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Author Topic: Serious flaws in Bitcoin monetary policy  (Read 6836 times)
GreenStox
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January 17, 2015, 04:51:21 PM
 #1

I don't know if it has been discussed yet, or that anybody observed it yet, so I apologize if it has been discussed already, but I`ve just observed a serious flaw in Bitcoins monetary policy which is very critical to the Bitcoin's price, and it's probably the main cause why the price of it drops for 1 year without stop.

Ok, I have a M.Sc in economics, so I know what I`m talking about, the flaw is in the mining/difficulty adjustment process/mechanism which makes the Bitcoin actually a heavy inflationary currency, and in some cases even worse than fiat.And also there are other problems.

Now i`m not saying that the fiat currencies are perfect, but surely the flaws of the fiat money has been thought about, and some solutions have been offered, while in Bitcoin i see none.

The main problem with bitcoin is the non-elasticity of the monetary supply, which means that it's monetary base it's capped. 21 million, and no more, which is not a good monetary policy.

Here's why, what happen's if there is a shortage in the supply ? For example everyone hoards the bitcoins in anticipation of a higher price, like we see now (it's a fact), which makes bitcoin a speculative currency, creating heavy swings in the price and not very viable for commerce.

So what happens if everyone hoards it (like it is happening without a doubt), is that the price will increase rapidly, and after there is no more supply left, the price will crash. You see, with a Central Bank, when they see a bubble forming, they immediately fire up the printing press, to add more liquidity into the market, and to slow down the speculative price increase by devaluating the currency (ok, the fact that they buy junk bonds and crappy assets is a side issue, but the QE itself is not a flawed principle, it has it's own need if liquidity is small)

Without QE, or any form of increasing the monetary supply, you will definitely have bubbles. Which is funny because bitcoin was created to avoid the flaws of the fiat currency (inflation and depressions), but without inflation you will get crashes  Cheesy Cheesy

So let's recap: if there is no way of increasing the monetary supply and people would not sell their bitcoins (because everyone hoards it, in anticipation of a bigger price), then bubbles will form guaranteed! And eventually it will pop out in a big crash.There is no way to avoid it, as we saw in 2014, when the bubble popped.

Second problem:
Elasticity & The mining/ difficulty adjustment mechanism

Pretty flawed in my opinion, here's why:

If the demand for mining is lacking, due to small prices ( as miners wont mine if the incentive is small/ the profit margin)
, then the difficulty will decrease ,yes ? Yes.
A decrease in difficulty will mean that, the other miners which have better equipment /a.k.a can mine at a cheaper price, so their profit margin is higher, they will keep mining, further more, at a lower difficulty level, they can mine more.
=>WHICH RESULT'S IN: HIGHER INFLATION. => EVEN LOWER PRICES

The mere fact that the difficulty drops due to lack of demand and lower prices, will make the other miners mine more faster, which will create more inflation, and will decrease the prices even further.

This is a huge flaw, I cannot believe nobody saw this before, so this mining mechanism is completely flawed, it will forever decrease the price, as the difficulty will drop, and create more inflation which will decrease prices even more!

Third problem

External demand: yes, both problem 1 and problem 2 can be avoided if the demand for BTC will always rise, but that's not the case. With problem 1 due to price swings and bubbles, merchants will have a hard time adopting a currency which fluctuates like madman, without any value stability.And without merchants you can hardly build an economy on it!

It's better to have a small inflation, than to have bubbles and crashes every single year.

And due to problem 2, as it's price decreases perpetually, perhaps we can gain some stimulus, so that people would consume, but not that much since i`ve seen nobody to shop with bitcoins if the price decrease, they will rather convert it back to fiat.

Keynesian consumer stimulus theory doesn't apply to it, because the monetary base it capped, so basically everyone will just buy bitcoins, to anticipate a better price, and not for to make a currency that can be used to build an online economy.

Because of this BTC will forever remain a speculative currency, and will have a really hard time becoming a real money that can be used in trading Sad

I`m really sad that this is the case, but this is the truth, now I`m not defending Keynesianism here, it has it's flaws aswell, fiat money is not perfect, but compared to bitcoin, i think its better.

Any opinions?

