Doubt about Bitcoin's growth potential

[kjj]

I don't agree. Bank runs caused by liquidity issues are a solved problem. Bank runs caused by insufficient equity (say due to bad loans) cannot be solved.

With Bitcoin, a bank run would look like an attempt to withdraw larger amounts of Bitcoins quickly, rather than queues forming in front of the banks. If there was a problem with withdrawals, people would start complaining in the forum, the news would pick it up and it could escalate very quickly. Even now when the amounts are, on global scale, negligible, it does not even take 24 hours for the word to spread.

The issue of liquidity is not solved at all. FRB works because banks issue short-maturity (even zero maturity) instruments, but the maturity of the loans they issue is higher (can be years). They carry the risk for this difference. If they were forced to liquidate the loans prematurely, they would need to take a cut, and this would result in undercapitalisation. Furthermore, as Taleb for example convincingly argues in The Black Swan, a lot of risk is not correctly modeled.

This is a smaller problem if FRB is merely a method of bringing together investors and creditors. People normally do not expect to withdraw their deposits immediately. If however those instruments are also used as a medium of exchange, people do expect to be able to use them for payment right away, and if this does not work, it has a direct impact on their business or lifestyle, and aggravates the panic. People can't pay rent, food, their suppliers or employees. That's an immediate problem.

I would say that most people depositing into traditional banks do not think of themselves as investors, or at least they don't think of their checking account as an investment.

There is a duration mismatch problem that is fundamental.  If a bank loans out money for a 30 year mortgage, but people want their money back sooner, the bank is screwed.  The bank is "good for it", but can't pay out today.  The modern solution is for a central bank to be able to create money out of thin air and lend it to the bank.

Since a bitcoin bank can't create money out of thin air, it always faces the possibility of a run.  Bitcoin banks could band together with an agreement to loan each other bitcoins as needed, and this would mitigate the problem during isolated or limited bank runs, but if everyone everywhere gets spooked at the same time, the game is up.

The solution is to be clear on both sides about repayment timelines.  The bank could not use demand deposits for duration loans, and the customers could not ask for early withdrawals on duration deposits.  Clever banks would attempt to mitigate this by creating markets for duration deposits, giving people an option to cash out early by selling the certificate to someone else at a discount (penalty), but it would need to be clearly understood on both sides that this system is not a promise of liquidity, but a last resort.

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[ChupacabraHunter]

The unpayable debts will be defaulted, either outright via repudiation and/or dissolution of governments, or via inflation. The consequences of these defaults are not avoidable but Bitcoin represents a way to prevent the situation from happening again.

How do you see that happening, how do you see Bitcoin forcing all the debt that is currently in the system to get defaulted?

The idea that Bitcoin will force the "repudiation and/or dissolution of governments" is a far-fetched notion.  They still have the ability to "make laws" at will, and to their own preservation. 

[ChupacabraHunter]

Ehh, firstly, it's the easiest thing in the world to create bitcoin-denominated credit. This is being done all the time on this forum. Of course because of the limited nature of the resource, no sane person wants to owe anyone huge amounts of bitcoins.

Bitcoin is not even supposed to replace inflationary currencies, but complement them. It is not clear if bitcoin can ever be technically scaled up enough to be the sole exchange medium in the world. On the other hand, sovereign nations need to be able to issue their own inflationary currencies through their central banks just to continue functioning, at least in the current environment.

I could see Bitcoin eventually replacing some "specialty" pseudocurrencies, like the SDR, if it really takes off. It won't ever replace fiat.

I and my friend agree... but what does that mean for it's growth potential?  So (he asks) why even have a new currency, if Bitcoin was supposed to get rid of the current hyper-inflationary system.  It is not really fulfilling its purpose, it is just staying there.  Right?

[ChupacabraHunter]

Bitcoin can be lent, but cannot create credit in the way that fiat currencies can.  Currently, large economies are making up (creating from thin air) huge amounts of currency to buy debt and other assets, manipulating the economy.  This is not possible with BTC which is one of the major advantages of it.  However, this is not the way the economy currently works.  BTC will give users a guarentee that it will not be devalued by a central bank printing more BTC, BUT it does make it less flexible for those central banks and will therefore never be adopted by them.  This is a currency of the people for the poeple!

Bitcoin can be used to create credit as long as two parties agree on terms with Bitcoin amount as notional.

[ChupacabraHunter]

One of the reasons why Bitcoin is so brilliant is that FRB (Fractional Reserve Banking) is actually much more difficult than with any other monetary system. Even with gold it's very much possible even though the base money (gold) can't be expanded. In a fiat money system even the base money can be expanded forever and ever, which is exactly what the central banks do.

With Bitcoin there is a radical difference. The base money is essentially as fixed as gold but the big difference is that it's independent of centralized institutions. With Bitcoin there is a very limited need or advantage to deposit your money anywhere. This is why a large portion of Bitcoin transactions will always move outside the banks and this will make it impossible to practise fractional reserve lending in any major capacity.

