Bitcoin Forum

I wrote this paper in a few hours after getting one of the key ideas from anon012012, so it's not yet proofread and I haven't worked too hard at spotting problems and logical errors yet. I welcome constructive criticism but please keep in mind that this is a very rough draft describing rough ideas.

Abstract

Among the many benefits of cryptographic virtual currencies such as Bitcoin [1] is the lack of a central authority to abuse the power of printing new units of currency. Although a hard cap on the number of currency units is a step in the right direction, the next logical step is to have balanced monetary policy undertaken by the network in a decentralized nature based on hard-coded rules. Although few people enjoy seeing the value of their currency erode over time, the opposite case is also harmful in a less-obvious way. As many economists have pointed out, hard-capped currencies are an excellent store of value but not so great as a medium of exchange. This is because like an inflationary currency, a deflationary currency changes behaviors and distorts market signals, sometimes even causing a deflationary spiral. An important attribute of an optimal currency is a stable, relatively fixed value relative to goods and services in the market.

Read the rest here:
https://www.dropbox.com/s/9h28rejw8718ppy/auto_mp_whitepaper_vs1.2.blocksigned.pdf?dl=0 (https://www.dropbox.com/s/9h28rejw8718ppy/auto_mp_whitepaper_vs1.2.blocksigned.pdf?dl=0)

Please let me know if you are developing an alt-coin based on this idea.

All based on the false premise promoted by so called economists who would never begin to "get" bitcoin. Also the false premise that people will not spend their virtual currency. The numbers prove such a premise wrong...so very very wrong...

http://media.coindesk.com/2014/05/Screen-Shot-2014-05-17-at-8.55.49-AM.png

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

It's not a perfect analogy, but people put off purchases of computers because they know that they will pay less for the same computer next year. It's human nature to reduce spending now in order to take advantage of lower expected prices in the future.

This is a central tenet of micro-economics. If a TV manufacturer expects higher prices next month, he may choose to sell less now in order to take advantage of higher prices later. It works the same with money, and has been demonstrated in the real world. Deflation has been serious problem in Japan for around two decades.

Furthermore, although it is one of the main ideas in my paper, preventing deflation is not the only one. Another potential use (although this may be difficult to accomplish) is creating a currency which could be "pegged" to a commodity such as gold, coffee or bacon.

I'm not suggesting that this system be implemented in Bitcoin. I like its deflationary nature for my own use and I am happy to spend it as well (although I always re-buy what I spend). I am merely suggesting ideas for the future as virtual currencies continue to innovate and advance.

EDIT: I don't dispute that chart, but one thing to consider is that many Bitcoin owners transfer bitcoin between addresses fairly often.

Highly expository exchange of intellectualism.Your views are noted,thank you.

I have been trying to comprehend this graph but the picture's just not clear.

Noel, compare the colors of the bands with the colors of the labels on the left side. The larger the band the more bitcoins are of that age. So as recently as 2010 most coins were older than 24 hours (age refers to the time since they were last spent), but by 2011, most coins were under 24 hours old.

I believe that only spent coins as opposed to all coins are counted.

So for instance the coins I sent earlier would be included if this chart was made today, but Satoshi's coins, which are untouched, would not be included.


I'm glad you liked it.

Hi there,

Firstly, I like the paper, and think it adds value to the crypto-currency concept.

A comment:

"benefits of cryptographic virtual currencies such as Bitcoin [1] is the lack of a central
authority"

Original paper has no limit to the number of bitcoins produced but now there is a soft limit of 21 million coins.

A hard fork was rectified by developers after an agreement was made between "people" not as per the original paper which says votes would be made per CPU.

Bitcoin is still experimental and is said to have bugs, which need to be fixed.

If SHA-256 is ever broken a new algorithm will be used by the developers.

If the developers are not the central authority then who has changed or can change the above?  What form of consensus is required to change the above?  Who decided on 21 million...and did they do it by themselves?  The hard ford because of software versions seemed to be a human based decision with block rewards being distributed between both forks if I understand correctly (could be wrong).

