Finite Supply vs Steadily Increasing Supply

[temp1029]

This is not a post intended to point out any flaws in Bitcoin nor is it intended to suggest any changes.  I am simply looking for input from the Bitcoin community on my ideas.

From what I understand the problem with many fiat currencies is the incentive for the printing authority to increase the number of notes in circulation.  The reason this incentive exists is because of the time-lag between the increase in the money supply and the corresponding increase in prices.  Additionally, when the printing authority and government are one in the same, there is an additional, political cause of this incentive in that it allows politicians to spend on programs that will keep them in office while not immediately and plainly passing the costs onto their constituents.

In the longer term, the inflated money supply causes price inflation.  However, despite this, Bitcoin is currently in an inflationary period (until all 21 million are mined) and there is actually price deflation overall (ignoring the ups and downs due to the current volatility).  I believe that this is because in the much longer run there is a known, finite amount of Bitcoin.  Basically, despite the current fluctuating quantity of Bitcoin, there is long term stability, which, from my understanding, is the ideal state for any currency.

While I believe this is a good thing, since I view inflation (and the following price inflation) as tantamount to theft, the downside is the risk of coin loss.  I am not concerned with an individual's loss of currency, but the loss to the system as a whole and over time.  This problem is made more dangerous, in the Bitcoin case, by the current concentration of coins in the hands of the few.  I will pause here to indicate that I believe any allocation of wealth to be just and take no issue with someone or group of someones amassing any degree of wealth, so long as they do so by honest means.

All of this being said, I wonder if a currency where the supply is constantly increasing, to replace lost or inaccessible currency, but at a defined and unchanging rate.  While this still would likely amount to overall inflation, the inflation would be totally predictable and controlled (the purported holy grail of modern central banking), thereby allowing people to predict and account for any price inflation that might follow.

To sum up, my basic argument is this

1) The best possible state for a currency is one of stability
2) Units of currency are lost or made inaccessible

Therefore;

Controlled and steady inflation is better than a static money supply.

Any further thoughts?

[kjj]

1) The best possible state for a currency is one of stability
2) Units of currency are lost or made inaccessible

Therefore;

Controlled and steady inflation is better than a static money supply.

1 is not a given.  You can't possibly define "best", much less "stable".  Hell, you probably can't even define currency, but that isn't important here.   At any rate, you certainly haven't tested various configurations to check their properties for bestness (whatever that is).

Also, it does not appear to me that your conclusion follows from your argument.  You have a bait and switch thing going on.

[minerva]

Constantly increasing the supply by X% adds another variable to the equation. A fixed supply eliminates a variable and thus increases stability.

...no it doesn't. It doesn't increase price stability.

[temp1029]

Thanks for your response, I was hoping for responses like this to help me flesh this out (or prove me wrong).

1 is not a given.

I take number one as coming from the essential functions of money, primarily that of a "store of value".

You can't possibly define "best", much less "stable".

Agreed that I cannot define those terms from an empirical standpoint.  I should probably have worded my first premise differently.  How about this:

1) Stability in supply supports the essential functions of money

Hell, you probably can't even define currency, but that isn't important here.

I do admit to falling into the definition of money vs currency trap (if that is what you were talking about) and am not careful enough with how and where I use those terms.  Any help in better differentiating when to use one versus the other would be appreciated.

At any rate I would be interested in your definition.

At any rate, you certainly haven't tested various configurations to check their properties for bestness (whatever that is).

Correct, this is a purely hypothetical exercise based on assumptions.

Also, it does not appear to me that your conclusion follows from your argument.  You have a bait and switch thing going on.

Given my redefined first premise, do you still think so?  If so, can you explain?

[temp1029]

Constantly increasing the supply by X% adds another variable to the equation. A fixed supply eliminates a variable and thus increases stability.

minerva already beat me to this, but I would like to expand on my reason as to why I don't agree with your statement.

First, 'X' can be thought of as variable, whereas in my suggestion it is not, but instead a statically increasing rate for all time (ignoring an initial growth period which is essential to any new system like this).

