about price stability, lack of price/supply feedback & long run electrical cost

[adam3us]

Some hypothetical thoughts about price stability, (lack of) price/supply feedback and long run electrical cost.
Not a call to change anything just some thoughts.

One observation people often make about the difference between bitcoin & gold is that gold reacts to price changes, by rate of supply increasing when price is high, and rate of supply decreasing when price is low.  This effect has some positive feedback loop in the direction of stabilising gold price.  Products with an inelastic supply function (like bitcoin or farming with long production lead times) result in gluts and shortages which take longer to self-correct than something with an elastic supply function.

While bitcoin cant directly know its price as that is an externality, one related thing it does know is the rate of difficulty change.  An indication that supply is too high would be that difficulty is slowing, or similarly an indication that supply is too high difficulty increasing too fast.  

So we could (hypothetically) change bitcoin to decrease subsidy per block if difficulty increase is above 10% per 2016 block period (2 week retarget).  What could we do with the unclaimed subsidy?  We could defer it so that bitcoin subsidy lasts for longer, and/or we could bring it forward again if difficulty slowed, eg for example increase the subsidy per block if difficulty increase falls below 0%.

If subsidy is not deferred, just deleted, that saves electricity and reduces the supply.

One might even speculate that the absence of price or rate of difficulty change feedback is currently causing price drops as mining difficulty is falling for the first time while the production cost (mining) is efficient (close to market price of coins) even for the most efficient operators.  Or put it another way miners in todays market would be happy to get another 5% at 13.125 btc/block over 12.5 btc/block.


A second question is if bitcoin is $10,000/btc or $100k or $1mil which would be supported by various real-life uses eg see page 5 of report comparing to different aspects of gold ownership https://cdn.panteracapital.com/wp-content/uploads/Bitcoin-vs-Gold.pdf then at those prices, what happens to electrical use and mining investment.  Is the result sustainable.

Now one argument is more security is needed for higher market cap $21 tril?  And another argument is you cant have mining cost artificially pulled below market price or people will expend that amount of money anyway to bypass, bribe, hack etc the artificial factor.  (eg Paul Sztorc makes that argument in his blog post http://www.truthcoin.info/blog/pow-and-mining/)  I notice Nick Szabo made a similar point in an old blog post also.  The cynic may like to think of the lack of mining for USD (or other fiat) leading to huge expended effort for people to lobby, bribe etc to get access to government funds, where those funds partly come from inflation (which is a form of taxation) and also quantitative easing and bailouts.  The resources arent actually saved, they they just go into lobbying efforts and create cost via inefficient allocation of capital that arises as a cost of moral hazard.

Maybe at these prices subsidy ends up being too high for the needed security and transaction fees cant go negative!  Anyway it would also be possible to voluntarily shrink subsidy per block (phased in over time to respect mining investments).

Adam

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[readerbtc]

So we could (hypothetically) change bitcoin to decrease subsidy per block if difficulty increase is above 10% per 2016 block period (2 week retarget).  

If there are already 10 million bitcoins, not creating additional 50 makes little difference, no?

[chriswilmer]

A second question is if bitcoin is $10,000/btc or $100k or $1mil which would be supported by various real-life uses eg see page 5 of report comparing to different aspects of gold ownership https://cdn.panteracapital.com/wp-content/uploads/Bitcoin-vs-Gold.pdf then at those prices, what happens to electrical use and mining investment.  Is the result sustainable.

Not if the block reward is 25 BTC per block (at $10,000/btc that works out to $250,000 every 10 minutes, and in another other thread someone calculated that in equilibrium [i.e., mining is marginally profitable, rest goes to pay electricity], something like 5% of the world's energy consumption would be Bitcoin mining... an ecological disaster!)

However, I don't see a problem with $10,000 bitcoins when the block reward is less than less than 1 BTC per block.

[go1111111]

Nice post. I think volatility and ensuring the network isn't either over or under secured are the two biggest unresolved problems with Bitcoin now.

