Bitcoin's first major deflation event, and its consequences

[mcgravier]

"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."

The question is: Who gets burned in the end?

Certainly not me, since im slowly selling my bitcoins, securing my gains in fiat.
Certainly not merchants who due to prices instability are converting into fiat instantly. They also dont seem to lose their customer base, since me and other people who are leaving the "hot potato game" love to buy stuff and have fun with it.

But

At whos expence we are buying those goods, services or fiat?

Hoarders? Naaaaaaah that cant be!

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[arepo]

"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."

The question is: Who gets burned in the end?

Certainly not me, since im slowly selling my bitcoins, securing my gains in fiat.
Certainly not merchants who due to prices instability are converting into fiat instantly. They also dont seem to lose their customer base, since me and other people who are leaving the "hot potato game" love to buy stuff and have fun with it.

But

At whos expence we are buying those goods, services or fiat?

Hoarders? Naaaaaaah that cant be!

you're exactly right. the bagholders will be the hoarders who bank on the deflation for profit. there is a lot of greed in the air on the speculations sub. 'cashing out' i.e. purchasing things with your profits, is the smart thing to do. hoarding coins is like re-investing interest payments into a ponzi, except worse because it is a self-reinforcing behavior.

[Vladimir]

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.

I do not see anything really unusual in current price action. This is what bitcoin was doing all along, except about one year break 2011/2012 due to market's temporarily insanity. LOL.

Sell and risk being left behind. Do you think all those who sold at 1$ ever had a chance to buy again at that price? Nope and before getting to 1$ it was at .30$. It is rather very typical not only for Bitcoin but for decent companies trading on stock market too. GOOG, APPL etc would be most recent examples. Sell GOOG for 120$ soon after IPO and you never see that price again, enjoy your 20% in a month profit and then kick yourself for missing on 6000% run over 6-8 years. Nothing new here.

[mcgravier]

"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."

The question is: Who gets burned in the end?

Certainly not me, since im slowly selling my bitcoins, securing my gains in fiat.
Certainly not merchants who due to prices instability are converting into fiat instantly. They also dont seem to lose their customer base, since me and other people who are leaving the "hot potato game" love to buy stuff and have fun with it.

But

At whos expence we are buying those goods, services or fiat?

Hoarders? Naaaaaaah that cant be!

you're exactly right. the bagholders will be the hoarders who bank on the deflation for profit. there is a lot of greed in the air on the speculations sub. 'cashing out' i.e. purchasing things with your profits, is the smart thing to do. hoarding coins is like re-investing interest payments into a ponzi, except worse because it is a self-reinforcing behavior.

My point is, that market simply punishes such disruptive behaviour, and promotes stabilisation. Losing large amount of money is one of strongest incentives NOT to repeat particular investing strategy. Im aware that bitcoin constantly attracts new people who dont get that they can harm themselfs by excessive hoardnig, but most of them will learn the lesson the hard way further or later.

[Vladimir]

Some people here argue against classic investing maxims.

"Let your profits run and cut your losses quickly."

You argue basically daytrading vs long terms investment.

[thefiniteidea]

twolifeinexile and thefiniteidea : I think you are missing his point. If Bitcoin's purchasing power goes up, you should expect to see a drop in the share price of Satoshi dice coupled with a drop in revenues in BTC. It is possible that you would suffer a loss on your investment in BTC terms. This should be further amplified as more competitors to SD come on board, whereas there does not yet appear to be any worthy competitor to BTC mainly because there isn't any real flaw in it and anything lacking can be built atop of Bitcoin as services(eg Facebook/email integration/etc..) and thus furthering the gap between BTC and any newcomer.

Not if Satoshi Dice is listed in BTC.

If Satoshi Dice is listed in BTC, its price would go up or down based on its own merit, as most of the costs/revenues are in BTC.
Just because the purchasing power of BTC goes up doesn't automatically mean less people will gamble ;P
It just means that when they do, they risk more in terms of STC, but they are still risking the same BTC.

