Bitcoin Forum

I've been reading about bitcoin now for just over a month and am fascinated with the economic possibilities. Myself and my partner managed to launch the largest Bitcoin Market so far at www.BitCoinWorldMarket.com (http://www.BitCoinWorldMarket.com)  Every day there seems to be new and exciting news regarding the growth and acceptance of bitcoin and I for one am so excited at the future and possibility of bitcoin becoming extremely widespread.

One of the very interesting things about bitcoin is that it is a deflationary currency. Normally economists list massive deflation as a bad thing. Bitcoin embraces that with its infinite divisibility.

The one weakness that I see in bitcoin is that the current model for loans and lending is incompatible with bitcoin.

Imagine Taking a loan out for 100 bitcoin at even 0% interest to keep it simple. At the end of the year you have to pay back that 100 bitcoin. If the point of your loan was to pay for something now so you can create more income in your business the volatility in the bitcoin market would make it infeasible to pay it back. If Bitcoin doubles for example in value it is like having to pay back 100% interest. If it drops in value by half the lender then is basically out half the money they lent out.

With the longterm likelihood of an overall gaining in value due to bitcoin being deflationary it just doesn't make sense to have any loans, interest, or even credit be issued in bitcoin. Fractional reserve banking in bitcoin is completely unlikely.

The only way i'd see loans or credit working is if you just get the loan in your national currency and exchange the money as needed and spend the bitcoin right at the moment.

As a business man this creates an interesting dilemma. Most small and medium business DEPEND on short term loans and credit. Suppliers accept Net 15 or Net 30 payment terms. Inventory costs are highly variable and often come all at once rather than at a rate related to income.

I see the future and complete acceptance of bitcoin as an alternative currency, however I don't see how we will ever separate it from daily exchange with a fiat currency.

Thoughts?

I love it when bitcoiners finally look directly into the mirror and a brief moment of terror washes over their faces when they realize what they've done.  It's always much too brief, and then they look away and try to find re-assurance in the echo chamber.

You almost realized that promoting bitcoins as a currency doesn't make any sense at all.  You were soooo close.

I think this is something that makes Bitcoin more suitable for equity, rather than debt investments. As the Bitcoin economy matures, it will also become easier to hedge against currency exchange fluctuations through the use of futures and such (this already exists for Bitcoins).

+5 :-D

Just like we were taught that deflation is bad, maybe we've just been brainwashed to think that loans are good.

This is based on a misunderstanding of what predictable deflation does in a market. In fact, predictable deflation is already priced into the current price of a bitcoin. If a bitcoin is expected to be worth $25 next year, it cannot possibly be worth $10 right now because all the people who would rather have $25 next year than $10 now would bid the price up.

On a more serious note, lack of divisibility isn't (at all) the problem with a deflationary currency, so infinite divisibility is not a solution.  You hit on one of the much more serious problems.  The other big one is that deflation likely encourages hoarding at the expense of consumption, so as a businessman, you should also expect very few customers.  Here in Bitcoinland, saying such sensible things gets you labeled as an ignoramus / troll, etc. and you get pointed to threads where the issues have been "settled" (never mind that a large majority of professional economists think otherwise).

So instead of starting yet another flame war, I have a proposal.  Presumably, like most of us here, you regard Bitcoin as an interesting experiment, as opposed to the thing that you're mortgaging your future on.  Experiments need data.  So, in the spirit of openness, my proposal is:

Would you be so kind so as to regularly update us as to how much business you're doing every day?

It would help the discussion enormously to see if actual businesses are getting any significant volume or not.

Right now, it's not clear to me if Bitcoins are inflationary or deflationary: it depends on whether the rate of new coin creation does or does not exceed the rate at which new people are joining the experiment.  Certainly Bitcoins will tend to be deflationary as the rate of coin creation goes down and/or the user base explodes (assuming this happens).  So what would be most useful is to see a trend over time.  For instance, when the subsidy switches to 25 BTC instead of 50 BTC, or when a news article with wide visibility brings in a sudden spike of new users, I'd expect your business volume to go down.  But who cares what *I* expect, the data would speak for themselves.

What do you think?

This is false. Deflation does not encourage hoarding. The argument that deflation encourages hoarding works just as well to argue the deflation encourages spending.

Say I hold some asset that's going to go up in value. The fact that the asset is going to go up in value means that the asset includes the right to hold that asset as it goes up in value. The more the asset is going to go up, the more the right to hold the asset as it goes up is worth today. So deflation encourages spending by increasing the present value of an asset, meaning that you can get more goods for it today than you could otherwise.

This is, of course, an invalid argument. But it's invalid for the same reason the argument that deflation will encourage hoarding is invalid. An asset that will be worth more in the future will be worth more today because the price today includes the present value of its expected future prices. Everyone who owns a bitcoin today also owns the right to have one bitcoin in five years. If we all agree a bitcoin will be worth X in 5 years, a bitcoin will never be worth than the present value of X in 5 years.

Businesses depend on loans because they are artificially so cheap right now. It would be like if there was an enormous subsidy for blankets for a decade. Everyone would find all kinds of ways to blankets because they were practically free. Ending the subsidy and making people pay whatever the right cost is for blankets is clearly the right thing to do even if it shakes up business practices for a while.

There is nothing wrong and plenty of things right with people needing to earn before they spend. The flip side of expensive borrowing is that you get very high interest in real terms for working and saving a while before you spend.

Instead of grinding away at a job for decades and having your savings devalued you work harder and spend less up front and in a year you have plenty of capital to get started.

It should also be noted that the bitcoin economy is not in a steady state. Right now the best play by far is to convert old economy assets to bitcoin. Later when most are in the bitcoin economy this explosion will be over and the new profit will be picking things that appreciate faster than the general economy which means committing some coins to stuff.

As I said in my post on fractions (http://forum.bitcoin.org/index.php?topic=26705.0), in a deflationary world, the way to treat shares and money may completely invert. Those with the least bargaining power may be given shares. Those with the most bargaining power may be given money and zero interest loans. This is a very long term scenario where bitcoin has stabilised.

Much more equity and much less debt in a bitcoin dominated future.


More businesses will move to shorter payment terms. This happens in any place where the money is valued highly.

In a hyper inflationary endgame, I could see more and more people borrowing in the native currencies to buy bitcoin, which is a typical hyper inflationary scenario. Prices being more and more stable in bitcoin and varying crazily in native currencies. But this is an unlikely scenario, since interest rate rises will put a temporary halt to the same.

Wow, an intelligent post on the economics forum!  What a treat!  I had to think this through for a while, so thank you for making me think.  Here's my best effort at thinking through the consequences of what you're saying; I may have more to say tomorrow as I think this through a bit more.


Well, first things first, this paragraph made no sense to me whatsoever, perhaps an example would help.


It's appealing to think this (and indeed, I've thought like this automatically when discounting things for inflation in the past), but here's how I think it goes wrong.  It's too simplistic for two reasons: (a) you haven't accounted for individual uncertainty in calculating the net-present-value of Bitcoins 5 years from now, and (b) you haven't thought through the consequences of people having different opinions on what a bitcoin will be worth in the future.

To not complicate the discussion, let's pretend the inflation rate for the dollar will be 0 for the next 5 years.  You could account for non-zero inflation, but it just muddles the larger point.

a.1) Even as an individual, I have no certainty of what the value of a Bitcoin will be 5 years from now.  All I have is a feeling for the probabilities of different outcomes.  For example, I may think there's a 50% chance that 1 BTC for $10 today will be worth $25 in 2016, or a 50% chance that it will be worth $0 (say, it never takes off as a currency, so people lose all interest).  You might think that I'd agree to pay $12.50 today for it, but since I'm taking a risk ($12.50 in my pocket has the same net present value), I'll only agree to pay $11.00 today for it (let's say that happens to be the market price).  Call the extra $1.50 compensation for sleepless nights worrying about a government on Bitcoin erasing my investment.  As time goes by, the probabilities of the different outcomes become sharper.  For the sake of argument, let's say that five years from now, it's clear that a Bitcoin is worth $12.50 with 100% certainty.  Again for the sake of argument, let's say that everyone else went through my same thought process.  Then it appears that the value of Bitcoins has gone up from $11.00 to $12.50 in the market over the five years 2011-2016, even though the net present value of a 2016 Bitcoin was constant throughout that period.  This should start popping up red flags about net-present-value arguments.  Uncertainty will create risk premiums for Bitcoins in the future, and right now, that uncertainty is quite high.  