It will of course be possible and even likely, but instead of banks having 10% reserves, Bitcoin banks will have much larger reserves. This is of course a VERY GOOD thing, don't let anyone tell you otherwise. Tell that "economist" to read something else for a change. Recommend Schlichter's "Paper Money Collapse".

Fair point.    But for Bitcoin to be successful, it should be widely accepted.  The point being contested is whether the gov'ts would even allow Bitcoin to grow given they control the nations' laws and armies.  Just like bitTorrent exists but cannot/have not eliminated copyrights.

[ChupacabraHunter]

Please help me understand/explain to an economist friend of mine...

He argues that Bitcoins have no chance in global success because a this system be used to create credit.

Bitcoins cannot be used to leverage. --> You cannot use Bitcoins to create credit.  ---> It can't replace existing credit already created by the current system.

For Bitcoins to be successful, it has to be able to replace the existing debt!

Please help me:

Where is he right/wrong?

He's wrong because I can owe you 100 bitcoins without having 100 bitcoins. Heck, I can owe you 25 million bitcoins even though 25 million bitcoins will never be in existence at the same time.

Unfortunately, no.  Just like the gold standard, a paper money system was created with gold as backing, and as gold backing was made redundant at a point.  It's equally plausible to create a paper system with 25 million bitcoins and get rid of Bitcoin backing at some point.  But the question here is whether Bitcoin can get to that stage. (?) 

[ChupacabraHunter]

Bitcoin highlights a lack of faith in unbacked Fractional Reserve banking. Sure, Bitcoin could be used as backing for someone elses fiat credit system, but it's not Bitcoin's problem if they decide to pull a Mugabe and "Quantitatively Ease" to oblivion. That's their own stupid fault.

This is pretty much the case in point, it is what my friend is trying to say!

[lonelyminer (Peter Šurda)]

Just like the gold standard, a paper money system was created with gold as backing, and as gold backing was made redundant at a point.  It's equally plausible to create a paper system with 25 million bitcoins and get rid of Bitcoin backing at some point.

As the "paper system" would not decrease transaction costs, it would not be accepted by market participants as a substitute for native Bitcoin. Acceptance is a prerequisite for both credit expansion, and a removal of backing ("fiatisation" of commodities). This is a critical difference between gold and Bitcoin.

[ChupacabraHunter]

For Bitcoins to be successful, it has to be able to replace the existing debt!

Whos debt? This reveals a thinking stuck in old system.

Should it replace, US debt? The Zimbabwe debt? whole worlds debt?
All money in the world, including chinese Yen or just the dollar?

Short answer is of course: No.

If the existing debt is not replaced, it must be written-off. This act will set a precedent to the creation of more debt.

There is really allready countries which has dual currency systems which works absolutely perfect.
In fact a dual currency system often works better.

Bernard Lietaer: Money diversity
http://www.youtube.com/watch?v=T9EI2PrDpmw&feature=related

It does not have to replace anything to be useful.
A glass can exist and be useful without having to replace all the old glasses.

I can get BTC10 that was not created out of debt, by selling something for them, doing some work, mining them, trading them
for debt based money.

I can trade a sock for 0.1Btc if I want. Without caring how many dollars a Bitcoin is worth.

When I have those. No need to use debt based money anymore.
(Except to pay taxes.)

Its not hard.

And Bitcoin does not belong to a single country.
Its independent.

In case of dual currency systems both currencies are still taxed, and they are within the control of a single gov't.  Given that Bitcoin is a "perfect" way to evade taxes, it's growth is likely to be curbed by unwilling governments.  In his opinion it makes it very difficult to co-exist as a major currency.

[ChupacabraHunter]

Just like the gold standard, a paper money system was created with gold as backing, and as gold backing was made redundant at a point.  It's equally plausible to create a paper system with 25 million bitcoins and get rid of Bitcoin backing at some point.

As the "paper system" would not decrease transaction costs, it would not be accepted by market participants as a substitute for native Bitcoin. Acceptance is a prerequisite for both credit expansion, and a removal of backing ("fiatisation" of commodities). This is a critical difference between gold and Bitcoin.

An ePaper system can be created, which would decrease transaction costs as well.  

Even in the current day economy the instrument that most investment banks create don't have more than 2 parties entering the transaction as long as the two parties are comfortable taking on the credit risk.  However the two parties being large financial institutions, they allow the credit risk to cascade further into the economy.  Bitcoin is not immune to this effect.  

[ChupacabraHunter]

Throughout the course of history, humans have always moved to better forms of currency.

Beads -> Sea shells -> Wampum -> Metal Coins -> Gold -> Paper money fiat -> Electronic money (paypal, credit cards) -> Return to gold? Bitcoin?

This is me talking (C.H.)... and I have to point you to Gresham's Law:

http://en.wikipedia.org/wiki/Gresham's_law

"When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation."

so, if Bitcoin's are "good money" there maybe a totally opposite effect to the "expected" ... humans are just so puny and inferior to their "own" Government's!  

I truly hope Bitcoin's insurgence will be one time when Gresham is proven wrong!