Second, I believe that a static supply has the potential to increase price VOLATILITY, since the quantity of the currency would slowly decrease over time (see premise #2) thereby driving up prices.

Please don't mistake my ideas to suggest that we could have perfect stability.  I only seek to determine if offsetting the loss of currency by steady inflation would help decrease the volatility of prices as compared to either fiat currency (where inflation is unchecked) and a system with a static money supply (where deflation would be unchecked).

In any case thank you for your post, it helped me being these points (previously omitted) out.

[maxxoccupancy]

This chart and the article attached to it explain the need for monetary stability much better than I ever could.  Basically, you have to start with a deflationary currency in order to get it widely established.  Once it's widely accepted, you lower the rate of return until you can get as close to zero as possible.  Ideally, you develop an inflation rate over the long run that tries to stay between 0-2%, which would not be difficult at all with a crypto-currency.

http://www.economicsonline.co.uk/Managing_the_economy/Stable_prices.html

It erodes the value of money and assets
It redistributes income between groups
It is bad for the balance of payments.
It causes uncertainty and falling investment.
Falling confidence is likely to force firms to postpone capital investment.
It creates ‘shoe leather’ and ‘menu’ costs.
It can create unemployment
Inflation distorts the price mechanism and creates inflation noise

[maxxoccupancy]

Perhaps I should say that the theoretical ideal for any altcoin is that the largest possible community gets involved with the highest possible market cap gain (for their efforts) with the lowest possible risk, thereby maximizing risk vs. reward.  There are funds on the stock market that err heavily on the side of lowest possible risk, rather than being get-rich-quick options.  In my mind, this would be a better altcoin option (for those who want or need greater stability for some part of their portfolio).  Money market funds, stable value funds, treasuries, and municipal bonds tend to offer poorer returns, but manage a large market cap anyway, because there is less chance that such diversified funds will decline.

Accomplishing the same with an altcoin, in my mind, means gaining maximum growth through CPU mining (since everyone has a CPU, and there are various barriers in place to buying altcoins with the cash in your pocket).  Developing a wide index of prices (precious and semi-precious metals, international price indices, etc) would be the difficult part.  Reading in those values each day to determine if and how much demand exists for reward coins is less difficult.  New altcoins are less known, are accepted by fewer vendors, and will be seen on fewer exchanges.  Early adopters need a real incentive to download the wallet and CPU-mine, but that increase can decline as such an altcoin becomes more widely used.

[teukon]

I am not concerned with an individual's loss of currecny, but the loss to the system as a whole and over time.

Here's your problem.  You concern yourself with one side of an equation while dismissing the other side.

The reward of monetary deflation is neatly countered by the risk of coin loss.  This is a truer stability, the stability of the average purchasing power of a position in Bitcoin.


"Bitcoin hoarder greedily increases holding as others lose keys.  Loses key."

[temp1029]

That is an excellent article and I really appreciate you sharing it.  I don't pretend to know what inflation rate would be ideal (nor do I think anyone could know for all time what it would be), but instead, an arbitrary, but informed, decsion would need to be made about the inflation amount, just like with the arbitrary limit of 21 million Bitcoins.

Developing a wide index of prices (precious and semi-precious metals, international price indices, etc) would be the difficult part.  Reading in those values each day to determine if and how much demand exists for reward coins is less difficult.

I don't think this would be needed, as the inflation amount would be a hard limit included as part of the protocol.

New altcoins are less known, are accepted by fewer vendors, and will be seen on fewer exchanges.  Early adopters need a real incentive to download the wallet and CPU-mine, but that increase can decline as such an altcoin becomes more widely used.

I believe the model laid out by Satoshi is correct, higher rewards at the beginning and diminishing over time.  I am just not sure that the reward should diminish to zero.

[temp1029]

I am not concerned with an individual's loss of currecny, but the loss to the system as a whole and over time.

Here's your problem.  You concern yourself with one side of an equation while dismissing the other side.

