The deflationary problem

[Traktion]

If a single, cheap, machine had enough hashing power to process all the transactions in the world, then the fees would be tiny.

No - block space is independent of hash rate. Competition for block space => increased fees => increased hash rate.

Assuming that:

- Transaction rate becomes stable.
- Mining ceases to be profitable.

Why would there be increasing competition for block space (in turn, an increasing hash rate)?

Logically, the hash rate only needs to be sufficiently high to process all of the transactions requested. If hardware to provide said hash rate continues to fall, at some point the cost of hardware to do this will fall to a price where it is economical to attack the network.

Apologies if I am misunderstanding something technical which is critical to this debate.

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[bitlancr]

The problem is in this statement:

Logically, the hash rate only needs to be sufficiently high to process all of the transactions requested.

The hash rate is technically independent of transaction volume. If the hash rate were to drop to 1Mhash/s right now, then the target difficulty would soon follow. Bitcoin is set up to produce a new block every 10 minutes, regardless of hash rate. Thus block space remains constant.

Now, given that block space is a finite resource, there will be competition. More competition (more transactions) will drive up fees, which will make mining more profitable, thus increasing the hash rate as more miners join in to get that profit. Conversely, less transactions means less competition, less fees, less mining, reduced hash rate.

Now, when hardware becomes cheaper, mining becomes more profitable. Thus more miners join in to get that profit. Any guesses what that results in?

Bottom line: as long as there is competition for block space, this entire thread is moot.

[Traktion]

The problem is in this statement:

Logically, the hash rate only needs to be sufficiently high to process all of the transactions requested.

The hash rate is technically independent of transaction volume. If the hash rate were to drop to 1Mhash/s right now, then the target difficulty would soon follow. Bitcoin is set up to produce a new block every 10 minutes, regardless of hash rate. Thus block space remains constant.

Yes, understood. However, this is just asserting that if the hash rate falls, the difficulty will adjust. The problem isn't the difficult level, but the falling hash rate (reducing the barrier against a network attack).

Now, given that block space is a finite resource, there will be competition. More competition (more transactions) will drive up fees, which will make mining more profitable, thus increasing the hash rate as more miners join in to get that profit. Conversely, less transactions means less competition, less fees, less mining, reduced hash rate.

Sure, I'm fine with this too. I asserted that 'if the transaction rate becomes stable', then so will the competition for block space. In turn, this implies a stable hash rate (fluctuations considered, ofc).

Now, when hardware becomes cheaper, mining becomes more profitable. Thus more miners join in to get that profit. Any guesses what that results in?

Bottom line: as long as there is competition for block space, this entire thread is moot.

I asserted that 'mining ceases to be profitable' as a boundary condition. I'm not convinced that miners drive the price of Bitcoin; It's the people who value Bitcoin that dictate the price. If it becomes too expensive to mine at the market rate, mining will not be done. Therefore, I'm not convinced that miners will necessarily step up to increase the hash rate.

To conclude, I am still unconvinced that this thread is moot. The hash rate needs to increase proportionately to Moore's Law and I'm not certain this will happen automatically (without some relatively minor alternations).

I'm happy to be proved wrong though, if you think I'm still missing something.

[gollum]

Deflation will kill bitcoin businesses - why spend your bitcoins today if they are worth more tommorow, or next week, or next month...
Bitcoin simply becomes an asset to speculate in or hedge against inflation instead of being used as a trading currency.
The best thing that can happen to the bitcoin community is a crash followed by a stable price for a long time so people get used to spend their coins instead of just hoard the coins.

One solution to the deflation problem is that if everybody votes for a change in the bitcoin protocol so a 2%  inflation can go on for ever even after 21 million coins have been mined.

[Traktion]

Deflation will kill bitcoin businesses - why spend your bitcoins today if they are worth more tommorow, or next week, or next month...
Bitcoin simply becomes an asset to speculate in or hedge against inflation instead of being used as a trading currency.
The best thing that can happen to the bitcoin community is a crash followed by a stable price for a long time so people get used to spend their coins instead of just hoard the coins.

