Bitcoin , deflation and slashdot

[notig]

I've been skimming around the boards on the internet lately... and it seems that one of the most widespread misgivings about bitcoin from people who think they understand it is the "deflationary spiral".

So I'd thought I'd take a shot at showing why they are wrong.

Deflation. If bitcoin deflates and the price rises... how does that hurt the users of that currency? Does it make it harder to transact larger purchases? No, it makes it easier. Does it make it harder to transact small purchases of less value since the bitcoins price is increasing? Not if we compare it to the dollar. Compared to the dollar... the lowest unit is a satoshi or 1 / 100 millionth. This means that if we were to say that the smallest unit of a dollar (the penny) is worth the same as the smallest unit of a bitcoin.......... the price of ONE bitcoin would have to rise to 1 million dollars per btc for this to happen. So in order for the deflation aspect of bitcoin to harm users in any way(the theoretical harm here is that the price is so much that it makes transactions more difficult) ... would mean that it would have to deflate to 1 million dollars. IF we are comparing it to the dollar. The argument "deflation causes hoarding" is the exact same as what I just described. The price would rise from hoarding. And it would only cause hypothetical issues at 1 million dollars per bitcoin. So if bitcoin deflation doesn't hurt users transacting with one another.. does it hurt acquiring them? Not really. If you have enough money to buy 1 bitcoin but wait for a year... and then the price has doubled you can still buy .5 bitcoin and you would have the same purchasing power as you would have had. So it doesn't hurt users transacting with other users... and it doesn't hurt acquiring them.. what does it hurt?


There is a second big mistake I see some people making...... and it's that the deflationary aspect of bitcoin causes the economy harm. Really? Just 5 years ago bitcoin didn't exist. Dollars existed. And now bitcoin exists and dollars still exist. So how could ANY aspect of bitcoin cause harm to the economy? Especially a deflationary one. That makes no sense whatsoever. They seem to be thinking from a philosophical standpoint as if bitcoin was the only currency that existed.  The truth is that competition is good. A new currency is good and people having more choice cannot cause harm except for those who don't use the right currency for their needs.

This brings me to my next point... frequently those who say deflation is a problem argue that prices are a problem because the money deflates. Once again........ this argument seems to be made from a philosophical standpoint and not a realistic one. Bitcoin isn't the only currency. So if it's value is volatile then you can just connect it to something less volatile(as is already being done).

And even if bitcoin ends up being used for larger transactions... there are even more alternatives now. Other cryptocurrencies. With our modern digital age it is no longer a problem to exchange from one currency to another and it is only going to get easier.

[audenx]

Great topic! Thanks for posting.

Yes, I see a lot of Bitcoin skeptics and detractors online who don't seem to understand the divisibility of Bitcoin. Maybe this is a naming issue — the idea of a "coin" is pretty firmly ingrained in peoples' experience as an indivisible physical unit, with a penny (or international equivalent) being the smallest unit. So some Bitcoin commentators end up thinking mistakenly that 1 BTC valued at $33 means someone would have to round all Bitcoin transaction prices to the nearest $33. Whoops! Hopefully these commentators will encounter some kind Bitcoin advocate willing to educate them

Per the deflation issue: There are different (sometimes conflicting) definitions of deflation, and lots of different economic circumstances that can cause deflation, so it's hard for much meaningful conversation to happen without very precise definitions of terms. I am no economist, but as an armchair Austrian school enthusiast, I've found Murray Rothbard's discussions of deflation to cut through the vitriolic noise on the subject.

A helpful article on deflation from Mises.org excerpts some of Rothbard's thoughts here (the whole article is worth reading, though!):

Just as inflation is generally popular for its narcotic effect, deflation is always highly unpopular for the opposite reason. The contraction of money is visible; the benefits to those whose buying prices fall first and who lose money last remain hidden. And the illusory accounting losses of deflation make businesses believe that their losses are greater, or profits smaller, than they actually are, and this will aggravate business pessimism.