I think the failure of previous digital currencies which had offices and CEOs which have in some cases been prosecuted, and the relative anonymity of Bitcoin has led to a speculation that there is no central authority as it is know in the physical world like we have with fiat currencies.  But Bitcoin as a virtual crypto-currency does not have a life of its own.  Perhaps a virtual distributed authority which operates differently to a central authority in lieu of the differences between fiat and virtual currencies.

And a question:

What is a node?  With pool mining, does the network even know that an individual miner exists?  Could a pool tell all its miners to choose the same value if the network can see individual miners?

In the original paper:  Nodes work all at once with little coordination.

Is this true for today? With pools I think there is plenty coordination, but could be wrong.

Other than that, I like the paper....though if you are seriously looking to publish it, your commodities of rice and bacon are funny and could detract from the idea you are trying to put across, and perhaps point to similar research that shows game theory has achieved the desired results you are looking for.  As I am a university student and deal with people talking about publishing all the time, my lecturer would suggest never referencing to wikipedia.

My 2 cents

CK

You are absolutely right that because the development of Bitcoin is more or less centralized, there is perhaps more centralized control than we might like to see, but as a whole the network does function in a decentralized manner and, in my opinion, does have a life of it's own. If the Bitcoin development team disappeared and no one provided updates, the network would continue to work without human intervention until a vulnerability was discovered or a scale-ability problem occurred.

A node is entirely different from a miner since most nodes don't mine anymore. The idea in my paper is that instead of having miners control the process, actual nodes would, and by randomly selecting a relatively small number of nodes, the threat of an attacker flooding the network with malicious nodes or coordinating to manipulate the network is mitigated.

Thank you for your advice. I'll try to find some time to make edits soon.

If having yet another currency that can be debased is so important, why not just create another altcoin and let the market decide which one they prefer?

In my view, deflation is just as bad as inflation, as both cause imbalances in the economy that waste resources. While inflation promotes wasteful spending, deflation promotes wasteful hoarding. In a mild deflationary scenario, people are slightly less motivated to use savings to generate income.

I don't believe the fear-mongers that claim that the slightest bit of deflation will turn into a deflationary spiral -- just as mild inflation does not turn into hyper-inflation. They ignore the success of industries where falling prices are the norm and they ignore the fact that people must generally spend most of their income to survive.

Regarding your paper, I believe it is both impossible to determine the right rules and impossible to implement or enforce them.

But isn't all of this theory on monetary policy based on the assumption that those using the currency don't have an ability to opt out?  With Bitcoin I can now choose the currency that has the monetary policy I prefer and don't need bankers and politicians to make monetary policy choices for me.  I don't care if someone else wants to use a currency without a hard cap on supply, that's their choice.  All I ask is that they not interfere with my choice.

Sure you can. I am not proposing changing the Bitcoin network. All I'm trying to do is propose new options and improvements for future currencies.

Payment processors like Bitpay have already proven this not to be the case as they have shown spikes in purchasing precisely when deflationary bubbles occur.

The reason for this is because Keynesian economists have it wrong and people are more relaxed to spend when they feel richer and thus take profits.

Deflation simply means that the costs of goods and services get less expensive with time which is a good thing for the average consumer but detrimental to predatory states who want the backdoor tax of inflation.

"Deflationary Spiral" is double speak and should be called "Currency that pays dividends" or "Appreciated Value Currency"

While that may be true (and I do think Keynsians tend to exaggerate the harm of a currency that is anything but inflationary so they can continue manipulating the currency for political reasons), the Bitpay example doesn't quite tell the full story. I suspect that there is a difference between a sudden price spike and slow, consistent increases in currency value over the long term.

I think part of the problem is that people's wages fall faster that their own ideas of currency value, sort of like what happens with inflation only in reverse. Because of this, they might tend to feel poorer despite the increase in real wealth. Once this happens, the economy actually does slow down because of reduced consumer confidence.

Deflation can occur for multiple reasons and assuming that a financial crisis was due to deflation in of itself is making a false cause fallacy.

The data shows that with both slow and steady deflation and hyper deflationary bubbles spending doesn't decrease.