One solution to the deflation problem is that if everybody votes for a change in the bitcoin protocol so a 2%  inflation can go on for ever even after 21 million coins have been mined.

That's not true. If it were, no one would hold inflationary cash, as they would be spending it today, rather than lose value tomorrow. It would also mean that no one would buy any computers.

Just as contracts can account for inflation, they can also account for deflation. The only real difference is psychological - more stuff has to be better than less stuff, right?

There is nothing to stop people taking out inflation rate trackers, which can go negative. That is, the repayments get reduced during a deflation. The real value remains positive regardless.

[Mosper]

there is a limit on bitcoin to try and prevent the calamity that is overprinintg of fiat currency by a central source to pay off debts, pay for wars and buy prostitutes.  Cap production, there is no oppurtunity for the inflation that occurs with fiat.

the proof of work problems are set up in a way way where the difficulty will increase exponentially, but there will never be an end to the proof of work difficulty, removing your so called deficit of hash, allowing a stable and secure network.  

There is a limit on bitcoin because the person who made it never intended it to be used the way this community has decided it should be used. Kind of ridiculous to ignore that fact and try to rationalize the nature of BTC away and make it fit nicely into your ridiculous internet libertarian world view.

[bitlancr]

I asserted that 'mining ceases to be profitable' as a boundary condition. I'm not convinced that miners drive the price of Bitcoin; It's the people who value Bitcoin that dictate the price. If it becomes too expensive to mine at the market rate, mining will not be done. Therefore, I'm not convinced that miners will necessarily step up to increase the hash rate.

To conclude, I am still unconvinced that this thread is moot. The hash rate needs to increase proportionately to Moore's Law and I'm not certain this will happen automatically (without some relatively minor alternations).

I'm happy to be proved wrong though, if you think I'm still missing something.

Ok, so let's assume everything is constant except for Moore's Law. By Moore's Law, the cost to produce a fixed level of hashing power will decrease over time. With all other things being equal, mining becomes more profitable. Now other potential miners will take note of this, so more miners will join, incentivised by the increased profit margin. Thus - all other things being equal - the hashing power will increase with Moore's Law.

I think your point about the price of Bitcoin is right - but that should be obvious. Bitcoin being less valuable means exactly that - it's less valuable, therefore it's only right that less hashing power is devoted to it. In this case, less hashing power is the effect of Bitcoin being less valuable, not the cause.

[alexeft]

Great, everyone gets absolutely filthy stinking rich for ever and ever... that cant be right

And it is not right. For someone to be rich, someone has to be poor.

I guess that even bitcoin has a natural point of equilibrium after which it will only deflate by the yearly value that its economy will produce.
If for example at equilibrium all bitcoin users have a total of 10 houses and someone builds one more, the total value of the 21 mil bitcoins will become equal to eleven houses and ALL bitcoin users will be richer by a house divided by their percentage of the total bitcoins.

[JoelKatz]

Guess I'm not seeing the "why buy today when its cheaper to buy tomorrow?" argument clearly. "Because I have to eat today" only covers a very small part of it. Unless we're living on the breadline then we can and will save for tomorrow with a deflatory currency and that saving will continue until there's only Satoshi's in circulation. Great, everyone gets absolutely filthy stinking rich for ever and ever... that cant be right :/ I guess if someone gets to be an all powerful dictator they'll be left with a useless blockchain if they piss to many folks off though.

Maybe you'll see it more clearly if you look at the same argument in the context of an inflationary currency or good that's appreciating in value. Suppose the price of gas has been rising continuously and fairly predictably, either because the currency is dropping in value or because the demand for gas is increasing. Are gas stations going to close down for a few weeks so that they can sell gas for higher prices in the future?

The answer is clearly no. Because if they were going to do so, that would simply mean the price of gas wasn't high enough *today*. You don't see a gas station closing because they'd prefer to sell their gas later when the price is higher. The price is already high enough -- supply and demand ensures it.

