Bitcoin, debt as deep as the banks couldn't have imagined.

[Rassah]

^^^^

"I made up this currency which I'm calling 'stable'. My friends and I are selling it for $21,000,000USD. Anyone interested in buying it? We take whatever currency our method you'll offer, as long as you give us $21,000,000 for it. We also need some other people to keep hashing blocks to secure it for us, and can't guarantee that it will be secure until enough people are hashing. Now, I know we said we have $21,000,000 worth of it that we are selling, and it's only only worth that much because we say so, but please don't all rush in to buy it all at once. There's plenty for everyone."

[1713503277]

1713503277

[1713503277]

1713503277

[Rassah]

The human mind doesn't calculate that. It also doesn't calculate all the possibilities.

The human mind is what came up with the precise mathematical calculations to calculate interest with all the possibilities. I'll grant you, the average person who doesn't understand money likely won't know the calculations, and the interest will seem confusing and scary to them, but really just means more people should take time to learn it. It's their money after all.

A set fee for a set time seems fairer. Perhaps there should also be a schedule for what happens if you can't pay - what exactly you will and won't lose. Lose your home? Donate a kidney? - if it's written down at the start at least everybody's clear on it.  

That's exactly what interest calculations tell in extremely precise detail: your set fee for every set period of time, based on how much you have borrowed, and how much of a risk you are to the person lending you the money (determined by interest rate). With some religions, the only difference seems to be that they charge you the interest all at once, and call it something else.

[FredericBastiat]

^^^^

"I made up this currency which I'm calling 'stable'. My friends and I are selling it for $21,000,000USD. Anyone interested in buying it? We take whatever currency our method you'll offer, as long as you give us $21,000,000 for it. We also need some other people to keep hashing blocks to secure it for us, and can't guarantee that it will be secure until enough people are hashing. Now, I know we said we have $21,000,000 worth of it that we are selling, and it's only only worth that much because we say so, but please don't all rush in to buy it all at once. There's plenty for everyone."

People already do this with what's called bailment. I set up a vault. You put gold in it. I give you a certificate for redemption. If you put a lot of gold in there, it could be worth $21 million dollars. I promise to secure it and insure it against theft. The fees I collect protect your investment. When you come a callin' I give you your gold for the certificate.

My case is only slightly different. I pre-mine the coin but they don't go into circulation until an equivalent $1 token certificate is supplied. The more I store fiat in the vault, the more bitcoin is used in circulation. There is no volatility until I run out of tokens (more fiat than bitcoin tokens), at which point the bitcoin tokens float against the major world currencies. Fees pay the "miners" or "transaction handlers" to secure the digital bitcoin tokens. This is where the deflationary effect of the bitcoin tokens takes effect.

The market is likely to handle bitcoin/fiat token certificate fluctuations a little smoother when there is a lot of volume sitting in the vault as opposed to bootstrapping the currency to an exchange market to begin with. Valuation of bitcoin was %1000+ in the last year and half alone. Not the kind of currency most people are familiar with.

[jothan]

If you look at actual activity on the lending sub forum you will see what has developed:  very short term loans at very high interest rates.  That is exactly what you would expect.

Can't wait to get paid to work in Bitcoins, then I can get a "great deal" on a payday loan !

[Explodicle]

Frederic -

What you're looking to do would be easily facilitated by Open Transactions. You can create anonymous digital cash backed by your private reserve. You're never going to escape centralization, so at least offer features which Bitcoin cannot.

