Bitcoins will die – an economics standpoint and possible solutions

[Guy Inkognito]

Bitcoins had quite a frenzy about them recently, being mentioned in mass media and their value increasing. However, they will die out even without governments etc. Intervening or clamping them down. Let me explain:

Bitcoins are not money. They are a (perfect) medium of exchange. Their properties are similar to gold: scarce (finite amount), divisible, stable, low volume / easy transport, secure. So they only fulfil two properties of money: exchange and storage of value. But they lack CREDIT.

Fiat however, is born out of credit (each dollar/euro/... cash or deposit is mirrored by an equal amount of debt). The next is zero. Money is debt. The debt money (fiat) arises from property rights: somebody needs cash so he will pledge his property against a loan. The bank demands interest for giving up her property right on the money (a compensation for not being able to use the money, NOT because of the credit risk). Fiat systems thus have inherent interest in debt contracts. This interest has not yet been created, in order to have the interest paid back, new money must be perpetually created. Obviously, over the course of many years, the fiat system leads to an unequal distribution of net worth, as people owning property earn interest and people needing money pay interest.
The advantage, however, of the fiat system is Credit: only Credit enables economic trade, investment etc. Everybody who started their own business or wanted to buy a house knows that.

But credit comes into place with property rights – the only conundrum is the interest which is inherent to it. If we could remove the interest, we could go towards more equilibrium and a more stable and sustainable economy.

Without credit, we would live in a mere barter society. That’s what the bitcoin world is at the moment – a bartering club.

Unless bit coins allow CREDIT, they will just be a scarce barter medium and will end in an awful way:
Due to their scarcity (and the relatively huge amount of fiat in circulation), a bubble is already building: many people buy bitcoins without the intention of even use them for barter. Easy to see, as mtgox a “exchange” is the biggest bitcoin accepting site. They are now valued at ten dollar, with about 8 million in circulation. I would not be surprised if they go to 100 dollars due to their scarcity and similar properties to gold. They are a highly deflationary medium.

Eventually, the bubble will burst however, as people suddenly find themselves on the selling side and convert their bitcoins into physical goods or fiat. (the velocity of money rises, everybody wants to get rid of them, prices of goods relatively rise, the currency plummets). This would lead to a sad end to a nice experiment. Just like with Tulipmania, Dot Com Bubble etc. People would lose a lot of fiat and staying away from alternative currencies for a long time.

So what can be done to avoid it?

1)   Bitcoins should not be completely scarce. A finite amount of bitcoins makes them highly deflationary. Similar to gold, a controlled mining should be allowed even after the intended stop, so their availability grows with usage

2)   Credit needs to be allowed and facilitated: As we don’t want to have another fiat experiment, bitcoins would be ideal to try true interest free credit:  please take a look at the following interest free credit/banking model which could be easily setup for Bitcoins
http://jak.aventus.nu/download/Uppsatser/MARK_BURTON_DISSERTATION_2.pdf
http://www.feasta.org/documents/review2/carrie2.htm

Thoughts / critique / discussion welcome!
Guy

[Vladimir]

What,  no usury? We are doomed!!!


P.S. I am no that sure that there can be no credit in bitcoin economy though... lots of things can be built on top of bitcoin.

[bitboy]

If you take the total amount of bitcoin in unit of Satoshi (that's 2,100,000,000,000,000) and devide by the worldwide population (6,775,235,700) based on the 2009 data from the world bank, each one of us will get 309,952.3164928417 Satoshis. More than enough, no?

[foo]

If you take the total amount of bitcoin in unit of Satoshi (that's 210,000,000,000,000)

You're missing a zero there.

[bitboy]

If you take the total amount of bitcoin in unit of Satoshi (that's 210,000,000,000,000)

You're missing a zero there.

Lol. Thanks for counting.

[Guy Inkognito]

If you take the total amount of bitcoin in unit of Satoshi (that's 2,100,000,000,000,000) and devide by the worldwide population (6,775,235,700) based on the 2009 data from the world bank, each one of us will get 309,952.3164928417 Satoshis. More than enough, no?

Hi, The problems is not amount, but growth. If you don't allow growth AT all after some point, the currency is deflationary, meaning people start to hoard the money, because they know that there will be more goods available tomorrow but the same amount of money.
Money get worth more - what we are seeing now with bitcoins.

