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Author Topic: Bitcoin Loans and Lending; The Weakness in The Bitcoin Economy  (Read 16591 times)
jtimon
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August 02, 2011, 07:12:58 PM
 #101

But with deflation, money has an advantage over other capitals. When you buy capital, you expect its yield to be at least as good as basic interest (real interest less risk premium), thus the price of given capital can be calculated at any time from the basic interest rate in the market and the revenue you obtain with that capital. Deflation decreases the revenue, devalues real capital and therefore discourages its accumulation.
With deflation more than ever, money becomes the better of the capitals.

Do you see something wrong with my example?
I think you're reasoning that whoever holds the money is paying the inflation tax and thus by loaning the money to someone else they have to pay the inflation tax. But if that were true, that would just make the money worth less today because taking the money would mean assuming the tax burden of inflation. It all cancels out however you figure it.

The cost of inflation is borne by the lender.

My example is not about inflation but anyway you're wrong. The costs of inflation are paid as you said earlier by all wealth owners.
The lender only pays more than other capital holders if the inflation is unexpected. If it is expected, he could just buy himself real capital instead of lending with no inflation premium. He knows that the nominal revenues and prices of capital are going to rise, so he could buy a capital, take the yields and then sell it instead of lending his money-capital.
The money holder can "escape" from inflation by going to any other capital or even just by buying a commodity.   

The benefits of deflation are reaped by the lender.

Deflation can affect the nominal interest through negative inflation premium, but not as linearly as inflation does. And, of course, the nominal interest can never be below zero with everlasting money.
To simplify, yes, the lender gets from deflation as much as the hoarder does.

2 different forms of free-money: Freicoin (free of basic interest because it's perishable), Mutual credit (no interest because it's abundant)
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August 03, 2011, 10:40:49 AM
 #102

This is essentially what I'm saying. The deflation value is present both at the beginning and the end of the loan, so it cancels itself out.

When you have the ten bitcoins you borrowed to spend, you are also spending the value of their deflation. When you have to buy back ten bitcoins to pay back the principle, you also have to buy the value of their expected future deflation. It cancels out and has no effect on the loan.
That doesn't work. When you spend the ten bitcoins initially, the value you get is affected by the effects of future deflation as anticipated by people now. When you have to buy back the ten bitcoins to pay off the principal at some point in the future, the value you get is affected by the anticipated effects of future deflation as perceived from that point in the future, plus the actual deflation over the time period of the loan. The two sides are neither the same nor likely to cancel out.

Suppose you borrow money for (say) two years. At the start of those two years people can only estimate deflation over the next few years rather than know for certain, and the further out they look the less accurately they can estimate. This uncertainty affects how much of the anticipated effects of deflation people are willing to take into account. In two years' time everyone will pretty much know what happened over those two years and will be in a better position to judge what will happen in the third and subsequent years, so more of the effect of deflation will be priced in.

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August 03, 2011, 12:12:32 PM
 #103

That doesn't work. When you spend the ten bitcoins initially, the value you get is affected by the effects of future deflation as anticipated by people now. When you have to buy back the ten bitcoins to pay off the principal at some point in the future, the value you get is affected by the anticipated effects of future deflation as perceived from that point in the future, plus the actual deflation over the time period of the loan. The two sides are neither the same nor likely to cancel out.
That's true if, and only if, the expected deflation either changes or the actual deflation doesn't well match the predicted deflation. I agree that you can get all kinds of strange and bad results if you try to denominate an agreement in an unstable or unpredictable currency.

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Suppose you borrow money for (say) two years. At the start of those two years people can only estimate deflation over the next few years rather than know for certain, and the further out they look the less accurately they can estimate. This uncertainty affects how much of the anticipated effects of deflation people are willing to take into account. In two years' time everyone will pretty much know what happened over those two years and will be in a better position to judge what will happen in the third and subsequent years, so more of the effect of deflation will be priced in.
Exactly. That's why you don't want to denominate an agreement in a currency that isn't very predictable over the time frame of the agreement. Otherwise, people will become very risk averse and tend to prefer shorter term agreements because it costs money to manage risk. It would be madness to offer or accept a 30 year mortgage denominated in bitcoins today.