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DanielT
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January 17, 2015, 05:18:51 PM
 #2

You cannot even claim to know what will happen when all coins are mined, no one knows.

First problem: You are trying to convince that QE is applied directly before the crash, and not after it. Is that even factually correct?
Stimulus packages inflate bubbles even more for obvious reasons.

Second problem: Supply is FIXED. By the way, inflation is controlled. 10% per year right now, and from now on, it will be less. (if bitcoin succeeds)

Third problem: Yes, you are defending Keynesianism.
GreenStox
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January 17, 2015, 05:57:55 PM
 #3

You cannot even claim to know what will happen when all coins are mined, no one knows.

First problem: You are trying to convince that QE is applied directly before the crash, and not after it. Is that even factually correct?
Stimulus packages inflate bubbles even more for obvious reasons.

Second problem: Supply is FIXED. By the way, inflation is controlled. 10% per year right now, and from now on, it will be less. (if bitcoin succeeds)

Third problem: Yes, you are defending Keynesianism.

I`m not even talking about when the coins will be mined, i`m talking about a bubble forming every year due to this flaw, way before all coins will be mined. But yes, i know what will happen then, massive selloff, and big crashes.

1) QE needs to be applied before crash to stabilize the price and deflate the bubble, which will prevent the crash.
Nowadays central banker wannabees do it inversely, which is stupid and irresponsible.

Stimulus package does inflate it more, you are correct, but i`m not talking about keynesian BS here, i`m talking about monetary base elasticity = monetary base adjusted to the supply/demand.

2) Inflation is not controlled, the mere fact that miners halt their progress, will create more inflation because they can mine more BTC now, is really stupid.

3) No this is not Keynesianism, it's only a principle of it, there are some good principles in the Keynesian theory, but as it is is just flawed I don't deny it, the whole central planning style economy is flawed, yes, but still, somebody needs to control the monetary supply.

That can be decentralized aswell, so i`m not advocating here central bankism, that can be a decentralized protocol aswell, but still something needs to control it, otherwise it's just chaos.


See the 2 illustrations I drawed (sorry for my poor artistic skills).

Scenario 1, with fixed monetary base (a.k.a current scenario, this is how bitcoin will end)



Scenario 2, with elastic monetary supply (monetary base adjusted directly to supply & demand)



Scenario 1 is not viable for commerce, and is fully speculative, while scenario 2 is closer to the perfect monetary policy (its nothing similar to the current monetary policy used by central bankers, it's actually the opposite)

With Scenario 2, you can just increase the monetary supply whenever there is a bubble forming (lack of supply/liquidity), and decrease it (delete X% of bitcoins from everyone's walled simultaneously), to make the bitcoin more valuable, and increase demand Smiley

I think the elastic monetary theory proposed by me is way superior to the current Bitcoin monetary policy, and to Keynesianism in general. It is the perfect monetary theory in my opinion  Grin

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odolvlobo
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January 17, 2015, 06:11:52 PM
 #4

#1

A. You believe that inelasticity is a problem only because you believe that central bank control of the money supply is a benefit. However, to many people, the central bank is the problem that Bitcoin is trying to eliminate. The idea that an organization can have enough knowledge of the economy in order to control it is preposterous. The central bank only adds another element of instability.

B. Your "problem" of inelasticity is only temporary. I believe that fractional reserve banking of Bitcoin is inevitable, and with FRB will come the inevitable central bank. It will be limited compared to a fiat central bank because it can't print money, but it will give the central planners something to keep them happy, hopefully not enough to really screw everyone.

#2

The difficulty self-adjusts to maintain an inflation rate that eventually goes to 0. The idea that "[when] miners halt their progress, [it] will create more inflation because they can mine more BTC now" is simply wrong.

#3

There is too much speculation and too many unsubstantiated conclusions to comment on. Plus, it depends on #2, which has been shown to be incorrect.


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GreenStox
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January 17, 2015, 06:46:07 PM
 #5

#1

A. You believe that inelasticity is a problem only because you believe that central bank control of the money supply is a benefit. However, to many people, the central bank is the problem that Bitcoin is trying to eliminate. The idea that an organization can have enough knowledge of the economy in order to control it is preposterous. The central bank only adds another element of instability.