Ideally, the amount should be fully flexible and based on economic activity: if Bitcoins take over the world, the amount should be allowed to grow in order to make the VALUE of the currency STABLE versus the ECONOMIC ACTIVITY / GOODS AVAILABLE it constitutes.
This is now very easy to measure with bitcoins due to the computing power in the network.

Also, if the activity slows (which is highly unlikely but possible), the amount of money should be REDUCED. They could withdraw from every client the tiniest fraction on a predetermined and announced date. Basically the currency/money should always be flexible with the economy, which moves in cycles.

Fiat currently is inflationary: they print MORE than the economy grows. Thus it LOSES value. They are doing exactly the wrong thing, but they need to do it, because interest needs to be paid. If you have an interest free monetery system, you can REDUCE the amount of moeny without creating a crisis.

[Guy Inkognito]

Sorry, I'm new. Just found out there is an economics forum.
Maybe an admin could kindly move the thread.

Thanks

[BubbleBoy]

I agree with the assessment that a fixed supply of money that does not increase with a size of the economy is a bad economic design that will lead to over-speculation and a a series of busts/booms (volatility). This much should be obvious to anyone that has marginal economic intuition and has witnessed an asset bubble during his lifetime (tech stocks, real estate, tulips etc.).

However I take offence with this:

The advantage, however, of the fiat system is Credit: only Credit enables economic trade, investment etc. Everybody who started their own business or wanted to buy a house knows that.

First, there's absolutely nothing stopping someone from creating a Bitcoin fractional reserve bank. The depositor spends the amount to the bank's private key, the bank sets aside a certain fraction of the bitcoins (which can be audited via the public block chain) and gives back to the depositor a signed piece of paper or string of bits claiming that the bank owes him the deposited amount plus interest. The rest of the bitcoins are lent out to interested parties that can provide adequate collateral. It's free banking, completely deregulated, and the reserve fraction, insurance scheme (if any) and what constitutes 'adequate collateral' is strictly up to the bank and depositor depending on their risk appetite, without intervention from a central bank, and with a limited amount of high powered money - up to 21 million bitcoins, banks couldn't be able create more.

Secondly, the foundation of economic investment is not credit, but savings. For economic development to occur the society need to divert some of it's existing output from consumption (sports cars) to development (oil rigs). This allocation cannot be fudged by inventing more resources in the future, someone needs to forfeit buying a sports care and redirect that steel for your oil rig. If someone 'makes up' more steel by giving you money to buy some, the net effect is that the same amount of steel (resources) are divided among more people, the price of steel goes up, and the credit has created inflation, equivalent to stealing a small part of the wealth of everyone.

The only thing banks to is match the investment with the savings; not everyone wants to put his money into oil rigs but most anyone saves. This saving is the prerequisite of investment, without which all development is inflationary. This is exactly what most governments do these days, and it's the reason you can't even fathom the thought of buying a house without the help of a government-sponsored bank. You have no chance to save the amount needed to buy a decent house because every penny saved is drastically eroded by inflation, while at the same time the existing real estate asset bubble generated by easy credit has put the price of a house so high that you would need a lifetime of savings.

[goatpig]

Quick, newbies screaming bubble and hating on deflation! Bitcoin will die, you guys should gtfo while you still can!!

[ShadowOfHarbringer]

Sorry, I'm new. Just found out there is an economics forum.
Maybe an admin could kindly move the thread.
Thanks

OMG Bitcoin will die - we are all doomed !!

So perhaps everybody who wants to escape certain doom, should sell me his bitcoins for $3 each. Do it now, before its too late !

[BitterTea]

I agree with the assessment that a fixed supply of money that does not increase with a size of the economy is a bad economic design that will lead to over-speculation and a a series of busts/booms (volatility). This much should be obvious to anyone that has marginal economic intuition and has witnessed an asset bubble during his lifetime (tech stocks, real estate, tulips etc.).

Tech stocks and real estate bubbles were fueled by artificially low credit created by the Federal Reserve, in addition to artificially low lending standards created by the government regulatory and law making bodies.

It seems to me that without these types of interventions, market forces would allow businesses to more quickly react to the change in individuals preference for saving or spending, which would limit the size of such booms and busts and ultimately lead to a more stable and productive society.