[westkybitcoins]

Just as fyi, I was trying to tackle this problem from a financial/lender point of view last summer, trying to figure out how loans and interest can even be calculated in a deflationary economy. The solution we came up with is a formula similar to the current Present Value of Annuity formula (example of it switched to calculate payments here http://www.financeformulas.net/Loan_Payment_Formula.html) that all lenders use to calculate term/interest/payment amounts, though a bit more complex. In summary, instead of you paying the same amount every month as you do with mortgages and car loans now, your payments would be heavily frontloaded, with the first payment being rather large, and each month's consecutive payment decreasing until the final comparably tiny payment. From the perspective of the lender, they get back the same amount of value they would get had they invested the bitcoin at the same interest they lent it out at, plus the deflationary value growth of bitcoin. From the borrower point of view, even though each month's payment is a different number, after bitcoin deflation is taken into account, the actual value of the payment remains the same.
Hope that made sense.

That actually sounds like a great way to handle interest payments in a deflationary currency.

Of course, it'll probably take a while before it needs to be implemented, considering the current volatility.

[stochastic]

...By lending Bitcoin you are replacing your BTC with a promise to repay. Further, you are probably doing it as % interest, something that is strongly advised against by every religion I can think of, and for good reason:

Religions against borrowing money?  I will add that to my list of reasons why I should become a lender.

Bitcoin is about taking the monetary power away from governments influenced by tyrannical despots, oligarchs, philosopher kings, or ignorant mobs.  I do not see it as a vehicle to remove profit motive or to destroy lending institutions.  In fact I see the future of bitcoin use not by humans but by bots, automated machines, and AI for an intermediate between fiat currencies and quick and cheap electronic way to allocate resources based on a machine's digital ecological value.

[FredericBastiat]

Frederic -

What you're looking to do would be easily facilitated by Open Transactions. You can create anonymous digital cash backed by your private reserve. You're never going to escape centralization, so at least offer features which Bitcoin cannot.

That was what I was hoping to achieve. Basically it's a hybrid between the decentralization of bitcoin and the facilitation of the Open Transaction account capability to effectuate a mass exodus from government fiat to a pseudo-anonymous alt-currency (bitcoin or equivalent). You need 2 systems: a bitcoin currency and a open source exchange service cryptographically tied together in a loosely federated trust network.

The idea is to maintain a 1:1 purchase parity with your digital currency until such time as it matches your fiat reserve by some relatively large quantity (i.e. 21 billion dollars of BTC equivalence, or some such large amount), then you float. This should make the market less volatile as the influx or outgo of USD by any one participant, at any one point in time, should cause less volatility. The price averages out quickly.

The question is how to prove your private fiat reserve is not being arbitrarily manipulated by the author/originator of the account? Can you make your account accessible by multiple traders so that they can guarantee the introduction of fiat in reserve is both auditable and grows in exact proportion to the digital coin you introduce into circulation?

To wit, can I create a smart contract that permits the release into circulation of exactly one, and only one, equivalent certificate of redemption (digital token coin) for every fiat dollar in reserve in an automated fashion and independent of the account holder?

[Explodicle]

Frederic -

What you're looking to do would be easily facilitated by Open Transactions. You can create anonymous digital cash backed by your private reserve. You're never going to escape centralization, so at least offer features which Bitcoin cannot.

That was what I was hoping to achieve. Basically it's a hybrid between the decentralization of bitcoin and the facilitation of the Open Transaction account capability to effectuate a mass exodus from government fiat to a pseudo-anonymous alt-currency (bitcoin or equivalent). You need 2 systems: a bitcoin currency and a open source exchange service cryptographically tied together in a loosely federated trust network.

The idea is to maintain a 1:1 purchase parity with your digital currency until such time as it matches your fiat reserve by some relatively large quantity (i.e. 21 billion dollars of BTC equivalence, or some such large amount), then you float. This should make the market less volatile as the influx or outgo of USD by any one participant, at any one point in time, should cause less volatility. The price averages out quickly.

The question is how to prove your private fiat reserve is not being arbitrarily manipulated by the author/originator of the account? Can you make your account accessible by multiple traders so that they can guarantee the introduction of fiat in reserve is both auditable and grows in exact proportion to the digital coin you introduce into circulation?

