The Trillion Dollar Question

[dacoinminster]

Somebody on Quora asked:

How could a new digital currency have more stable prices than Bitcoin?

Both from a technical and a market/economics perspective.

It seems like if there was a smart way to prevent wide swings in price of the currency...it'd be much more useful as a store of value. I am not sure how this could be done though. How could that be achieved?

I feel like the frequency that they are issued could vary or something like that but I don't know how that could be managed

My answer:

Congratulations. You have just asked the TRILLION-dollar question. If someone does manage to create a distributed currency which also achieves good price stability, the biggest barrier to distributed currency adoption will have fallen, and the world will be changed forever.

I have thought about this topic endlessly, and I wrote a paper about it. I have some very important news for you, so please pay attention:

Bitcoin, or something like it, CAN provide price stability. There are three ways this could happen:

• Friction: This is the default answer for most bitcoin enthusiasts, and I believe I have heard Gavin himself espouse this view, although I can't find the quote. If enough merchants and businesses support bitcoin, it becomes harder and harder for the price to swing around wildly, because there are so many goods and services available for buying and selling denominated in bitcoins. Friction stability is a long LONG way in the future, if it ever happens at all.
• Colored coins: If I buy a warehouse full of gold, I could annoint a few Satoshis (the smallest unit of bitcoin) as being worth 1 ounce of gold each, and then sell them. People could then engage in trade, buying and selling things denominated in gold using these "colored bitcoins" I created. I would agree to purchase back these tokens on demand for the current price of gold. I could do the same thing with U.S. Dollars or any other currency or commodity. The disadvantage of course is that people would have to trust the issuer. Incidentally, this is almost exactly the model used by Ripple, but running on top of the bitcoin protocol. I could imagine this working rather well if a reasonably trusted entity such as MtGox started selling them. The development effort for colored coins can be found at Bitcoinx.org
• Self-Stabilizing Coins: Bitcoin lovers don't like centralization, and while colored coins may someday provide stable value and anonymous transactions, they also require centralized trust in a currency issuer who could betray that trust or be raided by a government entity. Consequently, there will eventually be new currency protocols built on top of bitcoin, much like how HTTP is built on top of TCP/IP. These currencies will provide the capability to create self-stabilizing tokens which leverage derivative markets to maintain a target value. There are probably dozens of different ways to go about doing this. I wrote a paper about one of them. However, nobody has ever actually PROVEN that this could work.

The potential huge market for stable coins built on top of bitcoin is why I own bitcoins and have no intention to sell them in the near future. Colored coins WILL happen. Self-stabilizing coins MIGHT happen. Either way, bitcoin price increases are just getting started.

[Cryptoman]

Someone could issue a Chaumian-blinded currency tied to the price of gold (or some basket of commodities) using Open Transactions.  This person could demonstrate sufficient backing for the currency by proving that they control a bitcoin address (using digital signatures) which has an amount of bitcoins in it at least equal in value to the amount of currency outstanding.  Hopefully Monetas or someone else is working on this as we speak.

[dacoinminster]

Someone could issue a Chaumian-blinded currency tied to the price of gold (or some basket of commodities) using Open Transactions.  This person could demonstrate sufficient backing for the currency by proving that they control a bitcoin address (using digital signatures) which has an amount of bitcoins in it at least equal in value to the amount of currency outstanding.  Hopefully Monetas or someone else is working on this as we speak.

Sigh. I wish someone would "explain open transactions to me like I'm 5". I've read plenty about it for a long time, but I've never seen it do anything useful, or seen any evidence that it could.

[yokosan]

Can't wait for colored Bitcoins to gain some traction.

[Mike Christ]

No colored bitcoin, por favor.  We've already seen what currencies backed by other currencies have done.  Friction is all we need.

[antibanker]

the japanese goxies are just as corrupt insider traders as Wall Str mo...f....

[fellowtraveler]

Sigh. I wish someone would "explain open transactions to me like I'm 5". I've read plenty about it for a long time, but I've never seen it do anything useful, or seen any evidence that it could.

I would be happy to sit you down and train you on it.

What city do you live in?

Or we can meet on IRC.

[Impaler]

Friction:  Too far off, and chicken and egg problem too, you will never get enough adoption to get the friction needed to get the adoption.  Also very little evidence that a REAL economy with no stabilizing mechanism is that stable and plenty to suggest it isn't.

Colored Coins:  Requires massive costly real world reserves and centralized trusted agent, also it only pegs the value of a tiny number of coins and that presents an obvious possibility of confusing those coins with non peged coins.

Self-Stabilizing Coins:  I'm not sure what your describing here, but I've though about stabilizing through an internal market mechanism that would control inflation rates, I don't think this can be done 'on top of' the BTC protocol but in it so its peer-2-peer and decentralized.


One idea I've been toying with lately is to peg coins to the one thing that CAN be know, controlled and revoked inside the system.  The ability to use the system as a user is a use-value that is fairly stable, if their were a FLAT fee in coins to have a wallet then it would put an upper boundary on the price of a coin.  If the market tried to drive that price above what people were willing to pay to use the system then they would jump ship and this would put downward pressure on the price.