It is true that deflation takes from one group and gives to another, as does inflation. Yet not only does credit contraction speed recovery and counteract the distortions of the boom, but it also, in a broad sense, takes away from the original coercive gainers and benefits the original coerced losers. While this will certainly not be true in every case, in the broad sense much the same groups will benefit and lose, but in reverse order from that of the redistributive effects of credit expansion. Fixed-income groups, widows and orphans, will gain, and businesses and owners of original factors previously reaping gains from inflation will lose. The longer the inflation has continued, of course, the less the same individuals will be compensated.

Some may object that deflation "causes" unemployment. However, as we have seen above, deflation can lead to continuing unemployment only if the government or the unions keep wage rates above the discounted marginal value products of labor. If wage rates are allowed to fall freely, no continuing unemployment will occur.

[oleganza]

If bitcoin deflates and the price rises...

What do people mean by "deflation" and "inflation"? These terms are abused without limit. Some say, inflation is "increase in money supply" (therefore, deflation must be the opposite). Others say inflation is "when prices rise". What does it mean "bitcoin deflates and prices rise". Bitcoin cannot deflate in terms of contracting the money supply. The money supply is either fixed or slowly growing (however you see it), lost coins affect everyone by 0.001% which is negligible. So if you say that "bitcoin deflates" means "price of BTC is rising", then why adding "and its price rises"?

In my opinion, the terms inflation/deflation are highly abused. The sound of these words suggests someone's control over the total supply. This is not the case with gold and BTC, but it is the case in fiat currencies. Gold can be lost and mined, but these two things are highly limited by the natural laws (e.g. people will tend to increase security of their gold to avoid losing it even more and miners will try hard to mine more, but it's limited by the total amount of gold on the earth that is technologically accessible).

I myself try not to use "inflation/deflation", but use "increase/decrease" in supply. In case of gold and BTC, this increase and decrease is highly limited and outside of anyone's control. Even you there is a single miner on the planet, his supply will still be no different from the supply of 1000 miners. Also, BTC supply does not really increase because everyone knows the future total amount. And even miners cannot know who exactly will earn it. We just know that given the diversity of miners, we can expect that the new money will be very likely to be spread in many different areas in the economy without creating disturbance in price structure. And even if the miners are not diverse, we can account for that risk, knowing how much hashing power is centralized. The more centralized - the more unstable the prices will be. But that's up to entrepreneurs to calculate.

So, Bitcoin total supply is constant, known in advance, price structure is not expected to be disturbed by the increase of supply. If more people demand Bitcoin comparing to people willing to sell it, its price will naturally rise. Will it create a "deflationary spiral"? Of course. But only up to the point of balance, when someone is willing to sell at a higher price. And what if no one wants to sell, but everybody wants to buy even more? Well, then no trade will occur. Does it mean total collapse? Of course, not. It only means that everyone got what they wanted.

Imagine an auction where unique paintings are sold. Everybody bought all the paintings and not selling them. Is there a market price for them? No, because nobody is willing to sell for any price. Do paintings lose any of their value? No, because their owners are very happy to keep them. In case of currency, this will only happen if you only have 10 satoshis left (while the rest is destroyed) and people simply collect them.

Now imagine, that some people only purchase BTC in expectation of quick rise. So everybody was buying until nobody sells more. So those speculators wait, wait, wait and see that no trade is happening at a higher price. Only some people exchange at some stable price, say $40. Now these speculators see that they don't want their coins anymore and rush to sell before their competitors do the same. The price naturally goes down to the point at which longer-term investors are willing to buy.

And the last point: the money does not "circulate". http://blog.oleganza.com/post/43378777734/on-circulation-of-money

[jerfelix]

Another argument is that "People will not spend their deflationary Bitcoins today, knowing that they will be worth more tomorrow".

There are several ways to argue against this point.

