
Bitcoin Deflation and Economic Activity - exogen
http://computationallyendowed.com/blog/2013/11/27/bitcoin-deflation.html
======
marcell
A few thoughts:

1) Conversely, why would I want to keep my wealth denominated in a currency
that loses 2% value every year?

2) Supposing 90% annual deflation forever, as this article does, is
disingenuous. Bitcoin is currently a 5 year old technology, and of course it
will have periods of significant volatility. In the long run, bitcoin will
stabilize, and deflation will be on the rate of global economic growth,
currently estimated at around 2% [1]

3) In the long run, people could keep their wealth denominated in bitcoin, and
spend dollars. There you have the best of both worlds: your wealth storage is
deflationary, and your spending currency is inflationary.

edit: 4) Perhaps most significantly, remember that bitcoins and dollars are
exchangeable at any point in time. Any dollar you spend on goods/services is a
dollar you could have spent on bitcoin. Have bitcoin enthusiasts completely
stopped spending dollars on goods/services?

[1]
[http://www.wolframalpha.com/input/?i=global+gdp+growth](http://www.wolframalpha.com/input/?i=global+gdp+growth)

~~~
brownbat
> In the long run, bitcoin will stabilize,

Why would this be true? Gold and silver have been around a long time, but both
are still relatively volatile.

I mean, I hope you're right, I'm just curious where you think volatility ends
up and why you think so.

~~~
jquery
> Gold and silver have been around a long time, but both are still relatively
> volatile.

Are gold and silver not less volatile than government-issued currencies, the
long-term value of which has traditionally ended at $0?

~~~
dragonwriter
> Are gold and silver not less volatile than government-issued currencies

Which government issued currencies? Government issued currencies are not all
alike.

> the long-term value of which has traditionally ended at $0?

Fiat currencies only end if the issuing entity ceases to exist or abandons
them, and even so the market value of currency issued may not become zero, so
the claim about ending value is suspect.

More importantly, though, volatility isn't even related to ending value, so
this claim would be a complete non-sequitur even if it was true.

~~~
jwallaceparker
> Fiat currencies only end if the issuing entity ceases to exist or abandons
> them

I'm curious - can you point to one example of this happening?

To my knowledge they've all gone to zero in a hyperinflation but I'd love to
know of a counterexample.

~~~
dragonwriter
> > Fiat currencies only end if the issuing entity ceases to exist or abandons
> them

> I'm curious - can you point to one example of this happening?

Obvious, clear, and fairly recent examples include all of the European
currencies that were retired in favor of the Euro.

> To my knowledge they've all gone to zero in a hyperinflation but I'd love to
> know of a counterexample.

A number have been abandoned (and often replaced by a new currency with the
same name) by the issuing state in the face of inflation (often not even at
the level typically labelled "hyperinflation"), but the nature of the "fiat"
in "fiat currency" essentially assures some minimal residual value as log as
the issuing state remains functional as a state and does not abandon the
currency.

E.g., the pre-1993 Mexican Peso was withdrawn and replaced by the New Peso
after a long period of double-digit annual inflation, but it neither "went to
zero" (prior to being withdrawn) nor suffered hyperinflation (monthly
inflation >50%.)

------
jwallaceparker
> why buy something today if it will be cheaper tomorrow?

Because you want it today.

The "fear of deflation" argument is now pervasive among monetary theorists.
The argument goes that if people know that prices will fall, they will
indefinitely delay all economic activity.

This ignores the time preference aspect of economic decision making. For
example, I will buy my cup of coffee today rather than wait a day or week to
save 1% because I WANT IT TODAY.

We've seen periods of significant economic growth coupled with falling prices.

Before going fiat, we had slowly falling prices in our nation's period of
largest economic growth, the late 1800's.

"Wholesale prices dropped 47 percent from 1879 to 1900 and economic growth
averaged nearly four percent per year." \- Ron Paul

[http://dailyreckoning.com/the-mythical-merits-of-paper-
money...](http://dailyreckoning.com/the-mythical-merits-of-paper-money/)

