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Author Topic: The deflationary problem  (Read 30789 times)
JoelKatz
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April 03, 2013, 06:23:36 PM
 #221

If I buy the iPhone with bitcoins and want to buy new bitcoins I have to transfer money to MtGox which costs money and take time, and I have to pay 0,6% fee to MtGox to buy bitcoin. And I also risk that buy back the bitcoins at a much higher price when I have funded my MtGox account.. the price might have moved 50% in two weeks.
Right, but in exchange, you get to offer the seller the currency they want most. If your assumption that people would much rather hold Bitcoins than dollars is correct, the seller should significantly reward you for giving them the currency they prefer. The costs you mention above are miniscule. There's no need for you to risk buying Bitcoins at a much higher price, you can buy them immediately. If Bitcoins are underpriced, you would have already funded your Mt. Gox account. The fact that you didn't shows you don't really believe Bitcoins are underpriced.

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Or I can just pay for the new iPhone with fiat$ and keep my coins. Much easier and I dont have to spend money on transactions or possible pice rise on bitcoin.
Right, but you'll pay much more for no reason. If your assumption that people would significantly prefer to hold Bitcoins over dollars is correct, you'd be giving the seller something they value much more highly. Unless the seller is irrational, they should make that well worth your while, and all your additional costs in doing so are miniscule.

I am an employee of Ripple.
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Sweft
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April 11, 2013, 08:38:43 PM
 #222

Sweft:  We at Freicoin have long understood the scenario you describe and are in agreement with you on the unsustainable nature of Transaction Fees to support BTC, velocity is far far below 1 so you would need terribly high fees to generate a revenue stream that would replace present mining rates.  So far the response to lower block rewards has been a rise in valuation, which appears to have blow through the mere doubling that would have kept miners at parity and is now an out and out speculative bubble.

The Freicoin solution is to reduce all wallet funds by 5% per year (in tiny amounts per block), all these funds are then payed to Miners.  Total monetary base dose not increase so their is no inflation, after a short initial distribution of 3 years miner rewards remain constant and the network never needs to depend on Transaction fees.  All users essentially pay to secure the network based on their wealth rather then by transaction fees, this is both better economically as well as intrinsically more fair.

We also believe their are a myriad of other detrimental macro-economic effects (Usury) cause by Deflationary currency (putting us radically at odds with the majority of the community that feels it deflation a good thing), and these were our primary motivations, but we've been aware of the death-by-transaction-fee scenario for a long time.  Our website is http://www.freicoin.org/

I'm not sure of the viability of Freicoin.  I will point out things that I dislike.

1) people don't like to lose money.
2) mining profit cannot increase unless the price increases.  Whether or not 5% mining profit is enough to keep up with Sweft's Law, I can't prove.
3) the 5% surcharge makes it prone to a mining attack where the miner takes approximate control proportional to his mining hash of network hash in approximately 30 years.  Ie. if miner controls 50% of hash he will control 40% of coins in 30 years.  If miner controls 90% of hash he will control 80% of coins in 30 years.  Or so, I didn't do the math.  This is problematic because people cannot hoard coins, which given a free market, people should be at liberty to do.  It removes some freedom and that will certainly affect the adoption of Freicoin.

It's much simpler to program inflation into coins rather than a tax.
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April 11, 2013, 10:51:30 PM
 #223

I will introduce the concept of Sweft's Law and Sweft Attack below.

Sweft's Law:  The network hashrate of a cryptocurrency must rise at a rate at least equal to that of the rate of Moore's Law to ensure minimum network security.

Sweft Attack:  A prolonged deflationary attack on a cryptocurrency network describing a situation in which a rogue miner processes transactions solely for the purpose of removing the fee of said transaction from circulation.  A necessary precondition for said attack is that the average transaction fee must exceeds the average rate of cryptocurrency inflation.

Edit:  originally titled the 2040 problem, a more apt title is the deflationary problem.  I use 2040 as a point where mining reward via block reward would be negligible.  I'm starting to believe this point where miners no longer profit enough to increase hash will come much sooner, perhaps by 2020.

 
In 2040 new block generation will be negligible, bitcoins will be fixed.  Miners will only be rewarded for transaction fees.  This may not seem like a problem, it IS.

The health of the network depends on constant hash growth.  Without constant hash growth, the network is prone to attack.  Why?

What protects the network right now is a high hashing rate.  This secures it from attack.  Without this, there is no security.  The price of bitcoins would fall.  The more hash, the more security, the higher the price will be.  Because it's impenetrable from exterior forces or supercomputers.  If a government were to be able to attack the network, 99% of the network, the system would fail.  If the system has the ability to fail, the price of bitcoins is worthless.

Thus, the whole network depends on hash.  The security and price, which is also reflective of hardware and electricity, and again, security.  The more hash the network has the more secure.

