Bitcoin's first major deflation event, and its consequences

[arepo]

So it seems that the bitcoin userbase has made a decision about the currency vs. store-of-value dichotomy and has overwhelmingly chose the latter.

A recent thread in the speculation forum seems to suggest that the common practice for most is to buy and hold (read: hoard).

while this is fine and dandy, and everyone can do with their bits as they please, it might have some unexpected consequences for bitcoin as a whole. one of these is a decreasing appeal as a currency. let's talk about the idea of a deflationary spiral:

the bitcoin wiki has a nice page describing how bitcoin is 'immune' to such a disaster, the reasoning being "Bitcoins only deflate in value when the Bitcoin Economy is growing."

there is no question that bitcoin has undergone (or is continuing to undergo) a massive deflationary period. this comes as no surprise because demand is rising and the total number of bitcoins, as everyone knows, is fixed.

let's talk about what isn't happening:

-it isn't about the block reward halving. everyone thought that that was already priced in, before it happened, in the rise from $5 to $10 in the early summer. i have reservations about whether or not that is really the case (the inflation rate decreasing by half doesn't mean that the value should double), but that aspect of the protocol must have been priced in already.

-it isn't about any major news either. the best candidate is the wordpress announcement, but the rally, again, started before and continued thereafter.

-it isn't about any new market opening up for bitcoin, either... the main drivers are still online gambling and the silk road.

-it also is not a bubble, as many have been saying. at the very least, we are not in bubble territory yet. there have been two large sell-offs that have let off a little steam while maintaining the upward momentum.

so what's going on? the bitcoin wiki swears that the bitcoin economy MUST BE GROWING in order for this massive deflation to occur. and the economy is growing, indeed, but which sector?

you see, just like the world economy, the 'financial' sector is about an order of magnitude larger than any real commerce. as evidence for this, i can point to that fact that more than 3/4 of the bitcoins that exist haven't moved much at all. this is troubling. if there are so many coins, where are the asks on mtgox? the answer: people are pulling them, skewing the supply, with the idea that hoarding will be very profitable as the slow and steady deflation pushes the price up, up, up.

this brings us back to a very important, and possibly dangerous, idea: the deflationary spiral. users are reluctant to sell their coins because of the idea of larger future worth (standard deflation), which causes them to hoard their coins which creates a feedback loop which increases the perceived value of the coins.

why is this dangerous? everyone knew deflation was built-in to bitcoin, anyway, right?

the problem is that if you are discouraged from spending your coins because you know they will be worth more in the future, the nash equilibrium is for everyone to hoard. this means no investments and subdued commerce. in other words, bitcoin turns into gold as we know it today. not a currency at all, but a store of value.

we are already seeing the effects of this. why invest in satoshidice shares when you'd be multiple times better off just holding onto the coins? even if you mean to purchase things with them and never convert to fiat, unless a large support economy exists the suppliers of the goods will have to convert to fiat to pay off their own costs. but the deflationary spiral disincentivizes the formation of this necessary support economy!

in other words, the bitcoin economy is growing. the "financial" sector is swelling like nothing we've seen before. and if it doesn't stop, we may never see bitcoin payment systems because they will simply not make sense.

even worse, the price as it stands today is much higher than it would be if 100% of the coins were in common trade. as it stands, less than 1/4 are. and now everyone is rushing to buy because they see the profits and protection of a deflationary store of value. so the game is to suck up as many coins as you can, and hold them forever? then what is the point? we've all been relying on the relative altruism of the early adopters and miners who are undoubtedly the owners of those large, quiet addresses. i'm rather afraid that some of them may be less altruistic than we believe.

i know that FUD is common when prices rise to unprecedented levels, but this is not speculation. this is a challenge to the economic fundamentals and goals of the project. i'm not saying that one of these big fish are going to cash out tomorrow, but as the price rises, the incentive for them to will only increase. is this a good direction for bitcoin?

edited for formatting

[markm]

Are you suggesting that everyone, or at least the large holding early adopters, will not be altruistic enough to actually buy anything when their bitcoins are worth billions of dollars so they will spiral up to trillions of dollars and still they will be so greedy and un-altruistic that they still will not spend any so it will spiral up to megatrillions and they still will not spend, gloating over their megatrillions while refusing to spend a satoshi of it?

