Whitepaper: Decentralized Monetary Policy for Crytographic Currencies

[Razick]

I wrote this paper in a few hours after getting one of the key ideas from anon012012, so it's not yet proofread and I haven't worked too hard at spotting problems and logical errors yet. I welcome constructive criticism but please keep in mind that this is a very rough draft describing rough ideas.

Abstract

Among the many benefits of cryptographic virtual currencies such as Bitcoin [1] is the lack of a central authority to abuse the power of printing new units of currency. Although a hard cap on the number of currency units is a step in the right direction, the next logical step is to have balanced monetary policy undertaken by the network in a decentralized nature based on hard-coded rules. Although few people enjoy seeing the value of their currency erode over time, the opposite case is also harmful in a less-obvious way. As many economists have pointed out, hard-capped currencies are an excellent store of value but not so great as a medium of exchange. This is because like an inflationary currency, a deflationary currency changes behaviors and distorts market signals, sometimes even causing a deflationary spiral. An important attribute of an optimal currency is a stable, relatively fixed value relative to goods and services in the market.

Read the rest here:
https://www.dropbox.com/s/9h28rejw8718ppy/auto_mp_whitepaper_vs1.2.blocksigned.pdf?dl=0

Please let me know if you are developing an alt-coin based on this idea.

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[Elwar]

All based on the false premise promoted by so called economists who would never begin to "get" bitcoin. Also the false premise that people will not spend their virtual currency. The numbers prove such a premise wrong...so very very wrong...

[Razick]

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

It's not a perfect analogy, but people put off purchases of computers because they know that they will pay less for the same computer next year. It's human nature to reduce spending now in order to take advantage of lower expected prices in the future.

This is a central tenet of micro-economics. If a TV manufacturer expects higher prices next month, he may choose to sell less now in order to take advantage of higher prices later. It works the same with money, and has been demonstrated in the real world. Deflation has been serious problem in Japan for around two decades.

Furthermore, although it is one of the main ideas in my paper, preventing deflation is not the only one. Another potential use (although this may be difficult to accomplish) is creating a currency which could be "pegged" to a commodity such as gold, coffee or bacon.

I'm not suggesting that this system be implemented in Bitcoin. I like its deflationary nature for my own use and I am happy to spend it as well (although I always re-buy what I spend). I am merely suggesting ideas for the future as virtual currencies continue to innovate and advance.

EDIT: I don't dispute that chart, but one thing to consider is that many Bitcoin owners transfer bitcoin between addresses fairly often.

[montello]

Highly expository exchange of intellectualism.Your views are noted,thank you.

[noel57]

All based on the false premise promoted by so called economists who would never begin to "get" bitcoin. Also the false premise that people will not spend their virtual currency. The numbers prove such a premise wrong...so very very wrong...

I have been trying to comprehend this graph but the picture's just not clear.

[Razick]

Noel, compare the colors of the bands with the colors of the labels on the left side. The larger the band the more bitcoins are of that age. So as recently as 2010 most coins were older than 24 hours (age refers to the time since they were last spent), but by 2011, most coins were under 24 hours old.

I believe that only spent coins as opposed to all coins are counted.

So for instance the coins I sent earlier would be included if this chart was made today, but Satoshi's coins, which are untouched, would not be included.

Highly expository exchange of intellectualism.Your views are noted,thank you.

I'm glad you liked it.

[CliveK]

Hi there,

Firstly, I like the paper, and think it adds value to the crypto-currency concept.

A comment:

"benefits of cryptographic virtual currencies such as Bitcoin [1] is the lack of a central
authority"

Original paper has no limit to the number of bitcoins produced but now there is a soft limit of 21 million coins.

A hard fork was rectified by developers after an agreement was made between "people" not as per the original paper which says votes would be made per CPU.

Bitcoin is still experimental and is said to have bugs, which need to be fixed.

If SHA-256 is ever broken a new algorithm will be used by the developers.

If the developers are not the central authority then who has changed or can change the above?  What form of consensus is required to change the above?  Who decided on 21 million...and did they do it by themselves?  The hard ford because of software versions seemed to be a human based decision with block rewards being distributed between both forks if I understand correctly (could be wrong).

I think the failure of previous digital currencies which had offices and CEOs which have in some cases been prosecuted, and the relative anonymity of Bitcoin has led to a speculation that there is no central authority as it is know in the physical world like we have with fiat currencies.  But Bitcoin as a virtual crypto-currency does not have a life of its own.  Perhaps a virtual distributed authority which operates differently to a central authority in lieu of the differences between fiat and virtual currencies.

And a question:

What is a node?  With pool mining, does the network even know that an individual miner exists?  Could a pool tell all its miners to choose the same value if the network can see individual miners?

In the original paper:  Nodes work all at once with little coordination.

Is this true for today? With pools I think there is plenty coordination, but could be wrong.