[BobbyJo]

Why does it need to replace the current debt system in order to be be a success?  They can run in parallell.  You dont have to have one or the other!  I think that the adption of bitcoin is a better measure of its success rather than the demise of the current system.

[Melbustus]

...
I could see Bitcoin eventually replacing some "specialty" pseudocurrencies, like the SDR, if it really takes off. It won't ever replace fiat.

I and my friend agree... but what does that mean for it's growth potential?  So (he asks) why even have a new currency, if Bitcoin was supposed to get rid of the current hyper-inflationary system.  It is not really fulfilling its purpose, it is just staying there.  Right?

I consider bitcoin to be a monetary superset of gold, since it has gold's properties (but better) plus convenient electronic transactability... So, it has two ways to become valuable: by servicing the store-of-value market-needs that gold currently covers, and/or via its transactional properties. It doesn't have to replace an existing major currency to be successful (valuable) long-term. Discussed more here: https://bitcointalk.org/index.php?topic=100065.0

[lonelyminer (Peter Šurda)]

An ePaper system can be created, which would decrease transaction costs as well.

With something like Bitcoin, this is very difficult to pull off. Bitcoin is form-invariant, i.e. can exist in almost any form. Any medium able to store 64 bytes of data can act as a native Bitcoin form. Furthermore, the acceptance of a credit instrument is burdened with counterparty risk and, for banks, the issuance is accompanied by the costs of maintaining reserves, and these need to be shifted over to the users. Neither of these exist when using specie, and they constitute a hurdle that a credit instrument needs to overcome to decrease transaction costs over specie.

Even in the current day economy the instrument that most investment banks create don't have more than 2 parties entering the transaction as long as the two parties are comfortable taking on the credit risk.  However the two parties being large financial institutions, they allow the credit risk to cascade further into the economy.  Bitcoin is not immune to this effect.  

There is a difference between credit and circulation credit, i.e. credit instruments that circulate as media of exchange. The latter, by definition, involves a counterparty risk.

[btcxyzzz]

i little bit of offtopic but it would be interesting to see the arise of the ones who adopted Bitcoin fully, but in the same time rejected every other monetary system. we just need the critical mass of them, for dollars and similar trash to really become useless... that would be "a complete success of Bitcoin", but the starter of the topic (his friend "economist") implies that ones who are heavily dependent on the system as it is right now, should somehow stay wealthy and continue to enjoy their parasite lives instead of being completely broke as they should become, after the full adoption of a Bitcoin.

[Severian]

I truly hope Bitcoin's insurgence will be one time when Gresham is proven wrong!

Gresham's law only applies to exchange rates as dictated by law. Bitcoin is a whole new beast as it's rates are beyond what the law can decree, so Gresham's law doesn't apply in this case.

After we see what happens with Bitcoin, perhaps we can formulate Satoshi's Law. 

[FreeMoney]

Why does it need to replace the current debt system in order to be be a success?  They can run in parallell.  You dont have to have one or the other!  I think that the adption of bitcoin is a better measure of its success rather than the demise of the current system.

It can only attain a tiny tiny fraction of current systems unless it is solidly better. Once it is widely accepted and solidly better it's just going to crush. The USD etc are not things that can partly crash. If ~half of the value rushes out of them and into bitcoin the rest will follow.

edit: maybe I didn't read carefully, I was just thinking "current system" and nothing about debt in particular. Debts are going to be denominated in whatever currency people use because that's the only convenient way to do it.

[Melbustus]

It can only attain a tiny tiny fraction of current systems unless it is solidly better. Once it is widely accepted and solidly better it's just going to crush.

Define "solidly better".

[Shagnasty]

My only concern so far with bitcoin is the lack of, or inability to, prosecute fraud and uphold contracts. That's what makes lending difficult in my opinion. Also, we could have institutions that practice fractional reserve banking, but it is not backed or guaranteed (FDIC). This means that customers (lenders) of the bank are at much more risk because of the high percentage of the reserves (customers money) being lent out. This makes their savings illiquid and risky. So in order to do this, the institutions would have to offer high interest rates and not be able to guarantee instant liquidation at moment's notice. 

[HDSolar]

My only concern so far with bitcoin is the lack of, or inability to, prosecute fraud and uphold contracts. That's what makes lending difficult in my opinion. Also, we could have institutions that practice fractional reserve banking, but it is not backed or guaranteed (FDIC). This means that customers (lenders) of the bank are at much more risk because of the high percentage of the reserves (customers money) being lent out. This makes their savings illiquid and risky. So in order to do this, the institutions would have to offer high interest rates and not be able to guarantee instant liquidation at moment's notice. 

This is a good point but I would not be worried because there are ways to fix this, my concern is wider growth or diversity usage of the currency.  The value of the currency is great but if the use could be diversified then I think stability would grow allowing for greater growth.  Guarantees will follow and there are ways to develop them but that will probably not happen until greater utility. 

Just my thoughts on the subject but I would like to see more guarantees offered too.