a.2) Uncertainty also has the effect of reducing the amount of money in the market.  Say I have $1,000,000 to invest, and will need $250,000 for a minimal retirement five years from now, and $500,000 for a comfortable retirement.  Hence, assuming every other financial obligation is covered (again, sake of argument), I can *definitely* invest at least $500,000 and will invest *at most* $750,000.  If there is no uncertainty, I'll invest the $750,000.  If there's huge uncertainty, then I'll invest only marginally above $500,000.  Why does this matter?  In a market as small as the currency exchanges, there may not be enough money on the table to bid up the price to what you'd expect from net-present-value arguments (with or without accounting for a risk premium).  In other words, if you're a buyer, you may see an offer from someone to sell that's below what you'd be willing to pay, but you may not be certain enough of its value that you're willing to risk losing your money.  So you don't buy, and the market price is not pushed up.  That's a second mechanism, especially applicable for the small market size of the exchanges, by which uncertainty will weigh on the present price of a Bitcoin without changing its net present value, beyond just a risk premium.

b) Getting back to deflation, here's what goes wrong.  Deflation means that prices for things 40 years from now will be lower than they are today*.  We do agree on this, don't we?  Now, if you have all the time in the world, then you can calculate the net present value of your bitcoins today according to just how quickly you think they'll deflate.  Let's say that that's how you decide how much to save for retirement.  However, not everyone can wait that long.  A miner may need to sell some of his Bitcoins soon to pay his electricity bill, even though he knows that holding those coins, they'd buy more electricity in the future.  Or maybe Satoshi's medically uninsured sister has a heart attack and needs to pay for hospital attention tonight, not in 40 years.  To both people, Bitcoins in the future are worthless, they need to sell them now.  So the amount they'll be willing to sell them for will be less than what they (and everyone else) think they're worth if they could wait.  If the exchange markets were deep, the difference between the two quantities might be as small as the trade commission, but at their current shallow depth, it's probably more.  You buy them and since you have no reason to sell them, you keep them for a long long time: you're in no hurry to spend them, and at the price that you're demanding, nobody's buying anyway.  You might want to invest them somewhere, but as businessman BitQuestr points out, few businessmen want to take out loans and give you interest in a deflationary world, so your investment opportunities are few and far between.  You're certainly not going to give out negative-interest loans (why on earth would you do that?).  Maybe you're willing to take a risk on your own, but you don't have to: in a deflationary world, you're guaranteed not to lose purchasing power, and this is your retirement after all.  By taking those Bitcoins out of circulation, now there are fewer Bitcoins chasing the same goods, so prices go down.  Everyone's Bitcoins are suddenly a bit more valuable (to those who have them), so it's a bit more tempting than before to not spend these things if you can afford to wait.

Sooner or later, most bitcoins in quick circulation will end up being captured by someone who can sit on them as long as they need to.  Maybe not in the first transaction, maybe not in the second, but once they land in one of these people's wallets, they're gone for a *long* time.  In other words, from your point of view, you might see lots of Bitcoins flowing through your account, but from a Bitcoin's point of view, they zap and zap between a few accounts before landing on a retirement stash and staying put for 40 years.

In an inflationary setting, removing money from circulation like that, with the concomitant decrease in economic activity, is punished by eroding the value of that money.  If you want to stay ahead of inflation, you *have* to invest the money somewhere, which keeps it moving.  When money is flowing in one direction, work is flowing in the opposite direction, and that work is what we actually care about in the real world.  For better or for worse, most people are not entrepreneurial, and if you tell them that if they keep their money under the mattress, all will be well, that's exactly what they'll do.  If you want think of profit as the carrot for investing, inflation is the stick.

* Be creative: imagine what food will cost compared to now if 9 billion people have to eat every day, and everyone demands their wallet balance to always be at least a day's worth of expenses.  hint: that's 0.002 BTC / person under complete equality and assuming each and every Bitcoin changes hands daily.  For comparison, the equivalent measure for dollars is about half a year, and for BTC now [discounting the "volume" generated by change transactions], about two years the same [sorry about that glitch].

I don't think bitcoin is incompatible with loans.

Once bitcoin matures reaches a stable user base, the rate of deflation will correspond roughly to the rate of global economic growth.

Say for the sake of argument that this is 5%. (There will be fluctuations above and below this mean, but lenders and borrowers can hedge against those).

Say for the sake of argument that the rate of inflation of fiat currency is 3%.

Say that a lender is prepared to lend at a real interest rate of 10%.  Then he could either offer a bitcoin loan at a nominal interest rate of 5% or of fiat loan at a nominal interest rate of 13%.  Competition will push towards a market equilibrium with this 7% points difference between fiat and bitcoin interest rates.  Then it makes no difference what currency you lend in, you are getting the same real interest rate for both.

The only thing that would not be viable would be lending bitcoins with a real interest rate below 5%, because you can make more money by just sitting on your bitcoins.  But that would not be viable with fiat money either.  Why would anyone lend for a real interest rate below 5%, if they can get 5% returns simply by investing in the  global economy?

Your refute is based on the misunderstanding that the deflation has to be predictable. It doesn't. There only has to be a reasonable chance of it happening, and there definitely is. This makes taking up a loan for a house or even something much cheaper denominated in bitcoins a much higher risk than any sensible person would take.

Reality does not agree with you, people are hoarding bitcoins like crazy.

No, businesses depend on loans because you have to spend money to make money. Of course, if the value of the money increase faster than most businesses can earn them then doing business will be bad business for most people who already have money. I'm sure you think you have a really good explanation for why this is a good thing too.

Not because they expect them to deflate due to scarcity, but because they expect the probability that the expected deflation will actually occur will increase. My argument only applies to expected (in the sense of generally agreed to be a near certainty) deflation.

Imagine if there was universal agreement that Bitcoins would be worth $1,000 each next year. The price would rapidly shoot up to near $1,000 now, nobody would sell for much less and nobody would buy for much more. Then there would no longer be any need to hold them to next year to get the deflated value.

The reason the price is going up is not because they will be worth $1,000 in ten years and it's getting closer to then. It's because people are becoming more convinced that the value might actually be $1,000 in ten years. That is, it's not deflation that's raising its value. It's that people are realizing they might actually deflate.

"Not because they expect them to deflate due to scarcity, because they expect the probability that the expected deflation will actually occur will increase"? Does this actually make sense to you? That's just desperate. Of course it's because they are scarce. We will seldom get closer to "expected deflation" in the real world than we have with bitcoins today, so the purely theoretical "expected inflation" you are arguing against is basically a straw man. There will never be a universal agreement about anything, and certainly not a bitcoin price, so why pretend that is what we are talking about? That does not stop people from hoarding bitcoins.

Yes. Many people believe Bitcoins will never depreciate but that bitcoins will be replaced by something else or cryptocurrency will fail long before that happens.

Scarcity is only one component of price. My poop is scarce, but it's not valuable. What's happening is that people are become more convinced that bitcoins will actually hold value.

The expected deflation only happens if bitcoins are an established currency with solidly established value and declining supply. Otherwise, people would just switch to some other currency.

At least you now seem to agree that bitcoin has what can be called expected deflation. Now you only need to realise the logical result of that. As Jalum said, "You are sooo close".

The logical result is that once such deflation is generally accepted as inevitable, the present value will be the greatest of the net present value of all future price points.

If a Bitcoin is forecast to be worth $1,000 USD in 2015. The current value of a bitcoin will have a market lower bound of whatever the present value of $1,000 USD in 2015 is. If I said "how much would I have to pay you today to get $1,000 USD in 2015" and you said "oh, about $815", then the present value of a Bitcoin will be bid up to at least $815, since a bitcoin includes the ability to have $1,000 USD in 2015 and that alone is worth $815.

This requires a general agreement that the deflation will actually happen. Unpredictable deflation will not have this effect.

So predictable deflation gives no incentive to hoard unless you'd prefer the value in the future. You can sell the deflating asset to get equivalent value today.

I don't think the argument about "deflation is not actually bad" or deflation is priced into bitcoin" is really relevant. It is what it is, and if bitcoin becomes dominant, we'll have to deal with it.

On that note, here's my answer to your original post: Currently loans are structured so that each consecutive repayment of the loan is actually worth less than the previous one. In nominal terms the amount is the same, but the value decreases due to deflation. So, a $1000 mortgage payment on your first month becomes the equivalent of a $411 mortgage payment on your 360th month at the end of the 30 year loan, assuming 3% annual inflation. Since we can't control the rate of inflation, can't control the amount of the loan, and can't, or shouldn't, change the interest rate earned on the money, since interest rate is basically the cost of holding or lending that money, our only real option is to change the principal (repayment) amounts. If we want to follow the established structure, we would need to figure out how to have the first payment be worth the equivalent of a $1000 payment, and the last payment be worth the equivalent of a $411 in real value amount (not nominal amount). My algebra skills have gotten EXTREMELY rusty, though, but here is the current level-payment annuity formula:

R = P / [ (1 - (1 + i)^-n) / i ]

R is the payment amount
P is principal amount
i is interest
n is number of terms
(If you wish to calculate monthly payments using an annual interest rate, say of 5%, you need to use i/12 for interest and n*12 for term)

Since we know that, in this formula, despite the nominal value of R remaining the same, the actual value of R is decreasing when using inflationary fiat, for a deflationary currency that formula has to be tweaked somehow to make sure that the value of R changes with every n term, decreasing in both nominal and real value as it approaches the maximum value of n, while still paying off the entire P principal and providing the entire i interest return to the lender. The end result will likely be a much higher than $1000 for the first payment though.
As I said, my algebra skills are really rusty, so if anyone feels like taking a stab at it, please do. Playing around in Excel got me nowhere, sadly.