The same is true of a deflationary currency. If it's actually encouraging hoarding, that would simply mean the price of goods wasn't low enough *today* to encourage people to buy them and the price would fall until it is low enough. But of course, that will have already happened -- having a deflationary currency means the price of goods has dropped.

[gollum]

Guess I'm not seeing the "why buy today when its cheaper to buy tomorrow?" argument clearly. "Because I have to eat today" only covers a very small part of it. Unless we're living on the breadline then we can and will save for tomorrow with a deflatory currency and that saving will continue until there's only Satoshi's in circulation. Great, everyone gets absolutely filthy stinking rich for ever and ever... that cant be right :/ I guess if someone gets to be an all powerful dictator they'll be left with a useless blockchain if they piss to many folks off though.

Maybe you'll see it more clearly if you look at the same argument in the context of an inflationary currency or good that's appreciating in value. Suppose the price of gas has been rising continuously and fairly predictably, either because the currency is dropping in value or because the demand for gas is increasing. Are gas stations going to close down for a few weeks so that they can sell gas for higher prices in the future?

The answer is clearly no. Because if they were going to do so, that would simply mean the price of gas wasn't high enough *today*. You don't see a gas station closing because they'd prefer to sell their gas later when the price is higher. The price is already high enough -- supply and demand ensures it.

The same is true of a deflationary currency. If it's actually encouraging hoarding, that would simply mean the price of goods wasn't low enough *today* to encourage people to buy them and the price would fall until it is low enough. But of course, that will have already happened -- having a deflationary currency means the price of goods has dropped.

If I managed an oil company and the price of oil was going up very quickly I would of course try to profit from the rising price by not selling to the market until the price has peaked.
Since oil demands huge volumes of storage It would be much easier to just deliver the oil to the customers, and instead buy one future contract for every barrel deliverd until our analysts would say the bubble is about to crash. (summer of 2008, oil peaked at 145$/barrel and crashed 80%).

[JoelKatz]

If I managed an oil company and the price of oil was going up very quickly I would of course try to profit from the rising price by not selling to the market until the price has peaked.

That's very dangerous because there is no way to know when it has peaked and there's always a risk that the price will fall before you can sell the oil you held back. Certainly some people will do that, but it's not a universally winning strategy.

Since oil demands huge volumes of storage It would be much easier to just deliver the oil to the customers, and instead buy one future contract for every barrel deliverd until our analysts would say the bubble is about to crash. (summer of 2008, oil peaked at 145$/barrel and crashed 80%).

The problem is that the predictable aspects of the future price are already baked into the present price. If the price wasn't rising fast enough, people would hold back oil, and the price would just rise faster.

All of these affects are already cancelled out in the present price. The present price must be fair to sellers, or it would rise. The present price must be fair to buyers, or it would drop. For any reasonably-liquid commodity priced in any reasonably-liquid currency, the price will be tend towards the price that is equally fair to the typical buyer and the typical seller.

[mobile4ever]

Reward for blocks will stop in 2040.  Yes or no?  If rewards for new blocks stop, miners will depend on transaction fees.   This decreases the revenue of the mining.  

I predict that by 2040 there will be so many transactions that people would rather not get a reward for their hashing out a block, just for the transactions. I cant prove anything, but that is what I believe.

[Adrian-x]

I don't thing fees will be necessary.

All electronic devises capable of performing a financial transaction will have Avalon SHA256 Asics built into the processor.  Everyone who is invested in making such transaction will be contributing. (if not everyone then all the serves providers who collect payments will.)

The value of Bitcoin will increase exponentially until it has some huge value. Once it does anyone with a single Bitcoin will be running a miner on their PC with an integrated SHA256 Asics just to secure their 1BTC on the network. Redundant relic SHA256 Asics will be on standby with monitors to detect any opportunity to profit from delayed transactions and auto power up.

If fees are even necessary, it will be determined democratically by choice in mining software, the idea that fees will be charges will create a huge buzz in the world, the talk will be all about the lucky winners in the lottery.  