1)  People buy computers, memory and disk drives, knowing that they could wait until tomorrow and buy so much more.    
2)  Every transaction has two sides, a seller and a buyer, yet this argument only looks at the buyer side.  If everyone "knows" they will be worth more tomorrow, then the same logic can be applied to the merchant.  They will WANT the deflationary currency, and will offer better deals to get it.  

I am highly motivated to hold my Bitcoin, believing that it will be worth much more tomorrow.  But I will spend it with Bitcoin merchants to reward them for accepting Bitcoin, and because I'm likely to get a "cash discount".  (My bitcoins are easily replaced.)

[cho]

Although I'm convinced deflation of prices isn't a problem in the bitcoin economy, I'll play the devil's advocate if you don't mind.

As far as I've read, the divisibility topic isn't a real problem. It's quite easy to explain the divisibility, give the names of the millies / micros / satoshis, and everyone seems to agree at the end of the day that there is no divisibility issue.

Constant price deflation seems to lead to more heated debates.
The anti-bitcoin point is : constant price deflation leads to hoarding. People do not spend their coins because they will have more purchasing power if they wait. This causes two things :
- Under-consumption, which is bad(TM)
- Under-investment, which is worse(TM?)


One other thing : I would be interested in your opinions on the topic of capped monetary base and the illusion of permanent growth. I'm beginning to think current fiat moneys are linked to the paradigm of infinite economic growth, whereas limited-supply moneys are rather linked to a stable economy ; the interesting point is that although most people would knee-jerkingly choose an infinite growth paradigm, the stable economy is obviously more in tune with living in a finite world. Any thoughts about this ?

[oleganza]

The anti-bitcoin point is : constant price deflation leads to hoarding. People do not spend their coins because they will have more purchasing power if they wait. This causes two things :
- Under-consumption, which is bad(TM)
- Under-investment, which is worse(TM?)

What do you mean by "bad" or "good" here? Who exactly is victim and who should be punished?

When you say "under-consumption is bad" are you saying, that in *your* eyes, *my* amount of "consumption" is too low?

When you say "under-investment is bad" are you saying, that investment in BTC is worse than any other investment? Worse for whom? If I invest in one production and not invest in another, who is to judge if I have "under-invested" because first line of production is "inferior" to the second one?

And, finally, what is "hoarding"? How much amount of paper cash in my wallet is considered "hoarding"? Is it your personal opinion, that if I keep more than $1000 in cash it is hoarding? What about some guy who keeps $1M on balance as an insurance for his corporation against unknown payments in the future?

The truth is, there is no "good" and no "bad" in voluntary trade. Morality only can arise when someone is stepping on someone's ability to escape. E.g. if I force you to participate in the trade. But when both of us come together for an exchange and there is no fraud, it's a win-win by definition. How exactly we value our "investments" is for us to decide, not for some external judge.

[memvola]

The gist of the matter is, when the market is almost completely fluid, none of the arguments really work. The rhetoric itself has plausible roots (in the context of regulated instruments, high friction, etc.), but the context is completely off with Bitcoin.

If you don't want to buy something with your BTC, you can buy it with your dollars. Simple, isn't it. Of course, the logical consequence of the argument is, "why would you buy that thing if you can buy BTC instead". Since you can buy bitcoins, investing in anything else is completely irrational, they suggest.

The mere fact that you can buy land, should without a doubt prove that it doesn't work that way in reality. Land is scarce. It can be bought and sold. Yet we still invest in other things. Why is that? Why isn't everyone buying land with everything they've got and sit on it until they starve?

The peculiar thing is, the critics tend to not even acknowledge these questions.

[cho]

@oleganza
When bitcoin opponents say that under-consumption or under-invesment is bad, the reasoning is usually the following :

Under-consumption
If I can sit on my bitcoins and get richer, then I will spend less, because every satoshi I spend tomorrow instead of today makes me richer. This is bad for the economy as a whole, because demand decreases, and this leads to the economy slowing down.

Under-investment
If I can sit on my bitcoins and get richer, then I don't have to invest my money in something productive. With fiat money, if I sit on my chest, my fortune will start eroding. Since I don't want that, I do invest my money in productive entreprises. This means bitcoin is bad for the economy as a whole, because there will be far less capital invested, and entrepreneurs won't be able to fund their projects.

