Bitcoin's largest hurdle as a useful currency

[Steve]

So basically, a price in each currency based on current exchange rates between them...how is that any different than what we have now? I mean, it still requires you to pay with the currency you hold. If you hold one that fluctuates wildly with respect to others, you'd dump it in exchange for something less volatile.

It's not that different except for the fact that you establish prices relative to other real goods (the index) instead of relative to any currency.  By doing so, your real prices aren't affect by the mismanagement of a currency or swings in the market.

I'm not sure what you think is in the realm of reality about the existence of volatility; What, exactly is flawed about the fact that relative to what you can get, goods-wise, BTC is more volatile than USD?

I never said btc wasn't more volatile than usd.  Most currencies are naturally going to be more volatile than the currency that is predominantly used for pricing purposes.

I'm talking about the natural tendency for mediums of exchange to disappear as such because they are more volatile, relatively, to others. It doesn't matter a whit whether it's backed by Mariah Carey's ruined tits, my pubes, or artificial diamonds. The more volatile "currency" dies in favor of the less.

Are you sure about that?  Gold is certainly more volatile than dollars relative to real goods.  Gold has not disappeared.

It just so happens that Fed-backed USD has a centralized control on it's volatility, whereas gold does not. This has potential problems, but is far beyond the scope of this discussion. Fact is, BTC sucks because of it's volatility relative to USD, whatever the reasnos, and people are choosing not to transact with it for this reason, among others.

Do you disagree with this?

I do.  I have transacted nearly as much in btc the last few months as I have in usd.  I'm finding many people that appreciate the convenience of bitcoin and like using it.  If people find it useful and use it, while it might be volatile, the long term trend will be up and people will tolerate the volatility.

[jtimon]

Steve, I have thought a lot about a bitcoin-like currency with stable prices and I think that's impossible.
Here I have a proposal for an index reference currency similar to the one you talk about:

https://bitcointalk.org/index.php?topic=11614

We can price in RFC (referenceCoins) and pay in bitcoins. Prices would be volatile in dollars too.
What we're talking about here is separating the "measure of value" function of money.
Loans and other contracts can be signed in RFC too.

[cbeast]

I don't get this whole "price fixing" and "pinning" bitcoin to anything. It seems to me this means someone must back bitcoin with something like the dollar used to be with gold and silver. Who would do that?

[jtimon]

No, bitcoin will fluctuate freely and the reference currency is not backed because it doesn't exists, it is not issued.
For example, you sell a beer for

1 reference currency  1 usd, 0.20 btc

with time you sell the same beer for say

1 rfc, 1.05 usd, 0.17 btc

No one can pay you with rfc because it is not an actual currency, you're just pricing in it.
If you define it, for example,
like 1000 rfc = {
1 barrel of oil +
100 gr of silver +
0.5 ton of wheat +
100 kgs of rice +
...
}
you don't have to store all those commodities, it's just a definition and you don't need to back it.
What I propose is voting inside a chain for the prices in btc of 1 barrel of oil, 100 gr of silver, etc so you can have the price in bitcoins of a rfc (or the price of a btc in rfc). Miners won't have any special incentive to lie in those price reports because it won't affect the issuance of btc, they will get the same lying or not and lying they take the risk of their block not being accepted.
You can also implement the reference currency just with a web following the definition, that last proposal was to decentralize the reference currency.

[cbeast]

So if BTC is pinned to an index, then your wallet would fluctuate with the market. Who would you trust to report the index?

[jtimon]

Would fluctuate only in rfc terms, not in btc terms. You can have a client denominated in btc, rfc or both.
Like I said, I'd like to trust a chain for that, but I could just trust various private rfc reporters and compare them.
The definition would be an open standard.

[Steve]

Steve, I have thought a lot about a bitcoin-like currency with stable prices and I think that's impossible.
Here I have a proposal for an index reference currency similar to the one you talk about:

https://bitcointalk.org/index.php?topic=11614

We can price in RFC (referenceCoins) and pay in bitcoins. Prices would be volatile in dollars too.
What we're talking about here is separating the "measure of value" function of money.
Loans and other contracts can be signed in RFC too.