So BTC's purchasing power wouldn't be a factor when buying/selling stock denominated in BTC.

BTC's purchasing power would only be a factor when buying/selling STC (or stock denominated in STC as you would have to convert to STC).

[xxjs]

...
I have many friends in the IT sector whom ive asked whether they have heard of Bitcoin, i was surprised that most who had heard of it did not think much of it or associated it with virtual play money and brushed it off. I have a friend with very high IQ who thinks Keynesian economics is valid and that inflation induces growth by forcing people to invest instead of hoarding cash. Then again so do Economic Nobel Prize winners. I came to the conclusion that as smart as they are, they lack critical thought to question mainstream thought. They can absorb and understand all the intricacies and theories of Keynes but they lack the conviction to question if it makes sense.

Here in Singapore, ive observed that many of our top students and scholars are what i call Textbook smart. They can absorb anything you throw at them, but they can never think critically or be skeptical of the theories thrown their way because you don't score in exams by arguing with the textbook.

The point im trying to make is that as much the small group of existing Bitcoiner's see the benefits of Bitcoin, there is a very high chance that the rest of the world is not capable of doing so, thus making the $100k Bitcoin a pipe dream. After all these are the same people who voted in the very politicians who brought them their current plight.
...

I have exactly the same experience with my own friends, smart and not so smart. The nice thing about the free market, however, is that it works even if no one understands how.

If some people understand, they will be able to speculate and make a gain. The side effect of the (successful) speculation is just that the price will more quickly reach its destination.

[twolifeinexile]

you're exactly right. the bagholders will be the hoarders who bank on the deflation for profit. there is a lot of greed in the air on the speculations sub. 'cashing out' i.e. purchasing things with your profits, is the smart thing to do. hoarding coins is like re-investing interest payments into a ponzi, except worse because it is a self-reinforcing behavior.

The why this is "worse", it is self-reinforcing, then rational people would do it. I guess you are probably from a point of view of bitcoin economy development, but that is never the motive for most people here, they are just "rational economic person". And no one could /should try to control other people's motives.

Maybe bitcoin's destiny is a speculative virtual asset, not a virtual currency, maybe before becoming the virtual currency, it has to first become a virtual asset and now we are in this phase?

It is just a wishfully thinking if you believe bitcoin's road to currency would be smooth and easy.

[arepo]

It is just a wishfully thinking if you believe bitcoin's road to currency would be smooth and easy.

this is probably </thread>. i'm just worried that the wave of new investors or whatever is behind this price action knows not what they do.

[molecular]

I read most of this thread and I had a lot to add, most of it I forgot. This is what I remember:

I've never fully understood how exactly a "deflationary event" works. The definition of deflation brought up ("increased demand + limited supply = lower prices of goods/services") makes sense. But what makes this a "deflationary event". It's just increased demand for the medium so value measured with it has a lower price. And how does "selloffs don't cause panics and are almost immediately absorbed by buying pressure, for one" follow from that. 2011 bubble was also increased demand + limited supply. Where's the difference?

Let's face it: Bitcoin doesn't really have an economy: silkroad et al just use bitcoin as a payment mechanism to transfer fiat from buyer to seller and satoshidice et al don't produce anything or "create value".

Bitcoin is indeed very much like gold. I would probably even like bitcoin if it didn't have the added feature of being useful for making payments (which gold is not). Bitcoin is unique in the sense that it has a limited supply yet can be used as a payment mechanism.

;tldr: I don't understand how "deflationary event/spiral" is a theory applicable to Bitcoin because Bitcoins unique combination of Store-of-wealth and payment functionality and also because of the lack of a real bitcoin economy.

arepo, if you want to discuss, can you answer the question(s) in the second paragraph?

[superduh]

what on earth is happening NOW.. why the crazy jump of 800% since about a year ago.. it's good.. but what seems to actually be driving the price up so fast lately..

[Vladimir]

You could also ask why on earth people were selling Bitcoin for 12% of its value a year ago.