One could suggest that spending in an economy based upon fiat where inflation is high would spur consumers to instantly spend their money because of inflationary fears. I don't believe we need any encouragement to spend capital quickly as doing so doesn't encourage one to allocate their resources on wise investments vs frivolous purchases.

People will always spend their money as evidenced with other examples of rapidly evolving technology. computers and cell phones have quickly been dropping in price and becoming obsolete. Why do people bother buying these items if they can do so much cheaper in 6 months? The reason is because they actually need them and value the goods and services more than any potential savings they could have made.

Do you have any examples of a deflationary financial crisis occurring in society without fractional reserve lending and specifically because a government reduced the currency supply? Bitcoin is different because the blockchain doesn't allow for fractional reserve lending, just third parties like exchanges and cloud mining companies which should be avoided.

Although the recent economic "recovery" has been the exception to this rule, wage grown has traditionally been faster then inflation (this can be accounted for by increases in productivity) so as a result people tend to make more money on an inflation adjusted basis

^ 100% Right. Very accurate and educational post. That really is the true definition of deflation. When things get affordable with lower prices, the government makes less through taxes(politicians want their money) so they start throwing out theorys to the public that the sky will start falling and wage rates will go down so deflation has to be a bad thing. But in the real world, people spend more money when things are affordable so employers will still have to pay reasonable wages to keep employees to make/deliver/serve those products that are being purchased more frequently because people can afford to buy those products because of deflation.

Interesting paper. I like the idea. It won't be Bitcoin, of course, it would be some altcoin.

One remark:


It is a common misconception that if the money supply is not fixed (as it will be in Bitcoin once all the coins have been mined), the currency will erode over time. It is simply not true in general.

First of all, you must understand that money is not wealth. Money is just a medium of exchange, the common denominator, the way to measure wealth. Wealth is determined by the productive power of the community - i.e., it depends on the number of people involved and their average productivity. The higher these numbers are, the richer that community is. Both numbers must be high - i.e., a country with a large population could still be poorer than a country with a small population but larger average productivity (e.g. Russia vs Japan) and a country with a productive but small population can still be poorer than a larger country (e.g., the UK vs the USA).

The second thing you must note is that human population and average productivity tends to increase over time, unless hampered by government action (wars, regulations, etc.). Humans multiply and invent new technologies to become more productive. So, if the money supply is not fixed and is, in fact, increasing - but is increasing slower (or at the same pace) as the population and the average productivity of the community, the currency involved will not "erode over time".

There are two problems with this concept. First, while population growth is relatively easy to quantify, average productivity growth isn't, so it's difficult to determine by how much exactly the money supply should be increased. I like the idea of the money supply being determined by the community itself via some kind of "free market" system. The second problem is that, human nature being what it is, every entity in history entrusted with regulating the money supply has erred on the side of "let's make more of it" in the attempt to solve the perenial "we don't have as much money as we'd like" problem. Again, I like the idea of solving this by entrusting the decisions not to a central entity but to the community as a whole.

This has less to do with Bitcoin itself, but rather with those 'got rich' stories related to Bitcoin. Thus this is a psychological effect that the media created spreading awareness about them.
Exactly how is deflation bad for the consumer? Over time I get more things (due to natural rise in value) for the same amount of money, so this is bad?  ::)

Else you will end up with people posting those pictures about 'dollar purchasing power'.

(Warning, I am not advocating the theory I will explain below. In fact, I happen to think that it is complete nonsense. But it is the theory accepted by the mainstream economists.)

The economy does not consist of consumers alone. You need producers. These producers must either invest their accumulated capital, or take on credit, in order to produce. If the value of the currency is increasing (due to deflation, i.e., due to its quantity decreasing or remaining constant while the population and the productivity is increasing), they will not invest (they will hoard capital instead, in the hope that it appreciates) and they will not take on credit (because they will have to repay in appreciated currency). Result - no production or at least decreased production. They will also lay off workers (not needed, since less is being produced), resulting in increased unemployment, meaning fewer money paid in wages to the consumer, meaning even less consumption, etc.

Did I ask about producers? No.

You should have, though. I already explained to you how, according to this theory, deflation will hurt consumers too, by hurting the producers (who pay they wages the consumers need, in order to pay for their consumption).