~~~
atmosx
Your analogy is flawed and completely unrealistic. BitCoin's fluctuations are
insane, we're talking about ~ 15 times compared to last year. Would you
seriously use a bitcoin to buy a cup of coffee _today_ ?

~~~
jwallaceparker
I don't use Bitcoin at all.

I'm just talking about the general idea of inflation.

I'm not arguing the merits of Bitcoin.

------
brownbat
I heard Krebs in a radio interview say that many criminals who are practical
experts in the actual use of experimental currencies require something like
Liberty Dollars for price stability.

Could a cryptocurrency build price stability in as a feature?

I know this is anathema to one of Bitcoin's founding principles, but what if
the payout for each round of mining was adjusted based on the average
transaction size in the last few blocks? If transaction sizes are going up,
you're getting deflation, so the algorithm would increase the rate at which
money is being printed.

Not sure how to control for the opposite, for inflation. Maybe some small
percentage of the transaction fees each round would get destroyed by the
system, instead of paid out to the miners (it'd have to be a small percentage
so you could keep people mining). Maybe better just leaving anti-inflation out
of the design, since it isn't yet a demonstrable problem, might not ever be.

You could fiddle with how aggressively the system fights for price stability,
trading off against the reliability of profitable mining.

------
InclinedPlane
I find many defenses of bitcoin _hilarious_.

A lot of people are pointing out how great it is that bitcoin increases in
value over time. Except there are at least two problems with this. One, few
people who say such things have any concept of economic theory. Two, nobody
seems to care where that value comes from. Somehow they just think it comes
from magic, or somehow it has no cost associated with it.

All in all it's precisely reminiscent of any and every speculative bubble
throughout history. The market will always go up! up! up! Where does the
increase in valuation _come from_? How is it possible for it to be sustained?
Who cares?! We're gonna be rich!

Yeah, good luck with that.

(Edit: all of which is to say, if you want to fly in the face of conventional
economic theory, go ahead, but bring some better arguments to the table than
"well, it's just been going up the last few years!")

------
Anderkent
The 'why buy something today if it will be cheaper tomorrow?' was never very
convincing to me. There are many markets, look for example at computer
hardware, where delaying a couple months can get you huge savings. And yet
people buy new hardware, all the time.

------
bigiain
Seems to me the problem pointed out only exists if you view the transactions
without taking their larger context into account.

Take his "100 Widget @ 1BTC each to produce, sell them later at a different
value of BTC." scenario, which he characterises as an 80% loss. Now consider
where the widget maker would have got his initial 100BTC from, and what he'll
do with the BTC he sold the widgets for. Using his numbers, lets say you sold
50lb of butter to get your initial 100BTC. Several months later, when you've
sold all your widgets (for the deflated 0.2BTC price) and you've got 20BTC in
your wallet, you convert that back into your original resources, and get
100lbs of butter at the new 0.2/lb rate. All of a sudden the exact same
scenario now looks like a 100% profit (50lb of butter becomes 100lb) instead
of an 80% loss (100BTC becomes 20BTC). Admittedly, hanging on to the original
100BTC would have allowed the widget maker to sit on his hands for a few
months and then buy 500lbs of butter, but looking at just the BTC deflation
without the outside context makes things look very much worse than they really
are. And ultimately, it's butter (or opamps or widgets) that you need to
eat/live and that have "real value" in some sense - those 100BTC could just as
easily have turned out to be worthless at the end of the widget production run
- and the widgets could still have been sold for USD or traded for butter. The
guy with a private key to a magic number proclaiming "100 BTC" might have had
_nothing_ Not a problem if you can afford the gamble - not such a great idea
if you _need_ that butter to feed yoru family.

~~~
InclinedPlane
You're missing the point entirely. It's about opportunity costs.

If you try to use a deflationary currency for any economic activity then you
get bitten by deflation, you end up losing money. The fact that the total
revenue you get back is still worth the same (in butter or what-have-you) is
irrelevant. You still had to buy equipment, you still had to pay people wages,
and so forth in that currency to start with.

But if you had not invested that money to start with you'd be even wealthier.

