Targeted Deflation Rate

[cunicula]

Limiting deflation is easy-simply issue more coins. Limiting inflation is harder because it requires destroying coins. One possible solution is to tax transactions. Suppose that all sends are taxed at a rate of 0.1%. Inflation could be controlled by making rules for distribution of tax revenue. If inflation exceeds the target rate most of the tax revenue can be destroyed with some residual distributed to miners. If deflation occurs the entire tax can be distributed to miners with no destruction.
This system would make the currency more costly to use, but would offer better protection against inflation risk. Essentially people who want to spend coins now would be taxed to support the miners and long term holders of the currency.

Thoughts?

[error]

What problem are you trying to solve?

[patvarilly]

I've been thinking about these kinds of issues too, in the context of setting up a new block chain where the money supply is more flexible.  Here's a system that I think might be workable, and would like to submit it to criticism from others.

Right now, there is a fixed monetary inflation schedule that we all "agree" on by dint of network effects, and there is no way to realistically change it.  It would be better if we could dynamically agree on how the money supply should grow or shrink.  The block chain is a fantastic tool for building consensus without trusting your peers.  So we could set up something like a voting scheme for what the monetary inflation/deflation rate should be.  Each miner that produces a block would add to it in a new field of the block header what they think the rate of monetary inflation/deflation should be (right now, it's fixed at 50 BTCs per block).  The actual inflation rate would then be the median of the voted inflation rates of the previous, say, 100 blocks (this bears resemblance to how "difficulty" is agreed upon nowadays).  If a block's coinbase transaction created anything but what the "consensus" inflation rate dictates, the block would be declared invalid.  Monetary deflation could then be implemented by forcing the miner to forfeit a portion of the transaction fees (if they don't, the block they produce is declared invalid by the network).  This is how a "transaction tax" might be implemented in a way that doesn't allow free-riders to ignore it.

The reasons I think this might work are the following:

a) In current monetary systems, a central bank rather opaquely decides how much money to create/withdraw, and any money created is hard to distribute without political influence.  While I happen to personally think that this system works reasonably well most of the time, I can empathize with the queasiness that lack of transparency produces.  Having a more transparent decision mechanism is certainly better (although shooting ourselves in the foot with the current transparent system that's transparently dysfunctional is much worse, IMHO).  I have a feeling that this queasiness is an important emotional factor in Bitcoin adoption today.  Voting on decisions about the money supply continuously would allow a decentralized consensus to emerge (dare I say, "letting the market decide").  Additionally, the money created goes to miners, instead of politically connected banks and treasuries, and the miners really are providing a valuable service (securing the blockchain). Additionally, in principle anyone can arrange to receive a part of the money created by joining a mining pool.

b) Using the median of the votes from a large number of blocks prevents all sorts of problems from free riding.  If, say, we were to allow any miner to decide how much to inflate/deflate without needing consensus, then the individual incentive is to inflate as much as possible, which, when unregulated, screws everyone over (cf. the tragedy of the unregulated commons).  By voting and forcing a consensus, you lose the immediate incentive to inflate everyone else away, and can vote on deflating or keeping the money supply steady.  If everyone else disagrees with you, at least you get to partake in the money creation.

c) The incentives are set up to keep investment in mining at a reasonable level.  If the consensus is to keep the supply steady or deflate, then miners that just want to get-rich-quick will be discouraged.  This would make it easier for miners that really want to increase the money supply to be the ones that find successful blocks, but they are forced to put their money where their mouth is and temporarily mine at a loss in order to register their votes for an increase.  This might occur when lots of new users join the network and/or there is pent-up demand for additional money due to increased desire for trade: the money supply should grow to accommodate the additional economic activity they'll bring online.  If, on the other hand, the consensus is to inflate, miners that want to deflate have to put their money where their mouth is and increase their mining activity to register enough down votes: in the time it takes to do this, they are participating in the inflation, which would subsidize the additional investment.  It also forces early-adopters to invest their hoards, lest their value be inflated away, which would mitigate the initial distribution problem.  In all cases, there is no threat that mining will be so discouraged that the security of the block chain is in jeopardy.

What are people's thoughts on these ideas?  Virtues?  Flaws?

[hugolp]

What problem are you trying to solve?

+1

Also, how do you decide which price inflation indicator to use? What we call price inflation is just the price index issued by the government. But Bitcoin has no government and the price index can be calculated in infinite ways.