Just want to say, brilliant point on this one. Thanks!

You keep repeating these trivial models, but the fact remains that your theoretical models are only good in theory. There is no universal agreement about anything, so in practice they have very little value. They only look convincing if you already believe or want to believe what they are saying.

Thing is, what he is saying is basically how our finance world and business already operates. NPV (Net Present Value) and annuity formulas are used to figure these types of things out all the time when making business, lending, or investing decisions. He's just pointing out that the same thing will pretty much continue to happen, but from a different angle.

What do you think the bond market is? Of course there isn't universal 100% agreement. But the closer you have to that, the more accurate the model is. Look, either we can know that bitcoins will deflate or we can't. If we can't, then you can't even say that deflation is a problem. And if we can, then you can't say deflation is a problem because my model applies.

It is, in fact, a perfect balance. Every bit of expected deflation is one pressure to hoard and one pressure not to. This is not some magic coincidence, it's the nature of markets. The extent to which the market is willing to bet on deflation is the extent that the market believes the currency will deflate.

The market will rationally take in all available information. If there's a 90% chance that a bitcoin will be worth $1,000 in 2015, then my argument will apply to 90% of the net present value of $1,000 in 2015. If there isn't, then bitcoins aren't deflating.

If your question is, "what happens if bitcoins deflate but nobody predicts it", I'd say, "what happens if dollars deflate but nobody predicts it?"  Every reason we have to think bitcoins will deflate is a reason to predict deflation. If you're outside of the realm of evidence, all claims are equally valid.

Assuming this: http://forum.bitcoin.org/index.php?topic=27166.0 (http://forum.bitcoin.org/index.php?topic=27166.0) is the expected value of Bitcoin at the end of the year, over 50% of the community believes price will be in excess of $36.  Over 22% believe the price will be greater than $100.  Yet Bitcoin currently sits at $14, substantially lower than the general consensus.

While your theories, similar to the efficient-market hypothesis, seem nice on paper are impractical when applied to real life.     

I agree that bitcoins cannot be reliably predicted now. They could become completely worthless if they're replaced by a superior cryptocurrency or if crytpocurrencies don't catch on. But the argument here is about what will happen if bitcoins are predictably deflationary. They aren't right now, so what's happening to them now isn't relevant.

The claim is that bitcoins will deflate, that people will know that they will deflate, and will therefore hoard them. I've argued that this isn't possible.

If you want to argue that people will not know that bitcoins will deflate, then you've found another way to refute the argument that deflation will lead to hoarding. If the deflation is a shock and surprise, people won't hoard in anticipation of it. People don't expect dollars to deflate, so they don't hoard them either.

Nobody can predict the future with 100% certainty and everybody knows it, so that's just another straw man. It's enough that people assume they will inflate, which a lot of people do, so they hoard them. The only reason to assume it will not inflate is if you don't think bitcoins will be a success. Apparently enough people currently thinks that to balance out those who think it will.

Then the argument that we can predict that bitcoins will deflate and cause hoarding is a straw man too. Your argument that we can't know anything for sure, therefore we can know that deflation will cause hoarding is self-refuting.

To the extent that we don't expect deflation, we don't expect hoarding. To the extent we do expect deflation, we can expect the price to be bid up to discourage hoarding. It's not coincidence that they cancel out, it's simple market mechanics.

To the extent we cannot predict what bitcoins will do, we cannot predict what will happen. I agree that an unpredictable currency is not as good as a predictable one. If bitcoins remain unpredictable over the long term, they will probably not be a viable currency.

In the short term, the advantages of bitcoins over other currencies are to some extent moderating the harm the unpredictability will do. Also, unpredictability brings volatility which brings speculators, which to some extent helps to balance out people driven away by volatility. Long term, bitcoins will have to become predictable to be useful as a real currency.

The market does even have ways to protect against unpredictability, but that's an awful lot of work to go through. Unpredictability functions like a tax on a currency because you have to pay to hedge it, and most people prefer not to gamble with the money they're trying to live on and run a business on.

Problem is, they can't cancel each other out in the long run unless you stop population and economy from growing. As long as the bitcoin economy gets larger the value of bitcoin will continue to inflate. As long as that happens it doesn't matter what price you put on bitcoin, the fact remains that it will be even more scarce in the future. That's why I said that the only reason to think the value of bitcoin will not continue to inflate is if you think it will fail.

They do cancel each other out. If the value change is predictable, it will be bid into the price, regardless of the source of the change in value.

If we all expect gold to be worth $5,000/oz next year, it will be bid up to very near the present value of $5,000 in one year. This is true regardless of why the price is expected to go up. In such a market, when you sell an ounce of gold, you are selling the right to have a $5,000 payment next year. So the value of an ounce of gold will be at least what the right is worth.

Population and economic growth are predictable.

People have to know it's going to increase in value to be incentivized to hoard. People don't hoard dollars, but they might go up in value. Why don't they? Because they don't expect them to go up in value.

You want to argue that we all know it will go up in value unpredictably. That's self-refuting.

Why do you hoard your $100 bitcoin if you know that it will be worth $120 in a year? Likely answer is so you can buy something in a year when your money is worth $120, meaning your money will have 20% buying power 1 year from now. What's to stop you from buying now if the merchant simply took the 20% deflation into account, and gave you a 20% discount on the item today? You'll have a choice of buying something for $80-equivalent today and have $20 left over, or $100-equivalent a year from now and have $20 left over a year from now.

(snipped your beloved "proof")
So why do people hoard gold at ever-increasing prices? Your theory obviously doesn't correspond with reality.

They hoard gold because they believe that gold will increase in value by more than everyone else does. That is, they hoard gold because they believe that it will unpredictably deflate. People who have expectations that differ from everyone else's do all kinds of things that seem irrational to everyone else. If their expectations are right and everyone else's is wrong, they'll profit. If not, they'll lose.

Another factor is that they believe their fiat currencies are crap. They hoard gold because they have no alternative investments denominated in anything other than fiat currency. This type of hoarding is good, assuming they're correct, it reflects rationally deferred consumption.

There will always be some irrational people with irrational beliefs who do irrational things for irrational reasons. It's hard to tell how much gold hoarding is rational and how much is irrational. But it's not because they agree with the consensus view about how much gold will go up in value. If they did, they'd hoard about as much gold as the average person does.

Talking about rational or irrational gold hoarding is meaningless, and so is talking about a consensus. There is no consensus. If there were everybody would sell because it's no use in holding on to something that has reached it's maximum price and does not pay interest.

By my count, JoelKatz seems to have won this thread several times over by now.

There are people who understand the economics behind your points, they're just (mostly) staying out of this.

I must admit, I skipped a half page before replying.  Basic premise....modern businesses rely on loans to conduct their business. Lenders make tons of money on interest.  Historically, have the businesses benefited most from loans and lenders?  Or from financing their own growth with their own profits?  You need to start with savings, your own capital, no liens or mortgages, to start off that way.  Lenders serve a purpose, certainly, and should expect some reward for their service...but when most business models require outrageous debt, interest, and no self-sufficiency, what do we get?  Ummmm.  Greece.  Lehman Brothers.  The U.S. Italy. Et cet.  you cannot have an economy dominated by consumers and lenders, it eats itself and everything around it.  Lenders do not produce new value, consumers do not produce new value, eventually everyone reverts to cannibalism.  Because there is nothing left to eat.  I would add something about bureaucratic functionaries, perhaps another time.

I think you may be sacrificing an important tool in the name of removing some of its misuses.  I will agree with you heartily that when someone uses a credit card to buy a $1000 plasma screen TV, or a $7000 luxury cruise in the Caribbean, but has no real savings to pay off the credit card, this is a terrible idea, and the economic "activity" that has taken place is unsustainable and undesirable.  As an individual, the only two assets for which I'm willing to go into to debt to are education and a home, and the latter only because, under most realistic scenarios of what the future has in stock for me, I won't be able to save for one before it's too late for me to reap the benefits of owning one (i.e., the timescale for saving for this is comparable to my lifetime, and I want to get to live in that home).