B. Your "problem" of inelasticity is only temporary. I believe that fractional reserve banking of Bitcoin is inevitable, and with FRB will come the inevitable central bank. It will be limited compared to a fiat central bank because it can't print money, but it will give the central planners something to keep them happy, hopefully not enough to really screw everyone.

#2

The difficulty self-adjusts to maintain an inflation rate that eventually goes to 0. The idea that "[when] miners halt their progress, [it] will create more inflation because they can mine more BTC now" is simply wrong.

#3

There is too much speculation and too many unsubstantiated conclusions to comment on. Plus, it depends on #2, which has been shown to be incorrect.



1)  A)
Who said here a need for a central bank? I only said that we need a mechanism that controls the money supply, it doesn't have to be a central bank, it can be just a decentralized protocol that watches the price, an AI if you will.

We can limit the corruption and the financial frauds just simply by estabilishing a decentralized control mechanism.

But we need a control mechanism, we can't just have a Laissez faire monetary policy, it won't work.

  B)
Not even that, i`m all for 1:1 leverage loans, fractional reserve system is flawed, I said nothing about it.
Since bitcoin is international, it won't facilitate the loans of any government, it can't create loans out of thin air from fractional reserve system.

The only way to increase the monetary supply (in my theory) was to make QE after every liquidity shortage, but only then, not before not after.

The money generated from QE will be used to redistribute it between miners , who will after sell it to the market.

In the bitcoin eco-system, the miners are the reserve banks, and the central bank (if would exist) would just be a protocol built into the system, there is no need for a government agency to control the money supply, it could be all automated and decentralized.

In the same way if there is a demand shortage, then a % of bitcoins will be deleted from circulation, be removing them from everyone's wallet simultaneously.

It can be all automated, I don't imply any sort of central bank!

2) Yeah but until that happens, we will see many crashes, and bubbles, after every major positive news, suppose giant corporations adopt BTC.

Speculators will hoard in BTC again, and year 2013-2014 will happen again, nothing will change.

And after all BTC will be mined out, it will be even worse, you could see 50% increase /decrease swings daily.

It will be forever a speculative currency unfortunately :|

3) Care to elaborate on that, or do you understand how supply & demand mechanism affect the price?

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GreenStox
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January 17, 2015, 06:53:36 PM
 #6

+1, every fiat system in history has returned to zero. Sterling and the dollar may look like exceptions but both have rarely gone more than a few decades without significant changes. Bitcoin emulates gold in its characteristics, neuvo economists might not like that but precious metals are the only means of exchanging value that's survived for millennia. Right now we're barely in its infancy, the PM equivalent of a few folks finding some shiny stuff in the ground and wondering what they can do with it.

EDIT: Just to expand on that, I'm not saying Bitcoins system is perfect but its far better to work from a foundation that's proved sound than one that's failed repeatedly. Bitcoin allows evolution of the system and that's something sorely missing from banking, its community is also aware of the KISS principle and that's something economists urgently need to adopt.

That is only because the fractional reserve banking is used to support the welfare state that is promised by irresponsible politicians.

So they grow a ponzi scheme global debt bubble and use QE as a tool to ease the debt.

But Bitcoin is already a 1:1 leverage system, no fractional reserve BS. You can't compare the fiat economy to it.

In my theory the QE will only be used to control the price and stabilize it in accordance to the supply & demand mechanism.

In my theory QE won't be used to pay off the debt aquired by irresponsible governments Smiley

There is a huge difference there!  Wink

Bitcoin QE generated money wont be used to buy bonds, it will be used to redistribute it  between the miners Smiley

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GreenStox
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January 17, 2015, 08:00:20 PM
 #7

True but why should the value remain stable? The so called money we're familiar with tries to maintain a stable value by introducing more as overall wealth increases and remove it as its reduced, in other words if a country is doing well only those issuing money get the benefit while with a fixed supply everyone feels the benefit.
There's also stagnation, QE has attempted to boost things by introducing more into the economy but its not getting to the consumers, its stuck in a big ball at the top and hasn't filtered down. Implement QE from the bottom up and it would serve its stated purpose but if its issued from the top down little will find its way into the hands of consumers and so won't have its intended effect.

EDIT: We're also blinkered by a single form of money, its used for different purposes so why not different kinds? A deflatory currency for savings and an inflatory currency for taxation?