[rini17]

I think no one here took into consideration major difference between bitcoin and fiat- fiat economy is closed by regulation and number of its "users" isn't growing much. Introducing new significant services into meatspace where fiat can be spent is hard. On the other side, btc economy is very open, there are many new people streaming in and some inevitably invent new ways for bitcoins to be spent, making large part of otherwise hoarded bitcoins circulate. So until bitcoin becomes widespread, I don't fear hoarders/deflation at all. The same incentive that drives hoarding, is also driving people who want to earn bitcoins from hoarders.

[niko]

what on earth is happening NOW.. why the crazy jump of 800% since about a year ago.. it's good.. but what seems to actually be driving the price up so fast lately..

This may help you start answering the question. Add in some speculative games by professional traders:

I'm going to keep this thread updated with the most important fundamental reasons (not technical) which will in the long term, move the price. Hopefully over the long term this reduces the number of "OMG?! why is the price going X??" I will be limiting the updates I make to this thread to only those items which have the power to significantly affect adoption/ move the market. I'm sure I missed a few things, so feel free to post and remind me.

Reddit - http://blog.reddit.com/2013/02/new-gold-payment-options-bitcoin-and.html
TLDR - One of the largest sites on the internet is now accepting bitcoin for their premium service!

Bitpay - http://blog.bitpay.com/search?updated-max=2012-12-06T10:13:00-05:00&max-results=7
TLDR - Merchants are signing up in droves with Bitpay's (and other payment processors) payment system

Wordpress - http://en.blog.wordpress.com/2012/11/15/pay-another-way-bitcoin/
TLDR - The largest blog network on the internet is now accepting bitcoins. This paves the way for wider, mainstream bitcoin adoption

Coinbase - http://blog.coinbase.com/post/42587245753/coinbase-is-now-selling-over-1m-usd-of-bitcoin-per
TLDR - It just got alot easier for users in the largest bitcoin market in the world (USA) to acquire bitcoins and it is showing up in the numbers.

SatoshiDice/gambling potential: http://calvinayre.com/2013/02/01/business/why-bitcoin-can-no-longer-be-ignored/
TLDR - While its not possible to gamble with dollars in the US, it is possible with bitcoins. The big players are starting to take notice of this fact and over the next few months its likely that we will see one emerge onto the scene

Blockchain: https://blockchain.info/charts/my-wallet-n-users?timespan=all&showDataPoints=false&daysAverageString=1&show_header=true&scale=0&address=

TLDL - The best online wallet is experiencing exponential growth of new users



As you can see, the new as of right now as of late is all good. If/when that changes, I will update this thread to reflect it.

[sublime5447]

First let me say that I didnt read all of the post, but that I agree with arepo, in fact I have really enjoyed most of his post. The problem that he is talking about relates first and foremost to price stability. I can tell from the responses that I did read that we don't have a lot of retail business owners commenting here. This price spike has pushed me right out of the market and has friends saying that they won't use it. I have a couple friends that were looking at buying and have said no way. "I feel like I am missing out on making a lot of money, but I just cant take that kind of risk" I would not even consider taking BTC as payment for my goods at this time. I simply can not take payments in a currency that is so volatile. This is the heart of the matter. If people are holding coins off the market it pushes up price and distorts the signals.  The only way for BTC to work is if it is used as money not a commodity. I find no reason what so ever to compare the two. BTC is 1's and 0's in the cloud with no intrinsic value what so ever.       

[arepo]

I've never fully understood how exactly a "deflationary event" works. The definition of deflation brought up ("increased demand + limited supply = lower prices of goods/services") makes sense. But what makes this a "deflationary event". It's just increased demand for the medium so value measured with it has a lower price. And how does "selloffs don't cause panics and are almost immediately absorbed by buying pressure, for one" follow from that. 2011 bubble was also increased demand + limited supply. Where's the difference?

the problem is that there is little difference, but this time around, we see the effect bolded above. during the first bubble, the prices were not sustainable because the irrational bulls converted all of their fiat to btc and there reached a point where the influx suddenly stopped. this caused a panic and a huge correction, which left many, many bag-holders in its wake.