Thus, miners need incentive to increase hash.  They do this by generating new coins.  Thus you increase hash and create a more secure network.

The problem is that in 2040 new block generation will stop, and coins will be fixed.  Now, people want to make you believe this is fine.  It's not.  It's stupid and beyond stupid.

The stupid part about is is that it removes an incentive for miners to increase hash.  It removes a revenue stream for miners.  New coin production is not BAD, it's GOOD.  Only a moron would think otherwise.

This is extremely important.

When you remove the reward for generation of new blocks, you remove a revenue stream for miners, hash will fall.  You say, who cares, hash falls.  

Hash secures the network.  It ensures that miners will profit and the miners ensure there is no double spending of coins.  If miners stop mining because intensives become smaller (loss of profit), hash goes down, the network is prone to attack.

Then the coin holders will be mining to protect their own money.  This will be an incentive of the richest members.  The problem is that every year hardware advances and you're no longer making as much money mining, maybe not even to cover the hardware costs to protect the network.  So now, the network is prone to attack.

This is irrespective of assuming whether or not transaction fees will support the network.  It's irrelevant.  The network will be weaker because you removed profit from miners.  Now, miners stop mining.  Thus, you decrease hash.

Bitcoins are only worth the hash(security) of the network.





Edit:  I haven't posted in two years but i will provide an updated analysis below.

For BTC to to have value, miners must secure the network. If miners do not constantly increase hash, Moore's law will catch up to the network and it will become prone to attack. This should be easily accepted as fact. If you don't accept this premise i can't possibly help you understand the deflationary flaw in bitcoin.

If you don't understand, let me try to explain it again. If hash remains constant and doesn't increase for a number of years, technological advancements (Moore's Law) will make an 51% attack more likely.

Now what some people seem to argue is that tx fees will support mining growth.

This is true in two scenarios.

1) bitcoins are sent/received more frequently (velocity) 2) tx fees increase

I will addresses the problems with both scenarios.

The problem with #2 is that there is a cap on maximum fee the miners can charge, at 100%. So velocity remains constant, miners cannot increase profit beyond 100% tx fee. So this cannot create increasing profit.

The problem with #1 is that bicoins can be permanently lost, and there is a hard cap on the amount of bitcoins. That means that there will eventually be more bitcoin lost than is generated by block reward. This should be known as the 'Sweft point' where bitcoin turns into a deflationary currency from an inflationary one. Thus, to believe that transactions will increase as coins are lost, aka deflation, is not a sound proposition.

Another issue is that rogue miners can mine the network, charging tx fees and sending the coins to the trash. This would further exaggerate the deflationary tendency of the bitcoin design.

Thus it should be obvious to anyone that understands the issues to also understand that there exists a simple solution which will make the person who implements it rich.

Make an alt currency with a cap minimum 3% inflation. This will satisfy the profits of the miners and hash of the network.

R

Bitcoin wont have to last until 2040 before something better replaces it.
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April 11, 2013, 10:59:08 PM
 #224

Golum/JoelKatz :  Yall are basically arguing over Gresham's law aka "Bad money drives out Good".  Golum believes in it, JoelKatz rejects it.  Bad in this context means soft aka inflationary or overvalued money and Good means hard money that's deflationary or undervalued.  People spend the bad money and hoard the good money, thus the good money stops acting as money and becomes a commodity, while the bad money dose the job of money.

BUT, Gresham's law as originally stated only works when Legal tender laws force the two currencies to be exchanged at equal face-value and the underlying commodity values are different (for example equal weight silver and brass coins having the same face-value).  When allowed to float freely we don't see classic Gresham's law.  In a hyper-inflationary environment the hyper currency actually disappears and commerce is done in a foreign (usually dollar if people can get them) currency.

Now it seems lots of BTC folks have concluded from this that if people reject hyper-inflationary currency for a mildly inflationary one.  Then they would reject the mildly inflationary currency for a hyper-deflationary one.  Golum's position or "Golums Law" seems to be that "Stable money drives out unstable money", and what people seek is not the maximally deflating currency but rather the maximally stable currency.

http://en.wikipedia.org/wiki/Gresham%27s_law

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April 11, 2013, 11:59:26 PM
 #225

 Golum's position or "Golums Law" seems to be that "Stable money drives out unstable money", and what people seek is not the maximally deflating currency but rather the maximally stable currency.