[cindylove]

If you take the total amount of bitcoin in unit of Satoshi (that's 2,100,000,000,000,000) and devide by the worldwide population (6,775,235,700) based on the 2009 data from the world bank, each one of us will get 309,952.3164928417 Satoshis. More than enough, no?

Hi, The problems is not amount, but growth. If you don't allow growth AT all after some point, the currency is deflationary, meaning people start to hoard the money, because they know that there will be more goods available tomorrow but the same amount of money.
Money get worth more - what we are seeing now with bitcoins.

Ideally, the amount should be fully flexible and based on economic activity: if Bitcoins take over the world, the amount should be allowed to grow in order to make the VALUE of the currency STABLE versus the ECONOMIC ACTIVITY / GOODS AVAILABLE it constitutes.
This is now very easy to measure with bitcoins due to the computing power in the network.

Also, if the activity slows (which is highly unlikely but possible), the amount of money should be REDUCED. They could withdraw from every client the tiniest fraction on a predetermined and announced date. Basically the currency/money should always be flexible with the economy, which moves in cycles.

Fiat currently is inflationary: they print MORE than the economy grows. Thus it LOSES value. They are doing exactly the wrong thing, but they need to do it, because interest needs to be paid. If you have an interest free monetery system, you can REDUCE the amount of moeny without creating a crisis.

I was thinking about the same thing the other day. I don't know that much about economics to say for sure whether bitcoin as deflationary as it is is the best or that something less so would be better. I was thinking that if BitCoin did cause problems in the long run, its replacement might have an algorithm that adjusts creation of bitcoin due to mining according to the amount of economic activity (transactions), sorta like how difficulty adjusts right now.

[BubbleBoy]

Tech stocks and real estate bubbles were fueled by artificially low credit created by the Federal Reserve, in addition to artificially low lending standards created by the government regulatory and law making bodies.

The part about bubbles being 'fuelled' by expansionary policies is probably correct, however it's not the same as 'caused'. More money should mean blanket inflation, if most prices stay the same while a sudden part of society decides that groceries.com is the wave of future, than we are talking about a speculative mania. The fact that money was easy to get does not exempt the investors who used it to inflate a bubble.

[goatpig]

The part about bubbles being 'fuelled' by expansionary policies is probably correct, however it's not the same as 'caused'. More money should mean blanket inflation, if most prices stay the same while a sudden part of society decides that groceries.com is the wave of future, than we are talking about a speculative mania. The fact that money was easy to get does not exempt the investors who used it to inflate a bubble.

That's called malinvestement, which you will note is spurred by inflationary and credit based economic models. The problem is simple, people fuck up, disregarding the economic model. The difference is, in a debt based economy, the fuck ups will trickle down to every part of the economy, since essentially, it was wealth one did not own that was lost, as well as wealth that was being expected and planned upon. A severe case of putting the cart in front of the horses. In a savings based economy, the losses will be limited to the poor investors themselves, and their wasted savings.

[kiba]

Bitcoin Bubble!  http://bitcoinweekly.com/articles/comic-reaction-after-dramatic-rise-of-bitcoin-s-value 


LOL! You "bubble" guys gimme an excuse to post a link to bitcoinweekly.com all the time.

[kjj]

Blaming deflation for economic woes is like blaming your hangover for drinking last night.

[stic.man]

can't bitcoins be broken down even into smaller denominations if necessary?  Like even beyond a satoshi?

[rezin777]

If we have easy credit to allow for growth like we had in the last century, I hope you are prepared for the obvious outcome.

Maybe it's time to rethink how we live our lives and start to focus on saving (resources and money) instead of spending and excessive consumption.

[marcus_of_augustus]

There will be no deflation because bitcoin are in a free market for currencies now the cat is out of the bag. Unlike the govt. monopoly on fiat, there will be created as many flavours of these things as the market demands.

Already, we have namecoins that can do dns BUT they will also be traded/stored/exchanged exactly like bitcoins and after them will Torcoins, and Bitgold and Bitsilver and Bitpot and who knows what else ... it is a brave new era. Sorry no deflation, try again, bitcoins will live.

https://exchange.bitparking.com/main

[goatpig]

can't bitcoins be broken down even into smaller denominations if necessary?  Like even beyond a satoshi?

Yes, there is no hard limit so to speak.