Whatever happened to the theory that actually some forms of greed might lead to spending at least some of one's riches?

-MarkM-

[notme]

Not this again....

[arepo]

Are you suggesting that everyone, or at least the large holding early adopters, will not be altruistic enough to actually buy anything when their bitcoins are worth billions of dollars ...

of course not. im suggesting that due to the effects of runaway deflation, there will be no support economy to make bitcoins economically wise to spend. as such, the only thing the big fish can do really is to 'cash out' -- to take profit, and to leave all these people who are busy sucking up the "cheap" $20 coins holding the bag.

Not this again....

i apologize if this has been covered already. i've been completely dumbfounded by the behavior of the price as a speculator recently, and decided to reassess the fundamentals. do you at least agree that this is bitcoin's first significant deflation event? i have read the bitcoin wiki's counterargument to why a deflationary spiral is not possible, and i am still not at ease. could you restore my confidence in traders' long-term awareness?

[arepo]

i understand that im not the first person to ever connect the dots between bitcoin and deflationary spirals. i also understand that the standard argument OHNOES BITCOIN IS GUNNA DIE CUZ DEFLATION is completely misinformed.

the threads you have linked fully exhaust the discussion regarding this matter in the general. i will edit the title to focus on the points i wanted to discuss:

Watching the first major deflationary event in the bitcoin economy, have your feelings changed about its future? Did everyone fully expect the price to quadruple in half a year?

Will this kind of price behavior change the perception of bitcoin either way regarding the currency vs. store-of-value dichotomy?

and

How do you feel about the fact that most coins have not moved? Did you expect this because of the deflationary nature of Bitcoin? Do any of the previous arguments about why people will NOT hoard make less sense in light of the data?

the point is, there is new data to discuss. i apologize if i did not make that clear in the OP.

[notme]

Are you suggesting that everyone, or at least the large holding early adopters, will not be altruistic enough to actually buy anything when their bitcoins are worth billions of dollars ...

of course not. im suggesting that due to the effects of runaway deflation, there will be no support economy to make bitcoins economically wise to spend. as such, the only thing the big fish can do really is to 'cash out' -- to take profit, and to leave all these people who are busy sucking up the "cheap" $20 coins holding the bag.

Not this again....

i apologize if this has been covered already. i've been completely dumbfounded by the behavior of the price as a speculator recently, and decided to reassess the fundamentals. do you at least agree that this is bitcoin's first significant deflation event? i have read the bitcoin wiki's counterargument to why a deflationary spiral is not possible, and i am still not at ease. could you restore my confidence in traders' long-term awareness?

Only 21 million ever.  We're still in price discovery mode and will be for quite some time.  We will either find some price well north of where we are now, or will be displaced by something better.  At that point maybe we can talk about inflationary or deflationary pressures.  Nobody knows about bitcoin now, and until most people have at least heard of it we can only guess what its value is.

As for failing to spend because price is rising, I don't find that to be an issue.  In fact, I spend more after a price rise, even if I expect it to continue.  I could be wrong about it continuing and then I would lose out.  If you have trouble letting go of bitcoins for goods, services, or other investments, maybe you should still be accumulating?  At some point you will feel you have enough bitcoins and be willing to spend some.

[jl2012]

People can use Bitcoin as a store of value AND as a payment network at the same time.  If I want to pay with Bitcoin, I will buy Bitcoin with fiat and pay, without moving my Bitcoin investment.

[Mike Christ]

I don't believe anyone will horde to the point they'll perish.  Eventually, you'll come up with a nice sum of coin and will want to put it to use; after all, why have wealth if it goes unused?