Conglomerates / mining pools will form to process the transactions, users will switch mines in coordinated efforts to try and keep free money transactions,  Conglomerates / mining pools, will be kept in cheque ever increasing there SHA256 processing power to ensure they have the dominant mining software to maintain the fee structure necessary to manage their efforts. All the while users benefit  by either increased security, or reduced costs, and it will be technology and news that drive the different trends.    

[chrsjrcj]

Deflation will kill bitcoin businesses - why spend your bitcoins today if they are worth more tommorow, or next week, or next month...
Bitcoin simply becomes an asset to speculate in or hedge against inflation instead of being used as a trading currency.
The best thing that can happen to the bitcoin community is a crash followed by a stable price for a long time so people get used to spend their coins instead of just hoard the coins.

One solution to the deflation problem is that if everybody votes for a change in the bitcoin protocol so a 2%  inflation can go on for ever even after 21 million coins have been mined.

Because people have to eat.
50 inch flat screen? I could hold out, but the Super Bowl is tomorrow.
Air conditioner breaks down in the middle of summer.

Apple comes out with a new iPhone every year. Why buy this years model when you know you can buy a better model next year, or this year's model at a lower price next year? Doesn't stop people from standing in line for 8+ hours.

[gollum]

Deflation will kill bitcoin businesses - why spend your bitcoins today if they are worth more tommorow, or next week, or next month...
Bitcoin simply becomes an asset to speculate in or hedge against inflation instead of being used as a trading currency.
The best thing that can happen to the bitcoin community is a crash followed by a stable price for a long time so people get used to spend their coins instead of just hoard the coins.

One solution to the deflation problem is that if everybody votes for a change in the bitcoin protocol so a 2%  inflation can go on for ever even after 21 million coins have been mined.

Because people have to eat.
50 inch flat screen? I could hold out, but the Super Bowl is tomorrow.
Air conditioner breaks down in the middle of summer.

Apple comes out with a new iPhone every year. Why buy this years model when you know you can buy a better model next year, or this year's model at a lower price next year? Doesn't stop people from standing in line for 8+ hours.

If I got 1000$ in my bank account and 1000 $ worth of BTC I would rather buy the new iPhone with my fiat-money than my BTC since the dollars decrease in value every year and the bitcoin increase in value every year. To compare currencies with iCrap is just foolish since some people are even ready to sell their organs for a new iPad...

[JoelKatz]

If I got 1000$ in my bank account and 1000 $ worth of BTC I would rather buy the new iPhone with my fiat-money than my BTC since the dollars decrease in value every year and the bitcoin increase in value every year.

That makes no sense. Why would you prefer this to buying your iPhone with Bitcoins and then just buying more Bitcoins?

If you really would significantly prefer to buy the iPhone with Bitcoins rather than dollars, that just means the price of Bitcoins relative to dollars is too low *today*. If that were true, people would be trying to buy Bitcoins for dollars and nobody would be selling them, which would cause the price to rise immediately. In practice, this simply never happens. The price of Bitcoins relative to dollars is already fair to the typical buyer and typical seller or it would already have changed.

[gollum]

If I got 1000$ in my bank account and 1000 $ worth of BTC I would rather buy the new iPhone with my fiat-money than my BTC since the dollars decrease in value every year and the bitcoin increase in value every year.

That makes no sense. Why would you prefer this to buying your iPhone with Bitcoins and then just buying more Bitcoins?

If you really would significantly prefer to buy the iPhone with Bitcoins rather than dollars, that just means the price of Bitcoins relative to dollars is too low *today*. If that were true, people would be trying to buy Bitcoins for dollars and nobody would be selling them, which would cause the price to rise immediately. In practice, this simply never happens. The price of Bitcoins relative to dollars is already fair to the typical buyer and typical seller or it would already have changed.

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.
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.

[MikeH]

yeah that's the problem I'm seeing at the moment - I'm happy to spend bitcoins as long as I can replace them straight away, as it is I would have to log in to Mt Gox and have some fiat on stand by to do that whereas it'd be preferable to just have like a 'pay and top up' button when making transactions.

[JoelKatz]

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.

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.

[Sweft]

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.