Why Bitcoin can’t be a currency

[allinvain]

I'm wondering if any of you have seen this dude's blog post and if so what you think of it:

http://undergroundeconomist.com/post/1528511369

His argument is that bitcoin will fail because it lacks a mechanism for dealing with demand, or "it lacks any mechanism for dealing with fluctuations in demand. Increasing demand for Bitcoin will cause prices in terms of Bitcoin to drop (deflation), while decreasing demand will cause them to rise (inflation)"

Is this in and of itself such a huge flaw? Can the free market mechanism be trusted to create an equilibrium or will bitcoin inflate or deflate itself out of existence?

So, what you all think?

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[Vasili Sviridov]

If there is a demand for bitcoins, the market can adjust by lowering prices, thus making bitcoin's purchasing capacity higher. Which, pretty much, achieves the same effect. (IANAE).

[bitdragon]

I find it a rather a positive feature and encourages a little bit of saving.
Exchange rates vary all the time, but maybe less abrubtly than USD/BTC and is something to deal with as long as merchants need to cash out in fiat to pay other things-

The best part, for me, is "The reason this can’t happen with government currencies is that government currencies *are* backed. They’re backed by bullets. If demand for USD starts to fall faster than the USG would like, the USG can just raise taxes without increasing spending, increasing demand and reducing supply simultaneously. "

How far does the USD need to drop then?

Found this 100 year graph today of USD vs CHF:

[FreeMoney]

The fact that supply does not respond to demand is what makes it an excellent money. Carrots, for example, won't ever hold much value beyond their costs of production because even if people mistakenly think that they are money and demand increases because of this the price will not stay up because new production is trivial. Gold is better because supply can only respond in a limited way. Bitcoin is built specifically to not have it's value harmed by increases in supply.

[silversurfer]

I'm wondering if any of you have seen this dude's blog post and if so what you think of it:

poppycock!  what a nincompoop.

[RodeoX]

OMG I'm selling off all my gold as It does not respond to demand!

[grondilu]

His argument is that bitcoin will fail because it lacks a mechanism for dealing with demand, or "it lacks any mechanism for dealing with fluctuations in demand. Increasing demand for Bitcoin will cause prices in terms of Bitcoin to drop (deflation), while decreasing demand will cause them to rise (inflation)"

I'm sorry I'm not a professor of economics, but isn't that precisely what the law of offer and demand is about


Demand for something increases.  As a result price increases.   And people look at it and start to work on finding a way to answer this demand.

High prices are an incentive for people to answer a demand.  This is what price is about, damn it!   I think it's called the "price signal" theory or something.

Here is what I found on wikipedia http://en.wikipedia.org/wiki/Price_signal, but I'm pretty sure there is a video of Walter Block somewhere, where he explains that extremely well.

[matt.collier]

Let's take the example of the guys who just started selling T-Shirts for BTC.  Within a week or two of when they announced they were selling shirts, the exchange rate for BTC/USD went from around 1:1 to 1:4.  Is it reasonable to expect them to reduce their asking price in BTC proportionately?  It seems like a difficult proposition to operate a retail business with industry standard margins under these circumstances.  Is it reasonable to expect merchant to run to the nearest BTC exchange immediately after every sale so they don't lose their shirt (sorry, I couldn't help myself) when the exchange rate goes down by 200%-300%?

[mewantsbitcoins]

I'm sorry I'm not a professor of economics, but isn't that precisely what the law of offer and demand is about


Demand for something increases.  As a result price increases.   And people look at it and start to work on finding a way to answer this demand.

High prices are an incentive for people to answer a demand.  This what price is about, damn it!   I think it's called the "price signal" theory or something.

I think it could also be called common sense  

[BitterTea]

Let's take the example of the guys who just started selling T-Shirts for BTC.  Within a week or two of when they announced they were selling shirts, the exchange rate for BTC/USD went from around 1:1 to 1:4.  Is it reasonable to expect them to reduce their asking price in BTC proportionately?  It seems like a difficult proposition to operate a retail business with industry standard margins under these circumstances.  Is it reasonable to expect merchant to run to the nearest BTC exchange immediately after every sale so they don't lose their shirt (sorry, I couldn't help myself) when the exchange rate goes down by 200%-300%?