The reward of monetary deflation is neatly countered by the risk of coin loss.  This is a truer stability, the stability of the average purchasing power of a position in Bitcoin.


"Bitcoin hoarder greedily increases holding as others lose keys.  Loses key."

But wouldn't the purchasing power of Bitcoins be increased by the loss of some Bitcoins (i.e. deflation)?  Since Bitcoin is designed to be deflationary, even if no-one ever loses a single coin, then loss of every coin increases that deflationary bias.

Again, I don't seek to find a perfect equilibrium, as I'm fairly certain that isn't possible, but instead to offset the deflationary effect of lost Bitcoins.  For me, the best way to do this seems to be via predictable inflation.

I see three scenarios:
1) Fewer Bitcoins are lost than are produced through inflation, so the newly created currency drives prices up at a rate people can account for, since they know the maximum it could be.
2) The amount of new currency produced is equal to the amount lost then no inflationary or deflationary effects ensue directly (for me this would be the ideal), people who accounted for inflation come out on top since the currency they have has retained its value.
3) More coins are lost than are produced via inflation, prices are driven down, people who counted on inflation are even better off than they would be in either of the two scenarios.

In scenarios 2 and 3, the spending of the "extra currency" (as people now have greater purchasing power than they expected) would create inflation, as pent up demand (from the purchases forgone to accont for inflation) is released.  Additionally, for number 3, this would also serve to offset the deflationary effects of the additional lost coins.

[I_bitcoin]

My .02 mBTC analysis.

It was hard/impossible to make dollars and gold infinitely divisible.  This meant inflation is required to ensure enough money supply to address rising populations and etc... Bitcoin, for our purposes, allows for this.   You don't need inflation to ensure sufficient monetary supply if the monetary supply is highly divisible.   Make sense?

[temp1029]

My .02 mBTC analysis.

It was hard/impossible to make dollars and gold infinitely divisible.  This meant inflation is required to ensure enough money supply to address rising populations and etc... Bitcoin, for our purposes, allows for this.   You don't need inflation to ensure sufficient monetary supply if the monetary supply is highly divisible.   Make sense?

Absolutely and I agree with you that this will work...to a point.

Over time the loss of coins can add up, especially if we consider Bitcoin as a long term currency.  Additionally, there is currently a high concentration of coins in the hands of a few (see https://bitcointalk.org/index.php?topic=316297.0), so the loss of any one of those private keys would be a major blow and cause severe instability as the supply was reduced.

A simple scenario I came up with involves the recent arrest of Ross William Ulbricht.  If he had gotten wind of them coming to arrest him (say by looking out his window as they rolled up) and was in a position to "nuke" all of the computers that housed the private keys to his and Silk Road's Bitcoins (maybe thinking that it would keep him out of jail), this would be a major problem.  If not a major problem immediately, then maybe down the road after similar scenarios play out again and again.

[I_bitcoin]

My .02 mBTC analysis.

It was hard/impossible to make dollars and gold infinitely divisible.  This meant inflation is required to ensure enough money supply to address rising populations and etc... Bitcoin, for our purposes, allows for this.   You don't need inflation to ensure sufficient monetary supply if the monetary supply is highly divisible.   Make sense?

Absolutely and I agree with you that this will work...to a point.

Over time the loss of coins can add up, especially if we consider Bitcoin as a long term currency.  Additionally, there is currently a high concentration of coins in the hands of a few (see https://bitcointalk.org/index.php?topic=316297.0), so the loss of any one of those private keys would be a major blow and cause severe instability as the supply was reduced.

A simple scenario I came up with involves the recent arrest of Ross William Ulbricht.  If he had gotten wind of them coming to arrest him (say by looking out his window as they rolled up) and was in a position to "nuke" all of the computers that housed the private keys to his and Silk Road's Bitcoins (maybe thinking that it would keep him out of jail), this would be a major problem.  If not a major problem immediately, then maybe down the road after similar scenarios play out again and again.