The major point is that bitcoins or dollars aren't actually worth anything
intrinsically. They have no value. Value exists in goods and services. With a
deflationary currency people are discouraged from economic activity which
produces more goods and services because it causes them to lose money.

~~~
bigiain
I think I was making a _different_ point.

I think BTC is a perfectly fine transactional tool. Much like credit cards. I
can buy and sell things with my credit card, but I can't eat positive or
negative numbers on my bank statement - in one sense it's not "real" until I
turn those numbers into something of "value", perhaps butter - perhaps some
other abstraction of "value" that I trust, like dollars.

Dollars as an "asset" are reasonably safe. Using dollar assets for investment
in other value-generating activity is fairly well understood. But ask anyone
from Greece or Zimbabwe if they'd entrust their families future to their local
fiat currency…

BTC as an "investment" or "asset" are quite different. There's _very_ much
more reason to hold on to BTC rather than invest them in any activity that's
going to return less than several hundred percent annualised returns (there's
a _very_ good reason why Silkroad's major commodities were what they were). If
I can expect to double the dollar value of my bitcoin holding just by waiting
another few weeks, of course I'm not going to invest any of that into widget
raw materials or manufacturing plants. But there is definitely a US property
market style risk for people sitting on large number of BTC. The notional
"value" keeps going up at a startling rate - but it's still a crap shoot -
there's nothing _guaranteeing_ you'll get any value at all out of your BTC -
it's even less "sure" then US residential property market or Credit Default
Swaps or Collateralized Debt Obligations from a few years back. It's not
impossible you could buy "$25kUDS worth of BTC" today, and find you've got
_nothing_ next year, instead of $50k or $100k or $500k - there were _lots_ of
investors and property speculators with expectations like that 5 or 10 years
ago≥

~~~
InclinedPlane
Given that bitcoin only has notional value: if it's not used as a currency,
with prices denominated in it, then what supports its value? If nothing does
then you have the recipe for a speculative bubble, and crash, and little else.

At least gold can be made into pretty jewelry and electronics.

~~~
bigiain
It's pretty much the same as post-fund-raising stock market "value". Snapchat
is "worth" 4 billion dollars in exactly the same way as a bitcoin is worth
$1000 - enough people _believe_ it's "worth" that much that you can buy and
sell some form of notional ownership of them - at least in small amounts –
based on that value. If everybody stops believing in bitcoin or Snapchat, that
value will plummet and perhaps disappear. The government will try to prevent
that happening to USD, but ask a Greek or Zimbabwe person how their fiat
currency has gone as a "reliable store of wealth". So long as people keep
believing in BTC it _might_ maintain a real value - it does provide some real-
world convenience to some people, so it's not impossible that it'll maintain
long-tern value I guess.

I can't help but think though, that there's way more people "talking it up"
because they have enough BTC stashed that another order of magnitude increase
in BTC conversion rates will have many of them jumping to exit with "fuck you"
amounts of money - with the inevitable deflation as their BTC all hits the
market in a big rush…

~~~
InclinedPlane
Hardly. Those companies make things. The provide services to people. That's
real, concrete value.

Companies can be _over_ valued, but certainly there is _some_ value even in
snapchat. There is zero non-notional value in bitcoin. It's just a currency.
But if it's only used as an investment and not a currency then it's unlikely
to retain value indefinitely.

Fiat currencies certainly have some similar problems, but because they are
used heavily as currencies much of those problems are mitigated. Everyone
around me is getting paid in dollars, everything at the store is denominated
in dollars. Taxes are in dollars. Etc. Because of economic activities there is
a tremendous amount of inertia to the value of the dollar. The only inertia
inherent in bitcoin is the market valuation, and that is dependent on,
effectively, a pyramid scheme. Once the value of bitcoin starts falling
everyone will want to divest from it as quickly as possible, merely
accelerating the collapse.

This is economics 101, we've seen countless speculative bubbles before, if you
don't believe that speculation is a risk in the BTC market then you're just
unaccountably naive.

If the BTC market started falling at the same rate it is going up right now,
and persisted in doing so for 6 months what would you do with your BTCs?