The education part is more interesting, and is connected to lending and credit serving a useful role.  If I educate myself, presumably my income will go up, and I can both pay back the loan and have enough left over to live a better life.  If I don't educate myself, presumably the amount that I can save per year might be so meager that I would die before I could finish saving for the cost of an education.  This logic is what goes on behind most business investment.  You borrow because the investment that you can make with that money will pay for itself much more quickly than you could save in order to make that same investment.  Since presumably that investment lastingly increases your capacity to receive income, the person who borrows and invests will be, *for the entire foreseeable future*, better off than the person that insists on never borrowing.  In other words, to answer your question, it's the businesses that borrow and invest, not the ones that grow with their own profits, that do best (this is why the OP was so concerned).  In this "good loan" scenario, *both* the lender and the business benefit, the lender because he gets interest for doing nothing but acknowledging that he doesn't need that money for a long time (so he can focus on other pursuits) and the business because the loan has paid for itself and grown the business much more quickly.  If you malinvest, as Greece, Leeman Brothers, etc. have done, then that's your problem that you haven't used loaning in a sensible way.  But it's not an argument against loaning per se.

The trouble with loans in a deflationary environment is that you have no incentive to make them unless the effective interest rate
you could get for them is at least as high as the deflation rate.  Hoarding your money is a zero-risk way of getting that effective interest rate.  On the other hand, in an inflationary environment, hoarding your money is *guaranteed* to make you poorer with time.  To avoid that, you either need to do something with that money yourself (which most people rarely, if ever, get to in their lives), or you need to lend it out to other people who can put it to work out there on your behalf.  The rate at which you lend it out for this to make sense doesn't even need to keep up with inflation (as happens with savings in a bank account, or lending to the US Treasury) because if you do this, the rate at which you become poorer is at least lower than if you keep your money.  *This* is the loaning logic that breaks down in a deflationary world.  You kill off all the low-cost (low-risk) financing, and only leave the high-cost financing behind, so the effective cost of financing anything goes way up, and you slow investment all around.  We are all worse off as a result.

I have a question that might be stupid and might have already been asked before, but I am gonna ask anyways.

Why would you ever want to hold an inflationary currency versus a currency that isn't? If someone has the option between using an inflationary currency or a deflationary one, why would they ever choose the inflationary one? I mean you personally.

OK like this scenario: 40 years in the future the US dollar is still being inflated, while bitcoin is fairly stably deflating (and it is not subject to the large swings that it is having now). Would you want your paycheck in US dollar or in bitcoin?

If you educate yourself...you owe nothing, libraries are free.  The internet is free-ish.  Learning by doing has its costs, but they aren't loans as such.  Learning does not automatically make you an indentured servant to loans unless you think that colleges are the only stores of real information.  Anyone that mistakes money for value does not understand how the map differs from the territory.  Don't worry about money.  Worry about how to make more real value than you need yourself.  Sell it, save it, give it away, whatever you want.  But learn about self-sufficiency first.

Provided both were predictable, it wouldn't make much difference.

A rational person would have no significant reason to prefer either. In both cases, adjustments to the amounts would be needed to keep the real payment constant. In both cases, the recipient could freely interconvert between currencies. In neither case would keeping the currency as currency be likely to provide the best investment return.

As I've said, it is trivial to understand his points, but they are also oversimplified to the point of being useless for real world use. If you think they are enough to make a valid argument you are a victim of the Dunning-Kruger effect.

HAHAHAHA...

This, now this is a special kind of stupid. I literally laughed quite audibly.

Why?  (That is, why is it stupid?  I assume that you laughed quite audibly because you thought it was funny)

I can't find any hole in that logic.

Well, currently there are no Bitcoin loans available, anyway. And I expext that to be the case as long as fiat money remains dominant. Who in his right mind would take a loan in a currency that can increase it's value tenfold over night? Once Bitcoin is widely adopted and 1 BTC is a Kilo of Gold this will change. A smooth 5% Deflation a year caused by growth of the Bitcoin economy will not prevent short term loans just as a OD interest of nearly 20% doesn't prevent people from using OD.

I am wondering about large, long term loans like mortgages, though. At 5% Deflation, everyone would delay buying a house because sitting on your saved bitcoins and paying rent is more rational. If there are no buyer because Bitcoin mortgages are too expensive, house prices must deflate much faster than the rest of the market.

So if Bitcoin really starts to displace fiat money, it's time to sell the house and buy it back when Bitcoin is the only game in town.

-Anu

LOL...it just never stops here.

Yes, I get that you're far smarter than I am - but please enlighten me.  Where is the hole in JoelKatz's logic?

Other than being false?

Which bit is false?  If something is going to be worth $X in the forseable future then it makes sense to pay nearly $X for it now.  The difference comes from the risk of it not being worth $X when you think it will and the value to you of having $X in your hand now.

Yes, if Bitcoin takes over, there will be major shifts in the ways we use cash. For instance long term bonds become verboten expensive. Bad news for the real estate market.

Good news for the victims of future wars. If long term bonds are incredibly expensive, wars will get incredibly expensive.

-Anu

That doesn't work. Assume that we knew with 100% certainty that the value of each Bitcoin would increase by 5% a year due to deflation forevermore. Then the value of each bitcoin should take into account that in a years' time it'll be worth 5% more - except that the value in a years' time will also take into account the fact that it'll be worth more in 2 years' time, and so on, and so forth - and the only rational value for a Bitcoin now would be infinite. This is obviously ridiculous.

Of course, there's no such thing as 100% certainty, but this doesn't help either. Assume that we have the same consistent deflation but we're only 95% certain that the situation will be unchanged in a years' time. Then the current price will take this into account - except that, if our prediction comes true, a year later we'll be 95% certain that in another year things will stay the same, and the price then will take this increased certainty into account. The two cancel each other out, leaving us with a 5% increase in the price of Bitcoins corresponding exactly to deflation!

I hope this helps demonstrate why the expectation of future deflation is irrelevant and only changes to the expected future deflation rate can possibly have any effect.

Two things. Firstly, they probably can't: they have to pay their costs now at current-prices, not in a year's time. More importantly, what's to stop you buying in a year's time from a merchant that takes the 20% inflation into account then and saving even more money?

Used to believe this too. Only issue with this that I realized after formal education is that, although all that knowledge is free, knowing WHAT to learn isn't out there. You can't Google search terms and concepts you don't know the names of.
Also, knowing you're paying a lot for a class kinda helps keeping you grinding through it, instead of getting lost in endless Wikipedia links :)

Logic does not agree with you.  Bitcoins aren't deflationary* until 2031.  At present they are inflationary (more are being minted every day).

How do you reconcile that with inflationary = spend; deflationary = hoarde?  The answer is that it's more complicated than that.

(In truth bitcoins aren't deflationary at all, they will be static)

We pretty much know for a fact that the USD is inflationary, with a long-term inflation rate of 3%. So, why isn't USD worth 0 now? (answer is because we don't calculate the value of money to infinity; only to the time we actually need to use it/invest is/repay it)


Their costs are likely discounted as well, since if they're not, then the seller of their raw materials will also go out of business. This discounting is distributed throughout the entire economy. As for next year, the $100 IS a discount on the $120 from the following year. This is how the time value of money works. In inflationary system, money now is worth more than money next year. Businesses, investors, and everyone else who deals with finances uses http://en.wikipedia.org/wiki/Time_value_of_money (http://en.wikipedia.org/wiki/Time_value_of_money) formulas to calculate the worth of their money, and use that to base the price of their investments, the future price of their products, the cost of their borrowed money, etc. In a deflationary economy those calculations won't change, other than the interest rate being inverted. Only actual issue that I see is that the minimum return on investments/loan rates will have to be at least as high as the deflation rate.

I tried coming up with a lending system/calculation that calculates each payment using a standard payment annuity formula, combined with a present-value modifier.

http://forum.bitcoin.org/index.php?topic=28859.0

Essentially, it makes payments decrease over time, with the first payment paying much bigger than the remaining ones (present value of a future payment is nominally larger due to expected deflation). I think I got something wrong in my formula, so help/comments are appreciated.

I agree. The assumption that predictable deflation is not built into the price leads to the conclusion that the price is too low, regardless of how high it is. Therefore, the assumption is false. Predictable deflation is built into the price. That's kind of my point.

The fallacy is thinking "the price is X, plus it has some additional value because it will deflate".

You need to look up what inflation means before you try to contribute to the discussion.

No, the fallacy is not taking into account that that is what "everyone" is thinking. It is not possible to set up a formula to calculate what the price "should" be, which your theoretical approach requires.

I know well what it means.

Printing money is inflationary, since more money is divided over the same sized economy.  Prices therefore go up.

50 bitcoins are created every ten minutes.  They are therefore inflationary at present.

Bitcoins will eventually stop being created; their supply will be fixed.  They will therefore be neither inflationary or deflationary (ignoring the small quantity that will be lost down the back of virtual sofas). If however we assume a growing economy, that same fixed supply will be divided over a larger economy, which will lead to price deflation; bitcoins will then be deflationary?

So... what exactly is it you think I haven't understood?

The argument being advanced was that bitcoins are now being hoarded because they are deflationary.  That is clearly not true, since they aren't deflationary right now.