It is very interesting to try to grok what might happen in the far future if Bitcoin has taken significant stake in economies.    We can scale all the way down to 1 Bitcoin so 100% loss is certainly not likely in our, or our great grand childrens, lifetime.

My assumption is that each loss eventually prices in to a basket of commodities (or dollars) if it is relevant.   If bitcoins are lying stagnant in a wallet there may be little/no loss to the economy.   Same way having all that money sitting on bank balance sheets is having no impact on inflation (unused means not relevant).

[qiwoman]

Now BTCis more in the hands of speculators and traders who can easily manipulate and create pump and dump mode but apart from this due to the fact that BTC was the first protocol of it's kind to be introduced as a form of monetary transaction this is now becoming more and more useful as a mainstream tool to interact globally in the transactions market. The more and more mainstream it becomes the less volatile the coin will be and although it will be played always in the trading rooms against other currency pairs it is now accepted as a new emerging monetary system of the future..

[teukon]

Again, I don't seek to find a perfect equilibrium, as I'm fairly certain that isn't possible, but instead to offset the deflationary effect of lost Bitcoins.  For me, the best way to do this seems to be via predictable inflation.

But that's just it.  The deflationary effect of lost Bitcoins is already offset by the risk involved with holding them.  There's already balance.

I feel that we are aiming for the stability of subtly different things.  Please tell me what you think about the following scenario (you may assume no variation in the size of the underlying economy, no coin loss, no block rewards, and no divisibility limit):

I design an altcoin called Deflatacoin.  This is identical to Bitcoin but where on each day, the balance of each wallet is reduced by 0.1% (0.1% of all deflatacoins are destroyed).  This causes serious price deflation (about 44% per year).

Is this price deflation economically problematic?  Should it be countered by an equal amount of monetary inflation?  Is this currency more stable with or without the extra inflation?

[teukon]

It is very interesting to try to grok what might happen in the far future if Bitcoin has taken significant stake in economies.    We can scale all the way down to 1 Bitcoin so 100% loss is certainly not likely in our, or our great grand childrens, lifetime.

To clarify:

Even if a whopping 10% of all available bitcoin were lost every single year it would take more than 175 years (from genesis) to reduce the total supply to 1 BTC.  This is about as far from "problem" as it's possible to be.

[maxxoccupancy]

Lots of people (including me) have lost bitcoins due to loss of hard drives, data loss, exchanges crashing, fraud, or just money lost in the system somewhere.  Who knows how all of these coins are getting lost, but these costs (theft, fraud, shoplifting, bank failures, stock volatility, etc) reduce the value of earning and investing dollars, euro, yen, yuan, etc.

[temp1029]

But that's just it.  The deflationary effect of lost Bitcoins is already offset by the risk involved with holding them.  There's already balance.

I think I am starting to see what you are saying here.  Is it something along the lines of "people know about the risk of losing Bitcoins and account for it accordingly"?  Sorry, I'm probably being dense on this one...

I feel that we are aiming for the stability of subtly different things. 

I am looking to make economic calculation as easy as possible.  The more stable prices are (i.e. the degree to which they are likely to change over time) the more easily someone can plan for the future.

Please tell me what you think about the following scenario (you may assume no variation in the size of the underlying economy, no coin loss, no block rewards, and no divisibility limit):

I design an altcoin called Deflatacoin.  This is identical to Bitcoin but where on each day, the balance of each wallet is reduced by 0.1% (0.1% of all deflatacoins are destroyed).  This causes serious price deflation (about 44% per year).

Is this price deflation economically problematic?  Should it be countered by an equal amount of monetary inflation?  Is this currency more stable with or without the extra inflation?

I would say it is not problematic as it is a static amount each day, which is something people can account for.  If the amount were variable, as in the case of lost Bitcoins, there is no way people could account for such loses.  Giving them a know offsetting amount allows them to plan better, although still not perfectly.