If the market would remain stable, then no QE is needed, remember QE and Rate hikes are both interventionist tools.

If the market performs well, then none of them is needed, but of course we know the economy is a very delicate mechanism and nothing will be ok forever, so we need both tools to fix it.

My model, is a bottom up model, miners in the bitcoin network are not centralized, because anyone can become a miner, so the distibution resulted by QE in the bitcoin system is more fair than the Keynesian QE distribution which only consists of giving 0% loans to Wall st. and big taxes to the main street.

You still confuse the QE as a tool with the Keynesian QE. I already explained, my QE is not used for "economic stimulus" or "consumer stimulus" because that is a direct form to facilitate fractional reserve ponzis.

Since we dont have fractional system, there is no need to "stimulate" anything (with more credit card debt, student loan, etc).

The QE in my theory is only used to adjust the price to demand & supply, thats all it will do.

So no bond purchase program, to cover the welfare deficit of socialist governments, and no stock market purchase to enrich the 1% strata of speculators and banksters.

It is only used to add more liquidity and all of the generated money will be fairly redistributed Smiley

Nobody can steal any of it in a fraudulent way because all of it would be automated.

I can't emphasize it enough, because you still confuse the concept of QE with the way it's used by Keynesian con artists Smiley

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January 18, 2015, 03:42:47 AM
 #8

I'm glad you brought up in inelasticty flaw.  Your analysis in the OP is spot on.  Unfortunately, Nobody here sees that because they're all speculators.  To them the cap limit is the pump used to sell the bitcoins.  "Hard limit means I can be in the 1%"

Their greed will doom them to losing it all because they can't think of external factors.

However, I think your proposal  of an "AI central bank" is lacking in foresight about the political realities.  Notice even in this crappy forum they all talk about politics when someone brings up economics

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R2D221
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January 18, 2015, 04:38:48 AM
 #9

Who said here a need for a central bank? I only said that we need a mechanism that controls the money supply, it doesn't have to be a central bank, it can be just a decentralized protocol that watches the price, an AI if you will.

Now you've got a bigger problem: develop a decentralized AI that doesn't require any trust. If someone can do this, then it would be a bigger achievement tan Bitcoin itself.

An economy based on endless growth is unsustainable.
eaglgenes101
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January 18, 2015, 05:25:19 AM
 #10

Who said here a need for a central bank? I only said that we need a mechanism that controls the money supply, it doesn't have to be a central bank, it can be just a decentralized protocol that watches the price, an AI if you will.

Now you've got a bigger problem: develop a decentralized AI that doesn't require any trust. If someone can do this, then it would be a bigger achievement tan Bitcoin itself.
You might want to check out a crypto 2.0 project such as Ethereum, Counterparty, or Truthcoin. They're all working on making it so any computable value can be computed without trust (thought Truthoin in a bit of a roundabout way). Once that hurdle is cleared, making an AI trustless will easily follow.
GreenStox
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January 18, 2015, 05:28:54 AM
 #11

I can't see how you plan on distributing it, Bernankies drop it from a helicopter solution sounds laughable but more realistic sounding attempts have had laughable results.
Miners aren't going to work, as already said Bitcoin mining has a fixed rate and while changing that and raising the reward would put more coins in circulation the only way to pull coins out without stalling network security would be to take from transaction fees and to do that they would need to be unacceptably high.
The coins actually reaching circulation is dubious, unless there's constant inflation miners are more likely to save than re-invest because with a floating rate profitability is unpredictable.
Haha, no. The mining mechanism would be the redistribution mechanism, of course it needs to be reworked to become flexible, and not perma-inflationary.

Also don't forget about deflation, if the demand drops, a deflation algorithm would clear up X% of bitcoins from circulation, from everybody's address.

So if you got 1000 bitcoins, and a 2% "rate hike" would set in, then you would lose 20 bitcoins, however the remaining 980 bitcoins of yours would value 1000 bitcoins of the previous.

This is just to boost demand, in case of price drop, nobody would lose anything actually.