An unpredictably inflationary currency, by the way, creates precisely the same issues. This is why we have currency hedge funds, TIPS, adjustable rate mortgages, and so on. These are all ways to manage the risk associated with a currency whose inflation is only somewhat predictable. A currency whose deflation was only somewhat predictable would create the same issues and more or less the same workarounds will reduce their impact.

Here's another example of the same error where it's easier to see: "Who would want to borrow money with an inflationary currency? The mortgage rate would likely have to be adjustable and could climb up really high, forcing you to pay back lots more money."

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August 03, 2011, 03:50:15 PM
 #104

That's true if, and only if, the expected deflation either changes or the actual deflation doesn't well match the predicted deflation. I agree that you can get all kinds of strange and bad results if you try to denominate an agreement in an unstable or unpredictable currency.
It's true even if expected deflation doesn't change and actual deflation matches the predicted deflation well; in fact I was assuming this would probably be the case. The reduction in uncertainty about deflation and other factors over the time period in question is what causes the value of the coins to increase.

Quote
Suppose you borrow money for (say) two years. At the start of those two years people can only estimate deflation over the next few years rather than know for certain, and the further out they look the less accurately they can estimate. This uncertainty affects how much of the anticipated effects of deflation people are willing to take into account. In two years' time everyone will pretty much know what happened over those two years and will be in a better position to judge what will happen in the third and subsequent years, so more of the effect of deflation will be priced in.
Exactly. That's why you don't want to denominate an agreement in a currency that isn't very predictable over the time frame of the agreement. Otherwise, people will become very risk averse and tend to prefer shorter term agreements because it costs money to manage risk. It would be madness to offer or accept a 30 year mortgage denominated in bitcoins today.
It doesn't matter much how predictable the currency is - as long as there's the slightest sliver of uncertainty about the future (and who can really say for sure what will happen in a thousand years or a million?) you will have this reduction in uncertainty over time causing more deflation to be priced in. I don't think the actual level of uncertainty even affects the rate at which deflation will be priced in on average over the long term - only changes to it matter. For example, suppose we have the following incredibly simplified situation where we're at the end of some year y, we know statement S0 is true and are uncertain about the rest of the statements S1, S2, ...

S0: The economy behaved the same in year y as in all previous years, with the same growth rate and the same 5% deflation, and it's 99.99 percent certain that a year later we'll confirm statement S1 is true.
Sn: The economy behaved the same in year y+n as in all previous years, with the same growth rate and the same 5% deflation, and it's 99.99 percent certain that a year later we'll confirm statement S(n+1) is true.

Up until the point one of the statements Sn is discovered to be false - which is by our assumptions impossible to predict in advance - all the years are identical and in every year we have identical expectations for the future, so the effect of expected deflation must necessarily be the same in each year and cancel out, making it impossible for that to compensate for the effect of the deflation on loans at all. This works because as the loan period passes we're more certain about deflation and the economy not just in that year but all the way into the distant future. You can change that 99.99 percent to 99.99999999 percent and the argument still works.

Here's another example of the same error where it's easier to see: "Who would want to borrow money with an inflationary currency? The mortgage rate would likely have to be adjustable and could climb up really high, forcing you to pay back lots more money."
That's not even close to the same statement. There is actually a fairly direct deflationary equivalent of this problem - unexpectedly high rates of price deflation could force you to pay back lots more than you were expecting to - but I'm just talking about the predictable, routine increase in the amount you owe in real terms.

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August 03, 2011, 07:50:14 PM
 #105

By my count, JoelKatz seems to have won this thread several times over by now.

There are people who understand the economics behind your points, they're just (mostly) staying out of this.

Confirming that JoelKatz has won this thread several times over.