------
zcarter
The 'depreciating currency is a problem' argument is true for the existence of
any asset having a higher yield than your widget factory. Why wouldn't you
invest in that high yield asset instead of your widget factory? In this way,
you can view _any_ appreciating asset as a reference unit of account. It is
just as easy to see your egg and milk purchases as units of the high yield
asset and delay your purchases for the same reason outlined in the article.
So, it's a nonsense argument.

If you have a strong prior that stocks are going to be worth 100% more
tomorrow than they are today, why would you buy milk and eggs with your
spacebux today? You could invest your spacebux in stocks, sell them tomorrow,
and buy milk and eggs tomorrow! Therefore, no one will buy milk and eggs today
if stocks are expected to rise in price.

~~~
john_b
The critical difference is that Bitcoin is intended to be a _currency_ and not
an _asset_. People use assets to store (and hopefully appreciate) value over
time. People use currencies to conduct business and as mediums of exchange.

If you think of or use Bitcoin as an asset, you immediately nullify any
comparisons with currencies because the two serve different purposes. You
could, in principle, buy a house with, say, 10 cars. But that is not done in
practice because the market for asset-to-asset transactions (bartering) is
small and illiquid.

If you are willing to ignore Bitcoin's purpose as a currency and only use it
as an asset, you need to consider what will drive its value in the long term.
For most things, that value is just a function of the supply and the demand.
While the supply of Bitcoins is fixed and the demand for items that can be
bought in BTC is increasing, what will happen when _everyone_ realizes that
BTC is a better asset than currency and stops using it for transactions? It
will become illiquid, and illiquid assets only have their tangible value.
Since Bitcoin isn't tangible like a house or a car, its tangible value is
zero.

For the record, I think Bitcoin has potential, but not with the present
economic dynamics.

~~~
nardi
How you "think of or use" things has no meaning. Everything that is traded,
whether "currency" or "asset" has a value that changes over time. Or do you
not know that people invest in currencies?

------
nardi

      After some careful calculation, you determine that it will
      cost you 1 BTC to produce, market, and sell a single widget,
      and that it is only worth your effort if you can sell each
      widget for 2 BTC, a handsome 100% margin.
    

I stopped reading right here.

------
mpg33
This is trying fit a deflationary currency into a debt/consumption driven
economy. Who says the best way to drive the economy is by taking on debt to
consume good and services? I would argue that debt counteracts a lot of the
gains set by consumption.

The falling wages argument seems irrelevant...what's the difference between
wages increasing 2% to keep up with 2% inflation and decreasing wages 2% to
keep up with 2% deflation. Don't confuse numbers with value.

I would argue however that the RATE of deflation is important. 90% is
brutal...2% not so bad. Theoretically the rate of deflation of bitcoin's
should decrease as time goes on.

~~~
Ashendar
Even in a non-debt driven economy debt plays a useful role at a micro level in
terms of financing productive investment, not just discretionary consumption.
Deflation will increase the real value of debt, making it increasingly
difficult to service the debt over time (since your wages would probably be
falling), whereas inflation reduces the real value of debt over time.

------
sciguy77
This is a fantastic article, and it highlights some of my worries as a Bitcoin
lover. It would seem the only times one would use Bitcoin over USD is if a
Bitcoin-specific benefit (for instance, anonymity when buying illegal goods)
outweighs the cost of using BTC over USD. In a deflationary economy I can't
fathom why someone would spend BTC over USD buying a legal good, except maybe
for the kick of having spent Bitcoin.

~~~
lukifer
If the deflation ever becomes stable(ish), the increase of value can be
accounted for in the price, as sellers will have a reason to prefer BTC and
offer discounts (not to mention eliminating all those 2.9% credit card fees).
We already buy all sorts of optional goods, even if those goods will
depreciate compared to letting money sit in a bank account and accrue
interest.

~~~
dragontamer
Bingo, we have a winner.

What is important is NOT deflation vs inflation, but to keep that value
_stable_. USD inflates at a rate of 3% year over year, so we can compare
investment vehicles against the rate of inflation and see whether or not they
are good deals.

But since BTC is extremely volatile, its impossible to use it as a unit of
value. Until it settles down and becomes predictable, it will become
impossible to form a "BTC Economy".