I haven't read your proposal in full, but yes, that's basically the idea.  Such a reference coin (and there could be many different ones indexed to different things that people derive real value from) could be used generally as a unit of account and for pricing.  When you think about it, it makes sense to think of the value of things relative to other things we desire since the whole reason we work is to afford those very things (either now or in the future).  The most basic such reference index could be: 1 = the price needed to provide 1 day of basic sustenance for the average person in some region

Also, I believe that over time the market will start to develop derivative instruments that either help to stabilize the value of a bitcoin, or that create derivative, privately issued coins, that use derivatives and hedging techniques to create stability.  Bitcoin itself might remain fairly volatile even once it has achieve broad use, but you might have an alternative to purchase company X's coins that provide more stability (and those coins could be made compatible with bitcoin based payment systems).  We're a long way from this of course, but I do see it as the likely shape of things to come.

I do agree completely that the volatility of bitcoin is an impediment to its use, however I also believe there are ways of dealing with it (today, and even more in the future).  Consider that you can buy bitcoins on an exchange today in cash...you can withdraw cash, make the deposit and you'll have the money in an exchange all within ~1 hour.  You can make the bitcoin purchase on the exchange and then buy something with it.  The merchant can then transfer those bitcoins to an exchange and sell them within ~1 hour (or use a service like bit-pay that can convert to dollars for a flat rate).  Total exposure to the bitcoin volatility is on the order of a few hours in that case.  Now, you might say why go through all that hassle, but you have to remember that bitcoin does have advantages in that it's an irreversible, 2 party transaction that is relatively private.  There are transactions for which those are important properties and which would warrant the effort.  The other possibility is that you accept the volatility but believe in the long term value proposition of bitcoin and hence you don't have an issue holding and transacting with some bitcoin.  Again, I agree with the OP that volatility is an impediment, one that can (and very likely will) be overcome in time.

[BitMagic]

Are you sure about that?  Gold is certainly more volatile than dollars relative to real goods.  Gold has not disappeared.

Ah, as a medium of exchange, it has certainly disappeared almost entirely, unless someone wants to bargain with it. As a commodity, it still exists. I was referring to volatility's role in currency, not commodity.

I need to read up on this price indexing system, to really understand what's happening here. I am having trouble imagining exactly how these would work, even with the explanations above. I'll be right back.

Edit: So let me get this straight. Reference currency is defined by a set basket of goods, and an index shows currency exchange rates against this reference currency. So in this case:

1 rfc, 1.05 usd, 0.17 btc

If I had 1.05 dollars or .17 btc, I could purchase a 1 RFC priced item, correct?

Question:
What determines these USD/RFC, BTC/RFC rates?

a) If rates are determined by sellers: then you have nothing new. Pricing responds to demand and increase/decrease of currency quantity just as before, and that volatility associated with this helps you decide which currency (in relation to RFC) is the most stable for what you can get with those goods. I'll leave out the simple example unless it becomes clear you don't know what I mean.

b) If rates are determined by central authority: ex: 1RFC = 1USD = 1BTC = 1JPY, you now have a complete Soviet-esque command economy. You are not actually suggesting this...?

[jtimon]

Also, I believe that over time the market will start to develop derivative instruments that either help to stabilize the value of a bitcoin, or that create derivative, privately issued coins, that use derivatives and hedging techniques to create stability.  Bitcoin itself might remain fairly volatile even once it has achieve broad use, but you might have an alternative to purchase company X's coins that provide more stability (and those coins could be made compatible with bitcoin based payment systems).  We're a long way from this of course, but I do see it as the likely shape of things to come.

This reminds me to sacarlson's beertokens, a privately issued block chain.
https://bitcointalk.org/index.php?topic=9493

He's developing multicoin to implement beertokens:
https://bitcointalk.org/index.php?topic=24209.0

[jtimon]

Ah, as a medium of exchange, it has certainly disappeared almost entirely, unless someone wants to bargain with it. As a commodity, it still exists. I was referring to volatility's role in currency, not commodity.