[billyjoeallen]

Deflation shouldn't be artificially limited. What you are discussing is a central plan. All central plans fail due to the economic calculation problem.  The greater the value of a bitcoin, the greater the incentive to spend/sell it. This is a natural limit. We have seen this principle at workk for several weeks now and there is no reason to believe it will stop working when bitcoin production slows.

[drmoo]

Bitcoin by design is a Deflationary economy. 
If you don't like it, don't put your money in it.

/thread

[patvarilly]

Bitcoin by design is a Deflationary economy. 
If you don't like it, don't put your money in it.

/thread

I haven't, have no intention of doing, and said "in the context of setting up a new block chain where the money supply is more flexible".  The underlying technical side of Bitcoin is rock solid, and there are many many people in this forum are thinking of ways of building on *that* without having to subscribe to deflationary economics.

[cunicula]

What problem are you trying to solve?

+1

Also, how do you decide which price inflation indicator to use? What we call price inflation is just the price index issued by the government. But Bitcoin has no government and the price index can be calculated in infinite ways.

You would probably have to use a proxy, like difficulty with some growth factored in automatically because of Moore's law.  Essentially you would rely on difficulty tracking electricity prices.

[Tawsix]

You know what they say, if it ain't broke...

[cunicula]

To clarify: the problem is inflationary risk faced by merchants who receive payment in bitcoin.

The proposal is to set aside some portion of sent money as a flow of insurance funds. In the event of inflation the flow of insurance funds is destroyed to reduce the money supply. In the event of deflation, the insurance monies are redistributed to miners as rewards for processing transactions.

I would allow money supply growth to equal a fraction of the max currency destruction rate. This is the product of send volumes and the tax rate. The fraction might be one tenth.  Since the max destruction rate is well in excess of the currency creation rate, the currency would still be deflationary.  The rules would make deflation more predictable. Spikes in transaction volume which indicate deflationary pressure would be offset by accelerated money growth. Drops in difficulty growth rates which indicate inflationary pressure would be offset by currency destruction. The outcome should be a more stable and predictable rate of annual deflation.

[twobits]

To clarify: the problem is inflationary risk faced by merchants who receive payment in bitcoin.

The proposal is to set aside some portion of sent money as a flow of insurance funds. In the event of inflation the flow of insurance funds is destroyed to reduce the money supply. In the event of deflation, the insurance monies are redistributed to miners as rewards for processing transactions.

That is a problem best solved with companies that will offer private insurance funds and other classic hedging solutions long in use in mutlicurrency trading.   There is no need to burden the currency itself and hence everyone with those costs.

[cunicula]

@pat

You are giving miners a huge amount of power in your system. Do they have good incentives to make prudent decisions? 

Miners can be made wealthier in two ways:
Increasing the total social surplus created by bitcoin = the good way

Increasing the share of this surplus distributed as mining rewards = the bad way

If miners were representative of all potential beneficiaries from bitcoin it might not be an issue. I don't think they are. There is a significant danger that the system of one mined block one vote will lead to miners assigning themselves excessively large rewards.

[cunicula]

To clarify: the problem is inflationary risk faced by merchants who receive payment in bitcoin.

The proposal is to set aside some portion of sent money as a flow of insurance funds. In the event of inflation the flow of insurance funds is destroyed to reduce the money supply. In the event of deflation, the insurance monies are redistributed to miners as rewards for processing transactions.

That is a problem best solved with companies that will offer private insurance funds and other classic hedging solutions long in use in mutlicurrency trading.   There is no need to burden the currency itself and hence everyone with those costs.

Whether everyone should be forced to participate in an insurance pool or just those who choose to is open to debate. Insurance can be prohibitively expensive when it is elective. Where can I purchase forward bitcoin contracts in non trivial volumes now? How much does this insurance cost?  How do i know that the insurer won't pull a 2008 banking crisis and fail to pay? I don't think usable insurance for bitcoin will ever materialize without revamping the generation protocol. This in my view is an Achilles heel.

[twobits]

To clarify: the problem is inflationary risk faced by merchants who receive payment in bitcoin.

The proposal is to set aside some portion of sent money as a flow of insurance funds. In the event of inflation the flow of insurance funds is destroyed to reduce the money supply. In the event of deflation, the insurance monies are redistributed to miners as rewards for processing transactions.

That is a problem best solved with companies that will offer private insurance funds and other classic hedging solutions long in use in mutlicurrency trading.   There is no need to burden the currency itself and hence everyone with those costs.