To wit, can I create a smart contract that permits the release into circulation of exactly one, and only one, equivalent certificate of redemption (digital token coin) for every fiat dollar in reserve in an automated fashion and independent of the account holder?

I believe so. I haven't done it myself, but in a video FellowTraveler shows how one creates digital cash. It's issued independently of the federated servers, so you shouldn't even need to keep it all running yourself - we just have to trust that you have the physical cash. The whole thing is based on smart contracts.

What I'm not clear about is how the floating phase works. Are the coins then backed by proof of work, a commodity/currency, or some combination?

[FredericBastiat]

I believe so. I haven't done it myself, but in a video FellowTraveler shows how one creates digital cash. It's issued independently of the federated servers, so you shouldn't even need to keep it all running yourself - we just have to trust that you have the physical cash. The whole thing is based on smart contracts.

What I'm not clear about is how the floating phase works. Are the coins then backed by proof of work, a commodity/currency, or some combination?

The BCT coins are always backed by a proof of work just as they are in the bitcoin network. You need this to prohibit (or at least make very difficult) the >51% double spending situation of the coin between BCT account holders. It is still needed so that the security of the network is maintained. You want to trust several individuals to manage the same pool of BCT coin when executing a BCT issuance. An example would be that any 90 of 100 account comptrollers would release a BCT coin into circulation whilst simultaneously auditing/verifying the vault has the equivalent fiat in reserve.

It's the fiat reserve that needs a similar paper trail blockchain functionality because they are the primary issuers of the pre-mined BCT coins, and you don't want them putting BCT into circulation without an equivalent fiat dollar stored in the vault. It's an issuance issue that would probably be handled by the Open Transactions server/client software. It's a hybrid smart property contract arrangement. To wit, all of the exchangers and BCT holders have a stake in both the issuance of the asset BCTs and the intra-account trading of the circulating BCT.

I've seen the Open Transactions video and that's why I find this idea plausible in the first place. I truly believe we need a federated trust interfacing system (automated auditing) between exchangers and also BCT-to-BCT interactions. There needs to be more fiat/BCT integration with the outside world. You would just prefer a large pool of fiat to deposit and withdraw from when the float happens.

The floating merely means that there are more fiat dollars in the vault than BCT coins to back them. You just convert to the foreign exchange format we use today and abandon the 1:1 redemption bailment methodology. Most of the fiat will likely remain in the vault. This is done completely in the open, and the event will be known and agreed upon by all of the participants. I truly believe that a deflationary currency is preferable because in real life all things are finite and in scarce supply. Physical reality should be emulated.

It's merely more preferable to absorb the rise and fall of fiat reserves from a large pool than a small one. It's sheer size (critical mass analogy) merely acts as a supply/demand shock absorber.

[Rassah]

People already do this with what's called bailment. I set up a vault. You put gold in it. I give you a certificate for redemption. If you put a lot of gold in there, it could be worth $21 million dollars. I promise to secure it and insure it against theft. The fees I collect protect your investment. When you come a callin' I give you your gold for the certificate.

My case is only slightly different.

The difference is that gold is already worth something. A closer analogy would be you setting up a vault and filling it with worthless mud bricks, which you then try to sell off for a total of $21million, by promising to hold on to the money people give you, should they want it back, in exchange for those bricks. Considering you'll be the central mud brick issuing authority, it would be no different from trying to establish fiat currency. Even if you can prove that you are not inflating your mud brick supply, the issues remaining are how will you prevent counterfeiting (who will do the hash mining for you?), and who will buy the these worthless mud bricks from you in the first place, especially since you'll be the ultimate "early adopter." Personally, if someone created something for nothing, and tried to pawn it off on other people for $21m, my first instinct would be to call them a scammer.

Oh, another issue is that when bitcoin gets issued and exchanged for fiat, you have one person holding bitcoin, and one holding fiat, both free to spend their money however they want. In your case, the fiat backing your mud bricks is tied up in the vault, required to back the bricks should anyone want to exchange it back, and being used to support the brick's value. Should the fiat in your vault start to severely inflate, the drop in value will translate to the bricks as well.