I don't think there's too many, but there's people trading with precious metals:
http://www.youtube.com/watch?v=nNtIsSWVJBI

Look who wanted to use it too:
http://www.youtube.com/watch?v=PLJu0X14vmg

Even if it weren't used as money, gold has most of its value from the fact of being money for thousands of years and that it has the qualities to become the medium of exchange again if people want it to.

[Steve]

Also, I believe that over time the market will start to develop derivative instruments that either help to stabilize the value of a bitcoin, or that create derivative, privately issued coins, that use derivatives and hedging techniques to create stability.  Bitcoin itself might remain fairly volatile even once it has achieve broad use, but you might have an alternative to purchase company X's coins that provide more stability (and those coins could be made compatible with bitcoin based payment systems).  We're a long way from this of course, but I do see it as the likely shape of things to come.

This reminds me to sacarlson's beertokens, a privately issued block chain.
https://bitcointalk.org/index.php?topic=9493

He's developing multicoin to implement beertokens:
https://bitcointalk.org/index.php?topic=24209.0

Exactly!  I hadn't seen that before.  So beertokens is both an index (to Leo Beer in Thailand) and a currency.  Unlike bitcoin, you have to trust a central issuer of the currency...holding a beertoken is basically a contract with this central issuer.  Beer would be fairly easy to hold as backing for this currency.  This is rather like any commodity backed ETF that holds the actual commodity, but with the key difference that the shares are issued as crypto coins and would be readily compatible with existing bitcoin payment infrastructure.  A Multicoin wallet capable of holding both beercoins and bitcoins would let you easily diversify your holdings without compromising privacy.  A beercoin would have absolute stability relative to the price of a can of Leo Beer in Thailand (as long as you trust the issuer).  You could decide what percentage of beercoin and bitcoin you prefer to hold and when making purchases, the system could automatically spend a percentage of each so as to maintain that balance.  Likewise, merchant that accepts both bitcoin and beercoin could decide what allocation of each they prefer to hold and have the system automatically maintain that percentage as they received payments for goods.

[Steve]

Ah, as a medium of exchange, it has certainly disappeared almost entirely, unless someone wants to bargain with it. As a commodity, it still exists. I was referring to volatility's role in currency, not commodity.

Yes, but that's primarily due to convenience issues...if it were as easy to use as checks, credit cards, or cash, and if the US gov't had not confiscated it in 1933, I'm quite sure people would still be using it regularly for exchange...once it became fully decoupled from the dollar (such that Gresham's Law would cease to apply), it might have even become the dominant form of money (which is probably why it was banned in 1933 in the first place).

Once something becomes widely used as a pricing mechanism, then it follows that its value will become much more stable...with one important assumption: that people don't change prices too often.  With point of sale software and highly liquid and easily integrated exchange markets, I'm not sure you can make that assumption any more.  Irrespective of bitcoin, more and more merchants might start setting prices based on real, continually updated indexes to real goods instead of indirectly via the dollar.  That's bound to increase the volatility of the dollar.

So, where does that leave bitcoin then?  Well, I think we can say that ignoring some near term usability and security shortcoming, if everyone used bitcoin as money, then it would be far more convenient, cost effective and private than using the traditional banking system.  By design, bitcoin would also hold its value over the long term better than a currency that uses debt for issuance and backing (pretty much all national currencies today).  Out of necessity, you have to expand the money supply of debt backed currencies, otherwise there wouldn't be enough money in circulation to repay old debts (the deflationary spiral problem that debt backed currencies have)...that makes it inevitable that the value of such a currency must fall over time.  So, given a choice of holding a currency that is going to decline in the long run and one that will appreciate, you'll want to hold at least some of the one that will appreciate (even if you're not entirely certain that something might cause that currency to completely fail).  You may even want a portion of your pay to be automatically converted into that currency.  And, once you have that currency, you'll want to use it to buy things (otherwise, there would be no point in holding it or any other currency at all).  And since there are some people that want to direct a portion of their income to bitcoin, there will be people willing to sell you things in exchange for bitcoin.