Producers benefit from deflation as well as long as the deflation is caused by a fixed monetary supply and not externalities and there is plenty of liquidity. Producers do not need a middle man to issue predatory loans as they can get credit for free by saving their deflationary currency. Other options are available such as angel investors and Venture Capitalists willing to offer money in exchange for stake or simple kickstarters.

There is plenty of liquidity within bitcoin because of the inherent divisibility of the currency. Even if 99% of coins are "horded" there is enough divisibility to be a functional unit of account and if more than 8 decimal places are needed a soft fork can accomplish that.

You are attempting to apply economic principles which are based upon flawed assumptions supported by special interests who are content at misleading he public. I have heard their reasoning for not mentioning true inflation rates which fail to include healthcare, food and fuel and it doesn't hold water .


We already have plenty of digital currencies which embrace keynsian economic principles to choose from, their called fiat. All we ask for is a option to use a currency that follows the wisdom from a different school of economics, namely Austrian.

Deflation is the reduction of money supply relative to the availability of goods and services. That is, you can have deflation by keeping the money supply fixed (not declining), provided that the amount of goods and services in the economy increases, which is usually the case. Or you can have deflation by reducing the money supply, but this is rare. Deflation is not "caused" by the relative reduction of money supply. Deflation is the relative reduction of money supply.


Yes, if they have savings (which are basically equivalent to investment). But if they do not, and cannot afford to save, which is the case for most business nowadays, they are forced to take on credit. As I said, our current society runs mostly on credit. We can argue whether this is "bad" or "good" or "how things ought to be" - but if we fail to admit how things actually are, we are just burying our heads in the sand.


I suspect that you have never run a business or at least have never had to do turn to a vulture capitalist. ;)

In any case, all these arguments are bogus. The correct argument against this theory is that producers make their profit from the spread between the production costs and the sale price, so they will thrive as long as the prices of raw materials and labor move (up or down) at the same pace as the prices of the end product, so deflation shouldn't really hurt them.


Liquidity or divisibility has nothing to do with this, although deflation can cause lack of liquidity in some cases.


And you have a problem with reading comprehension. I clearly stated above that I personally think that this theory is complete nonsense. So, I am not doing anything of the kind you are accusing me of. I am just trying to explain the theory used by most mainstream economists; a theory I personally disagree with. Learn to read before you post.


You haven't researched deep enough. They have done something much worse - they have redefined "inflation" to mean "rising prices", instead of "increase of the money supply relative to the available amount of goods and services", which used to be the proper definition for centuries. Ludwig von Mises has a nice critique of this nefarious move in one of his articles. The real problem is not that the core CPI does not include food and energy; the real problem is that they have redefined "inflation" to mean one of the symptoms instead of the actual thing.


I am a fan of the Austrian school of economics myself, but the knowledge of it that you are demonstrating here is rather shallow.

While deflation is indeed a relative reduction in monetary supply there are many potential causes for this relative reduction and many economic conditions coinciding which give rise to a financial crisis.



Strawman fallacy. Your original statements I was refuting was your insinuation that credit wouldn't be available or taken with a deflationary currency. This isn't an argument refuting the non exhaustive list of options for available credit with a deflationary currency which doesn't depend upon a fixed loan interest rate.
Savings (credit from appreciation) , angel investors, venture capitalists, crowd funding, loans from friends and family, non profit donations, credit agencies who take no stock but a percentage of future sales till loan is paid off, ect... all represent different forms of credit.

Producers need credit at certain times regardless of the spread between the production costs and the sale price.


Thus the reason I pre-empted potential concerns and how bitcoin is different than fiat with limited divisibility.


I read you correctly the first time. Don't take things personally, as I am arguing against your statements and obviously not against you.


Non-sequitor. I believe misleading the public about the true CPI is a problem. We can discuss the relative importance of different problems if you would like.


Let's stick to addressing the arguments directly themselves instead of venturing off into ad hominem territory.

