple is a possibility, or open transactions. I can’t see how any real repo financing market could emerge until participants can measure credit risk. Incorporating repo collateral that consists of the same or very similar liquidity, market and counterparty profile to the loan seems to create a loop in achieving the measurable funding security and risk stability required to make it work.

In the above paragraphs you basically discribe    what Quark achieved.

Also take into account distribution time relationship with price stability , what fixed currency supply is issued over say 100 years?

All of these flawed models will been shown to be less than efficient in the market, and they are.

"not to be confused with the "Friedman K% rule", which is not optimal in any standard model.) If the latter cost dominates, then inflation rates should be set to 0."

The k-percent rule I contest is optimal and none of the standard models apply*, as crypto does not function under a debt based monetary principals.

Crypto can better be described as decentralized economic , its a merger of Austrian principals + decentralized network effects.

So on one hand the monetary side is very much simplified,  and in the other their are added socioeconomic complexities.

Anyone that has been "traditionally" economics educated ( and im not saying this ys yourself) may struggle with the simplicity of the monetary side.

And find the decentralized aspect alien.


* the only time that rule is not optimal is in a time when there are needs for sharp shifts in expansion Wars are an example, but are easily taken into account. 

Regarding the modified proposal, I believe it is not a repo deal any more, it's more like a fx swap deal. As a result, Rr is not real repo rate of repocoin, but a function of the rates of both coins. If so, how could we apply these numbers to adjust repocoin's PoS interests rates?

Yes, it's an interest rate swap, but implemented as a repo in order to reduce the contractual requirements. You're correct that it's non-trivial that the market clearing mechanism will return the right interest rates, as we have two interest rates to pin down from the intersection of two surfaces. But the given market clearing mechanism ought to work. To see this, suppose there were opportunities for investing bitcoin and repocoin with net (e.g. 0.02) risk free interest rates r_r and r_b. Furthermore, for simplicity, let's forget about the lost interest on the locked coins (it can be shown that everything we say ignoring the locked interest on the locked coins also holds in the limit as the time interval goes to zero). Then the seller (no matter how risk averse) will wish to participate in the swap/repo at least if R_b>=1+r_b and r_r>=R_r-1, likewise the buyer (no matter how risk averse) will wish to participate at least if R_r>=1+r_r and r_b>=R_b-1. Solving these four inequalities gives R_b=1+r_b, and R_r=1+r_r. Thus, in the presence of heterogeneity in risk aversion in the market, we should expect to see highest trade volume when R_b=1+r_b, and R_r=1+r_r i.e. when the "repo" interest rates reveal the true interest rates.

I LOVE how you portray this as a positive thing when it's really the start of where all the fraud began.  People started to deposit gold into facilities with people having last names like "Goldman", "Goldberg", "Goldstein", and they would give them paper certificates representing that value.  They realized not everyone tried to withdraw all of their gold at once, so they started lending fractional reserve, and so began the fraud of the millennium.

Massive amounts of lobbying, coercion, military force, etc, was then used to maintain this fraud.  People did not just "choose" to be scammed for perpetual eternity.

If it fails the Occam's Razor test for a currency, IT'S A SCAM.  You don't need a magician behind the curtain setting variable interest rates at a whim and all this other jibberish you're talking about.

The Roman empire ran on a fiat-like system where coins were valued higher than their metal contents, they did pretty well for a long time. The British empire used tally sticks for some 6 or 700 years, and did pretty well. The US...

Of course, there's a pretty imperialistic theme to go with those monetary systems, but you can't question their ability to produce. With a "math-based" cryptocurrency that ascribed to emulate fiat a bit more than bitcoin, there should be no reason to presume that the imperialism or fraud themes would continue anymore than they would in bitcoin, because governments and banks don't control it all the same. If you're worried about manipulation, clearly bitcoin and other closed systems are not immune.

Y'all may not have noticed this, but local rhetoric aside where 'fiat' is always short for 'government fiat', from an economist's perspective, or a literalist's, Bitcoin is absolutely a fiat currency. 

A fiat currency is defined by the fact that there is no one promising to exchange it for a fixed quantity of some valued object or service as a way of guaranteeing its value.  Nobody's offering to give you a beer (or whatever) per bitcoin even if the bitcoin price drops below the price of a beer (or whatever), and that makes Bitcoin a fiat currency. 

the seller would participate in the swap/repo if R_b>=1+r_b and r_r<=R_r-1, only if his gain on one leg is greater than the loss on the other leg. No need to gain on both legs.

In fact, suppose the real interests rates of Repocoin and Bitcoin were r_r and r_b. Currently, Alice holds B bitcoins and Bob holds B*P repocoins (P is the current price of repocoin in one unit bitcoin). Alice and Bob make a one week swap deal, and will get B * r_b bitcoins and B * P * r_r repocoins after the deal respectively. In a equilibrium market, the new price of repocoin one week later will be P * (r_r / r_b).

However, in my opinion, the real interests rates of both coins can't be independently revealed by the market. Even a well functional market can only reveal the relation between r_r and r_b, more specifically, r_r / r_b. When I am putting or accepting an order with 3 quantities: B, r_r and r_b, another order with 0.5B, 2r_r and 2r_b is almost same to me. The only difference is the latter has a leverage of 2 times.

They have very different exposures to exchange rate risk though. The market rates will be the safest, so demand should cluster at that point. I accept it's not perfect though. This may be an argument for the preferability of a Ripple-esque system without collateral.