Since I'm at it, I will add another line :
Capital accumulation
With fiat money, the constant increase in money supply erodes capital. With bitcoin, capital doesn't erode. Thus bitcoin will lead to even more concentration of capital than there is today

To sum it up, oleganza, the "bad" or "good", in this line of reasoning, is "bad or good for global economic activity, bad or good for the total output of the economy"

[Richy_T]

With fiat money, if I sit on my chest, my fortune will start eroding.

To be picky, this phrasing implies it is a passive thing. Your fortune will be gradually stolen.

The deflationary spiral scare story is an invention of those who wish to steal your wealth with impunity. Time to start calling them on it (though it is likely too late).

[misterbigg]

Slashdot is full of retards now, it's easy to see just by reading the highest rated replies to their "news" articles. The comments made in response to Bitcoin articles expose pure ignorance.

[oleganza]

@cho, I'll reply to each point:

"If I can sit on my bitcoins and get richer, then I will spend less, because every satoshi I spend tomorrow instead of today makes me richer. This is bad for the economy as a whole, because demand decreases, and this leads to the economy slowing down."

You make a lot of unproven assumptions at once. First, how do you know that you'll be richer tomorrow? There are plenty of people who have reasons to doubt that the bitcoin will not crash any day soon. Second, how do you define "demand" so it decreases? Demand is reflected in price. If BTC grows in price, it means growing demand. When the price does not grow, it means demand does not change (or it grows as fast as supply, but supply grows very slowly today). Third, what is your metric for "economy speed", so you say "it slows down"? Do you know that the amount of physical matter does not really change: all people are doing is transforming matter to fit individual needs. So the "economy" does not move anywhere. It's just each individual acts in expectation to be slightly better off than he is now. And for everyone it means different things. Someone  wants to be rich and famous, someone wants to leave alone on a boat.

"If I can sit on my bitcoins and get richer, then I don't have to invest my money in something productive. With fiat money, if I sit on my chest, my fortune will start eroding. Since I don't want that, I do invest my money in productive entreprises. This means bitcoin is bad for the economy as a whole, because there will be far less capital invested, and entrepreneurs won't be able to fund their projects."

What's the difference between "investing" and "buying bitcoins"? When you "invest", say, in a factory, you give the factory workers salary immediately because you expect higher demand for a result of factory's work, than for all raw materials and workforce separately. Does anybody guarantee you that the demand for the product will be higher? No. You can easily waste all your money on something that nobody needs. But, based on your knowledge, you speculate that you will be better off by investing. At the same time employees think they'll be better off getting salary today instead of risking their time and money in some long-term investment projects. When you buy BTC, it's all the same: you give something immediately useful to the seller, so he can do something "productive" right away while you expect the higher demand for BTC in the future. What is the difference? In the first example you have some abstract "company shares" while your dollars buy materials and labor, in the second example you buy abstract "digital shares", while your dollars buy materials and labor. Ultimately, customers will judge if your decision was productive or not. If your factory builds a useful product, or people see that BTC is becoming more useful for their operation, they'll come back to you and give you more money: for your product, or your shares, or your BTC, or financial advice.

"With fiat money, the constant increase in money supply erodes capital. With bitcoin, capital doesn't erode. Thus bitcoin will lead to even more concentration of capital than there is today"

Capital is rarely "eroded". It can be either destroyed, or relocated, or partially destroyed + relocated. When your fiat money loses in value, it's because some people are creating more of it, giving it to some other people. That hurts your business calculations and makes you invest in something that turns out to be non-profitable. When something is not profitable, it simply means that you gifted some part of your capital to someone else. Then, if you have to sell the whole business to a bank, it fully relocates the reminder of the capital to the bank. So you can say that "capital concentrates" in the hands of those who print money. Because the first receivers of new money have it cheapest and can outbid everyone else. With bitcoin, capital may or may not concentrate. But it will surely move towards those who make more efficient business decisions. In controlled economy, you can be potentially more productive, but since a portion of your capital is taken out by force, you may fail. On free market, the capital can only be moved voluntarily, so it'll move to whoever is more productive. And will move out to someone else anytime customers change their minds.