Robert Sams recently released a paper recently about the volatility issue:  https://github.com/rmsams/stablecoins/blob/master/00-main.pdf?raw=true . He talks about using mining difficulty and transaction fees to get some estimate of the Bitcoin price, so that the coin supply can be adjusted accordingly. The other idea he talks about is splitting a cryptocurrency into two types of coins -- a stable coin, meant for transactions, and a more volatile one representing a share of the system. The system would automatically trade these two types of coin against each other to ensure stability of the coin meant for transactions. One problem with just releasing new coins slower vs. faster is that there's no mechanism to reduce coin supply if the price is going down.

Vitalik also wrote a detailed summary of the stability issue as well as various approaches, including Robert's paper: https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/.

[lunarboy]

One observation people often make about the difference between bitcoin & gold is that gold reacts to price changes, by rate of supply increasing when price is high, and rate of supply decreasing when price is low.  This effect has some positive feedback loop in the direction of stabilising gold price.  Products with an inelastic supply function (like bitcoin or farming with long production lead times) result in gluts and shortages which take longer to self-correct than something with an elastic supply function.

Realistically the bitcoin supply acts inversely to gold in this regard. Price decrease forces miners to sell more coins to the market to cover electricity costs. Thus exacerbating the problem.

great post as usual.

[PodBayDoors]

The gold price is not a result of a free market changing price in response to supply and demand of the shiny metal. Instead, it is controlled, and very easily at that, by leveraged speculation and by paper and illegal tricks to trade "gold" far in excess of physical demand. One example is the LBMA, where 100:1 leverage is readily available. Another is the futures market, where it is common to see trades for 25,000 contracts placed at the slowest possible time on Sunday night where trades of that size will inordinately move the price. The people making those trades can only lose money, which means they are profiting elsewhere, usually the options market, which is another place highly leveraged trades take place. Another place trades take place that move the gold price is in gold ETFs, which are supposed to be pass-through vehicles that actually hold the underlying metal, but unless you have > $10M, when you sell your ETF shares you must settle the trade for cash (dollars etc) and not in bars of gold.
Bitcoin has a similar problem, but to a lesser extent. Small investments are required to move the Bitcoin price at 50X leverage (Bitfinex etc). Now there are swaps dealers who will take the other side of large Bitcoin trades, and they are not even required to hold Bitcoins (you're relying on the credit of the swap counterparty, not on the fact that he holds any Bitcoins whatsoever).
Bitcoin has a few other problems besides leveraged speculation. One is that it is "automatic money" in other words regardless of demand a certain amount are created constantly. Another macroeconomic problem is that mining is a "natural monopoly" in other words it will always make economic sense for two miners to join forces, reduce their costs, and thereby increase their profits.

[bcearl]

I don't get why anybody would want that. Why should Bitcoin be more like gold in the first place? It is fine how it is.

I also doubt that you could convince the Bitcoin community to adopt such a fundamental change.

[Abdussamad]

If the subsidy varies according to past difficulty changes that would make it harder for miners to predict revenue and plan their investments.

I also don't think it is entirely accurate to say that supply is in-elastic. Production of bitcoins is constant but the number of bitcoins that miners are willing to sell can and does adjust according to price.

Mining is still profitable and that is why difficulty is rising again. The price will continue to decline for some time to come.

[go1111111]

I don't get why anybody would want that. Why should Bitcoin be more like gold in the first place? It is fine how it is.

Volatility is a huge reason why people don't want to use Bitcoin today. Volatility prevents people from denominating contracts or setting prices in Bitcoin. It pretty much makes Bitcoin useful only as gold 2.0 and as a payment network that most people want to get in and out of as fast as possible.

People who do see Bitcoin as an investment should really want to solve the volatility problem, because more use cases being unlocked means a higher price.

[adam3us]

If the subsidy varies according to past difficulty changes that would make it harder for miners to predict revenue and plan their investments.

I also don't think it is entirely accurate to say that supply is in-elastic. Production of bitcoins is constant but the number of bitcoins that miners are willing to sell can and does adjust according to price.