Price = Current Price(or cost) * (1 + Rate) ^ term length

If I'm selling something for $10, I know I won't get access to the money for 2 months, and the inflation rate is 3%/12 = 0.25%, my price is 10*(1+0.25%)^2 = $10.05

If I'm selling something for B$10, I know I won't get access to the money for 2 months, and the deflation rate is -3%/12 = -0.25%, my price is 10*(1-0.25%)^2 = $9.95

So, I would sell for $10.05 in inflationary USD and for $9.95 in deflationary BTC. If I don't, I'll either not cover my expenses, or will be under-priced by my competitor.

What inflation is, your explanation is still wrong. As I've already suggested, you should look it up.

My two cents: it would help to say "price inflation" or "monetary inflation" instead of just "inflation".  Apparently, the meaning of the bare word has been shifting over the past decades, and the resulting miscommunication has led to all sorts of unnecessary flame wars in the past.  This link was posted in an older thread, and I thought it was quite an interesting read:

http://www.clevelandfed.org/research/commentary/1997/1015.pdf

I always though "inflation" meant "price inflation" and everyone else agreed.  While I understand that that's true nowadays for most people (except for the goldbugs and the libertarians), I was surprised to learn that historically, that hasn't always been the case.

Sounds like a great business model. You can lend me 1000 BTC today, and I'll give back 996 BTC in two months. That way you'll even earn 1 BTC. 10.50 is obviously wrong, btw. 9.95 isn't exactly right either, but close enough for this.

Thank you for keeping up the good fight, Grinder!  I tried my best to get this exact point across earlier and apparently didn't get through.

If I was to lend you 1000 Bitcoin today, I would charge you a 3% rate for the deflation, so you'd have to pay me back 1000*(1+0.25%)^2 = 1005.01BTC in two months. That's because BTC itself deflates. If let you borrow a product that doesn't deflate, like a few boxes of copy paper, and you were to pay me back in BTC in two months, I would be fine if you paid me 995BTC for it, since in two months, with BTC deflating, I would be able to buy the same amount of paper for that amount that have to pay 1000BTC for today. So, two months from now, I go out, use your 995BTC to buy the exact same amount of paper, and let you borrow it again, this time you paying me back 991 in two months. That's of course assuming I didn't charge interest.
P.S. Feel free to replace "buy" with "cost to produce in today's dollars/BTC."

As for $10.50, I meant $10.05. I'm a bit lysdexic, but the formulas are still right.

Whatever the price is, that's the general consensus on its worth. It takes into account whatever affects its worth. There is no difficulty in embedding the expected future value of something into its present value. Everybody does that all the time.

No it's not, and you can repeat that as much as you like, doesn't change it.

Inflation means, these days, means price inflation.  It can also mean money supply inflation.  Money supply inflation causes price inflation (in the absence of other factors).

Do you dispute the fact that bitcoins are being created?  Do you not think that is money supply inflation?  Given that that is true, how does any argument that says people are hoarding coins now because they are deflationary make any sense?

The number of bitcoin users has recently increased far more quickly than the money supply:

http://forum.bitcoin.org/index.php?topic=29043.0

The argument can make sense if people think that the demand for bitcoins will grow more quickly than their supply, making it a good idea to hoard coins that cost you little to produce eight months ago until the suckers next month beg you to buy them off of you at a much higher price.  This is either because they think they'll be greater fools, or because they think that the bitcoin economy will expand faster than the money supply.  I don't see the latter happening, so I'm going to go with the former.

That's a reasonable argument; but it's not deflation.  It's the other way around, instead of people buying because the currency is deflationary, it's the currency becoming more valuable because people are buying.  When the euro devalues against the dollar, we don't talk of the euro deflating -- the size of the euro economy could be the same, and the number of euros could be the same.  We don't speak of oil being "deflationary" when it becomes more expensive do we?

I'm actually not sure that the bitcoin economy is large enough, consistent enough, or varied enough to make terms like "inflation" and "deflation" have any meaning -- they certainly aren't measurable; how are we going to create a "standard basket" for creating a price index in a bitcoin economy?

It's these reasons that make me think that those who say bitcoin is, at present, a commodity rather than a currency are correct.

I'm not arguing the facts of the situation, I'm arguing that this chucking around of the words "deflationary" and "inflationary" to mean increasing and decreasing in value is incorrect.

I suppose I should be surprised that it doesn't take more to obfuscate the transaction for you, but then not many here seem to understand much about economy. This and giving credit for 2 months is exactly the same transaction. You are loaning people money for two months. If you say that the customer can pay 10 BTC now or 9.95 BTC in two months, then you have loaned them 10 BTC and only get 9.95 back. You can pretend it's different because they bought something as well, or because you also give them the option to pay in a currency that devalues, but it's not.

I read what patvarilly wrote in his olive branch message to you, you don't look cleaver just by repeating it. This meaning doesn't make sense in the context of the thread, though. I still suggest you read about inflation, you'll learn useful stuff about the relation between money supply, size of economy and inflation.

I'm not sure why a new economy would need to be debt-ridden. It's a bit like people telling Henry Ford that they wanted his new technology to be like a faster horse.

In the Bitcoin economy, perhaps investors will buy equity rather than making loans. It could be quite a positive thing, because the investor has a bigger stake in ensuring the profitability of the business in which they are investing.

Also, saving works well using Bitcoin so people with a productive idea for a business can save for a little while, then invest in their own ideas.

But they are not buying money, they are buying product. If I carve something out of wood, and the cost is just the wood and a knife, I won't care if you pay me less for it a few months from now, if the amount I get has the same value as it did two months ago. That's why my price would decrease.
Now, if I bought that wood with borrowed money and the cost of that wood is tied to the value of the money, then yeah, I'm stuck charging you for whatever I borrowed the money for. Though that just means that to be competitive, I have to sell my stuff as fast as possible, and have the most efficient inventory with the least dependence on loans. Which is kinda what's already happening in our economy, with all loans having interest, and the value of the loan also being "deflationary"

A LOT of loans exist in business because a lot of businesses operate with very little cash, and there is a delay between obtaining a product and being able to sell it.
In my last company we sold candy. We bought it on credit from the factory, and we sold it for credit to the stores. Stores paid us within 30 days (hopefully), and we paid off the factory, keeping the profit. In the end, we needed very little cash on hand to operate.
Without a loan, we would need to accumulate a few $10k worth of cash before making a purchase (bulk shipping containers). We would then need to sell the candy and get cash right away, to be able to buy the candy again. The main problem with this is that our business is limited by how quickly we get paid, and the business expansion is limited by the amount of extra cash we can get. So the company can only grow either at the speed of the profit, or at the speed we can raise more equity. Loans/investments from venture capitalists means the business can grow big fast, and expand and contract more easilly to adjust for economic situations.

As I said, it doesn't matter. You have given them 10 BTC worth of something, and you are saying that if they wait 2 months they only have to pay 9.95 BTC. I suppose this is something your brain just filters out for you because it creates cognitive dissonance when combined with what you obviously want to believe, but it is no less true.

I think you're the one not realizing that whatever it is that I give them is NOT increasing in price itself. If I invest in a box paper, my return on that paper will be 0%. Obviously I would prefer to sell that paper NOW and get the whole 10BTC, but if I can't sell it, and say a year down the road someone produces paper and pays their employees and sources deflation-adjusted costs, they'll be able to sell it at deflation adjusted prices, undercutting me.

Look at it from the inflation side. Why is it that I can't sell a box of printer paper for $100 today, and can only sell for $97? And if I want to sell for $100, I have to wait until the end of the year? And if I do sell the paper for $97, am I lending that buyer $97?
Yes, I do understand that there is a deflationary value/earning involved. But in a competitive market, the prices will still trend down.

So you're saying bitcoins suffer from some magical equivalent of physical depreciation and obsolescence?

...

Am I? I thought I was saying that the product produced by bitcoin may suffer depreciation? It's perfectly fine for the product to still be worth way more than the bitcoin used to produce it though.
Regarding the original comment about selling for less being like lending, I would ask, with an inflationary dollar, why would I sell you a product for $97 now when I can just sit on that product and sell it to you for $100 in a year?

But the problem with your example isn't that you can't sell it for 10 BTC now, it's that you refuse to sell it for 9.95 BTC now. You are saying that they can't get it for that price unless they wait 2 months. Your formula breaks down if you accept 9.95 now instead of in 2 months, because then you should also accept 9.95 worth of dollars now.

I don't think I ever claimed that I would refuse to sell, now or later. If it seemed like that, you may have misunderstood. At most, I may not be able to sell it at 9.95 BTC without taking a loss, since I may have spent 10 BTC producing the product, but that just means that my business structure is weak, and likely someone is able to out-compete against me. I'm not looking at it as a single merchant with a single changing price point, I'm looking at it as a flow of goods within a distributed production system a constantly downward price pressure.
As for accepting that many worth of dollars now, I would if I had a guarantee that I could swap them for BTC instantly. If the dollar transfer took 2 months, accepting 9.95 BTC worth of dollars now would cost me the 0.5% in dollar deprecation, and wll make it more difficult to buy products needed to continue my business 2 month from now.
Feel free to substitute your own formulas if you can use them to explain things better.

