Bitcoin is a Zero-Sum Game - Long-term interest bearing instruments viable?

[Dalkore]

I just wanted to point out as "food for thought" that Bitcoins are a fixed issue currency.   This means is can not be expanded at this point beyond the initial 21 million projected coins.   I believe we have some people that have not really applied this to how they think about Bitcoins.   It is very interesting to see any long-term interest bearing arrangements that are marketed.   

If I agree to accept your coins and pay you an interest, that means regardless if my business idea I use creditors funds for is profitable, I still need to continually go into the market to not only cover principle but also the interest.  This becomes increasingly difficult with Bitcoins.  Like the title says, its a zero-sum game, to get Bitcoins, someone needs to sell Bitcoins.   As the supply gets more and more concentrated that will cause the nominal price of a Bitcoin to increase.    Even through Bitcoins are a useful exchange unit, I believe more people are actually "saving" Bitcoins as a store of wealth.   

This is why I question any long-term interest bearing arrangement or instrument that is not paying out in USD (or other currency) with the OPTION to get paid in BTC at the current spot price to remove the exchange risk from the person running the investment operations. 


What do you think about this perspective?


 

[Vandroiy]

If you mean that trading BTC futures is risky, then I agree. We all know price might suddenly go to 100$ or 1$, and one side of the deal is screwed.

Calling it a zero-sum-game is misleading though. That's like saying a market is a zero-sum-game, which it isn't. Trade is an important part of various forms of productivity, so if someone makes money by trading things around, it's a strange thing to say that someone else must have lost the same amount.

What kind of "long term bearish arrangements" are you talking about?

[SgtSpike]

I had similar thoughts when I initially learned about Bitcoin.  Deflation is going to kill the economy, etc etc.  But then, some people pointed out to me, perhaps inflation is artificially inflating the economy by encouraging bad investments and increasing debt-based ventures?

To me, the ideal currency would have a supply that inflates exactly according to GDP growth.  Thus, it would neither inflate nor deflate pricing, and wouldn't over-encourage bad investments or too much saving.  There's no perfect way to achieve such a system though.  Bitcoin is interesting too, and would only result in effective deflation equal to the increase in GDP growth + deflation due to lost coins.

*shrug*

It definitely discourages investments, but it certainly won't stop investments entirely.  People will just start weighing the opportunity cost of holding BTC vs other investments.

[Dalkore]

If you mean that trading BTC futures is risky, then I agree. We all know price might suddenly go to 100$ or 1$, and one side of the deal is screwed.

Calling it a zero-sum-game is misleading though. That's like saying a market is a zero-sum-game, which it isn't. Trade is an important part of various forms of productivity, so if someone makes money by trading things around, it's a strange thing to say that someone else must have lost the same amount.

What kind of "long term bearish arrangements" are you talking about?

It is zero sum because there is no built in inflation past the known issuance of 21 million coins.   Coins don't just come out of no where.   Its not a perfect analogy but I hope you see the part I am trying to apply to Bitcoin for this discussion?


"Interest bearing" not "bearish".   Basically anything arrangements that pay out an interest rate over time, not a one-off deal.

[justusranvier]

It means that loans will be rare in a Bitcoin economy. Growth will come from savings (capital formation).

Instead of being able to borrow money to buy a car and a flatscreen TV you'll need to save the money first.

[dissipate]

It means that loans will be rare in a Bitcoin economy. Growth will come from savings (capital formation).

Instead of being able to borrow money to buy a car and a flatscreen TV you'll need to save the money first.

Why would loans be rare? All you do is adjust the interest rate for the expected amount of deflation.

[evoorhees]

Bitcoin is an asset with a limited supply. Thus, it is like almost every normal asset out there - lumber, corn, gold, oil, etc.  None of these things can be "printed" out of thin air. They are scarce by their natural properties.

A monetary system could work with any of these commodities - markets will figure out how to price the borrowing of money. The idea that a money must be, by its nature, unlimited in supply, is a sophism (and a very dangerous one).

[SgtSpike]

It means that loans will be rare in a Bitcoin economy. Growth will come from savings (capital formation).

Instead of being able to borrow money to buy a car and a flatscreen TV you'll need to save the money first.

Why would loans be rare? All you do is adjust the interest rate for the expected amount of deflation.