Mining is still profitable and that is why difficulty is rising again. The price will continue to decline for some time to come.

Bitcoin already includes some damping measures: eg difficulty retarget is capped at 4x up or 4x down.

This is another hypothetical damping measure, depending on the parameters.  You could eg split the retargetting 50:50 (geometrically) between reward and difficulty. 

As such that doesnt affect miners as the net-effect is the same: lets say difficulty was about to go up by the maximum 4x, then geometric mean is 2x difficulty and 1/2 supply.  To a miner its net neutral if they get 6.25 coins at difficult 1 trillion vs vs 12.5 coins at difficulty 2 trillion.  However it adjusts the supply reactive to rapid difficulty adjustments which damps price swings (volatility).  And that is good for miners if miners like predictability.

As it is bitcoin mining is a kind of derivative on bitcoin price: its sort of slim-to-mildly profitable for the various efficiency operators, so there is a sort of keep the mine operating maintenance mode, and then if bitcoin price spikes by 2x and sustains, then it takes a three months for new equipment to be produced.  Old equipment could be turned back on if the price change makes it break-even again, and longer term that could be a good thing for stability, but currently moore's law catchup is too fast so that old equipment becomes quite obsolete within a year perhaps.

(And bitcoin-mining with a few asics has so far is looking like a small loss making for me and probably many other hobby miners due to electrical cost and my lack of economies of scale).

Adam

[adam3us]

I don't get why anybody would want that. Why should Bitcoin be more like gold in the first place? It is fine how it is.

I also doubt that you could convince the Bitcoin community to adopt such a fundamental change.

Its a pair of long-term hypothetical what-ifs, as I disclaimed not proposing anything, though its interesting to observe that if there was enough motivation and self-interest, there are things the bitcoin super-majority could hypothetically do.  Some people find confidence from long-term possibilities that bitcoin can technically and even economically adapt without violating its social contract.  (Otherwise these people reject bitcoin because of projected hypothetical end-game problems).

A) could volatility be damped by dual-retargetting (difficulty & reward/block) and

B) could electrical cost be reduced if security subsidy overshot or reached scaling limits (shortage of reasonable power).  

Massive electrical demands can create economies of scale, where politically connected people can get power.

We might see government wealth funds holding bitcoin (if thats not already the case) and/or governments taking strategic mining positions (possibly small loss making with subsidised power) within a few years - who knows!  If your country (or company, bank etc) depends on the secure operation and decentralisation you may want to participate to counter-act centralisation power-grabs from other countries.

Bitcoin is a better gold, and gold served as the predominant world currency for 6000 years.  The current debt based fractional fiat currency has its own seemingly inherent limitations.  Who knows, maybe it'll happen that bitcoin continues to grow in this kind of role.

Adam

[mmeijeri]

Once the global hashrate stabilises, there might be a limited short-term stabilising effect. A temporary drop in price would cause marginal miners to switch off, temporarily slowing down bitcoin production. This would of course lead to an adjustment, but adjustments deal with current production, they do not try to force cumulative production to a pre-set time schedule. Similarly, a temporary rise would cause new hardware to be switched on. This limited stabilisation shouldn't affect long term trends, but it might reduce intraday volatility.

[LiteCoinGuy]

I don't get why anybody would want that. Why should Bitcoin be more like gold in the first place? It is fine how it is.

Volatility is a huge reason why people don't want to use Bitcoin today. Volatility prevents people from denominating contracts or setting prices in Bitcoin. It pretty much makes Bitcoin useful only as gold 2.0 and as a payment network that most people want to get in and out of as fast as possible.

People who do see Bitcoin as an investment should really want to solve the volatility problem, because more use cases being unlocked means a higher price.

Volatility is already solved with "LOCKS" from coinapult and other services like circle will adopt that too.

[go1111111]

Volatility is already solved with "LOCKS" from coinapult and other services like circle will adopt that too.

That's a useful feature, but true volatility would be much better. Locking services only "solve" the problem for consumers making day to day purchases who don't mind having their funds in a centralized service.