Exactly. This argument doesn't work for inflation because you can invest the money now in something that will hopefully give you good returns, so it doesn't matter that it would eventually be worth nothing if you just sat on it. The problem with deflation is that just sitting on your money is actually a realistic scenario.

Except that the problem is that if we had price deflation, no one will be able to charge $120 to buy the product in a year's time, because the money would be worth more by then and that'll force prices down, not up.

Ironically, the thing you're not quite grasping here is the time value of money. Receiving 995 BTC now is worth more than receiving 995 BTC in two months time, because having it now encompasses both the possibility of having it in two months' time and the possibility of spending it in the meantime. This is still true if deflation means that 995 BTC is worth more in two months' time, because you can take advantage of this even if you're paid it now. So if you're willing to sell delivery of some good now in return for 995 BTC later, you should be even more happy to do it for 995 BTC right now.

No. My point is that predictable deflation cannot be built into the price, because the only rational price would be infinite (at least in this oversimplified scenario). More interestingly, look at what happens when everyone's only mostly certain about future deflation: the effects of predictable deflation on the price cancel out and price deflation occurs at exactly the same rate as it would have anyway. (This is again slightly oversimplified: in practice future expectations should help smooth out the rate of price deflation, but over the long term it has no effect.)

This is self-evidently false. The value of deflation can be built into the price and it's obviously finite.

The problem is, you're starting with the assumption that deflation is not built into the price and then showing that it cannot be built into the price. Of course if it is not built into the price, it cannot be built into the price. You do this by saying "The value is X today, but it also has additional value because it will deflate. Let us calculate that additional value." The X already includes the deflation value, just as the future X's also include the predicted future deflation value past that point. There is nothing else to add.

If you want to say "The value is X today, but it has additional value because it will deflate", your X must be the current value less the deflation value. And the future values you calculate the present value of must also be exclusive of the deflation value. If the deflation value is actually infinite, then the present value less the deflation value is infinitesimal, and the future values less their deflation values that you are adding to the present value are also infinitesimal, so you have a sum of an infinite number of infinitesimals which can be, and in this case must be, finite. This is especially so because a time frame of over, say, 1,000 years is self-evidently absurd. Nobody can be confident something will deflate for that long. Heck, we may not have physical bodies in 1,000 years.

Competition is for dogs.  If you produce what you need, you need no other.  If you produce more than you need yourself, you are in business.

So, deflation has been built into the value of bitcoin as it's fluctuated from $0.00 to $30.00 and back down to...$10?

I think you're missing some appreciable percentage of your parietal lobe...

I think you're trying to argue this from a "wtf is this?" layman's point of view, while others are trying to argue this from a "standard business practices" point of view, and as a result, the two discussions are on completely different wavelengths.
Yes, if I was running this business, I would have deflation expectations built into my prices, just as I have inflation built into my USD prices. Currency fluctuation is just something completely different I have to deal with, having nothing to do with deflation, which is something I already deal with when dealing with USD/EUR

Aha! I have a feeling there's a problem with one of your assumptions, and I suspect may be the process by which the value of X takes deflation into account. There's already something driving the value of X - it's the prices of goods that can be purchased for X - and I don't think that in general the value of X can be such that it both matches the prices of goods that can be purchased for X and takes deflation into account. This is quite tricky to think through, though, because that's a fairly fundamental assumption of economics and I've never been that good at it at the best of times.

(Edit: Ah, that's interesting but not it, I think. However: changes to the value of X due to anticipated future deflation affect the rate of price deflation themselves, and that may be an issue.)

You can't actually add up infinities like that. In any case, if we're not entirely certain about the future, then it's a lot simpler: over time we acquire new knowledge about future deflation, and unless there's suddenly some reason to consider it less likely this extra information will drive the value of X up over time. (Except for that one small outstanding issue...)

A symbol of value does not hold value.  It points to it.  The value of a sandwich, the value of a house, the value of gold....they do not change much.  You want some of the above everyday.  The 'value" of Cabbage Patch Kids or Magic the Gathering cards or comicbooks or stamps or modern currencies change all the time, and drastically, because they have no intrinsic value.  You can't eat them, you can only gloat about having them.  For a time.

You can't eat gold neither.
A symbol of value can hold value. For example an IOU, a dollar, a bitcoin or an ounce of gold.
The monetary value of gold has nothing to do with its industrial value.
There's no such thing as intrinsic value, value is always external to the object being valued, maybe how one values himself is intrinsic value, but nothing else.
If you mean that an object is valued similarly for many people then, yes, gold has been historically valued as a currency, as money, but its monetary value could drop to zero just like with fiat currencies. Because "gold is money" is like an agreement that could be canceled.

value comes from desire, and the desire changes from time to time. Some desire seldom changes and is predictable, like the desire for food and housing etc... 300 years ago no one want petroleum, now... and 300 years later no one want petroleum

Yes. Many factors affected its value, but deflation wasn't a significant one of them.

How do you figure?

That depends on your definition of "much". http://www.sharelynx.com/chartstemp/USHLSPOG.php

It cannot work that way. 10 bitcoins today includes the right to have 10 bitcoins at any point in the future one desires. So 10 bitcoins will never be valued at less than the net present value of the expected future value of those 10 bitcoins at any point in the future.

You are thinking that bitcoins have a certain market value and then they have some extra value due to deflation. But this is not true. The market value includes the deflation value. There is nothing extra to use to offset the interest rate. The value from the deflation of the borrowed coins was part of what was borrowed from the bank and must be paid back to the bank in addition to the bank's interest.

Say an ounce of gold is generally expected to be worth $3,000 next year. Regardless of the present value of an ounce of gold, if you borrow an ounce of gold from me, you are borrowing at least the right to have $3,000 next year and I would insist that you pay me back at least the value of that right plus interest.

You're close. But you are incorrect that borrowing takes a double whammy. Yes, of course you pay interest when you borrow. But the deflation cancels out. You benefit from the deflation on the borrowing end, because the bitcoins you borrowed are worth more to people today because they are expected to deflate. This cancels out most of the whammy on the deflation when you go to pay the money back.

To put it another way, expected deflation will make people want to hoard bitcoins so they can spend them later when they are more valuable. But they will also make people want to pry bitcoins out of other people's hands today so that they can hoard them. You will be borrowing these highly desirable deflating bitcoins that others will work very hard to get from you so they can sit on them. This partially cancels out the higher value of the bitcoins when you have to pay them back.

A few of us on another thread have calculated out a loan repayment system that may work ok in a deflationary system. Basically, your first few payment will be higher than normal, with each consecutive payment decreasing until the last payment is fairly small compared to where you started. The loan is similar to an inflationary currency loan, where although each payment is the same amount, the value decreases over time, and it manages to pay back both bank's interest and compensate for deflation. One major assumption of it though is that deflation stays constant. The deflation amount may be adjustable on the fly, but I haven't played with that yet.

Although it may decrease interest rates (negative inflation premium), deflation can never take them below zero.

I still think deflation makes borrowing to invest less desirable.
Say we have a potential secure investment that yields 5% of its value annually and interest rates are at 5%.
Our baker starts his bakery (and discounting its own wage and other costs) profits a 5% of the investment that goes to pay interest. After twenty years, the baker sells his bakery at the same price and pays back the full loan.
With stable prices, the investment covers its financial costs and therefore is economically viable.
With deflation, you also have to cover the gains of money from deflation to get the loan.
Say we have 5% annual deflation.
That same investment won't get the loan.
Producing exactly the same and selling the products at lower price each day, the baker can lower his wage to compensate deflation and will buy its supplies at a lower price, but he cannot lower the interest. Even if the loan is made in a way that the monthly payment of interest for the whole period takes deflation into account, the borrower will not be able to pay the loan after that period.
We have assumed a constant revenue of 5% and assuming there's no changes in the competition, there's no reason to expect it to go down.
But the nominal revenue has decreased. What has happened is that the capital (the bakery) has devalued. In our case to 0.95^20 = 0.358485922 % of its original price.

The business should have grown at a 5% rate too to compensate deflation. The interest paid monthly could be nominally constant in this case. Only the very best investments will get funded with deflation.

Edit: this example is also discussed here (https://bitcointalk.org/index.php?topic=11627.msg423646#msg423646).

All other things being equal, the benefit of investing over hoarding should be currency-neutral. That is, if an inflationary currency would lose 3% due to inflation if hoarded but gains 2% due to interest, a deflationary currency should also perform roughly 5% better if loaned rather than held.

There are two fallacies that lead people to the opposite conclusion:

1) Thinking that a deflationary currency is extra valuable to hold and forgetting that this means it has greater spending value too because the person you spend it with gets to hold it if they want. The value of the deflation comes from the lender and is carried through the transaction to the end.