Yes, but keep in mind, the interest rate on a loan can't go lower than 0% (and really, why would anyone want to give out 0% loans anyway?), but if deflation beyond 6% hits, most people are going to stop taking out loans to buy houses.  If deflation beyond 10% hits, people probably aren't going to take out loans for cars.  If deflation beyond 20% hits, people are probably going to avoid taking out any sort of loans altogether.

However, I don't see this as a bad thing... people borrow too much money, and it is, in large part, due to inflation being present in the money we use.  Inflation encourages overspending and too much debt.  Deflation encourages saving and too little debt. Maybe it is time we bring deflation into our lives and see what happens?

[evoorhees]

I had similar thoughts when I initially learned about Bitcoin.  Deflation is going to kill the economy, etc etc.  But then, some people pointed out to me, perhaps inflation is artificially inflating the economy by encouraging bad investments and increasing debt-based ventures?

To me, the ideal currency would have a supply that inflates exactly according to GDP growth.  Thus, it would neither inflate nor deflate pricing, and wouldn't over-encourage bad investments or too much saving.  There's no perfect way to achieve such a system though.  Bitcoin is interesting too, and would only result in effective deflation equal to the increase in GDP growth + deflation due to lost coins.

*shrug*

It definitely discourages investments, but it certainly won't stop investments entirely.  People will just start weighing the opportunity cost of holding BTC vs other investments.

People should not be so scared of prices that change. From where did this notion that prices must be flat come from? Who suggested such a thing? Is it so hard to imagine that a world can work in harmony with prices which generally fall, instead of generally rise, over time? Is it so hard to imagine a world where an employee doesn't get wealthier over time by a nominal increase in his wage, but by a nominal fall in his costs? Indeed, such a world is different than what we know, as we all grew up in a highly inflationary world, but this is no reason to assume it ought to be so.

It is okay for prices to fall. Do not be afraid. The more constant a money supply, the better, for it is by the stability of money which market participants navigate. There is no reason to think money supply must increase with GDP - instead of seeking stable prices (which runs counter to how markets operate), merely seek stable money, and you will find a happy economy.

[Adrian-x]

Adam Smith: Labour was the first price, the original purchase - money that was paid for all things. It was not by gold or by silver (or Bitcoin), but by labour, that all wealth of the world was originally purchased.

Interest is an agreement to share the efforts of your labour.
The laws of supply and demand dictate:
All free markets will tend to optimise to the maximum benefit for the lowest cost.

Capital will only have value if the economy is shrinking while there is capacity to grow.
If the Economy is stable or rescaling capital will bear no interest.
  
As the value of Bitcoin goes up your purchasing power increases, or if the economy grows, price deflation is experienced.
As a result there should be little demand for interest bearing loans in BTC while the economy grows.
The increase in value offsets the need for interest.  

[evoorhees]

Inflation encourages overspending and too much debt.  Deflation encourages saving and too little debt.

One encourages saving, or the abstinence of consumption.

The other encourages spending, or the abstinence of capital formation.

If you believe that wealth and prosperity result from consumption, you will hate Bitcoin. If, on the other hand, you believe that wealth and prosperity result from production, you will love Bitcoin.

Many will argue, "but you can't have production without consumption" and this is nonsense. I can go produce things without there being a buyer. Yet, I cannot consume things without there being a seller. Consumption is the effect - the result of - production, though unfortunately we live in a world in which people have come to believe the opposite.

[SgtSpike]

Inflation encourages overspending and too much debt.  Deflation encourages saving and too little debt.

One encourages saving, or the abstinence of consumption.

The other encourages spending, or the abstinence of capital formation.

If you believe that wealth and prosperity result from consumption, you will hate Bitcoin. If, on the other hand, you believe that wealth and prosperity result from production, you will love Bitcoin.

Many will argue, "but you can't have production without consumption" and this is nonsense. I can go produce things without there being a buyer. Yet, I cannot consume things without there being a seller. Consumption is the effect - the result of - production, though unfortunately we live in a world in which people have come to believe the opposite.

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

[Adrian-x]

...If deflation beyond 20% hits, people are probably going to avoid taking out any sort of loans altogether.
...However, I don't see this as a bad thing... people borrow too much money, and it is, in large part, due to inflation being present in the money we use.

When you save you are contributing more than you consume. = wealth building
When you borrow you are consuming more than you contribute. = wealth erosion

When people stop taking loans to consume, consumption shrinks to that of supply, this will also have a profoundly positive effect on the ecological environment. 