Whether everyone should be forced to participate in an insurance pool or just those who choose to is open to debate. Insurance can be prohibitively expensive when it is elective. Where can I purchase forward bitcoin contracts in non trivial volumes now? How much does this insurance cost?  How do i know that the insurer won't pull a 2008 banking crisis and fail to pay? I don't think usable insurance for bitcoin will ever materialize without revamping the generation protocol. This in my view is an Achilles heel.

Forcing the costs on those who don't need it will make even more ventures prohibitively expensive,   also for most current ventures we are choosing to self insure, why should we lost that right?   bit-pay already is offering this type of service for merchants from what they say, and if you really need non trival amounts there is always lloyds of london.    You can also cross insure if you want as well.   You are never going to get rid of all the risk in life.    I also see the generation protocol as a potential failure point, but not for the reasons you do.  I see what you want to do as far worse then what we have now.

[patvarilly]

@pat

You are giving miners a huge amount of power in your system. Do they have good incentives to make prudent decisions? 

Miners can be made wealthier in two ways:
Increasing the total social surplus created by bitcoin = the good way

Increasing the share of this surplus distributed as mining rewards = the bad way

If miners were representative of all potential beneficiaries from bitcoin it might not be an issue. I don't think they are. There is a significant danger that the system of one mined block one vote will lead to miners assigning themselves excessively large rewards.

Perhaps there are different ways of registering these votes?  The reason why I thought miners might do the trick is that the barrier to entry to mine is not too high, so anyone who wants to register their opinion about inflation rates can start mining and join a mining pool.  Right now, deepbit (the dominant mining pool) accounts for ~50% of new blocks.  I should also add that one might also implement speed limits on the rate at which the target inflation rate can be changed, in the same way that difficulty now can't be increased or decreased by a factor of more than 4 every two weeks.

Originally, I had liked Suggester's old suggestion of tying mining rewards to hash rates, so that the money supply would at least roughly track the number of active users weighted by their investment in the system.  But that doesn't really allow for monetary deflation when it's necessary, and it also ties up huge resources in mining, neither of which seems like a good idea.

I'd be happy to hear of other ways in which the target inflation rate might be determined.  Personally, I would favor something democratic and dynamic over an algorithmic solution, as a way to acknowledge that we're all fallible and can't perfectly predict the future, so we need a mechanism for allowing consensus decisions to be changed.

[markm]

Its called open source.

We simply start different blockchains fixing different imaginary and/or non-imaginary "problems", catering to various whims and so on and so on, and let the market decide.

("Heck if your kind had their way Satoshi would've bought shares of PayPal or something and made ad-hoc "adjustments" to "the system" instead of writing bitcoin..." )

-MarkM-

[bitterness]

Also, how do you decide which price inflation indicator to use? What we call price inflation is just the price index issued by the government. But Bitcoin has no government and the price index can be calculated in infinite ways.

Most viable would be imho a theoretical exchange rate against a basket of all major fiat currencies. But if you don't believe in them, that's probably not an option. Historians have a similar problem and afaik they often use a very basic and overall consistent measurement, the price of a cow.

[hawks5999]

What problem are you trying to solve?

Bitcoin not being enough like Federal Reserve Notes.

Let's go ahead and leave it busted.

[cunicula]

Also, how do you decide which price inflation indicator to use? What we call price inflation is just the price index issued by the government. But Bitcoin has no government and the price index can be calculated in infinite ways.

Most viable would be imho a theoretical exchange rate against a basket of all major fiat currencies. But if you don't believe in them, that's probably not an option. Historians have a similar problem and afaik they often use a very basic and overall consistent measurement, the price of a cow.

I agree that Euros and dollars will have a more stable long run valu than difficulty, but this requires a trusted mechanism for reporting exchange rates to the system. I don't see how this could happen without centralization. If someone has a clever mechanism for incentivizing nodes to make truthful reports to the blockchain, I would be very excited by that. (nerdgasm) It needs to be relatively low cost and incentive compatible (truth must always be more profitable than falsehood). Good luck with this designing these systems is challenging/maybe impossible.

[cunicula]

What problem are you trying to solve?

Bitcoin not being enough like Federal Reserve Notes.

Let's go ahead and leave it busted.

Different from the FED in that the goal would be to achieve deflation of around 2% or more per year. FED aims for inflation of around 2%. Also different in that currency generation is specified by an algorithm rather than an appointed commitee. Similar to the FED in that the system takes currency in and out of circulation to limit price volatility.