That's actuallly true, for some; but provablely not true for all.  This can also be said for Gresham's Law.  Part of this Regression Theorem, as trader's generally expect that bitcoins will be worth tommorrow roughly what they were worth yesterday.  If there is great insability (as we presently have) or either significant inflation or deflation then traders can no longer be confident of the value of those bitcoins tommorrow, and thus one party to the transaction faces an increased risk of some kind of loss if there is significant movement in trade value in the near future.  In the case of inflation, it's the merchant who accepts such a currency that faces potential losses; while in the case of deflation, it's the buyer who faces a potential loss due to increasing opprotunity costs.  In either case, relative stability contributes to bitcoin's value as a medium of exchange.  Hyper deflation is as bad for a trade currency as is hyper inflation, but it's 'delta' rate of change that matters, not so much the direction.

"The powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations. Each central bank...sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world."

- Carroll Quigley, CFR member, mentor to Bill Clinton, from 'Tragedy And Hope'
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April 12, 2013, 01:08:21 AM
 #226

Well historically if we look at the full history of BTC it has deflated at a rate of around 1000% a year, or roughly one order of magnitude per year.  In its MOST stable period which was 2012 it managed to only increase 300% but this was a lull between two massive bubbles and crashes.  So I think it's quite reasonable to say that BTC lives up to it's intended deflationary nature and is by any reasonable definition is hyper-deflationary.

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marcus_of_augustus
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April 12, 2013, 01:20:57 AM
 #227

Well historically if we look at the full history of BTC it has deflated at a rate of around 1000% a year, or roughly one order of magnitude per year.  In its MOST stable period which was 2012 it managed to only increase 300% but this was a lull between two massive bubbles and crashes.  So I think it's quite reasonable to say that BTC lives up to it's intended deflationary nature and is by any reasonable definition is hyper-deflationary.

Yes but this during adoption phase when the needed network effect to establish as a currency is being established. Bitcoin does no have the luxury of a big bad govt. overnight declaring it the coin of the Internets (and wouldn't want to anyway).

That order of magnitude per year is a figure Vladimir and I discussed way back in late 2010 I think and is a ballpark figure to keep in mind as the network adoption is growing. Networks often grow exponentially over fixed time periods ... until they mature.

So this most recent run up could be seen as the combination of reverting to exponential growth after being beaten down by previous Gox fiasco ... so should have been $10 at end of 2011, $100 at end of 2012 ... and euphoria looking towards end of 2013 ($1000).

MoonShadow
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April 12, 2013, 05:16:02 AM
 #228

Well historically if we look at the full history of BTC it has deflated at a rate of around 1000% a year, or roughly one order of magnitude per year.  In its MOST stable period which was 2012 it managed to only increase 300% but this was a lull between two massive bubbles and crashes.  So I think it's quite reasonable to say that BTC lives up to it's intended deflationary nature and is by any reasonable definition is hyper-deflationary.

Only for the time being.  This is the adoption phase.  It is to be expected.

"The powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations. Each central bank...sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world."

- Carroll Quigley, CFR member, mentor to Bill Clinton, from 'Tragedy And Hope'
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April 12, 2013, 05:30:21 AM
 #229

So your saying you expect it to stop?  I find little evidence that it will ever stop, the continual halfing every 4 years of mining rewards clearly points to a about ~20% deflation per year over the long term as the price of BTC must rise to keep mining profitable.

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April 12, 2013, 06:10:10 AM
 #230

So your saying you expect it to stop?  I find little evidence that it will ever stop, the continual halfing every 4 years of mining rewards clearly points to a about ~20% deflation per year over the long term as the price of BTC must rise to keep mining profitable.
Not necessarily. Fees can rise, as well.

Once we get closer to market saturation, and have a better developed economy - by which I mean more goods and services valued directly in bitcoin - we'll see a lot smoother price movements.

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April 12, 2013, 06:20:57 AM
 #231

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Make an alt currency with a cap minimum 3% inflation. This will satisfy the profits of the miners and hash of the network.
You will need a central bank/authority that would exchange dollars to bitcoins, and that would set difficulty based upon that.

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April 12, 2013, 07:12:19 AM
 #232

 This should be known as the 'Sweft point'

Ego problems?

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April 12, 2013, 07:41:34 AM
 #233

I will describe another flaw that can be exploited in a deflationary cryptocurrency.  It will be known as a Sweft attack and is described below.

Sweft attack: A prolonged deflationary attack on a cryptocurrency network describing a situation in which a rogue miner processes transactions solely for the purpose of removing the fee of said transaction from circulation. A necessary precondition for said attack is that the average transaction fee must exceeds the average rate of cryptocurrency inflation.


Why is that a condition for this attack?  Can't he remove the coins he got as block award as well?  Can't he also buy them on an exchange and remove them?  What makes those coins in the fees so special?

Also, after he collect a huge amount, and the price increases because of that, your miner will have a hellova big incentive to spend those coins, wouldn't you say? 
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April 12, 2013, 07:58:56 AM
 #234

If tx fee is .5%, the amount of currency needed to move to get the equivalent of 2% inflation would be 4x the amount of btc in circulation.