Other than that, I like the paper....though if you are seriously looking to publish it, your commodities of rice and bacon are funny and could detract from the idea you are trying to put across, and perhaps point to similar research that shows game theory has achieved the desired results you are looking for.  As I am a university student and deal with people talking about publishing all the time, my lecturer would suggest never referencing to wikipedia.

My 2 cents

CK

[Razick]

You are absolutely right that because the development of Bitcoin is more or less centralized, there is perhaps more centralized control than we might like to see, but as a whole the network does function in a decentralized manner and, in my opinion, does have a life of it's own. If the Bitcoin development team disappeared and no one provided updates, the network would continue to work without human intervention until a vulnerability was discovered or a scale-ability problem occurred.

A node is entirely different from a miner since most nodes don't mine anymore. The idea in my paper is that instead of having miners control the process, actual nodes would, and by randomly selecting a relatively small number of nodes, the threat of an attacker flooding the network with malicious nodes or coordinating to manipulate the network is mitigated.

Thank you for your advice. I'll try to find some time to make edits soon.

[shawshankinmate37927]

If having yet another currency that can be debased is so important, why not just create another altcoin and let the market decide which one they prefer?

[odolvlobo]

In my view, deflation is just as bad as inflation, as both cause imbalances in the economy that waste resources. While inflation promotes wasteful spending, deflation promotes wasteful hoarding. In a mild deflationary scenario, people are slightly less motivated to use savings to generate income.

I don't believe the fear-mongers that claim that the slightest bit of deflation will turn into a deflationary spiral -- just as mild inflation does not turn into hyper-inflation. They ignore the success of industries where falling prices are the norm and they ignore the fact that people must generally spend most of their income to survive.

Regarding your paper, I believe it is both impossible to determine the right rules and impossible to implement or enforce them.

[shawshankinmate37927]

In my view, deflation is just as inflation, as both cause imbalances in the economy that waste resources. While inflation promotes wasteful spending, deflation promotes wasteful hoarding. In a mild deflationary scenario, people are slightly less motivated to use savings to generate income.

I don't believe the fear-mongers that claim that the slightest bit of deflation will turn into a deflationary spiral -- just as mild inflation does not turn into hyper-inflation. They ignore the success of industries where falling prices are the norm and they ignore the fact that people must generally spend most of their income to survive.

But isn't all of this theory on monetary policy based on the assumption that those using the currency don't have an ability to opt out?  With Bitcoin I can now choose the currency that has the monetary policy I prefer and don't need bankers and politicians to make monetary policy choices for me.  I don't care if someone else wants to use a currency without a hard cap on supply, that's their choice.  All I ask is that they not interfere with my choice.

[Razick]

Sure you can. I am not proposing changing the Bitcoin network. All I'm trying to do is propose new options and improvements for future currencies.

[inBitweTrust]

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

Payment processors like Bitpay have already proven this not to be the case as they have shown spikes in purchasing precisely when deflationary bubbles occur.

The reason for this is because Keynesian economists have it wrong and people are more relaxed to spend when they feel richer and thus take profits.

Deflation simply means that the costs of goods and services get less expensive with time which is a good thing for the average consumer but detrimental to predatory states who want the backdoor tax of inflation.

"Deflationary Spiral" is double speak and should be called "Currency that pays dividends" or "Appreciated Value Currency"

[Razick]

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

Payment processors like Bitpay have already proven this not to be the case as they have shown spikes in purchasing precisely when deflationary bubbles occur.

The reason for this is because Keynesian economists have it wrong and people are more relaxed to spend when they feel richer and thus take profits.

Deflation simply means that the costs of goods and services get less expensive with time which is a good thing for the average consumer but detrimental to predatory states who want the backdoor tax of inflation.

"Deflationary Spiral" is double speak and should be called "Currency that pays dividends" or "Appreciated Value Currency"

While that may be true (and I do think Keynsians tend to exaggerate the harm of a currency that is anything but inflationary so they can continue manipulating the currency for political reasons), the Bitpay example doesn't quite tell the full story. I suspect that there is a difference between a sudden price spike and slow, consistent increases in currency value over the long term.

I think part of the problem is that people's wages fall faster that their own ideas of currency value, sort of like what happens with inflation only in reverse. Because of this, they might tend to feel poorer despite the increase in real wealth. Once this happens, the economy actually does slow down because of reduced consumer confidence.

[inBitweTrust]

I think part of the problem is that people's wages fall faster that their own ideas of currency value, sort of like what happens with inflation only in reverse. Because of this, they might tend to feel poorer despite the increase in real wealth. Once this happens, the economy actually does slow down because of reduced consumer confidence.

Deflation can occur for multiple reasons and assuming that a financial crisis was due to deflation in of itself is making a false cause fallacy.

The data shows that with both slow and steady deflation and hyper deflationary bubbles spending doesn't decrease.

One could suggest that spending in an economy based upon fiat where inflation is high would spur consumers to instantly spend their money because of inflationary fears. I don't believe we need any encouragement to spend capital quickly as doing so doesn't encourage one to allocate their resources on wise investments vs frivolous purchases.