[FredericBastiat]

The difference is that gold is already worth something. A closer analogy would be you setting up a vault and filling it with worthless mud bricks, which you then try to sell off for a total of $21million, by promising to hold on to the money people give you, should they want it back, in exchange for those bricks. Considering you'll be the central mud brick issuing authority, it would be no different from trying to establish fiat currency. Even if you can prove that you are not inflating your mud brick supply, the issues remaining are how will you prevent counterfeiting (who will do the hash mining for you?), and who will buy the these worthless mud bricks from you in the first place, especially since you'll be the ultimate "early adopter." Personally, if someone created something for nothing, and tried to pawn it off on other people for $21m, my first instinct would be to call them a scammer.

Oh, another issue is that when bitcoin gets issued and exchanged for fiat, you have one person holding bitcoin, and one holding fiat, both free to spend their money however they want. In your case, the fiat backing your mud bricks is tied up in the vault, required to back the bricks should anyone want to exchange it back, and being used to support the brick's value. Should the fiat in your vault start to severely inflate, the drop in value will translate to the bricks as well.

We all created digital bitcoins out of thin air haven't we? What happens to bitcoin when all of the bitcoins are mined? What will secure the network then? I would assume that to be via the processing power dedicated to the transaction fees. Bailment services aren't worthless (the do require a certain amount of trust however). They've been done for 100's of years (without computers for the most part). I just want a hybrid open source federated trust fiat/bitcoin exchange system. Then everybody can verify where their money is (both reserve fiat and token BCT coins).

There is a fixed pre-mined limited supply of BCT (deflationary). If the fiat (which is inflationary by government design) in reserve becomes greater than the BCT coins in circulation the BCT value actually goes up not down. They, are for the most part, inversely related, but then you knew that already.

None of this is technically much different than Mt Gox. or PayPal or Dwolla per se.

[Rassah]

None of this is technically much different than Mt Gox. or PayPal or Dwolla per se.

As mentioned in the other topic, Mt Gox or PayPal or Dwolla are fundamentally different in that they are ONLY transaction facilitators between two other unrelated parties. They don't issue or keep the money, they only let two other people exchange it, holding USD/BTC briefly, and after the transaction is done, have no more obligations to those two people.

From what I understand, and correct me if I'm wrong, your idea would result in an entity that itself creates the BTC, holds it until a buyer comes along, sells it directly to the buyer for USD, and then maintains a long term obligation to that buyer by promising to repurchase their BTC with the same USD they sold for. Am I correct? And can you see the difference? I have to trust Mt Gox, PayPal, and Dwolla for a day or two at most. I have to trust your issuer for as long as I hold your money.

[FredericBastiat]

As mentioned in the other topic, Mt Gox or PayPal or Dwolla are fundamentally different in that they are ONLY transaction facilitators between two other unrelated parties. They don't issue or keep the money, they only let two other people exchange it, holding USD/BTC briefly, and after the transaction is done, have no more obligations to those two people.

From what I understand, and correct me if I'm wrong, your idea would result in an entity that itself creates the BTC, holds it until a buyer comes along, sells it directly to the buyer for USD, and then maintains a long term obligation to that buyer by promising to repurchase their BTC with the same USD they sold for. Am I correct? And can you see the difference? I have to trust Mt Gox, PayPal, and Dwolla for a day or two at most. I have to trust your issuer for as long as I hold your money.

You are under no obligation to permanently park the money in the vault, and are free to withdraw it at any time (i.e. to a bank), but then the vault would have little to no stored fiat value and gain no critical mass (it would probably still have a relatively high money velocity). This is why a shared trust system is critical, otherwise you may remain a bailment service indefinitely. Not really a big deal per se, but you'd rather unpeg sooner than later I'd think. In any case, you are either trusting me (the participating trusted federated exchange servers), the blockchain, another financial service provider, or your bank. You still have to choose. You have to trust somebody, somewhere, eventually.

