lbassotto (OP)
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Initial assumptions:
With the objective to make the comprehension of this article and the model exposition easier, we must adopt the following assumptions: The main currency in the economy is Bitcoin; The fiat money have lost their value constantly the way it's not even possible anymore to value them in terms of Bitcoin.
Introduction:
Nowadays there is a lot of challenges surrounding the Bitcoin, they are the rise of fees prices, lack of acceptance, Interface not friendly to new users and too much volatility in its price, what results in the low confidence of people to adopt the currency as a means of payment. However, it's a fact that Bitcoin is only 10 years old of existence and the market agents are still attempting to learn it's real value.
Taking a look at the revolutions that happened along the human history, we can see that there are complementary innovations that arise only to complement the productive process that is being practiced among the industries. There are either the disruptive innovations that happen in a short space of time and replace the whole productive process along the industries. Looking at Bitcoin ecosystem is to perceive that it's a disruptive technology distributed in a worldwide computer network that works under the trust principle in order to obtain rewards.
When there is no third party to mediate transactions, its cost tends to fall because of exclusion of a third part what will result in no more minimum value transaction necessary to occur. It will reduce the costs that involve a transaction because the two parts of this transactions don't need to know each other anymore so it reduces a lot of bureaucracy.
The purpose of this paper is to study the viability of an based on Bitcoin economy, where its agents make transactions, create new business and make economic calculus over this currency. For this, we will study the main obstacles and its possible solutions and chiefly shows the main advantages of an economy that has a decentralized, non-inflationary and trustable coin like the Bitcoin.
The high price of transactions fees:
Nowadays the Bitcoin demand presented an exponential growth, and his price grows up in a quick way too, what is resulted when we stand before a currency that has a very scarce and limited supply even in the long term. Therefore, the number of transactions that compete for trough the taxes in order to be registered in the upcoming block have growth too.
The Bitcoin inside its current structure can handle the number of 7 transactions per second, what is irrisory when compared to other mechanisms of payment like VISA and Mastercard. When there are too many transactions competing to be inserted into the block of 1MB size, the price of fees rises up exponentially what results in a long queue of hundreds of thousands of transactions waiting to get a single confirmation, this way the service becomes expensive and bad, so he becomes inviable to being adopted in business.
However, the Bitcoin code can be only modified through the community consensus (miners, developers, and nodes) and the modification (Bitcoin Improvements Proposal) must be lead in the best way as possible, in order to keep its core purpose and integrity, what results in a long wait until the appearance of a new and good solution. But it detaches the currency reliability because no modification can be done without the appropriate studies, evaluations and community consensus.
Today has a big team of programmers that work on Bitcoin code, moreover, there are near solutions upcoming that are being developed together with the community, chiefly the Lightning Network (that rises up the Bitcoin transaction potential to 1.000.000 of transactions per second). The LN opens a channel between two pairs that wishes to make a transaction, so the transactions will happen off-chain, separated from the Blockchain and there's a lot of tests that show the LN working and people making transactions paying a very cheap fee. It implies in many little value transactions will happen outside the main network (Blockchain), occurring inside the LN channels, this way the high-value transactions that need more confidence will occur inside the Blockchain.
There are others solutions that aren't a consensus among the community members, like the increase of the block size, what would make possible to Blockchain manage more transactions per second and the fees price to fall. But this would provoke the increase of transactions registry size, and this will result in the increase of structure cost to maintain the network up, centralizing her on enterprises that own enough capital to buy more computational structure to store the Blockchain, that may become bigger as it is used.
The Bitcoin scalability is not the main problem because there are near solutions both in the short-term and long-term being developed and adopted like the Lightning Network one. There are still solutions being developed for the long term that will solve the problem of the fee's high price without compromising the Bitcoin's principles: decentralization and confidence among the network members.
Lack of acceptance and the not friendly interface to the new users
There is a huge number of people that even know the Bitcoin and so far knows how does it work, what difficult companies to adopt the currency as a definitive payment service. Moreover, the operation and Bitcoin use may be complex for people that aren't used to face technology daily. If people don't use the cryptocurrency there is no demand for them on market and if there is no demand, it doesn't make any sense to accept this coin because there aren't any clients using them.
However, this problem solution may be reached through the education, the companies that deal with this technology must focus on educational products so the population can understand the reason, how it works, how to use and how to store the Bitcoin. As people are getting older, having fewer children and the quality of life is rising up around the world, the education must be focused on the elderly part of the population that will be the majority until the year of 2050.