"To sum it up, oleganza, the "bad" or "good", in this line of reasoning, is "bad or good for global economic activity, bad or good for the total output of the economy"

There is no "global economic activity" which can be "healthy" or "ill". There are real people who cooperate and respect their own and each other's interests. They move and transform stuff in expectation of increased happiness, without any sort of "output". Millions of tourist that move back and forth around the globe, eat, sleep and litter, do they "create global economic output"? They are just making themselves happy in a way that others are willing to provide, because it makes happy other people too. And what's wonderful today may not be so tomorrow, some people will change their minds and move to some other direction. Anyone who comes out with a global metric of "global wealth" or "total happiness" is no better than any crazy dictator. Because he thinks he can control others and that it'll be "good" for them.

[Walter Rothbard]

Great topic! Thanks for posting.

Yes, I see a lot of Bitcoin skeptics and detractors online who don't seem to understand the divisibility of Bitcoin. Maybe this is a naming issue — the idea of a "coin" is pretty firmly ingrained in peoples' experience as an indivisible physical unit, with a penny (or international equivalent) being the smallest unit. So some Bitcoin commentators end up thinking mistakenly that 1 BTC valued at $33 means someone would have to round all Bitcoin transaction prices to the nearest $33. Whoops! Hopefully these commentators will encounter some kind Bitcoin advocate willing to educate them

This is one reason I'm starting to use the term "Bitcoin" in the singular.  i.e., I didn't "buy 10 bitcoins," I "bought 10.0 bitcoin."  Just like you might have 10 ounces of silver, not 10 ounces of silvers.

[Walter Rothbard]

Another argument is that "People will not spend their deflationary Bitcoins today, knowing that they will be worth more tomorrow".

There are several ways to argue against this point.

The best way to argue this point is to sell or spend some Bitcoin, or point out that people spend and sell Bitcoin every day and there is Bitcoin for sale and being spent right now that they, too, could acquire, if they were interested.

[Walter Rothbard]

@oleganza
When bitcoin opponents say that under-consumption or under-invesment is bad, the reasoning is usually the following :

Under-consumption
If I can sit on my bitcoins and get richer, then I will spend less, because every satoshi I spend tomorrow instead of today makes me richer. This is bad for the economy as a whole, because demand decreases, and this leads to the economy slowing down.

The answer is that "demand" is not a single number in an economy.  There is demand for horses, and demand for yachts, and demand for notebook paper, and demand for entertainment, and so on.  And there is demand for money.  And this scenario simply describes an increase in the demand for money.  If they are arguing that the economy needs increased demand, this is increased demand.

Two good books to give people, if they show any interest:
http://mises.org/money.asp
http://www.mises.org/books/time.pdf

[asdf]

Basically, the argument is that if prices in BTC rise too fast, people will stop using them because they'll be worth more. They fail to consider that the fact that prices are rising is because more people are using them. The very idea of a deflationary spiral is self contradicting. An over regulated fractional reserve currency is a bit different, but that's another story.

... and yes, slashdot is full of liberal retards who think they understand things. The worst kind.

[cho]

@asdf
I think your "self-contradicting deflationary spiral" point is very good, because it's very easy to understand and convincing

@oleganza
Thanks for the detailed answer.
I do agree with you on 95% of your reasonings (and I won't detail the other 5% because it's not my point). However I do realise that understanding them requires stepping back from the main paradigm through wichi most people understand the "ecomony" (stopping thinking in terms of GDP, global demand, deflation fear, libertarian fear, etc). Thus I fear your way of thinking will have a hard time convincing current bitcoin skeptics. Am I wrong ? When you expose your arguments to some bitcoin skeptic, are you generally succesful at making him/her think and move his/her line of thinking ?