People will always spend their money as evidenced with other examples of rapidly evolving technology. computers and cell phones have quickly been dropping in price and becoming obsolete. Why do people bother buying these items if they can do so much cheaper in 6 months? The reason is because they actually need them and value the goods and services more than any potential savings they could have made.

Do you have any examples of a deflationary financial crisis occurring in society without fractional reserve lending and specifically because a government reduced the currency supply? Bitcoin is different because the blockchain doesn't allow for fractional reserve lending, just third parties like exchanges and cloud mining companies which should be avoided.

[funtotry]

-snip-
I think part of the problem is that people's wages fall faster that their own ideas of currency value, sort of like what happens with inflation only in reverse. Because of this, they might tend to feel poorer despite the increase in real wealth. Once this happens, the economy actually does slow down because of reduced consumer confidence.

Although the recent economic "recovery" has been the exception to this rule, wage grown has traditionally been faster then inflation (this can be accounted for by increases in productivity) so as a result people tend to make more money on an inflation adjusted basis

[Billbags]

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

Payment processors like Bitpay have already proven this not to be the case as they have shown spikes in purchasing precisely when deflationary bubbles occur.

The reason for this is because Keynesian economists have it wrong and people are more relaxed to spend when they feel richer and thus take profits.

Deflation simply means that the costs of goods and services get less expensive with time which is a good thing for the average consumer but detrimental to predatory states who want the backdoor tax of inflation.

"Deflationary Spiral" is double speak and should be called "Currency that pays dividends" or "Appreciated Value Currency"

^ 100% Right. Very accurate and educational post. That really is the true definition of deflation. When things get affordable with lower prices, the government makes less through taxes(politicians want their money) so they start throwing out theorys to the public that the sky will start falling and wage rates will go down so deflation has to be a bad thing. But in the real world, people spend more money when things are affordable so employers will still have to pay reasonable wages to keep employees to make/deliver/serve those products that are being purchased more frequently because people can afford to buy those products because of deflation.

[Vessko]

Interesting paper. I like the idea. It won't be Bitcoin, of course, it would be some altcoin.

One remark:

Although few people enjoy seeing the value of their currency erode over time

It is a common misconception that if the money supply is not fixed (as it will be in Bitcoin once all the coins have been mined), the currency will erode over time. It is simply not true in general.

First of all, you must understand that money is not wealth. Money is just a medium of exchange, the common denominator, the way to measure wealth. Wealth is determined by the productive power of the community - i.e., it depends on the number of people involved and their average productivity. The higher these numbers are, the richer that community is. Both numbers must be high - i.e., a country with a large population could still be poorer than a country with a small population but larger average productivity (e.g. Russia vs Japan) and a country with a productive but small population can still be poorer than a larger country (e.g., the UK vs the USA).

The second thing you must note is that human population and average productivity tends to increase over time, unless hampered by government action (wars, regulations, etc.). Humans multiply and invent new technologies to become more productive. So, if the money supply is not fixed and is, in fact, increasing - but is increasing slower (or at the same pace) as the population and the average productivity of the community, the currency involved will not "erode over time".

There are two problems with this concept. First, while population growth is relatively easy to quantify, average productivity growth isn't, so it's difficult to determine by how much exactly the money supply should be increased. I like the idea of the money supply being determined by the community itself via some kind of "free market" system. The second problem is that, human nature being what it is, every entity in history entrusted with regulating the money supply has erred on the side of "let's make more of it" in the attempt to solve the perenial "we don't have as much money as we'd like" problem. Again, I like the idea of solving this by entrusting the decisions not to a central entity but to the community as a whole.

[Lauda]

Elwar, it has nothing to do with people not spending, but everything to do with people spending less. Deflation really does reduce spending because people see their money as an investment. I spend more dollars and less bitcoin today because I know my dollars are falling in value while I anticipate my bitcoin will rise over time.

This has less to do with Bitcoin itself, but rather with those 'got rich' stories related to Bitcoin. Thus this is a psychological effect that the media created spreading awareness about them.
Exactly how is deflation bad for the consumer? Over time I get more things (due to natural rise in value) for the same amount of money, so this is bad?  

Else you will end up with people posting those pictures about 'dollar purchasing power'.

[Vessko]

Exactly how is deflation bad for the consumer? Over time I get more things (due to natural rise in value) for the same amount of money, so this is bad?  

(Warning, I am not advocating the theory I will explain below. In fact, I happen to think that it is complete nonsense. But it is the theory accepted by the mainstream economists.)

The economy does not consist of consumers alone. You need producers. These producers must either invest their accumulated capital, or take on credit, in order to produce. If the value of the currency is increasing (due to deflation, i.e., due to its quantity decreasing or remaining constant while the population and the productivity is increasing), they will not invest (they will hoard capital instead, in the hope that it appreciates) and they will not take on credit (because they will have to repay in appreciated currency). Result - no production or at least decreased production. They will also lay off workers (not needed, since less is being produced), resulting in increased unemployment, meaning fewer money paid in wages to the consumer, meaning even less consumption, etc.