this time around, the influx of new buyers isn't slowing. people with little to no exposure of bitcoin are rushing to buy simply because the price has been going up, up, up. it's the same psychology, except the scale is much larger and the price is much higher for many more coins. smart money pulls its asks because it sees that the fundamentals are different this time around, and there won't be a huge crash. selloffs are immediately absorbed by new buyers who don't understand the risk of purchasing an asset whose price has made 500% gains in the last year.

this is going to lead perhaps not to a bubble as it did before, but a massive deflationary event that pushes the purchasing power of bitcoin far above its track for healthy growth (see the height above the SMAs that the price is at right now) and will inevitably lead to massive profit-taking, predatory speculation, and price volatility. many new investors who thought they were going to be rich will find themselves in the same position as those who bought coins at $30. the growth of the userbase is good and should be encouraged not by predatory speculative behavior where earlier adopters laugh as the new users line their pockets, but lower-risk lower-price-point profit-taking that won't introduce massive volatility into the market. the former will help the bitcoin community grow in the long run. the latter will hurt the adoption of btc in the short run.

in other words, it's short-sighted and introduces systemic risk into the community. this is an example of a nash equilibrium that leaves players worse off than if they played in a pre-coordinated manner, like the Prisoner's Dilemma. everyone would be better off if the price of the coins were growing but with less risk of suddenly crashing. at this point purchasing coins is again a very high-risk investment because users have decided to distribute risk amongst the entire userbase while they continue to play musical chairs.

what on earth is happening NOW.. why the crazy jump of 800% since about a year ago.. it's good.. but what seems to actually be driving the price up so fast lately..

don't let them fool you. traders will point to good news during rallies and bad news during sell-offs but the cause and effect is less clear. i say it's very straightforward, positive-feedback loop deflation.

First let me say that I didnt read all of the post, but that I agree with arepo, in fact I have really enjoyed most of his post. The problem that he is talking about relates first and foremost to price stability. I can tell from the responses that I did read that we don't have a lot of retail business owners commenting here. This price spike has pushed me right out of the market and has friends saying that they won't use it.

thanks for the bump. the responses in this thread made me more worried than when i first made the post because of the unchecked bullish sentiment.

[sublime5447]

It is very clear to me what is happening and why it is bad for BTC. Everyone around here is wearing green colored glasses. We cant all get rich, markets dont work like that. This time is not different!! It is never different.

[hazek]

It is very clear to me what is happening and why it is bad for BTC. Everyone around here is wearing green colored glasses. We cant all get rich, markets dont work like that. This time is not different!! It is never different.

Oh how I yearn for the day far in the future when all of you with sophistry infatuated people will get your meeting with the cold hard reality and when this "Deflation is bad, mkay?!" idiocy will have been destroyed once and for all much like "Earth is the center of the universe, mkay?!" once upon a time was.

I really can't wait.

[niko]

It is very clear to me what is happening and why it is bad for BTC. Everyone around here is wearing green colored glasses. We cant all get rich, markets dont work like that. This time is not different!! It is never different.

Yes, we can all get rich if we keep voluntarily assigning value to bitcoins in terms of goods and services we trade via Bitcoin network. If more and more people keep valuing their labor, fiat, or property in terms of bitcoins, the value of coins will keep rising. The opposite applies, too.

[sublime5447]

It is very clear to me what is happening and why it is bad for BTC. Everyone around here is wearing green colored glasses. We cant all get rich, markets dont work like that. This time is not different!! It is never different.

Oh how I yearn for the day far in the future when all of you with sophistry infatuated people will get your meeting with the cold hard reality and when this "Deflation is bad, mkay?!" idiocy will have been destroyed once and for all much like "Earth is the center of the universe, mkay?!" once upon a time was.

I really can't wait.

Foolish foolish fool you craaazzy fool. http://www.youtube.com/watch?v=pYaXFCFgMpA. A little sublime for you ass from sublime5447. With respect.