2) Forgetting that the cost of inflation comes from the expansion of the money supply. This expansion acts as a tax on all wealth since the newly-printed money can claim any wealth in the economy. The cost of the inflation acts as a claim against the lender's wealth and is also carried through the transaction to the end.

The benefit to the borrower is from being able to consume earlier than he could otherwise. This value is currency-neutral and it is this surplus that is split between the lender and the borrower.

I'm afraid the effect that you're hoping will cancel out the effects of deflation will mostly just cancel itself out. As a borrower you'll need to get hold of bitcoins to pay back the loan, but those bitcoins will again be worth more to the people you're trying to get them off because they're still expected to deflate, and you'll then be competing with all the people looking to get hold of those "highly desirable deflating bitcoins" to sit on. So even if you can get more for your loan because of expected future deflation, your income from which to repay it with will be less by roughly the same amount.

This is essentially what I'm saying. The deflation value is present both at the beginning and the end of the loan, so it cancels itself out.

When you have the ten bitcoins you borrowed to spend, you are also spending the value of their deflation. When you have to buy back ten bitcoins to pay back the principle, you also have to buy the value of their expected future deflation. It cancels out and has no effect on the loan.

The same is true with inflation. To the extent people are willing to part with dollars rather than hold them, your dollars are worth less today when you borrow them. But that also means they are worth less when you need to acquire them to pay them back.

I'm assuming 5% nominal interest for both cases in my example.


In my example, the baker spends the money to buy real capital, he doesn't hold the money.


Yes, monetary inflation acts like a tax over any wealth and (if unexpected) damages in a special way to lenders.
If expected, it is just added to the nominal interest to maintain the real interest.


But with deflation, money has an advantage over other capitals. When you buy capital, you expect its yield to be at least as good as basic interest (real interest less risk premium), thus the price of given capital can be calculated at any time from the basic interest rate in the market and the revenue you obtain with that capital. Deflation decreases the revenue, devalues real capital and therefore discourages its accumulation.
With deflation more than ever, money becomes the better of the capitals.

Do you see something wrong with my example?

I think you're reasoning that whoever holds the money is paying the inflation tax and thus by loaning the money to someone else they have to pay the inflation tax. But if that were true, that would just make the money worth less today because taking the money would mean assuming the tax burden of inflation. It all cancels out however you figure it.

The cost of inflation is borne by the lender. The benefits of deflation are reaped by the lender. Otherwise, they have no effect on the mechanics of the loan except to offset the interest rate. All other things being equal, the benefit of lending over hoarding is the same.

If you hoard, you get whatever the money would do naturally. If you lend, you get whatever the money would do naturally (because you still bring that to the table in the first place) plus your share of the surplus created by the borrower being able to timeshift his consumption.

My example is not about inflation but anyway you're wrong. The costs of inflation are paid as you said earlier by all wealth owners.
The lender only pays more than other capital holders if the inflation is unexpected. If it is expected, he could just buy himself real capital instead of lending with no inflation premium. He knows that the nominal revenues and prices of capital are going to rise, so he could buy a capital, take the yields and then sell it instead of lending his money-capital.
The money holder can "escape" from inflation by going to any other capital or even just by buying a commodity.   


Deflation can affect the nominal interest through negative inflation premium, but not as linearly as inflation does. And, of course, the nominal interest can never be below zero with everlasting money.
To simplify, yes, the lender gets from deflation as much as the hoarder does.

That doesn't work. When you spend the ten bitcoins initially, the value you get is affected by the effects of future deflation as anticipated by people now. When you have to buy back the ten bitcoins to pay off the principal at some point in the future, the value you get is affected by the anticipated effects of future deflation as perceived from that point in the future, plus the actual deflation over the time period of the loan. The two sides are neither the same nor likely to cancel out.

Suppose you borrow money for (say) two years. At the start of those two years people can only estimate deflation over the next few years rather than know for certain, and the further out they look the less accurately they can estimate. This uncertainty affects how much of the anticipated effects of deflation people are willing to take into account. In two years' time everyone will pretty much know what happened over those two years and will be in a better position to judge what will happen in the third and subsequent years, so more of the effect of deflation will be priced in.

That's true if, and only if, the expected deflation either changes or the actual deflation doesn't well match the predicted deflation. I agree that you can get all kinds of strange and bad results if you try to denominate an agreement in an unstable or unpredictable currency.

Exactly. That's why you don't want to denominate an agreement in a currency that isn't very predictable over the time frame of the agreement. Otherwise, people will become very risk averse and tend to prefer shorter term agreements because it costs money to manage risk. It would be madness to offer or accept a 30 year mortgage denominated in bitcoins today.

An unpredictably inflationary currency, by the way, creates precisely the same issues. This is why we have currency hedge funds, TIPS, adjustable rate mortgages, and so on. These are all ways to manage the risk associated with a currency whose inflation is only somewhat predictable. A currency whose deflation was only somewhat predictable would create the same issues and more or less the same workarounds will reduce their impact.

Here's another example of the same error where it's easier to see: "Who would want to borrow money with an inflationary currency? The mortgage rate would likely have to be adjustable and could climb up really high, forcing you to pay back lots more money."

It's true even if expected deflation doesn't change and actual deflation matches the predicted deflation well; in fact I was assuming this would probably be the case. The reduction in uncertainty about deflation and other factors over the time period in question is what causes the value of the coins to increase.

It doesn't matter much how predictable the currency is - as long as there's the slightest sliver of uncertainty about the future (and who can really say for sure what will happen in a thousand years or a million?) you will have this reduction in uncertainty over time causing more deflation to be priced in. I don't think the actual level of uncertainty even affects the rate at which deflation will be priced in on average over the long term - only changes to it matter. For example, suppose we have the following incredibly simplified situation where we're at the end of some year y, we know statement S0 is true and are uncertain about the rest of the statements S1, S2, ...

S0: The economy behaved the same in year y as in all previous years, with the same growth rate and the same 5% deflation, and it's 99.99 percent certain that a year later we'll confirm statement S1 is true.
Sn: The economy behaved the same in year y+n as in all previous years, with the same growth rate and the same 5% deflation, and it's 99.99 percent certain that a year later we'll confirm statement S(n+1) is true.

Up until the point one of the statements Sn is discovered to be false - which is by our assumptions impossible to predict in advance - all the years are identical and in every year we have identical expectations for the future, so the effect of expected deflation must necessarily be the same in each year and cancel out, making it impossible for that to compensate for the effect of the deflation on loans at all. This works because as the loan period passes we're more certain about deflation and the economy not just in that year but all the way into the distant future. You can change that 99.99 percent to 99.99999999 percent and the argument still works.

That's not even close to the same statement. There is actually a fairly direct deflationary equivalent of this problem - unexpectedly high rates of price deflation could force you to pay back lots more than you were expecting to - but I'm just talking about the predictable, routine increase in the amount you owe in real terms.

Confirming that JoelKatz has won this thread several times over.

On another note, why do people who have not even the slightest interest in using bitcoins stick around this forum for months and make hundreds of posts? (rhetorical)

You can't have it both ways. You can't say that there's uncertainty and therefore more and more deflation will be priced in. If it's uncertain, then deflation might get priced in or might get priced out or might not change at all.

In any event, uncertain deflation (assuming there's not a huge amount of it) is a manageable risk. If you are harmed if deflation increases, you find someone who is harmed if deflation decreases and you hedge with them. We already do precisely this to hedge around uncertain inflation. It works the same way with deflation.

Yes, and you might win the lottery tomorrow. Even if the odds of anything other than the expected happening were as slim as you winning the lottery, the tiny sliver of uncertainty should still be enough to cause more deflation to be priced in over time at a very noticable rate, but would you rely on the possibility of winning the lottery to help repay a loan?

There's also a bigger reason why I'm ignoring the possibility the odds could work out in the favour of someone needing to pay back a loan. The reason there's always going to be uncertainty is because of the lingering possibility of some kind of totally unanticipated economic disaster. An economic meltdown is unlikely to be good for your ability to pay back your loan, even if it does reduce the amount you owe in real terms. It's also a bit difficult to plan for due to the whole "unanticipated" part.

Of course it's a manageable risk - but as far as I can see that still doesn't help, because it only protects against unexpected changes in deflation and the problem here is that as a borrower you lose out even if nothing unexpected actually happens.

JoelKatz, in simple laymen's explanation terms, if I were to take out a 30 year loan with predictably deflationary Bitcoin, where a level payment will become progressively more painful to pay, would the only option be to use the decreasing nominal payment thing I mentioned/worked out in the other forum? Or is the "pricing in of deflation" going to make level monthly payments somehow manageable? That's the only part I'm somewhat confused on.

I don't know what you people mean by winning a thread. I share my view and I try to understand other people's view.
If I change my mind the one that gains more its me, not the other person.
I have the intuition that his view is based on dogma, but if I discover that he's only based on true assumptions and logic I have no problem admiting that I was wrong.
In fact I love to change my mind. The feeling that you were blind and now you see is very good.