[solex]

This price rise is good for bitcoin because merchant websites will see it is a strong currency and will be more tempted to accept it for goods. The hoarding/saving/investing is also healthy. The market needs to be trusted. Everyone will spend some of their hoarded bitcoins at some point in the future.

[lassdas]

What is this first major deflationary event in the bitcoin economy that you're watching?
What kind of price behaviour is it, that will or will not change the perception of bitcoin either way regarding the currency vs. store-of-value dichotomy?

I really don't get it, I don't see any unusual price behaviour, nor deflationary event.


And for most of the coins not being moved, why would I care? All I care about is that it's possible for me to move them around, superfast, supereasy, supercheap.
I just don't care about what other people do with their coins, hoarding, spending, burning, it's their choice, not mine.

[foggyb]

I don't believe anyone will horde to the point they'll perish.  Eventually, you'll come up with a nice sum of coin and will want to put it to use; after all, why have wealth if it goes unused?

+1000.

Howard Hughes type scrooges are rare in this world because most people just want to have nice things. Hoarding does not go on forever because people know they'll get old and die.

As for failing to spend because price is rising, I don't find that to be an issue.  In fact, I spend more after a price rise, even if I expect it to continue.

Same goes for me.

[niko]

I don't believe anyone will horde to the point they'll perish.  Eventually, you'll come up with a nice sum of coin and will want to put it to use; after all, why have wealth if it goes unused?

+1000.

Howard Hughes type scrooges are rare in this world because most people just want to have nice things. Hoarding does not go on forever because people know they'll get old and die.

Unless they believe the singularity is coming. I wonder what Kurzweil's thoughts on Bitcoin are.

[gmg]

the problem is that if you are discouraged from spending your coins because you know they will be worth more in the future, the nash equilibrium is for everyone to hoard. this means no investments and subdued commerce. in other words, bitcoin turns into gold as we know it today. not a currency at all, but a store of value.

Let's turn this argument upside down for a moment: if BTC price was doing nothing but falling for a month, people would be encouraged to spend their coins because they know they will be worth less in the future, so the nash equilibrium would be for everyone to spend. this means incredible amounts of investments and widespread commerce. in other words, bitcoin turns into fiat as we know it today. Not a store of value at all, but a real currency.

Does this make any sense?

[solex]

... Not a store of value at all, but a real currency.

Does this make any sense?

Only products can buy products. The whole point of money is a medium of exchange between products (labor, food, TVs). Money has to be a store of value in order to be used later to buy a product. Currency is a structured form of money as it also needs to be a unit of account.

If the value of bitcoin kept falling it would be as popular as the Zimbabwean dollar, merchants would reject it.

[Nagato]

im suggesting that due to the effects of runaway deflation, there will be no support economy to make bitcoins economically wise to spend.

What support economy does gold have? Yet it has risen continuously(in dollar terms only) for 12 years.

Unlike inflation, deflation of a currency cannot continue indefinitely.
If 1 bitcoin could buy the entire planet, i or anyone for that matter would cash out long before this point.

Did we expect the price to quadruple? If you've been hanging around these forums, many here are expecting a 10000x increase.

I was initially spooked by the suddenness of this rally without any news event until i thought about it logically, a single wallstreet banker alone could drive this rally with his pocket change, let alone a hedgefund managing billions.

Eventually there will come a price(much higher than today) when volatility will be akin to that of the major currencies.

[phatsphere]

the problem is that if you are discouraged from spending your coins because you know they will be worth more in the future, the nash equilibrium is for everyone to hoard. this means no investments and subdued commerce. in other words, bitcoin turns into gold as we know it today. not a currency at all, but a store of value.

Let's turn this argument upside down for a moment: if BTC price was doing nothing but falling for a month, people would be encouraged to spend their coins because they know they will be worth less in the future, so the nash equilibrium would be for everyone to spend. this means incredible amounts of investments and widespread commerce. in other words, bitcoin turns into fiat as we know it today. Not a store of value at all, but a real currency.