On another note, why do people who have not even the slightest interest in using bitcoins stick around this forum for months and make hundreds of posts? (rhetorical)

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JoelKatz
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August 03, 2011, 09:30:31 PM
 #106

It doesn't matter much how predictable the currency is - as long as there's the slightest sliver of uncertainty about the future (and who can really say for sure what will happen in a thousand years or a million?) you will have this reduction in uncertainty over time causing more deflation to be priced in.
You can't have it both ways. You can't say that there's uncertainty and therefore more and more deflation will be priced in. If it's uncertain, then deflation might get priced in or might get priced out or might not change at all.

In any event, uncertain deflation (assuming there's not a huge amount of it) is a manageable risk. If you are harmed if deflation increases, you find someone who is harmed if deflation decreases and you hedge with them. We already do precisely this to hedge around uncertain inflation. It works the same way with deflation.

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August 03, 2011, 10:10:43 PM
 #107

You can't have it both ways. You can't say that there's uncertainty and therefore more and more deflation will be priced in. If it's uncertain, then deflation might get priced in or might get priced out or might not change at all.
Yes, and you might win the lottery tomorrow. Even if the odds of anything other than the expected happening were as slim as you winning the lottery, the tiny sliver of uncertainty should still be enough to cause more deflation to be priced in over time at a very noticable rate, but would you rely on the possibility of winning the lottery to help repay a loan?

There's also a bigger reason why I'm ignoring the possibility the odds could work out in the favour of someone needing to pay back a loan. The reason there's always going to be uncertainty is because of the lingering possibility of some kind of totally unanticipated economic disaster. An economic meltdown is unlikely to be good for your ability to pay back your loan, even if it does reduce the amount you owe in real terms. It's also a bit difficult to plan for due to the whole "unanticipated" part.

In any event, uncertain deflation (assuming there's not a huge amount of it) is a manageable risk. If you are harmed if deflation increases, you find someone who is harmed if deflation decreases and you hedge with them. We already do precisely this to hedge around uncertain inflation. It works the same way with deflation.
Of course it's a manageable risk - but as far as I can see that still doesn't help, because it only protects against unexpected changes in deflation and the problem here is that as a borrower you lose out even if nothing unexpected actually happens.

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August 04, 2011, 05:14:46 AM
 #108

JoelKatz, in simple laymen's explanation terms, if I were to take out a 30 year loan with predictably deflationary Bitcoin, where a level payment will become progressively more painful to pay, would the only option be to use the decreasing nominal payment thing I mentioned/worked out in the other forum? Or is the "pricing in of deflation" going to make level monthly payments somehow manageable? That's the only part I'm somewhat confused on.

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August 04, 2011, 08:57:56 AM
 #109

By my count, JoelKatz seems to have won this thread several times over by now.

There are people who understand the economics behind your points, they're just (mostly) staying out of this.

Confirming that JoelKatz has won this thread several times over.

On another note, why do people who have not even the slightest interest in using bitcoins stick around this forum for months and make hundreds of posts? (rhetorical)

I don't know what you people mean by winning a thread. I share my view and I try to understand other people's view.
If I change my mind the one that gains more its me, not the other person.
I have the intuition that his view is based on dogma, but if I discover that he's only based on true assumptions and logic I have no problem admiting that I was wrong.
In fact I love to change my mind. The feeling that you were blind and now you see is very good.

On another note, why do people who have not even the slightest interest in using bitcoins stick around this forum for months and make hundreds of posts? (rhetorical)

Well in all likelihood they believe in the technological aspects of the project not necessarily the specific implementation and believe for the fate of the technology it is better to alter the implementation than to compete with it or may not have the technical skills to do it on their own.

Seems obvious to me.....

If you're talking about me, I have much interest in using bitcoin, because it is much better than the monetary system we have now.
I see two main groups within the monetary system critics.
From the austrian school we criticize the central bank role.
Within the local currencies trend, the critique is usually more focused on interest.
I criticize both and that's why I propose freicoin and support ripple (although you can have interest with ripple I think the rate would tend to zero).
I also support bitcoin, many people around me know bitcoin thanks to me. I don't talk about freicoin when I introduced them to the bitcoin concept.
I'm a software engineer (well, I don't have the paper that says so yet, I have to finish the final project, but I'm already working as programmer) and I could develop freicoin if I study the bitcoin code. It's a simple change for someone who already knows the code.
But there's no point in having the code if most people who know the idea don't like it.
Also I don't think I have the experience needed to coordinate a free software project like that.

