To me, success for bitcoins means massive adaptation and wide usage for online transactions. However, bitcoins limited money supply combined with low rate coin creation inhibits a feasible grand scale adaption by general public. Below follows a brief discussion of the supply related problems and a proposal to overcome them by creating a hard forked branch with a faster coin creation.
Key problems with the limited supplyThe last few weeks has shown that there is huge public interest in bitcoins and fascination and its underlying technology, and that people are willing to change part of their fiat money into bitcoins. Inspiring as this is, bubble behavior and wild price swings is not promising.
The main criteria for bitcoin becoming successful alternative to fiat currencies are:
1. A large number of people must take bitcoin into use
2. The rate of exchange (price) must have a certain level of stability
Because bitcoins are limited in supply, and a small amount of people holds the majority of the existing coins, instability and bubble dynamics will take place due to the following positive feedback loop:
1. A large number of people buying bitcoins drives the price up
2. The increase in price creates incentives for hoarding
3. The hoarding reduce the volume of coins in trade, giving further price increase
4. At some price level big holders start selling off, triggering massive sell-off and price crash
A key part of the problem is that before the general public became aware of bitcoin in March 2013, a very small group of people already possesses all the bitcoins that exist. The rate of new coins created are low, and in one year from now the amount of new coins will only be 12% of the current supply. At the same time, the public interest has increased with several orders of magnitude. A naïve opinion is that the early adapters will gradually sell off as the demands increases and balance somehow will manage it by market mechanisms. I think that is not going to happen. There simply aren’t enough coins.
Another aspect is ideological: Some of the motivation for people to be involved in bitcoins comes from distrust in the central banks to control the money supply. But bitcoins haven’t changed the problem; it has only put the money supply in hands of other. With central banks we at least know who the suppliers of money are, contrary to the case of the large bitcoins holders. My point is not a moralistic one; it is only the fact that if millions of people are to put part of their wealth into bitcoins, they are vulnerable to the doings of a small number of unknown people. And the big holders of coins is not necessarily only the early adopters/early investors – it may also be banks or other financial corporations, which easily can manipulate bubbles and crashes in the fragile bitcoin market, thereby obtaining large parts of the total volume. Ill-motivated holders with such amounts can easily cause repeated bubbles and crashes and eventually destroy public trust in bitcoin.
I also want to remark that The European Central Bank has made an investigation of October 2012 to assess the possible threats virtual currencies may pose to the central banking system. Interestingly, they concluded that the limited money creation and inherent instability of virtual currencies are key factors keeping virtual currencies from getting large enough to pose a threat. The report is found here.
http://www.ecb.int/pub/pdf/other/virtualcurrencyschemes201210en.pdfAs many have before me, I conclude that the limited supply and low rate of coin creation infers price instability, fragility and disable bitcoin from fulfilling its potential prospects. The main problem is that supply cannot accommodate a grand inflow of new adapters.
A more rewarding branch of bitcoinFollowing the discussion above, massive adaptation of a cryptocurrency will require:
1. The amount of new coins produced must in reasonable time become larger than the amount produced before general public is aware of the new currency.
2. The rate of new coins being produced must be sufficiently large keep price growth moderate, making it possible to be used for selling and purchasing.
Bitcoin is a publically known concept, its origin is mythical and most important of all, and it has the important community of early adopters. Therefore I will not propose another altcoin, but rather find a way that utilizes the existing bitcoin chain.
My proposal is to create a hard forked branch of bitcoin, with a network of new clients building on the new chain. The main difference from the original chain is that the miners reward for creating new blocks is held constant, at a number of 200 coins. This is four times larger than the original reward and eight times larger than the current. I will argue below that this rate will not create inflation, and that we still will see a formidable increase in coin value.
The new chain will contain the addresses of existing bitcoins at the time of fork. This means that all existing owners in the old branch will own their same coins in the new branch, and can spend them in both. If coins are sent to an address in the new chain, they will remain in that chain. If it is possible the branched chain should also incorporate bitcoin transactions in old chain, this would make transfer from the old chain seamless also after the fork.
Another feature with the new chain is that mining would always be profitable. The new chain will produce about 10.5 million coins each year. If the chain starts at September 1st 2013, the future coin supply and percentage of growth (inflation) is as follows:
Year(end of) Volume (mill) increase
2013 15 38 %
2014 25 72 %
2015 36 42 %
2016 46 30 %
2017 57 23 %
……….
2023 120 10 %
2031 204 5 %
Many people will reject the idea of an inflationary bitcoin. But the term ‘inflation’ here only reflects the increased supply, not the exchange value or purchasing power. If the new coin manage to get massive adaption, one is likely to see a strong increase in value, i.e. deflation. And even with a constant growth in supply, the ‘inflation’ drops off as 1/x, approaching zero with time. The main issue is to create a supply of money that can accommodate a large inflow of new adapters, and create world market.
Value growthAlthough it is impossible to predict the price growth one may make some rough guesstimates. Let us presume that the new chain will replace the old one with respect to public attraction. One the careful side we may assume a linear increase in market cap, on the more optimistic side, a parabolic increase. Assume for both cases a market cap of 1 billion dollar by end of 2013:
Year market cap (million USD)
linear parabolic
2013 1000 1000
2014 2000 4000
2015 3000 9000
2016 4000 16000
2017 5000 25000
Naturally, the constant increase of market cap gives a constant price while a parabolic increase gives a linear increase in value. If bitcoin shall become a currency that can be of practical use, the market cap growth is likely to be closer to the parabolic case - or even higher. For comparison, the volume of online retail shopping is $318 billion. It is time for bitcoin to get out the sandbox and take a fair share of that market!
To conclude, it is my firm belief that the cryptocurrency to eventually make a major success will have a faster coin creation. However, bitcoin is the major player and may stand in the way for such a currency to reach forward, ironically becoming a showstopper for the whole idea of cryptocurrencies. The branched block chain as proposed is a way to create a potential escape route from such a scenario. And a better way to maintain the values of existing bitcoins. In contrast to the origin of bitcoin, it is of utterly importance that the whole community is made able to take part when mining of a new branch starts.