[benjamindees]

A fractional reserve, fiat currency is a dynamo of bullshit.  Allowing the dynamo to break down is a deflationary catastrophe.  But allowing it to continue, and to suck up and destroy all real wealth in the process, is a bigger one.

[zebedee]

I've been skimming around the boards on the internet lately... and it seems that one of the most widespread misgivings about bitcoin from people who think they understand it is the "deflationary spiral".

So I'd thought I'd take a shot at showing why they are wrong.

Why bother though?  Let them continue to believe it.  It keeps the coins cheap.  One day, after empirical evidence has proved them wrong a day too many, they'll revisit their assumptions and perhaps learn something.

That's good for everyone; too many people believe the rubbish you read in the MSM.  This is the way to change society and the world we live in, for the better.

[zebedee]

The gist of the matter is, when the market is almost completely fluid, none of the arguments really work. The rhetoric itself has plausible roots (in the context of regulated instruments, high friction, etc.), but the context is completely off with Bitcoin.

If you don't want to buy something with your BTC, you can buy it with your dollars. Simple, isn't it. Of course, the logical consequence of the argument is, "why would you buy that thing if you can buy BTC instead". Since you can buy bitcoins, investing in anything else is completely irrational, they suggest.

The mere fact that you can buy land, should without a doubt prove that it doesn't work that way in reality. Land is scarce. It can be bought and sold. Yet we still invest in other things. Why is that? Why isn't everyone buying land with everything they've got and sit on it until they starve?

The peculiar thing is, the critics tend to not even acknowledge these questions.

Thank you!

[joecascio]

I'm a total bitcoin enthusiast. I absolutely love that there is a commodity as free as the internet and out of government control. I also love that I've easily doubled or tripled my small speculative investment of dollars into bitcoin. I have a pretty extensive traditional investment portfolio and nothing in it comes even remotely close to matching bitcoin's rate of appreciation. So I am a big supporter of bitcoin. I think it can solve a number of problems and make life so much easier and freer for regular consumers and small businesses alike, mainly by getting banks out of places they're not really needed.

That said, I also have concerns that center mostly around, yes, deflation and hoarding. These have little to do with bitcoin per se, but rather with human behavior when it comes to money and valuable commodities.

Deflationary spirals and inflationary spirals are two sides of the same coin, which is positive feedback. Currency value sits on a sort of knife edge. Once it drifts off to one side or the other, people's expectations and resulting behavior in response to those expectations push the currency even further off, which fuels stronger expectations and behavior, and so on.

Periods of both deflation and inflation have happened many times in history and it's wise to take a look at these instances to see what actually happens.

During the Great Depression in the 1930s, the value of the dollar soared as did unemployment, which reached 25%. People who were out of work had little cash and no expectations of that changing, so what did they do? What would you do? You'd hold onto your cash like grim death and only spend when you absolutely had to. This causes a decrease in demand which leads to sellers lowering prices (ie, the value of the dollar goes up more), falling production, hence more unemployment which creates the vicious circle. This really happened, guys, it's not just some grumpy 70 year-old technophobe banker that doesn't get it. What finally broke the deflationary spiral was government deficit defense spending as the Second World War loomed. This pumped money back into the economy where it was really scarce, so people could start spending again.

What does this all mean for bitcoin? I wish I could say. But all of bitcoin's wondrous technological features don't change human behavior toward money or valuable commodities. Until people start selling bitcoin (ie, trading it for goods and services) instead of merely hoarding it, it will become ever more scarce and hence ever more valuable. If I am paid in bitcoin now, why would I ever want to spend it to pay my vendors, when it's rising several percent a week?

What might make sense is to make the mining algorithm responsive to demand for bitcoin. If its value starts to rise and demand for it goes up, the miners might produce more. I don't have the answers guys, but you can't make believe these economic forces don't exist, or that somehow bitcoin is immune from them. It isn't, and the continually rising price of late proves that.