[godislove]

To sum up, my basic argument is this

1) The best possible state for a currency is one of stability
2) Units of currency are lost or made inaccessible

Therefore;

Controlled and steady inflation is better than a static money supply.

1)  Yes, a stable value in a currency and money is that the prices of products and wages and the numbers written in all kinds of contracts do not change with time.  This allows everyone to easily estimate the value of things and make long term contracts. The best way according to the brightest thinkers of the 20th century is to track a basket of commodities.  This is because commodities are the basic input to everything else society does. Problems arise in trying to decide how the government "print" and "unprint" the money to reflect changes in the supply of the basket of commodities.  As the physical existence of the commodities on the world or national market increases or decreases, you increase or decrease the amount of money.  This prevents macro bubbles in the economy.  You basically strangle the economy when there are not enough commodities in the pipeline to support the amount of money that gets into the marketplace and starts demanding it.  If it is a sustainable demand for over a year, the signal gets through and after about 5 years the commodity producers have increase supply to meet demand.   If the currency starts getting adopted outside of your country, then its supply domestically is reduced which increases its value which would mean the written number for store prices and wages are too high compared to the reality.  People who have stored wealth in terms of the currency would get wealthier.  Those who have large incomes relative to what they spend also get wealthier.  Those barely scraping by stay the same, still spending everything they make.   Notice that the wealthier got wealthier without doing anything for it (unless they are part of the reason the currency was demanded more in the world).  All the numbers in the market are now distorted, slowly adjusted to be correct.  Your workforce is no longer competitive in the world market, if you have free trade.  So the thing to do is increase the money supply in order to let the world use your currency.  The government can just simply print it and spend it on something like a bloated military.  If you don't print the extra money to make up for the increase in its use, you better enact trade blocks to protect your workforce, or do like China and enact blocks on the currency.  Both methods force your people to work for what they get, and even more than that like in China.  Making the people work harder enables wealth to build up in the system.  For example, China is building up gold and not telling just how big it is, not reporting the results of a massive domestic mining effort.  I expect China to announce a free-floating RMB back by gold when the dollar finishes collapsing.  They should be mostly out of excess U.S. dollar holdings in 2 years.  When this happens, they'll be able to buy up the world's commodities with a strong viable currency that was created by hard work.  By 2020 they'll have 10 times more engineers than the U.S. to make good use of it and the rest of the world will have reduced workforce, so they don't even need to enact trade blocks to offset the increase in the value of the currency.  It'll just rise to where it should be anyway, unless the world adopts it...which I hope not!  What are we going to do if not bitcoin? End the Fed?  That would be bitcoin's worst nightmare.  Actually they already have 10 times as many real engineers working compared to so many U.S. engineers that simply have a degree and a non-productive job.  The use of your currency also expands if your GDP expands.  If your GDP expands, your commodity availability should have expanded, and therefore you have enough currency to meet the larger demands of its use in the market.  However, if you have a fake GDP because you're measuring bank and insurance company incomes as GDP instead of restricting the GDP measurement to manufacturing and useful services, then the GDP expands without a concomitant increase in the commodities that support a real economy.  So by inflating currency only with commodity increases, you will strangle non-useful economies before they get into a housing bubble that was being pushed by banks that flooded the market place with money.  This is why commodities went up in price a 300% since 2000. Fair value for gold back then was about $400 even though actual price was biased low, about $250.  So today's $1200 for gold is almost no increase at all compared to the average of all other commodities.  

2) Yes, if you own bitcoin, you want as many people as possible to lose theirs so that your wealth increases without doing any work at all.  

No, steady inflation is not the answer.  Intelligent inflation and deflation by a useful central authority is needed.   This seems impossible in the U.S. so the answer right now is bitcoin.  Since we can't have an intelligent currency that responds to the needs of the marketplace, we need an unforgiving currency to destroy banks, government, and stupid people who voted them into office so that we can start over.

[kjj]

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Nowhere in your wall of text did you realize that contracts could specify valuation in terms of a basket of goods without putting the currency itself in the hands of madmen?