Like you say, we can't compare Bitcoin to fiat and that's the real problem, they're two incompatible systems. If anything it serves to highlight the biggest weakness of fiat, there's simply too much of it and that's eroded the very concept of value. Market's no longer function as a means of assigning value, of judging confidence in a company or the balance of supply and demand of a commodity, they're a playground for all that excess, pump it and dump it until it all turns out to be make-believe.
That is why we need this mechanism to prevent pump and dumping. My theory is exactly blocking the pump and dump scheme, by discouraging speculators to form bubbles.

Markets themselves are the problem, they're abusable so they get abused and piling on regulations does nothing to fix that fundamental flaw, it just keeps piling on cures for the symptoms. HFT clearly amplified the flaws and so helps identify the cause, bottlenecks, different rates of flow, areas of hysteresis, its largely to do with speed. One option would be to have everything free flowing, a global superconducting analogue supercomputer, that's the ideal solution but its not practical so we're stuck with the tick. A single global means of settlement with a relatively steady tick allows everything to move in sync at a pace humans can deal with, every 10 minutes or so would be ideal.
So just decentralize it.

HFT's are not a problem, bitcoin transactions take 10 minutes to confirm, you can't HFT here, this is actually a strength of bitcoin.

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687_2
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January 18, 2015, 05:34:23 AM
 #12

The main problem with bitcoin is the non-elasticity of the monetary supply, which means that it's monetary base it's capped. 21 million, and no more, which is not a good monetary policy.

BTC supply is 100% known and predictable. Predictability allows for stability, which is what markets need to function properly.

It's better to have a small inflation, than to have bubbles and crashes every single year

The giant boom-bust cycles we see in modern economies seem to occur about every 8 years or so, and are very difficult to predict. When a vehicle like BTC cycles more frequently it allows business to more reliably anticipate market fluctuations.


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January 18, 2015, 05:41:13 AM
 #13

I've suggested somewhere else that if a coin has a proof of stake mechanism, we can use that as a monetary policy instrument without too many adverse effects: Make it higher if we want to expand and make it lower if we want to contract. This leaves the Proof of Work "taproot" in place, but Proof of Stake isn't much of a security mechanism by itself, so changing PoS reward isn't too bad.

If you want 100% stability, find someone to sign a futures contract with. That's not the job of monetary policy.
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January 18, 2015, 06:11:59 AM
 #14

The main problem with bitcoin is the non-elasticity of the monetary supply, which means that it's monetary base it's capped. 21 million, and no more, which is not a good monetary policy.

BTC supply is 100% known and predictable. Predictability allows for stability, which is what markets need to function properly.

It's better to have a small inflation, than to have bubbles and crashes every single year

The giant boom-bust cycles we see in modern economies seem to occur about every 8 years or so, and are very difficult to predict. When a vehicle like BTC cycles more frequently it allows business to more reliably anticipate market fluctuations.




And you know this because.....err....we just witnessed the price drop like 80% in a year.  Yep, 100% known and predictable

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January 18, 2015, 09:08:00 AM
 #15

The giant boom-bust cycles ... seem to occur about every 8 years or so, and are very difficult to predict.

An amusing contradiction.

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GreenStox
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January 18, 2015, 07:35:33 PM
 #16

...

We shall see, it will be a nice economic experiment, elasticity vs deflation, which one will win.

But to my common sense, I just can't see a comercially used currency to be deflationary, in some nasty way, devaluation does boost demand Smiley

Although Bitcoin could have a future as a partially commercial but largely savings oriented currency, where you can get loans from BTCJam or other services, and invest in it.

You could see BTC savings accounts in the future, and decentralized banks operating on the blockchain, so it's not a desperate case.

Otherwise I would not be in the bitcoin myself.

I personally just use BTC as a savings currency, but I have my own instrument GREENSTOX built on the layer of bitcoin by using Counterparty as a mediator Smiley

I really like what Counterparty did, you can just add many layers of instruments on one another and create all sorts of complicated derivatives Smiley

I`m also excited about Ethereum, they enhanced this feature even more.

So I`m very excited to create my own financial instruments, I think this is how the world should work, everything to be decentralized, not just a few crooks in CB seats to dictate the monetary policy.

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GreenStox
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January 18, 2015, 08:11:58 PM
 #17

...

Well my instrument is a double derivative, as the base instrument is the Bitcoin, BTC's derivative is the Counterparty (XCP), and my instrument GREENSTOX is a stock derivative based on Counterparty.