You want something akin to GoldMoney where they hold an unallocated amount of gold, in the aggregate, within a secured vault and then permit you to trade token quantities between GoldMoney approved accounts. The gold doesn't move much due to it's physical intrinsic nature (taking possession is logistically more difficult), so the trust level must be extremely high, in addition to the fact, they are very centralized. Nevertheless, you can withdraw physical gold specie if you want (for a substantial fee).

I do understand the implications, but they really don't have to represent a long-term relationship or obligation. Also, your money doesn't necessarily make a one-way trip into the vault (although that is preferable, by avoiding intermediary logistics). For example, vault-to-paypal, vault-to-paxum, vault-to-dwolla, vault-to-cheque, vault-to-bankwire, etc.

Notwithstanding, if you sold/traded the BCT back to the exchange pool (as opposed to somebody in the network), which effectively redeems your fiat, it would be removed from circulation by being put back in the primary account (the initial pre-mined origin block) to be recirculated at a future date, thus maintaining the 1:1 ratio as represented by total vaulted fiat reserve. The BCT coins would then be temporarily retired as it were.

[Timo Y]

Deflation is going to stabilize once bitcoin matures. The nominal interest rate will adjust to take deflation into account.

[DeathAndTaxes]

Deflation is going to stabilize once bitcoin matures. The nominal interest rate will adjust to take deflation into account.

This.

Today interest rates take into account inflation.

When you get a home loan at say 6% the bank has an inflation expectation, lets say it is 3%.  What the bank is saying is they want a 3% RETURN (actually less once you factor in risk of default but lets assume no risk of default to keep it simple).

So the bank says we are willing to lend at 3% + inflation expectation.  While your nominal interest rate is 6% your paying with inflated dollars (which are worth progressively 3% less each year).  So your carrying cost is a 3%.

Imagine a stabilized Bitcoin where deflation expectation is 3%.  Assumming the same risk above vhe bank would lend you money at 0%.  While your NOMINAL inflation rate is 0% your cost hasn't changed.  Since you are paying the bank back in deflated dollars (worth progressively more each year) you carrying cost is still 3%.

Likewise imagine a future Bitcoin where deflation expectation is 7%.  The bank would lend you money at a NEGATIVE interest rate (yes the amount repaid would be less than amount borrowed).  In the scenario above it would be -4% interest.  It still won't matter as the buying power of Bitcoin will rise by 7% per year your carrying cost is 3%.

[Kluge]

Deflation is going to stabilize once bitcoin matures. The nominal interest rate will adjust to take deflation into account.

This.

Today interest rates take into account inflation.

When you get a home loan at say 6% the bank has an inflation expectation, lets say it is 3%.  What the bank is saying is they want a 3% RETURN (actually less once you factor in risk of default but lets assume no risk of default to keep it simple).

So the bank says we are willing to lend at 3% + inflation expectation.  While your nominal interest rate is 6% your paying with inflated dollars (which are worth progressively 3% less each year).  So your carrying cost is a 3%.

Imagine a stabilized Bitcoin where deflation expectation is 3%.  Assumming the same risk above vhe bank would lend you money at 0%.  While your NOMINAL inflation rate is 0% your cost hasn't changed.  Since you are paying the bank back in deflated dollars (worth progressively more each year) you carrying cost is still 3%.

Likewise imagine a future Bitcoin where deflation expectation is 7%.  The bank would lend you money at a NEGATIVE interest rate (yes the amount repaid would be less than amount borrowed).  In the scenario above it would be -4% interest.  It still won't matter as the buying power of Bitcoin will rise by 7% per year your carrying cost is 3%.

Why would anyone lend to someone at a negative interest rate given there are still scammers (which, by one established lender's count, accounts for ~10% of all loan requests [ETA: that's all defaulters, not just scammers]) and when they could just hold onto it?

