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December 05, 2017, 03:09:49 PM |
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Let's talk economic incentives for a sec. It seems to me that this sensitive topic needs to be discussed.
First, I would like to emphasize that I do not agree with economists comparing crypto-currencies to the tulip bulb mania, since I believe crypto-currencies do deliver real value and fulfill certain needs in society.
Nonetheless, I believe that bitcoin and other coins have built-in economic incentives that induce bubble creation.
The programmed scarcity of the coins and the rising difficulty of mining new coins create an incentive for early adoption (coupled with a good use-case or story behind the coin). This is a good thing from the developers' point of view as it promotes the adoption of the new coin and provides a very nice return on their investment, since the developers hold a sizeable share of the first coins. But is it good for the community? I believe that the negatives out way the positives. I'll explain.
The positives of these schemes (not scams...) are:
1. It promotes network creation - as mining is potentially very lucrative for early adopters;
2. It creates demand - as users and speculators want to buy early;
3. It encourages innovation and entrepreneurship - it provides very nice return for the developers who own the initial coins and encourages creation of new and better coins.
The negatives are:
1. It promotes speculation and bubble creation - as coin value rises (increasing demand meets limited supply) it creates an ever-increasing FOMO (Fear of Missing Out) which induces even more speculative demand and further value increments. Why is this bad? Well, very quickly the demand deviates from the REAL demand, meaning the demand for the coin usefulness/benefit, and becomes more and more speculative. Speculative demand is based on the belief that the price will keep rising and is very unstable. As this bubble grows and attracts more and more speculators it becomes less and less stable, as the last buyers have more and more to lose from a large price drop. This process will go on until some event such as a "whale" cashing in on a large amount of coins, an exchange crash, a regulatory crack down or some other unknown event will create a panic and the bubble will pop.
Why do we need to care about this as a community? Well, when this occurs it could mean catastrophe for many people, many of them young people, who will lose a lot of their hard-earned money. If this bubble grows even larger, attracting more and more investors and institutions, it could really pose a systemic risk for the economy, and can create a recession.
Furthermore, such a catastrophic event would be a huge setback (maybe for years) for crypto currency adoption as many people will lose faith in these initiatives. It will probably invite a certain regulatory crackdown on the entire eco-system that would prove very counterproductive.
2. Mining overkill and sustainability issues – the more the price deviates from the REAL value due to speculative demand, the more it increases the reward for mining and thus gives an excessive incentive to invest resources in mining. This is a waste of resources affecting the real world's environment. Needless to say, that in case of a huge crash, as described above, many miners and hardware providers will suffer dire consequences.
3. Stifling real demand and adoption for crypto-currencies - The deflationary programmed nature of the coins attracts speculative demand and stifles REAL demand. It encourages people to simply buy and hold (HODL) the coins instead of using them to invest in new business or to buy stuff. Furthermore, it does not allow for loaning money and does not allow for businesses to hold inventories (which lose their value very quickly). All of these phenomenons do not allow for businesses to develop in the eco-system and limit the usability of the coin.
My conclusions from this partial analysis are as follows:
A. There is a conflict of interests - between the private interests of coin developers, speculators and other stakeholders in the ecosystem, and the public interest.
B. There is need for a serious discussion of these issues without the usual divisiveness. Let's presume we are all in support of the crypto economic revolution ok?
C. There is a need for self-regulation in the community, setting norms for "monetary policy", economic incentives, transparency and so forth.
At the end of this process I hope we will create a socially responsible crypto-currency. A Coin that would not encourage bubble creation, A coin with sustainable mining practices, and a coin that would truly promote an emerging crypto-economy.
What are your thoughts?
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