In relation to the difficulties of interface like the reading of a Block Explore, difficulties on the wallet use and other problems. There are a lot of companies focused on Customer Experience when they offer services and it changes the scenarios when we talk about issues about usability because these companies that offer services like Wallet, Storage, Block Reading, investment and others, are focused on offering a clean and user-friendly interface to the few experienced users. Anyway, the difficulties are being solved in a very fast way by companies and developers that focus on Customer Experience and they are compromised on usability improvements.
Volatility
The problem of volatility comes up when it is considered the fact that the Bitcoin still is traded on the Fiat Money x Bitcoin pair. As the agents are still learning its real value, his price will oscillate until it reaches a conclusion through the interactions of Inelastic Supply and Extremely Elastic Demand. There are cases that the currency shows a 10% volatility for more or less what difficult its adoption for companies because the prices should be remarked every minute what would appear that the economy is living a very extreme deflation or inflation case.
However, the price of fiat money currency in terms of Bitcoin is going down in an accelerated way as the year's pass, in function of that, it's perfectly imaginable the scenarios what the fiat money is gradually being placed by the cryptocurrency because the agents are losing the confidence over the fiat money.
The fiat money has the feature of not having any coverage or scarcity because its value is merely based on trust. Because of this features the fiat money becomes an extremely inflationary currency and therefore, there is the fact she is centralized and her use is forced by the federal laws and the government has its monopoly of emission. The Bitcoin other side is the antithesis of these features presented by fiat money, once he is covered by the mathematical laws and he is extremely scarce, non-inflationary, decentralized and his use can choose if people really want it.
The economic agents must price their assets in terms of Bitcoin purely, they can use the fiat money to start a price base, however, the price must be expressed in terms of Satoshis (monetary unity of Bitcoin) purely with this price floating according to interactions between supply and demand inside the economy, using other words, this market must be a pure competition market.
In a Bitcoin-based economy, would not have inflation and the prices would be changed according to the market necessity and not remarked month by month because of inflation. That would make easier to count the costs, the incomes and the profits, what will make the companies balance sheet more legit with time because the balances will not be adjusted according to the inflation and the entrepreneurs really know how much profit are they getting. The market will become more rational in terms of supply because the entrepreneurs will get a better knowledge of how much are they spending and gaining, so the projects will become more rational and will spend fewer resources that will be needed in the future.
An rational economic system with Bitcoin
Before studying Bitcoin it is necessary to study his emergence context. On the peak of 2008 financial crisis, the richer economies central banks (Europeans and Americans) started to adopt the use of Quantitative Easing that consists of new money creation in order to buy toxic assets from important banks inside the economic system, reducing these banks obligations and avoiding their insolvency, using other words, the Quantitative Easing consisted in bailout for banks.
These events exposed the failures of this present economic model being practiced nowadays which is a model that has its foundations on centralization, big banks cartelization, and economic irrationality. Many people lost almost all their money, what arisen the questioning: "Am I the actual owner of my money and wealth?"
The Bitcoin proposes a disruptive solution to the present economic system, he proposes a solution where the people don't own financial independence anymore but the financial freedom. The concept of financial freedom consists in the fact that people are free to manage their money by themselves, without depending on great institutions like banks and governments. The Bitcoin makes possible to people actually be the real owners of their wealth because it is a trustable monetary system, decentralized, non-inflationary and rational.
The inflation is an evil that corrodes the entire economic structure over time. It can be defined as an increase of money supply inside the economy meanwhile the production of goods and productivity are stagnated. The result is a generated and continuous rise of prices in the economy because the productivity and goods have not been increased too. The entering of new money among the economy doesn't happen through the linear form, in other words, there are people that receive that new money before and there are people that will only receive this money much more later. This increases the purchasing power of the ones who got the money earlier (Banks, public agents, and the state services providers) when compared with who got this new money later (generally the poorest part of the population and far from the great financial centers).
We can say that inflation doesn't occur like described on Quantitative Theory of Money, where the increase of 30% money supply will result in 30% rise of economy prices, she happens in different stages and sectors inside the economy. The inflation can be illustrated like different waves on the ocean who gets more and more larger over time. The government has the monopoly of money emission guaranteed by law so the central banks and the rest of the banks can create money from nothing like magic thanks to the fractional-reserve banking system.