How do you know how much security is enough?

If, with those numbers, there is only 1% of BTC in circulation each year (instead of your 4x), is that enough security or not?




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April 12, 2013, 08:24:35 AM
 #235

The deflationary aspect of bitcoin destroys the vibrancy of the mining ecosystem

What the fuck does this mean?

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April 12, 2013, 08:27:35 AM
 #236

The deflationary aspect of bitcoin destroys the vibrancy of the mining ecosystem

What the fuck does this mean?



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April 12, 2013, 01:51:24 PM
 #237

So your saying you expect it to stop?  I find little evidence that it will ever stop, the continual halfing every 4 years of mining rewards clearly points to a about ~20% deflation per year over the long term as the price of BTC must rise to keep mining profitable.
Not necessarily. Fees can rise, as well.

Once we get closer to market saturation, and have a better developed economy - by which I mean more goods and services valued directly in bitcoin - we'll see a lot smoother price movements.

I already addressed this issue, please read the thread.

Fees are capped at 100% so increasing fees cannot support exponential growth.

You have three means to secure the network once bitcoin becomes deflationary.

1) exponential growth of velocity which is almost impossible given the deflationary nature.
2) exponential growth of price which would lead to hoarding and less coin velocity
3) mining at a loss of profit to protect the network and your coins

All of these are situations are irrelevant given moderate inflation.  Inflation supports network hash by supporting mining profits
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April 12, 2013, 04:42:50 PM
 #238

So your saying you expect it to stop?  I find little evidence that it will ever stop, the continual halfing every 4 years of mining rewards clearly points to a about ~20% deflation per year over the long term as the price of BTC must rise to keep mining profitable.
Not necessarily. Fees can rise, as well.

Once we get closer to market saturation, and have a better developed economy - by which I mean more goods and services valued directly in bitcoin - we'll see a lot smoother price movements.

I already addressed this issue, please read the thread.

Fees are capped at 100% so increasing fees cannot support exponential growth.
If bitcoin is still experiencing exponential growth in 2140, the world will have much greater problems than securing the bitcoin network, because that will require many times the current world population and that the population also be growing exponentially.

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April 12, 2013, 05:35:00 PM
 #239

So your saying you expect it to stop?  I find little evidence that it will ever stop, the continual halfing every 4 years of mining rewards clearly points to a about ~20% deflation per year over the long term as the price of BTC must rise to keep mining profitable.
Not necessarily. Fees can rise, as well.

Once we get closer to market saturation, and have a better developed economy - by which I mean more goods and services valued directly in bitcoin - we'll see a lot smoother price movements.

I already addressed this issue, please read the thread.

Fees are capped at 100% so increasing fees cannot support exponential growth.
If bitcoin is still experiencing exponential growth in 2140, the world will have much greater problems than securing the bitcoin network, because that will require many times the current world population and that the population also be growing exponentially.

Network hash must grow at least at the rate of Moore's Law.  This is also known as Sweft's Law.  If Bitcoin fails to satisfy this condition, then it will be prone to attack.

I'm not sure what you're talking about, honestly, and neither do i think that you, yourself, know what you are talking about.

The other issue is that there must exist a base hash which would be proportional to world hash computational output on which then Moore's Law is applied to satisfy Sweft's Law.  Growing at the rate of Moore's Law is insignificant if the baseline threshold for attack is low.

Let me make it more clear.

If we take 70,000ghash and divide by 60 and multiply by 2000 we can arrive at the cost to replicate the bitcoin network security.  This is assuming 60ghash can be purchased for 2000$.

So, currently, the network hash is worth about 2.3m and valued at 600m.  So bitcoins are worth about 230x network hash.

To have a secure network from which we can then apply Sweft's Law the ghash should be about 100,000 times larger.  This would cost 230,000,000,000$ to replicate the network or 230b.   From there we apply Moore's Law and the network must grow in accordance to the Law to ensure minimum security

I just don't think that deflation will satisfy Sweft's Law and I believe thst a competing alt 2-3% inflationary cryptocurrency will eventually outcompete bitcoin for the various reasons i have outlined.
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April 12, 2013, 06:04:14 PM
 #240

I just don't think that deflation will satisfy Sweft's Law and I believe thst a competing alt 2-3% inflationary cryptocurrency will eventually outcompete bitcoin for the various reasons i have outlined.
The inflation in the economy is cause for Malinvestment, it is a cost industry pays at the expense of efficiency and environment, the net energy in mineral  / energy mining and environmental damage and wasted recourses as a result of the inflation caused Malinvestment, will be much higher than the cost of a fixed currency infrastructure through the Hash rate. 

To make your argument you will have to prove why the hash rate will scale relative to number of transactions, the to functions do not scale symmetrically, your assumption that they do is the error that makes your argument.   

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