Does this make any sense?

what gmg is actually trying to say, is that your "nash equilibrium" assumption is wrong. holding or spending bitcoins is a mixed strategy. therefore, your feedback loop and whatnot assumptions are wrong and all conclusions.

[Lethn]

Here's the problem with the 'hoarding' naysayers logic and it's another case of ignoring basic economics and mathematics all over again, in order for these 'hoarders' to make a profit from 'hoarding' Bitcoins they have to sell them otherwise all that happens is they have a bunch of worthless coins as everyone else stops playing along with their game and doesn't buy any of them. Adding to that people bitching about people who stash away Bitcoins are forgetting that you can break up Bitcoins into eight decimals as well so even if someone did somehow get there hands on several million Bitcoins and kept them from everyone ( which is extremely unlikely ) everyone else in theory could still trade with a few hundred 'full' Bitcoins in the market.

So enough with this bullshit logic, enough with ignoring mathematics and stop spamming topics about it, as for the comments about gold being a store of value? LOL! Gold and Silver were regularly used as an actual currency for hundreds if not thousands of years the only reason it has stopped recently is because banks have found it far more convenient to just print paper money and keep the Gold and Silver for themselves no one was the wiser until recently. Paper money is a fucking con, it isn't real, they were originally used as receipts for gold and silver, the real money was stolen a long time ago and digital currencies are just enabling us to take it back, with your questions about which sector is growing I suspect unless people volunteer the information to us we probably won't ever discover which sectors are growing because of course Bitcoin is mostly anonymous.

Sorry if the tone is a bit ranty but as people have pointed out there have been several topics about this and a lot of the time it's someone who doesn't understand the subject and writes bullshit as if it's a fact. >_<

[Adrian-x]

i apologize if this has been covered already. i've been completely dumbfounded by the behavior of the price as a speculator recently, and decided to reassess the fundamentals. do you at least agree that this is bitcoin's first significant deflation event? i have read the bitcoin wiki's counterargument to why a deflationary spiral is not possible, and i am still not at ease. could you restore my confidence in traders' long-term awareness?

No apology needed. This is a true dilemma with no immediate solution, I share your concerns.

The phenomenon of deflation in Austrian economics is a an automatic market managed correction and this is true  and fitting  solution to mis-allocated resources responsible for economic growth but wrongly used to argue the point you bring up.

The phenomenon is actually the "paradox of thrift" a Keynesian idea.

2 possible solutions (not advice but a personal opinion):

1) adjust the adoption curve to mimic that of gold (Bitcoin 2.0)
https://bitcointalk.org/index.php?topic=99928.msg1217724#msg1217724

Or

2) adjust your participation to fit the Bitcoin economic model.
https://bitcointalk.org/index.php?topic=141815.msg1512782#msg1512782

I am still very interested in understand how this will unfold
so please keep brainstorming.

Thanks for the concern.

[johnyj]

Many times I asked myself:

How come this Satoshi guy invented such a stupid game that reward people with 50 coin for wasting some electricity do hash calculation and there are so many people become adicted to it?

Then after I discovered that FED are playing an even more stupid game called open market operation and all of the bankers are still adicted to it, I realized that Satoshi is a genius  

[hazek]

is this a good direction for bitcoin?

Boy am I glad that nothing can be done even if it were. 


As for your sophistry.. I just love Bitcoin and I also love my bitcoins, but unfortunately I can't eat them, I can't wear them and I can use them as clothes so eventually I will be forced to spend, no matter what game theory says is the smart move, I can survive holding bitcoins and so I will have to spend them. And that right there completely obliterates your delusional theory.


Btw I'd also challenge your assertions that we haven't had any good news.. We had plenty of good news: from wordpress announcement, to bitpay VC announcement, to their customer adoption announcement, to bitcoin-central announcement, to coinbase announcement, to satoshidice announcement, ect ect ect

We had immense progress and a huge amount of good news lately and you better believe we also had a huge increase in user base as evidenced by the volume coinbase is now reaching monthly or the records blockchain.info/mywallet is breaking..