This is only a problem during Bitcoin's adoption phase. Once you can pay for the necessities of life with bitcoins, you don't need to peg your bitcoin prices to dollars, and you can keep a more or less constant price no matter the exchange rate.

There are ways merchants can mitigate these problems, some of which you mentioned. They don't necessarily need to sell all of their bitcoins from each sale, only enough to cover their costs. If they believe bitcoins will be worth more in the future, they can keep the rest as profit, otherwise sell them too.

There are tools available to merchants if they want to peg their prices to another currency other than Bitcoin. For instance, they could offer their products prices in bitcoin, based on how much fiat currency they could exchange the bitcoins for at that moment in time, even if they don't plan on doing so.

As far as the risk of a large drop in exchange rate... it's possible, but I don't think it would be permanent, and would perhaps be a good thing as it allows many more participants to enter the market at a lower cost. I know that if the exchange rate dropped (say to under a dollar), I would buy a lot more coins.

[grondilu]

I've just realised the real meaning of the initial message.  I get it, it's about demand for bitcoins as money, not about demand for an product priced in bitcoins.

I doubt this makes any sense, but it deservers a full, extensive answer.  I'll write about it later.

[ffe]

So, what you all think?

I think bitcoin will be a great substitute for gold but will never replace national currencies for setting prices and wages.

No one sets prices and wages in gold today. You'd be fixing the price of gold and allowing everything else to swing all over the place as economic activity varied. That may be ok if you choose to ignore debt. If debt is denominated in gold (or bitcoin) a swing in value relative to the ability of debtors to pay back, through wages for example, will drive them to default and drag the economy down.

Can you imagine your mortgage denominated in gold? It would be crazy to accept that as a borrower. As it is the last downturn drove millions to default and that was with the Fed trying hard to supply liquidity to the market. Imagine if their mortgages were denominated in gold.

[bitcoinex]

This guy says exactly what I said. Therefore, you should not believe to this shit - just buy bitcoins now!

[BitterTea]

I think bitcoin will be a great substitute for gold but will never replace national currencies for setting prices and wages.

No one sets prices and wages in gold today. You'd be fixing the price of gold and allowing everything else to swing all over the place as economic activity varied. That may be ok if you choose to ignore debt. If debt is denominated in gold (or bitcoin) a swing in value relative to the ability of debtors to pay back, through wages for example, will drive them to default and drag the economy down.

Can you imagine your mortgage denominated in gold? It would be crazy to accept that as a borrower. As it is the last downturn drove millions to default and that was with the Fed trying hard to supply liquidity to the market. Imagine if their mortgages were denominated in gold.

If prices were set in gold, then the price of gold wouldn't vary drastically. The only reason the price of gold and bitcoins vary drastically is because they are being compared to the dollar and a) the demand for dollars vs. bitcoins or gold varies over time and b) central banks arbitrarily alter the supply of fiat money.

If you look to history, you will see that prices and wages were once set in gold, but have not been since the establishment of legal tender laws. Particularly, look at the attempted introduction of state backed notes on the west coast, and how they fared compared to gold/silver until federal legal tender laws were enacted.

[ffe]

If prices were set in gold, then the price of gold wouldn't vary drastically. The only reason the price of gold and bitcoins vary drastically is because they are being compared to the dollar and a) the demand for dollars vs. bitcoins or gold varies over time and b) central banks arbitrarily alter the supply of fiat money.

If prices were set in gold, then the price of gold wouldn't vary one iota. An ounce of gold would cost exactly an ounce of gold. My point is that as demand for gold went up, it would cost a lot more of other stuff to pay for an ounce of gold.

If you're not in debt and gold went up in value it wouldn't effect you very much, but if you're in debt, then the real cost of your loan just went up substantially since your salary would have to get smaller.

If you look to history, you will see that prices and wages were once set in gold, but have not been since the establishment of legal tender laws. Particularly, look at the attempted introduction of state backed notes on the west coast, and how they fared compared to gold/silver until federal legal tender laws were enacted.

I'm not familiar with this history on the west coast. I'll try to read up on it. Maybe if you had a pointer? I'd appreciate it.