[jtimon]

Using the beertoken software, you could also issue a full backed USD chain currency. With that and contracts we could have decentralized exchanges. Instead of trusting mtgox for holding your bitcoins and dollars, you just trust them for issuing chain currencies.
Even with merged mining, you need a way to reward USDcoin miners, transaction fees I guess.
The issuers can live on redemption and/or issuance fees.
We could have EUR, JPY and other currencies and trade between them in a decentralized fashion too.

[Steve]

Using the beertoken software, you could also issue a full backed USD chain currency. With that and contracts we could have decentralized exchanges. Instead of trusting mtgox for holding your bitcoins and dollars, you just trust them for issuing chain currencies.
Even with merged mining, you need a way to reward USDcoin miners, transaction fees I guess.
The issuers can live on redemption and/or issuance fees.
We could have EUR, JPY and other currencies and trade between them in a decentralized fashion too.

If you have to trust the issuer to provide the backing (exchange for beer or usd at a certain rate), then you may as well also trust them with maintaining the transaction history (block chain)...hence, no need for proof of work based block chain creation.  But yes, this would enable decentralized bitcoin exchange, especially if combined with a ripple style routing of privately issued coins (maybe you trust mtg usd coins but I trust tradehill's. ...as long as mtg and tradehill trust each other, a trade can still happen).

[jtimon]

But yes, this would enable decentralized bitcoin exchange, especially if combined with a ripple style routing of privately issued coins (maybe you trust mtg usd coins but I trust tradehill's. ...as long as mtg and tradehill trust each other, a trade can still happen).

Great idea!
The ripple concept is so useful...

[Cryptoman]

One option is to create a new, stable currency using Open Transactions--let's call it StableCoin.  StableCoin can be guaranteed by the issuer to be equivalent to some basket of commodities or other suitable target.  For example, I decide that I'm going to issue 1000 StableCoins which might have a starting value of 1 USD each.  To back these StableCoins, I need to purchase 1000/5=200 BTC at today's exchange rate.  I send these Bitcoins to a special address and publish the address.  I could even place the wallet under the control of an escrow agent.  Anyone who wishes to exchange USD or BTC or whatever else I accept for StableCoin can look at how many StableCoins have been issued and how many BTC are backing them.  The combination of Open Transactions and the Bitcoin blockchain allows a zero-knowledge proof of the issuer's solvency.  As the StableCoin/BTC exchange rate fluctuates, I (the issuer) need to maintain a sufficient BTC balance to cover the outstanding StableCoins.  The nice thing about using Open Transactions to do this is you can add another layer of anonymity on top of Bitcoin's pseudonymity.  

[jtimon]

The problem with your proposal is how to back a basket currency without actually backing the commodities. I guess they could use the right option contracts to do that, but then maybe the issuer needs part of the bitcoin funds to do that.
You can fully back a bitcoin or usd OT currency though.
For the btc/usd OT market, it would be useful to have a special type of trade that executes a set of trades atomically.
This way, I could trade bBTC for aUSD only if I can also trade those aUSD for bUSD atomically.
By implementing that, you effectively have ripple inside OT. I've been discussing this with fellowTraveler, but he insists that a new "ripple credit connection" instrument would be needed.
I don't think so. You just can implement this thing and people will issue "unbacked" OT currencies instead of Ripple IOUs.
You can think of ripple as a means for everybody to issue their own currency. The backing of each currency is the goods and services each person provides. The only thing OT needs to have ripple are these atomic multi-trades.

[Boussac]

How much volatility is there over one hour ?

you must be new here.

A: with bitcoin, the price could easily swing 50% or more either way in just an hour.

When did that happen last ?

[payb.tc]

How much volatility is there over one hour ?

you must be new here.

A: with bitcoin, the price could easily swing 50% or more either way in just an hour.

When did that happen last ?

i don't recall it ever happening.