If somebody would create a stock option based on my GREENSTOX stock, that that would be a triple derivative  Cheesy

You see you can build layer upon layers of instruments ,which could mitigate the basic risks of BTC.

If you don't like the ever decreasing price of BTC you can just create a derivative where you can short it, and hedge against the risks.

So based on this mechanism, if BTC is a savings currency, you can still create a commercial "token" or asset that can be used as a commercial currency, by adding inflation to it.

Mastercoin and Counterparty have these features, while Ethereum will also have it soon after it will be released.

You could issue 1,000,000,000 units of a derivative currency and make it inflationary, and control the price of it with this mechanism, while the base instrument would be deflationary.

Although one feature I miss from Counterparty is the lack of a "monetary base tightening" option, where you can delete X amount of units from circulation.

It has a basic "callback" feature but that is only a 1 time and you can't modify it. I would like to see a feature when you can just tighten the monetary base without restriction, and also loosen it without restriction.

I hope Ethereum will have these features.

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BitmoreCoin
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January 18, 2015, 08:44:53 PM
 #18


Second problem:
Elasticity & The mining/ difficulty adjustment mechanism

Pretty flawed in my opinion, here's why:

If the demand for mining is lacking, due to small prices ( as miners wont mine if the incentive is small/ the profit margin)
, then the difficulty will decrease ,yes ? Yes.
A decrease in difficulty will mean that, the other miners which have better equipment /a.k.a can mine at a cheaper price, so their profit margin is higher, they will keep mining, further more, at a lower difficulty level, they can mine more.
=>WHICH RESULT'S IN: HIGHER INFLATION. => EVEN LOWER PRICES

The mere fact that the difficulty drops due to lack of demand and lower prices, will make the other miners mine more faster, which will create more inflation, and will decrease the prices even further.

This is a huge flaw, I cannot believe nobody saw this before, so this mining mechanism is completely flawed, it will forever decrease the price, as the difficulty will drop, and create more inflation which will decrease prices even more!


The supply of coin is somewhat constant when the difficulty changes. Some miners get more does mean some other miner will get less. The total is the same.
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January 18, 2015, 09:25:24 PM
 #19

@bitmorecoin

For coin supply, you have more inflation when hashrate grow fast, because difficulty increase after hashrate increase.

The fastest the hashrate grow, the shortest will be the average blocktime, so more coin supply.

When hashrate goes down, block time goes up...
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January 18, 2015, 09:27:26 PM
 #20

...

That all sounds like economology to me but it also sounds like you're getting the kind of tools that really work for you Smiley.
Tbh that kind of stuff is my biggest issue with economics, something having value in its self because its based on something elses value doesn't inspire trust and trust in value is the foundation of any economic system. The vast majority only have a blind trust in todays fiat and the more they're exposed to financial workings the less sense it makes and so the less they trust it.
21 million with 8 decimal places is easy to understand and so easy to trust. I'd love to think the whole world will see it the same way but that's not going to happen Smiley Voodoo economology will flourish and judging by the progress with its tools it will be a far better playground than anything the competition has to offer. That will pull coins out of circulation and everyone feels the benefit Smiley


Sorry but I don't do promos, maybe the odd alt here and there that has features worth looking at but certainly not investments, I always assume burned until proven otherwise and I wouldn't wish that on anyone Smiley

Well I`m an economist so, yes financial instruments are my toys  Wink

It's not that hard to grasp, bitcoin will provide the basic trust needed, and you can build upon that whatever you wish.

It doesn't have to be complicated, but since no system can ever eliminate risk entirely, if you design a system, that atleast tries to do it, then it could be much more flexible than to just hope for the best.

Despite the fact that derivatives got so infamous in the 2008 crisis, they are not that of a boogieman , they are actually very very useful, if used correctly, and only then.

If a CDO is used to clean up the debt of irresponsible politicians, it's not the CDO's fault that it does that, its the politicians fault.

The CDO can also be used responsibly as an investment vehicle on smaller scales aswell. Forcing mortgages to be written into these instruments is never a good idea.

I`m for free market, but also lets face it, somebody has to clean up the mess when it all goes wrong, and its never the banker who will do it.

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