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August 04, 2011, 03:19:11 PM
 #110

Within the local currencies trend, the critique is usually more focused on interest.

Is there anyone else on this forum besides you that criticizes interest?

I criticize both and that's why I propose freicoin and support ripple (although you can have interest with ripple I think the rate would tend to zero).
I'm a software engineer (well, I don't have the paper that says so yet, I have to finish the final project, but I'm already working as programmer) and I could develop freicoin if I study the bitcoin code. It's a simple change for someone who already knows the code.

How will you convince people to switch from currency that hold value, to currency that is guaranteed to slowly lose it, at the stage where the currency is worth almost $0 to begin with? Bitcoin's sales pitch was that it's $0 now, but put your money into it because it'll be $100's later. What's your sales pitch?

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August 04, 2011, 04:19:50 PM
 #111

Within the local currencies trend, the critique is usually more focused on interest.

Is there anyone else on this forum besides you that criticizes interest?

Not that I'm aware. The RBE people maybe?
Most people I've talk with in the forum think that I want to somehow make interest static, and I don't.
I just want to allow further real capital accumulation. Lower the "tax" (basic interest) that money charges on commerce.
Like inflation, you may not see it, but it's there.

I criticize both and that's why I propose freicoin and support ripple (although you can have interest with ripple I think the rate would tend to zero).
I'm a software engineer (well, I don't have the paper that says so yet, I have to finish the final project, but I'm already working as programmer) and I could develop freicoin if I study the bitcoin code. It's a simple change for someone who already knows the code.

How will you convince people to switch from currency that hold value, to currency that is guaranteed to slowly lose it, at the stage where the currency is worth almost $0 to begin with? Bitcoin's sales pitch was that it's $0 now, but put your money into it because it'll be $100's later. What's your sales pitch?

For speculators, almost the same that bitcoin: it's $0 now, but it will be $97 later.
For merchants, accept it because people prefer to spend these.
For entrepreneurs, take cheaper loans in this currency.
Well, that last one would be only after the value of the currency reaches some equilibrium, after the big initial price deflation.

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August 04, 2011, 06:08:46 PM
 #112

For speculators, almost the same that bitcoin: it's $0 now, but it will be $97 later.

If I understand it correctly, freicoin will lose value while you hold it, and will provide incentive to give it to someone else (like merchants). Why would speculators, the first people to exchange real money into this experimental money, expect their freicoin to be worth more in the future, if this money is by design supposed to lose value? And isn't them holding currency that appreciates in value the root of your "money interest from holding money" problem?

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August 04, 2011, 08:09:34 PM
 #113

JoelKatz, in simple laymen's explanation terms, if I were to take out a 30 year loan with predictably deflationary Bitcoin, where a level payment will become progressively more painful to pay, would the only option be to use the decreasing nominal payment thing I mentioned/worked out in the other forum? Or is the "pricing in of deflation" going to make level monthly payments somehow manageable? That's the only part I'm somewhat confused on.
You borrowed the right to hold that money as it appreciated, you invested the value of that right, why would paying it back be a problem?

Whether you would prefer decreasing nominal payments or level payments depends on what the borrower plans to do with the money and what the lender wants to get for his money. Some people may prefer one lump payment at the end of the loan term. I think generally borrowers generally prefer increasing real payments, so level nominal payments may be preferred because that implements decreasing real payments. It depends why you're borrowing the money.

For example, if you're borrowing the money to buy a car and you expect your income to be level in the deflationary currency, you would prefer level nominal payments. If your income shrinks because the currency is very deflationary, then you would prefer decreasing nominal payments. If you're investing in a business that won't get off the ground until later in the loan term, you may prefer increasing nominal payments.