[Dalkore]

Very nice opinions so far.  

I want to be clear I am not making a value judgement in interest itself.  I study economic history on my off-hours and this occurred to me when I was thinking about Bitcoins and what examples we have to draw from.  Obviously after reading all the comments after the Pirate collapse and then looking at all the other deals out there, I wondered if it was really viable in Bitcoin.

This is why I made a point to talk about long-term arrangements over a single deal where I am repaying by my creditor.  I see transactions more like reshuffling a 21 million coin deck each time.   Over time if someone is getting interest "rent", it has to come from somewhere and as evoorhees correctly said, Bitcoin is a limit asset.

[Melbustus]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

[2_Thumbs_Up]

It means that loans will be rare in a Bitcoin economy. Growth will come from savings (capital formation).

Instead of being able to borrow money to buy a car and a flatscreen TV you'll need to save the money first.

Why would loans be rare? All you do is adjust the interest rate for the expected amount of deflation.

Yes, but keep in mind, the interest rate on a loan can't go lower than 0% (and really, why would anyone want to give out 0% loans anyway?), but if deflation beyond 6% hits, most people are going to stop taking out loans to buy houses.  If deflation beyond 10% hits, people probably aren't going to take out loans for cars.  If deflation beyond 20% hits, people are probably going to avoid taking out any sort of loans altogether.

If.. if.. if.. My question to you is why? why? Why do we have (price) deflation in an economy with a constant money supply? The answer is because we have the same amount of money chasing more stuff. There is an implicit premise here that we actually have an increase in the amount of stuff to sell i.e. economic growth. The argument that a constant money supply prohibits economic growth is a contradiction, since price deflation caused by a constant money supply requires economic growth to even happen in the first place. A means not A.

So, with a constant money supply, deflation is the direct effect of economic growth. If we have 10% deflation it's because we've simultaneously had a 10% increase in the amount of goods and services (i.e. the same money supply chasing 10% more stuff). Without the growth, the deflation will not take place at all (same money supply chasing the same amount of stuff).

So your scenario with 20% deflation builds on a premise of 20% economic growth in the first place. That seems like a pretty unreasonable scenario to me, but if it isn't, that would be even better. 20% economic growth is far better than any country manages to do today.

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

The only way to achieve that is without a money supply. Changes in the money supply affects the interest rate, and the interest rate affects peoples decision to save or spend. A better goal for the money supply would be one where the interest rate reflects the time preference of market participants as closely as possible.

The general goal of a price is not to be high or low, but to be true.

[evoorhees]

  Over time if someone is getting interest "rent", it has to come from somewhere and as evoorhees correctly said, Bitcoin is a limit asset.

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

[Dalkore]

  Over time if someone is getting interest "rent", it has to come from somewhere and as evoorhees correctly said, Bitcoin is a limit asset.

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

Yes and where did these profits come from? (agreeing with you).    The extra 1 BTC you earned by getting my to see value in your service and price.   

[SgtSpike]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

Let's continue with the maths then.

Say I am looking at a potential investment in a company that has a 95% chance of succeeding, and if it does succeed, it'll grow my investment at an average rate of 7% per year, but if it doesn't succeed, then I lose everything.  I might value that investment as a potential 2% growth on my money.

Now, say that I know that prices are dropping at a rate of 3% per year (purchasing price increasing, due to deflation in the monetary supply).

Why would I invest in said business with my money to make 2% per year, when I could just keep the money in my pocket and make a certain 3% per year?

I can know everything about the specifics of the money supply, but that wouldn't change the fact that 3% > 2%, and thus saving instead of investing is the wiser business decision.

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

[2_Thumbs_Up]

By the way, there is one kind of inflation that is harmless according austrian theory that could eliminate all price deflation. That would be a completely even distribution of the newly created money. We could let the money supply double at the end of every year, as long as the newly created money is distributed proportionally according to how much money you currently have (the value of each bitcoin adress is simply doubled). All this would cause is that prices would instantly double as well (and lending contracts would start compensate for this). No one would lose or gain any purchasing power.

In fact, someone could even create an inflationary bitcoin client without even forking the block chain. Just change the unit of representation in the UI at the end of each year, without changing the underlying code. So at the 1 of January every year, everyone's balance doubles. Thinking about it, this would actually be a really good idea to shut the inflationists up. Just give them their inflation client, where they can pick their own rate of inflation.