Therefore, inflation is the way to economic disaster leading the economic agents tending to evaluate the present goods instead of future foods, what will result on a higher time preference inside the whole economy that will lead to higher interest rates in the present time. The agents of inflationary economy save less money because there is no reward or incentive to make savings because the agents will expect that the prices will rise in the future time, so there is no reward for abstaining the present consumption. Which means the demand for the entire goods from this economy will be changed to the short-term instead of the long-term, so the chain of production becomes less extensive and less complex.
A higher time preference will result in lowest levels of society savings what will lead to higher interest rates. The higher interest rates will make the credit inside this economy more expensive, what means the entrepreneurs will not invest in expensive capital because their real profits will be lower when discounted the loan rates from their profit rates. When it happens the economy becomes less productive and becomes stagnated without presenting any development.
On the other hand, a lower time preference will result in highest levels of saving from society what will result too in a lower interest rate. The lower interest rates will make the credit become cheaper so the entrepreneurs can invest now in more complex projects oriented to the long-term because the society will demand more goods in a future time. The companies start to build a more complex and efficient means of productions inside the industry. The technology improves and this economy starts to develop for the future so the society gets richer in the future.
The government can use the laws in order to lower the interest rates so the investment gets cheaper, this way, the entrepreneurs tend to think there are more funds being saved by society at the present time. They start to make more complex projects oriented to the long-term and to make longer their productive chain to offer more goods in the future.
The problems start when happens a mismatch between supply and demand of goods, because the businessmen are now thinking in the long-term meanwhile the consumers are thinking in the short-term because the reward for saving is lower and the mortgage costs become cheaper. The consumer, therefore, will keep his usual consumption and when the consumers go the market again the mismatch will become evident because that whole chain of complex production will be revealed as a complete waste of capital once there is a larger demand for present goods instead future goods.
All that investment will be revealed as irrational, or mal-investments and the companies will need to fire employees and settle their capital. This process will result in very companies facing the insolvency of the whole industries that employed thousands of people. When the demand is reduced the economy will hit a recession until it comes back to the normal situation, what can take a long time depending on how much time the low-interest rate politics was in force.
This kind of pattern happened in 1929 crash and repeated in 2008. The Austrian School of Economics was the single economic school capable trough her theory "Austrian Theory of Economic Circles" of anticipating the events that triggered both economic disasters. The central point of this theory is that the government through the money creation or interest rates manipulation can deceive the economic agents into a systematized error along the entire economy. They will face a certain period of abundance also known as "Boom" but there will be a hard depression, also known as "Burst".
The Bitcoin helps to avoid this scenario of economic disaster. Once it is impossible for a single one entity to control his supply because she is very limited to 21 million, this way there is no inflation in an economy based in Bitcoin. When we face a society where there is no inflation the agents will be more responsible when they have to consume because this currency can worth more in the future. In other words, the people will experience an increase of their time preference, what will make them save more because the future goods will be cheaper.
A greater saving volume which is possible because of lower time preferences results in a lower interest rate. The entrepreneurs will capture these legit signals from the market so they can improve the chain of production of their companies. The productivity will be increased and the companies will invest in more technology and the future goods will be increased so the country will become richer and prosper over time.
Conclusion
At this article were shown the difficulties relational to the Bitcoin implementation at companies, where shown either the solutions for these difficulties and that many are already in course. Besides, it is noticed that Bitcoin will be only viable in an economy only when the exposed problems in this article have been solved and he is the only one currency in the economic arrangement. The market agents would need to price their good exclusively in terms of Bitcoin, excluding so the exchange between the fiat money and Bitcoin, because this exchange would provoke a lot of volatility in the prices.
Therefore, was shown how the Bitcoin can make possible the economy more rational, avoid great recessions and financial crisis that happened in the human history. We must be careful with this cryptocurrency because it is new kind of asset and it is facing constant changes, however, having the comprehension that Bitcoin can change permanently the economy as we know today it is a must.
Bibliography:
What has the government done to our Money? (Murray Rothbard)
Action, time and knowledge (Ubiratan Iorio)
Bitcoin: a peer to peer electronic cash system. (Satoshi Nakamoto)
Democracy: The God that Failed (Hans Hermans Hoppe)
Human Action (Ludwig Von Mises)
This article was written by Lucas Bassotto da Silva. Economics student and present Community Manager of FoxBit.
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