A deflating currency will put a preference towards decreasing nominal payments. But that will go into the mix of preferences based on what the lender wants and what the borrower wants.

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August 05, 2011, 06:20:21 AM
 #114

I would dearly love to know at what point saving your own excess production for long enough to reinvest it properly became known as "hoarding".  I would also be delighted to have explained to me how borrowing money at interest is EVER in my best interests.  Yes, we do 7 day or 15 day or 30 or even 90 day terms.  But paying a late fee, or interest on it is acceptable only as a punishment for changing a contract after it is accepted.  NOT a sensible part of the original contract.  There is nothing to prevent me from accepting 30 day terms for face value and nothing more. Unless, of course, I was a usurious parasite that fed on interest payments while making nothing else of value but symbols of other peoples' wealth.
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August 05, 2011, 09:51:48 AM
 #115

For speculators, almost the same that bitcoin: it's $0 now, but it will be $97 later.

If I understand it correctly, freicoin will lose value while you hold it, and will provide incentive to give it to someone else (like merchants). Why would speculators, the first people to exchange real money into this experimental money, expect their freicoin to be worth more in the future, if this money is by design supposed to lose value?

The currency is designed to lose nominal value, but if the freicoin economy grows, you can't avoid deflation.

And isn't them holding currency that appreciates in value the root of your "money interest from holding money" problem?

Not exactly. The interest comes from the money not losing value and being necessary for trade. The money holder can exploit that need, but you don't need deflation for that. Our current monetary system has not deflation and has interest (although the system is also designed to cheat small lenders).

Freicoin (like bitcoin) would eventually reach a user base equilibrium and have an increasing value based only based on growth.
But if the deflation rate is lower than the demurrage rate you still have an incentive to spend or lend your money.

In fact I think that bitcoin could have more deflation than freicoin since the deflation comes sometimes from shrinking credit, which you need periodically to mitigate the exponential growth of debt debt, an effect of interest. Yes, I believe that business cycles are based on interest. Central banks and fractional reserve only makes them worse, but they are not the root cause.

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August 05, 2011, 09:54:19 AM
 #116

I would also be delighted to have explained to me how borrowing money at interest is EVER in my best interests.  Yes, we do 7 day or 15 day or 30 or even 90 day terms.  But paying a late fee, or interest on it is acceptable only as a punishment for changing a contract after it is accepted.  NOT a sensible part of the original contract.
You currently make $11/hour working as a cashier, which you hate. You got a job as a pizza delivery driver that pays $19/hour, which you would love, but you need a car to accept that job. You don't have enough money to buy a car, but you could borrow $2,220 at interest to buy a car.

You designed a cash-for-bitcoins terminal. You can buy the hardware for $1,900 and sell them for $2,400. You only have about $5,000 cash. You just signed a contract for 1,200 terminals, but you need to provide them all within three months. You don't have the $2.3 million you need to order 1,200 terminals, but if you borrowed it with interest, you could pocket $350,000 in profit.

Sometimes it is most efficient to produce value before you consume it. But it is also sometimes much more efficient to consume value prior to producing it, such that the amount ultimately produced is much greater. Interest consist of two people sharing this benefit because they both made it possible.

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August 05, 2011, 11:50:09 AM
 #117

@ viperjbm

1) The lack of divisibility problem.

I didn't look for the thread for you to read, but modify bitcoin divisibility would be easy.
If a satoshi is worth too much, the code will be changed to accept smaller denominations.

2) The lost wallets problem.

I'm not very concerned about this problem, but freicoin solves it. The lost wallets will be reintroduced in the system by demurrage.

3) Non compound inflation.

That's not possible or I don't understand you.
0.1% monetary inflation + 1% wallets losses = 0.9% monetary deflation. What am I missing?
Anyway, if your concern with deflation is its effects on the financial market, freicoin has a better effect than expocoin, right? It also lowers interest.
If you want the inflation to make transaction fees cheaper (or increase security), freicoin is equivalent to expocoin.
I will be happy to discuss anything related with creating monetary inflation in the proposed chains thread.
I think the main topic here is "Does predictable modest deflation has any effect on the financial market?".