[BitterTea]

Sure. I originally came across this while reading What Has Government Done to Our Money?. Here is the particular passage I had in mind, from chapter 3 section 11:

In America's first depression, 1819-1821, four Western states (Tennessee, Kentucky, Illinois, and Missouri) established state-owned banks, issuing fiat paper. They were backed by legal tender provisions in the states, and sometimes by legal prohibition against depreciating the notes. And yet, all these experiments, born in high hopes, came quickly to grief as the new paper depreciated rapidly to negligible value. The projects had to be swiftly abandoned. Later, the greenbacks circulated as fiat paper in the North during and after the Civil War. Yet, in California, the people refused to accept the greenbacks and continued to use gold as their money. As a prominent economist pointed out:

"In California, as in other states, the paper was legal tender and was receivable for public dues; nor was there any distrust or hostility toward the federal government. But there was a strong feeling ... in favor of gold and against paper ... Every debtor had the legal right to pay off his debts in depreciated paper. But if he did so, he was a marked man (the creditor was likely to post him publicly in the newspapers) and he was virtually boycotted. Throughout this period paper was not used in California. The people of the state conducted their transactions in gold, while all the rest of the United States used convertible paper."

Anyway, it's quite obvious that gold and silver were for quite some time used to price goods and wages. The only reason they no longer are today is because of legal tender laws and fractional reserve banking. Not that if legal tender laws were revoked, people would switch back to gold all of a sudden, but had they never been implemented, I'm pretty sure we'd still be using gold, or at least gold backed notes (physical or digital) as money.

Another article, still at Mises, but I'm having a hard time finding articles discussing gold vs. fiat use in the frontier states in the mid 1800s.

http://mises.org/daily/4625

[Darth Severus]

I´ve read only the initial message, so I may repeat something. Sorry for that.
I think Bitcoin is like a gold currency would be, and this worked fine in the past over a long period of time. How could deflation be a problem for a currency? I think it can´t. Even if one thinks the lack of inflation is not good for the economy, then it´s still not destroying a currency. There is also noch technical problem: Bitcoin can be splitted in smaller and smaller parts. I thought today a slowly increasing BTC value would be perfect for the most users.
(Real) inflation is if someone creates more money than the economy grows, not the decreasing value of a currency (this is newspeak). So on the long run (real) inflation is absolutely not possible in Bitcoin. Decreasing value of BTC may happen, but severe scenarios are hard to imagine, except a huge speculation bubble bursts. There may be interventions then, but not with newly created money, which would be the same fraud like within the fiat money systems today. Or maybe if it would be worldwide forbidden to shop with BTC but cashout would still be possible, then the value could really drop. It would go to far to discuss this any further here.

To The Underground Economist´s comment:

Who wants to give up money that’s constantly rising in value?

Some people like to consume. And Bitcoins can be splitted, so theirs always enough money.

or the merchants will get tired of changing their prices every few seconds

They can calculate with a price they want and must not change their prices all the time.

If this manages to start any inflationary momentum at all, you’ll see the deflation scenario played out in reverse. And who’s going to stop it? The supply of Bitcoin is fixed and there is no other use for it besides as a currency. I doubt prices will have much of a chance to rise, since this will happen so fast. Merchants will go from taking one coin for a year of porn to not taking Bitcoin at all, and a bunch of people will be left with worthless Bitcoin.

BTC are always having a value through their usefullness, and people may speculate on a comeback of the value. It´s an advantage that there would be no goverment or Fed which is able to print money or change all the rules.

Before you call yourself a post-Austrian just read their books, or at least one of them. I´m not calling myself an economist, but I know more about it than this guy.

[mndrix]

Is this in and of itself such a huge flaw?

I suppose it depends on the magnitude of the associated price swings.  The Bitcoin economy is currently very small.  An article in a popular magazine can dramatically increase demand in a short period of time.  However, if the Bitcoin economy were 10 or 100 times larger than it is now, exchange rates wouldn't vary as rapidly.  For example, Silver prices dropped 19% in 3 days.  That was the biggest drop in 28 years.  In Bitcoin-land, we see swings like that every week

I suppose a healthy options/futures market could substantially reduce negative effects also.  If a vendor can buy a 30-day put option, he can price his goods in Bitcoins without worrying what the markets do.

[mintymark]

Surely one of the biggest problems with gold is that its hard stuff to "manufacture" yet while it is in use as currency its not actually in use at all. In particular, at one stage all the gold (and silver) ended up in vaults, never touched for years or decades on end, with notes circulating instead. Sure the notes were backed by gold bars, but the point is, is it really making good use of this expensive to manufacture, much in demand material to lock it in a room? Imagine the miners contempt, when you tell him that he spends his life mining and refining this material for it to be put in a vault and weighed every 5 years, and that is all that EVER happens to it.  Compare that with silver used in photography or platinum used in a catalytic converter, those are good uses of materials that are hard wrought.