What would really help decrease BTC interest rates is if there were enough BTC users to do loans locally where it's practical to have contracts enforced. Edit: Alternately, having many GLBSE users, where someone could just post transfer ownership of shares as security for the loan, would go a long way toward lowering interest rates.

[DeathAndTaxes]

Why would anyone lend to someone at a negative interest rate given there are still scammers (which, by one established lender's count, accounts for ~10% of all loan requests [ETA: that's all defaulters, not just scammers]) and when they could just hold onto it?

The risk of default is a whole separate topic.  It doesn't matter if Bitcoin is inflationary, deflationary, or perfectly managed to never have inflation or deflation.

The examples above illustrated an extremely low risk loan (home loan interest rates).

Risk simply raises interest rate independently of inflation/deflation.
If the bank wanted a 5% return, with 3% inflation, and estimated loss rate of 10% then the bank would charge 5% + 3% + 10% = 18%. The "real" (economic term for adjusted for inflation) cost to borrower is 15%.
The "real" return (adjusted for default losses) for lender would be 5%.

In a 4% deflationary environment the bank would charge 5% - 4% + 10% = 11%.
The "real" (economic term for adjusted for inflation) cost to borrower is still 15%.
The "real" return (adjusted for default losses) for lender would be still 5%.

What would really help decrease BTC interest rates is if there were enough BTC users to do loans locally where it's practical to have contracts enforced. Edit: Alternately, having many GLBSE users, where someone could just post transfer ownership of shares as security for the loan, would go a long way toward lowering interest rates.

Well spreading risk around doesn't lower risk.  The topic was about the effects of loaning in deflationary environment.  Default risk is a different topic.

[Kluge]

Why would anyone lend to someone at a negative interest rate given there are still scammers (which, by one established lender's count, accounts for ~10% of all loan requests [ETA: that's all defaulters, not just scammers]) and when they could just hold onto it?

The risk of default is a whole separate topic.  It doesn't matter if Bitcoin is inflationary, deflationary, or perfectly managed to never have inflation or deflation.

The examples above illustrated an extremely low risk loan (home loan interest rates).

Risk simply raises interest rate independently of inflation/deflation.
If the bank wanted a 5% return, with 3% inflation, and estimated loss rate of 10% then the bank would charge 5% + 3% + 10% = 18%.  The "real" (economic term for adjusted for inflation) cost to borrower is 15%.

In a 4% deflationary environment the bank would charge 5% - 4% + 10% = 11%.
The "real" (economic term for adjusted for inflation) cost to borrower is still 15%.

What would really help decrease BTC interest rates is if there were enough BTC users to do loans locally where it's practical to have contracts enforced. Edit: Alternately, having many GLBSE users, where someone could just post transfer ownership of shares as security for the loan, would go a long way toward lowering interest rates.

Well spreading risk around doesn't lower risk.  The topic was about the effects of loaning in deflationary environment.  Default risk is a different topic.

Apologies. I re-read what I wrote -- I wasn't trying to veer the thread off-topic and mis-interpreted your post. I assumed you were trying to suggest that, were Bitcoin to steadily increase in price, lenders would begin offering loans at negative interest.

[Rassah]

So, this: http://goo.gl/4XmYU

This is the formula to calculate monthly payments in a deflationary currency loan

PMT = ((1-d)^t*P*(d+i))/((d-1)*(-1+(1+i)^(-n)*(1-d)^n))

d = deflation %
n = number of pay periods
t = period for which payment is calculated (t=1 at first payment, t=n for last payment)
i = loan interest
P = principal amount borrowed

Using this formula, each successive payment will be less numerically, but the same in value, so a $600/month payment now will still be the equivalent of $600/month in a few years, making loan repayments easier to manage. At the same time, the lender gets the return on value from both, the deflation interest, and the loan interest.