Even if we leave aside that it wasn't "my" argument, that wasn't the argument at all. The argument wasn't about a "deflationary currency", the argument was about deflation in general. In deflation, currency tends to appreciate, cetes paribus. This doesn't necessary mean that credit will not be available - it means that those who have already taken credit will suffer and those who could use credit will be afraid to take it.


Savings aren't credit. Having worked with vulture capitalists myself, I assure you that going to them is generally a desperate move. I haven't found one who was interested only in "percentage of future sales" yet. They wanted all sorts of things, like dictating how the company is to be run, supporting the company only as long as they could sell it for profit and so on. Of the other forms of credit - it doesn't really matter, unless the creditor is willing to have the principal adjusted (down!) for deflation. Even if the credit is interest-free and you have to return only the principal in nominal terms, it will still hurt you if the currency has appreciated meanwhile.

That doesn't mean that it is not possible to manage a business in a deflationary environment - but it does mean that the current modus operandi of most businesses becomes unworkable and many of them would fail. That, in itself, might not be a bad thing in the long run - but it is one of the reasons why the current society is unlikely to accept a deflationary environment voluntarily.


They do now, yes. They won't, if they evolve to survive in a deflationary environment. But it would be a painful process.


I believe that you are wrong. :) In fact, the whole concept of CPI is nonsensical, because there is no such thing as "general price level" and it, of course, cannot be measured. The invention of the CPI is just one of the scams to mislead the public about inflation via money creation out of thin air. Its constant manipulation to understate inflation is just a minor shenanigan in the grand scheme of things.

I think we are talking past each other.

Bitcoin and deflationary currencies will be disruptive. Those that don't hedge their bets will suffer, businesses will shutdown, and governments will start migrating over to different ways to fund operations like higher sales tax and VAT.

I welcome it all.

A fixed money supply would not cause deflation, it would cause there be to neither inflation nor deflation (all else being equal).

Deflation would be caused by either a falling money supply or a falling demand for products.

Producers would be hurt by deflation because the price/value of what they produce would decline between the time they buy the raw materials to produce something and the time they can actually sell their product. Any company that is attempting to realize any kind of economy of scale will need to have inventory on hand, a general rule of thumb is 2 months supply of their inventory.

Angel investors and VC investors still expect to earn a return on their investment just like lenders/creditors do. If either of these kinds of investors can earn a return (by having their money be worth more by having it sitting under their mattress over time) then they will be less likely to invest in companies with potential

The confusion in this thread is an excellent illustration of von Mises' critique that the banksters have muddled the issue by re-defining inflation and deflation to mean one of the symptoms (price movement) and leaving us with no term for the real thing. :)


The "all else being equal" part is critical here. In reality, all else is never equal. :) Deflation is the reduction of money supply relative to the available pool of goods and services. That is, you can have a fixed money supply and still have deflation if the pool of available goods and services is expanding (which is usually the case, as human civilization progresses). That's why they say that Bitcoin is a deflationary currency. Or you can have an expanding money supply and still have deflation if the pool of available goods and services is expanding even faster. That's why they say that gold is a deflationary currency.


No, deflation isn't "caused" by that. Deflation is the reduction of money supply relative to the available pool of goods and services.

It is falling prices that are caused by falling money supply or falling demand for products (among other things). Most people know that prices depend on the balance between supply and demand. Few people realize that they actually depend on the balance of four things:

1) The supply of products.
2) The demand for products.
3) The supply of money.
4) The demand to hold money.

The last one is especially difficult to quantify. Basically, money is a good like any other; the good with the highest liquidity. The laws of supply and demand apply to it too. In fact, products are always paid with products; money is just the medium of exchange.


True in general but the reality is a bit more complex than that. It depends on what time we are talking about and how much the currency appreciates during this time. If the numbers involved are relatively small (i.e., deflation is mild), most businesses will still thrive.


Exactly. And if deflation becomes stronger, this can increase the demand to hold money, putting additional downward pressure on prices - the so-called deflationary spiral. This is what happened during the Great Depression and this is what has the mainstream economists scared to death. A simple, mild deflation isn't really a problem and can be actually beneficial for the economy, since it stimulates savings and savings are equivalent to investments and capital accumulation.