Using difficulty as a proxy for price

[TierNolan]

One of the issues with bitcoin is that it is has a constantly changing price over time.  

This creates large menu costs.  This is where people have to constantly adjust their prices to keep things aligned.

Difficulty and price tend to be well aligned.  Over the long term, cost of electricity, hashing hardware and other optimisations have an effect.  However, it is reasonably slow.

From this spreadsheet, the price vs  difficulty ratio has been reasonably constant.  Any deviations will cause more hashing to come online or switch off.

1 BTC is equal to 100 million Satoshi, so maybe the unit could be 100 million divided by the difficulty.  The difficulty is currently 9 million, so 1 unit would be equal to 11.1 BTC.  If difficulty increases, then so would the value in the wallet.
 
The graph calls the ratio the "Solex Factor", so maybe the unit could be called the Solex or Sol or something.

Merchants could price their stuff in Sols and the variation would be around the same as other fx trading.  Users would see their Sol total increase over time on the client as the value of the BTC changes.

There would need to be a warning that the BTCs are "real" and the Sols are just a guideline of value.

The BTC vs $ price varied from 5 cents to $70 and the $ to difficulty only varied slightly.  The peak was 60% higher than the trough.

[Raize]

Be very careful with the association of difficulty and price. A good number of folks have been burned on this, including myself (to a degree). I *do* think that in a bear market, the cost to mine a Bitcoin is the perceived "floor", however there were two separate occasions during the dip from $30 to $2 where I bought at what I thought was that floor that I later regretted as the difficulty continued to fall. You should first look for support at the present difficulty. In other words, watching the difficulty increase after a series of declines. IMHO, we're about to see another bubble, after which we'll see the price decline to around an ROI approaching infinity, much like we experienced in November 2011. It is during that crash that the best opportunities to buy will come about.

For Reference:
https://bitcointalk.org/index.php?topic=53949.0 (I've locked this thread, but you'll notice both theymos and evoorhees disagreed with me while I was proven right over the course of the following months.)

[TierNolan]

Be very careful with the association of difficulty and price.

I wasn't suggesting it as a rock solid measure.  However, it is vastly more stable than the price of bitcoins  itself.

[amincd]

Great job. This could be used for pricing transaction fees. It's vastly better than the current method of miners manually coming to a consensus on a new fee once in a while to keep up with price changes.

[TierNolan]

This could be used for pricing transaction fees. It's vastly better than the current method of miners manually coming to a consensus on a new fee once in a while to keep up with price changes.

Yeah, that's a good idea.  I was just thinking of it as a more stable "face" that the system presents the user.

Having said that, once block space becomes scarce, fees will be set by the market.

This could also be used for automated exchanges.  You could short bitcoin by offering to trade BTC for Sols at some point in the future.  Both values can be calculated directly from the block chain.

[wiggi]

From this spreadsheet, the price vs  difficulty ratio has been reasonably constant.  Any deviations will cause more hashing to come online or switch off.

Cool spreadsheet, thanks  
I dare to predict the "Difficulty vs. Price" will become alot less stable in the future (i.e. couldn't tell
whether btc price is 50 or 500 20 or 2000 if you would see the hashing power chart for next 12 month)
Gamers would switch their GPUs off when Btc price is weak. ASICs will always be on, and production rate
isn't very flexible.

[TierNolan]

From this spreadsheet, the price vs  difficulty ratio has been reasonably constant.  Any deviations will cause more hashing to come online or switch off.

Cool spreadsheet, thanks  

I didn't create it, so your welcome for me typing the search string into Google .

I dare to predict the "Difficulty vs. Price" will become alot less stable in the future (i.e. couldn't tell
whether btc price is 50 or 500 20 or 2000 if you would see the hashing power chart for next 12 month)
Gamers would switch their GPUs off when Btc price is weak. ASICs will always be on, and production rate
isn't very flexible.

It will still track long term.  However, you are right.  If someone has a mining rig that can only do mining then they will leave it on all the time.

However, it depends on what is the main cost.

If electricity is 25% of the cost of mining and the rest is equipment cost, then the price has to fall 75% before it is better to save electricity.

On the other hand, if electricity is 95% of the price and the hardware is cheap, then mining firms in countries with high electricity prices would switch off when the price drops.  This would also cause companies to move to countries with low electricity prices.

[amincd]

This could be used for pricing transaction fees. It's vastly better than the current method of miners manually coming to a consensus on a new fee once in a while to keep up with price changes.

Yeah, that's a good idea.  I was just thinking of it as a more stable "face" that the system presents the user.

Having said that, once block space becomes scarce, fees will be set by the market.

That's assuming the max block size cap is not lifted. If it is, I think a rule of thumb for fee structure will still be needed, and using difficulty as a proxy for price seems to be an automated way of doing it that will avoid situations like the current $0.06 default fee.

This could also be used for automated exchanges.  You could short bitcoin by offering to trade BTC for Sols at some point in the future.  Both values can be calculated directly from the block chain.

Yea that's true.

[TierNolan]

That's assuming the max block size cap is not lifted. If it is, I think a rule of thumb for fee structure will still be needed, and using difficulty as a proxy for price seems to be an automated way of doing it that will avoid situations like the current $0.06 default fee.

Actually, that is interesting too .  Effectively, you set the max block size as a function of difficulty.  If difficulty goes up, it means the price has risen.

Again, the main point is that while long term, mining costs would change, in the short term they are inherently linked.

This would give time for the "economic majority" to decide to update the system.

[Stampbit]

Looks like someone has already created how this would work:

https://bitcointalk.org/index.php?topic=178279.0

[amincd]

Again, the main point is that while long term, mining costs would change, in the short term they are inherently linked.

This would give time for the "economic majority" to decide to update the system.

Exactly. What do you think about a BIP being created proposing default fees be linked to difficulty according to a ratio that can be adjusted occasionally?

[TierNolan]

Exactly. What do you think about a BIP being created proposing default fees be linked to difficulty according to a ratio that can be adjusted occasionally?

I think that's a good plan.  However, the fee isn't supposed to be constant.  Once the block size limit kicks in, it could rise.