Today, we spent most of the gold on other things, like winning the 1st world war, and generally having our cake and eating it. Thats a good thing because we really have had our cake at least twice in a very real sense, those gold backed notes still circulate, even though the gold is gone.

But discussion about those good old days when gold coins circulated as the only form of money do miss the point, really modern money does perform a bunch better than the old money did from the point of view of boom and bust, at least thats what I understand. And, yes the current crisis is bad, but not typical. Measuring that performance is what economists do and is not a straightforward science, shrouded in history as it is, but I have a feeling that allthough we all beef about it, modern money is, generally but not always better.

Bitcoin does have the same flaw. After all, its possible to imagine a currency where the difficult act of creating a coin, necessarily difficult, to avoid worthlessness, was of itself useful. Lets imagine that instead of hashing random numbers we were protein folding at home, discovering new drugs.  That would be just as valid as doing SHA256 sums, use just as much electricity, but is not so easy to regulate, and so at present we cannot use it in bitcoin. Maybe one day.  Its necessary that coin generation has very carefully controllable characteristics, and one day we may know how to predict these for real unsolved problems, but this is not easy stuff. So yes, I do think bit coin has these flaws.

But lets not loose sight of the advantages of bitcoin, advantages that may well completely overshadow othercurrencies in the computer age. Today more commerce is done over the internet. More and more actual services are transmitted over the internet. Many of us live our lives on the internet. There is no real way to transmit either gold or another currency over the internet until bitcoin came along. More than this, transmitting money to other countries has been a need for hundreds of years, and banks charge a pretty penny for this service - they need to because for other currencies or gold its hard to do. (Look what problems the spanish had trying to get gold from south america to span!!) Bitcoin does this effortlessly, fast and scaleably.  With the aid of exchangers in many countries this will change banking for ever. Micropayments over the internet are another area that has just never worked properly with other currencies but is perfect with bitcoin. Lastly, existing currencies have so much corruption built in, the idea of something that really cannot be faked, is just such a breath of fresh air to most people that I cannot see how bitcoin can fail. And it has a long way to go yet.

Will bitcoin ever be a currency? I just don't know. Will it ever be the major currency? Not in my lifetime I'd say.  But I am certain that it will be successful, and you will know what that means when you see it.

[abyssobenthonic]

The fact that supply does not respond to demand is what makes it an excellent money. Carrots, for example, won't ever hold much value beyond their costs of production because even if people mistakenly think that they are money and demand increases because of this the price will not stay up because new production is trivial. Gold is better because supply can only respond in a limited way. Bitcoin is built specifically to not have it's value harmed by increases in supply.

There is a short-term response to supply and demand.  Is it a surprise that in the past couple of weeks, as BTC/USD has increased dramatically, we've been consistently seeing 8-10 blocks being solved per hour?  It could be a random aberration, but I suspect it's because the ramping of BTC/USD has a) gotten a lot of people interested in mining and b) brought mining capacity that was previously uneconomic back online.  As it stands though, the debasement rate of existing bitcoins is running about 50% where one would have expected it to be.  The difficulty adjustments will eventually come, but in the meantime, there is some elasticity and the difficulty adjustments don't appear to try to make-up for the increase in production (e.g. by adjusting every two weeks so that the next two weeks will average with the previous two weeks for 6 blocks/hour).  The past couple of weeks, by itself, is slightly increasing the number of bitcoins that will be mined at infinity.

Since I don't have a mega-powerful GPU (I'm a die-hard Matrox fan... quality open-source Linux drivers and amazing Xinerama support are what I like), I didn't really pay attention to that (and am too lazy to look it up) but aren't nvidia GPUs about a third as fast as AMD/ATIs?  At the current prices, even nvidia-mining may be mildly profitable...

This isn't even like with gold, where what's in the ground (and the price that will allow those deposits to be profitably extracted) is approximately knowable and is baked into the price.  The amount of GPU capacity out there and its marginal tendencies toward BTC mining are rather unknowable so that's rather difficult to add that consideration to the mix.