If you're talking about me, I have much interest in using bitcoin, because it is much better than the monetary system we have now.
I see two main groups within the monetary system critics.
From the austrian school we criticize the central bank role.
Within the local currencies trend, the critique is usually more focused on interest.
I criticize both and that's why I propose freicoin and support ripple (although you can have interest with ripple I think the rate would tend to zero).
I also support bitcoin, many people around me know bitcoin thanks to me. I don't talk about freicoin when I introduced them to the bitcoin concept.
I'm a software engineer (well, I don't have the paper that says so yet, I have to finish the final project, but I'm already working as programmer) and I could develop freicoin if I study the bitcoin code. It's a simple change for someone who already knows the code.
But there's no point in having the code if most people who know the idea don't like it.
Also I don't think I have the experience needed to coordinate a free software project like that.

Is there anyone else on this forum besides you that criticizes interest?


How will you convince people to switch from currency that hold value, to currency that is guaranteed to slowly lose it, at the stage where the currency is worth almost $0 to begin with? Bitcoin's sales pitch was that it's $0 now, but put your money into it because it'll be $100's later. What's your sales pitch?

Not that I'm aware. The RBE people maybe?
Most people I've talk with in the forum think that I want to somehow make interest static, and I don't.
I just want to allow further real capital accumulation. Lower the "tax" (basic interest) that money charges on commerce.
Like inflation, you may not see it, but it's there.


For speculators, almost the same that bitcoin: it's $0 now, but it will be $97 later.
For merchants, accept it because people prefer to spend these.
For entrepreneurs, take cheaper loans in this currency.
Well, that last one would be only after the value of the currency reaches some equilibrium, after the big initial price deflation.

If I understand it correctly, freicoin will lose value while you hold it, and will provide incentive to give it to someone else (like merchants). Why would speculators, the first people to exchange real money into this experimental money, expect their freicoin to be worth more in the future, if this money is by design supposed to lose value? And isn't them holding currency that appreciates in value the root of your "money interest from holding money" problem?

You borrowed the right to hold that money as it appreciated, you invested the value of that right, why would paying it back be a problem?

Whether you would prefer decreasing nominal payments or level payments depends on what the borrower plans to do with the money and what the lender wants to get for his money. Some people may prefer one lump payment at the end of the loan term. I think generally borrowers generally prefer increasing real payments, so level nominal payments may be preferred because that implements decreasing real payments. It depends why you're borrowing the money.

For example, if you're borrowing the money to buy a car and you expect your income to be level in the deflationary currency, you would prefer level nominal payments. If your income shrinks because the currency is very deflationary, then you would prefer decreasing nominal payments. If you're investing in a business that won't get off the ground until later in the loan term, you may prefer increasing nominal payments.

A deflating currency will put a preference towards decreasing nominal payments. But that will go into the mix of preferences based on what the lender wants and what the borrower wants.

I would dearly love to know at what point saving your own excess production for long enough to reinvest it properly became known as "hoarding".  I would also be delighted to have explained to me how borrowing money at interest is EVER in my best interests.  Yes, we do 7 day or 15 day or 30 or even 90 day terms.  But paying a late fee, or interest on it is acceptable only as a punishment for changing a contract after it is accepted.  NOT a sensible part of the original contract.  There is nothing to prevent me from accepting 30 day terms for face value and nothing more. Unless, of course, I was a usurious parasite that fed on interest payments while making nothing else of value but symbols of other peoples' wealth.

The currency is designed to lose nominal value, but if the freicoin economy grows, you can't avoid deflation.


Not exactly. The interest comes from the money not losing value and being necessary for trade. The money holder can exploit that need, but you don't need deflation for that. Our current monetary system has not deflation and has interest (although the system is also designed to cheat small lenders).

Freicoin (like bitcoin) would eventually reach a user base equilibrium and have an increasing value based only based on growth.
But if the deflation rate is lower than the demurrage rate you still have an incentive to spend or lend your money.

In fact I think that bitcoin could have more deflation than freicoin since the deflation comes sometimes from shrinking credit, which you need periodically to mitigate the exponential growth of debt debt, an effect of interest. Yes, I believe that business cycles are based on interest. Central banks and fractional reserve only makes them worse, but they are not the root cause.

You currently make $11/hour working as a cashier, which you hate. You got a job as a pizza delivery driver that pays $19/hour, which you would love, but you need a car to accept that job. You don't have enough money to buy a car, but you could borrow $2,220 at interest to buy a car.

You designed a cash-for-bitcoins terminal. You can buy the hardware for $1,900 and sell them for $2,400. You only have about $5,000 cash. You just signed a contract for 1,200 terminals, but you need to provide them all within three months. You don't have the $2.3 million you need to order 1,200 terminals, but if you borrowed it with interest, you could pocket $350,000 in profit.

Sometimes it is most efficient to produce value before you consume it. But it is also sometimes much more efficient to consume value prior to producing it, such that the amount ultimately produced is much greater. Interest consist of two people sharing this benefit because they both made it possible.

@ viperjbm

1) The lack of divisibility problem.

I didn't look for the thread for you to read, but modify bitcoin divisibility would be easy.
If a satoshi is worth too much, the code will be changed to accept smaller denominations.

2) The lost wallets problem.

I'm not very concerned about this problem, but freicoin solves it. The lost wallets will be reintroduced in the system by demurrage.

3) Non compound inflation.

That's not possible or I don't understand you.
0.1% monetary inflation + 1% wallets losses = 0.9% monetary deflation. What am I missing?
Anyway, if your concern with deflation is its effects on the financial market, freicoin has a better effect than expocoin, right? It also lowers interest.
If you want the inflation to make transaction fees cheaper (or increase security (https://bitcointalk.org/index.php?topic=6284.msg388084#msg388084)), freicoin is equivalent to expocoin.
I will be happy to discuss anything related with creating monetary inflation in the proposed chains thread.
I think the main topic here is "Does predictable modest deflation has any effect on the financial market?".

@ everybody
Since predictable modest inflation (created without lending) doesn't have any real effect on the financial market because it only rises the nominal interest rate, some people think that the same must be true for deflation, but interest rates cannot be negative.
Even if all capital yields were negative at the same time, people would prefer to keep their money. With demurrage, they would prefer to put it in a secure store of value or buy consuming goods in advance.

Real capital yields 5% and 10% inflation = 15% nominal interest = 5% real interest
Real capital yields 5% and 10% deflation = I don't know, but not -5% (2% nominal interest ??, then  = 12% real interest) = lend and hoard are both better than invest = nobody borrows and there's no new investments

What am I missing there?

I don't care about the word (http://www.wordreference.com/es/translation.asp?tranword=hoard). The difference between hoarding money or hoarding other goods is that when you hoard money you're making the whole society wait for your decision on how do you want to be compensated for the services you've already provided. That is important and affects other people's decisions.


But is not about morals, is about what lenders can ask. Is how markets work.
If you introduce a regulation that makes starting a new bakery very complicated an expensive, bakers can and will rise their prices because of the artificial lack of competition. There's nothing wrong about it (well, yes, the regulation).
While lenders can claim the interest they will do it. The "regulation" here is the money system people chose to use.


They made something of value at some point. But if they decide to never redeem that value and lend it at interest, the value to be redeemed will grow until its growth unsustainable. It's just how exponential growth works.
If you were immortal, you could save one coin once, keep on working and consuming your whole wage until the initial loan grows big enough through compound interest, and live on the interest of the big sum forever.
An ounce of gold lent at 5 % interest looks like this in 300 years: 1.05^300 = 2 273 996.13
This of course is unsustainable and that's what business cycles are about.

Sorry, I was specifically asking why people would start. When Bitcoin was worth $0.001 penny, you could buy thousands of it, hold onto it, and watch it eventually become $0.01, then $1, then $10. Why would people buy $0.001 freicoins if they know that thanks to demurage it'll be worth $0.000 in a short while?

Assuming a 3% demurrage rate.
1 frc will still be 0.97^5 = 0.858734026 frc in 5 years.

Why if 1 frc is at $0.001 today 0.858734026 frc must worth $0.000 in a short while in 5 years?

I do understand how borrowing now with the expectation of earning more later from the loan than you will pay in interest is of value to both parties.  I really do.  The current Federal debt of $14.58 trillion when we only created new value (GDP) last year of $14.53 trillion dollars strongly suggests to me that this whole spend now what you have not yet earned model should be once again relegated to a last resort, not a standard business practice, and certainly not a model for a nation.  Or an individual.  Or a state.  All I'm sayin'.  As an aside, those that cater to the desperate on a small scale are mostly either charities or drug-dealers.  As above, so below.

Without electricity there wouldn't be internet, web will go off then. So.. Without this, we can't access or use any of our crypto. And trading also wouldn't be possible