@ everybody
Since predictable modest inflation (created without lending) doesn't have any real effect on the financial market because it only rises the nominal interest rate, some people think that the same must be true for deflation, but interest rates cannot be negative.
Even if all capital yields were negative at the same time, people would prefer to keep their money. With demurrage, they would prefer to put it in a secure store of value or buy consuming goods in advance.

Real capital yields 5% and 10% inflation = 15% nominal interest = 5% real interest
Real capital yields 5% and 10% deflation = I don't know, but not -5% (2% nominal interest ??, then  = 12% real interest) = lend and hoard are both better than invest = nobody borrows and there's no new investments

What am I missing there?

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August 05, 2011, 12:21:39 PM
 #118

I would dearly love to know at what point saving your own excess production for long enough to reinvest it properly became known as "hoarding".

I don't care about the word. The difference between hoarding money or hoarding other goods is that when you hoard money you're making the whole society wait for your decision on how do you want to be compensated for the services you've already provided. That is important and affects other people's decisions.

I would dearly love to know at what point saving your own excess production for long enough to reinvest it properly became known as "hoarding".  I would also be delighted to have explained to me how borrowing money at interest is EVER in my best interests.  Yes, we do 7 day or 15 day or 30 or even 90 day terms.  But paying a late fee, or interest on it is acceptable only as a punishment for changing a contract after it is accepted.  NOT a sensible part of the original contract.  There is nothing to prevent me from accepting 30 day terms for face value and nothing more.

But is not about morals, is about what lenders can ask. Is how markets work.
If you introduce a regulation that makes starting a new bakery very complicated an expensive, bakers can and will rise their prices because of the artificial lack of competition. There's nothing wrong about it (well, yes, the regulation).
While lenders can claim the interest they will do it. The "regulation" here is the money system people chose to use.

Unless, of course, I was a usurious parasite that fed on interest payments while making nothing else of value but symbols of other peoples' wealth.

They made something of value at some point. But if they decide to never redeem that value and lend it at interest, the value to be redeemed will grow until its growth unsustainable. It's just how exponential growth works.
If you were immortal, you could save one coin once, keep on working and consuming your whole wage until the initial loan grows big enough through compound interest, and live on the interest of the big sum forever.
An ounce of gold lent at 5 % interest looks like this in 300 years: 1.05^300 = 2 273 996.13
This of course is unsustainable and that's what business cycles are about.

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August 05, 2011, 01:49:35 PM
 #119

Freicoin (like bitcoin) would eventually reach a user base equilibrium and have an increasing value based only based on growth.
But if the deflation rate is lower than the demurrage rate you still have an incentive to spend or lend your money.

Sorry, I was specifically asking why people would start. When Bitcoin was worth $0.001 penny, you could buy thousands of it, hold onto it, and watch it eventually become $0.01, then $1, then $10. Why would people buy $0.001 freicoins if they know that thanks to demurage it'll be worth $0.000 in a short while?

jtimon
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August 05, 2011, 03:24:01 PM
 #120

Freicoin (like bitcoin) would eventually reach a user base equilibrium and have an increasing value based only based on growth.
But if the deflation rate is lower than the demurrage rate you still have an incentive to spend or lend your money.

Sorry, I was specifically asking why people would start. When Bitcoin was worth $0.001 penny, you could buy thousands of it, hold onto it, and watch it eventually become $0.01, then $1, then $10. Why would people buy $0.001 freicoins if they know that thanks to demurage it'll be worth $0.000 in a short while?

Assuming a 3% demurrage rate.
1 frc will still be 0.97^5 = 0.858734026 frc in 5 years.

Why if 1 frc is at $0.001 today 0.858734026 frc must worth $0.000 in a short while in 5 years?

2 different forms of free-money: Freicoin (free of basic interest because it's perishable), Mutual credit (no interest because it's abundant)
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