~~~
lukifer
I think of it as owning shares of stock in a DAC (Distributed Autonomous
Corporation). At some point, those shares of stock might become worthwhile as
a day-to-day currency.

As is, though, I think it's already more stable than local currencies for some
parts of the world (though perhaps still not more so than the dollar).

~~~
dragontamer
It isn't a stock however, and never will be. The reason why people invest in
companies is to make more money. Companies may not offer dividends today, but
eventually they will. (IE: Even Apple, once allergic to the idea of dividends,
offers a regular one to its investors). Any company that churns a profit will
eventually share those profits with its investors.

"Owning" BTCs is not about churning profits eventually, its 100% about
speculating about its future value. Building BTC Mining equipment is where the
real "value" of owning BTCs is in, since that puts you in control over a
number of BTC transactions.

The BTCs themselves can NOT be compared to stocks. Stocks mean you actually
own the company, you eventually partake in that company's profits... and even
partake in choosing the board of directors. (who then in turn... choose the
CEO).

A BTC on the other hand, is like speculating on Oil, Gold, or Timber. Its a
_commodity_ , not a "share".

~~~
lukifer
I suppose the proof-of-stake coins act a little like stock, in that one gets
to contribute to the 51% that writes the rules of the network, but I take your
point.

Ultimately, crypto-coins are a new type of financial instrument that don't fit
cleanly into either currency or commodity (given that they're not exchangeable
for something tangible). Owning BTC is subjectively stock-like, in the sense
that its present value is based primarily on network effects, and its future
value is highly uncertain.

------
skizm
What would happen if bit coins were produced at a steady rate indefinitely?
Maybe not linearly but at some predictable growth rate. The amount of bitcoins
in circulation would always go up and therefore decrease the value of each in
circulation?

Obviously I don't know much about economics but I can't see why this wouldn't
work. Why does bitcoin have a hard limit on the total number of bitcoins
produced?

------
stevedekorte
The deflation argument:

1) If value of X increases relative to Y, people with X that want Y will wait
to trade for X.

If we make X money and Y some good and you have the deflationary spiral
argument.

But notice that the structure of the argument is unchanged if we make X a good
and Y money.

What does this suggest about the argument?

------
whyenot
There's deflation, and then there is DEFLATION! Five days ago Litecoins were
selling for approximately $7/coin on BTC-e. As I am writing this, the price is
over $36/coin. If you had bought $100 of Litecoins last Friday, that purchase
may now be worth $514. There is almost nothing that you can spend Litecoins on
-- with the exception of buying other cryptocurrencies. It reminds me of the
height of the dot com bubble, except several times "worse."

------
unreal37
"There is a limited supply of bitcoins". Not really true. Bitcoin is
infinitely divisible (unlike a dollar). Having only 21 million is not an
issue, because pretty soon we will be talking about micro bitcoins as the base
unit of transactions.

And then there will be another Bitcoin competitor (Litecoin). And another. And
another. We will never run out of bitcoin and equivalent products.

Stabilizing the price is definitely an issue. Can it be stabilized?

------
lumberjack
Don't we the customers and the capitalists already have the same situation
with dollars? I could either buy a PS4 or I could buy some penny stocks. I
could either try my luck with a startup or I could put that seed money into a
CD or a fairly low risk index fund.

So it all depends on the actual realistic rate of deflation if Bitcoin ever
reaches widespread use.

~~~
john_b
Except that Bitcoin's intended purpose is as a currency, so to make meaningful
comparisons you would need to look at other currencies or currency substitutes
(gold/silver/jewelry/etc).

Assuming that it reaches widespread use ignores the chicken and egg problem
that producers of goods will not want to use it if the depreciation is too
high. Currently you can spend bitcoins mainly through intermediaries and
various online purchases that quickly convert the BTC to some fiat currency.
I.e. pay a company for server space, they quickly turn it into dollars or
euros to pay their electricity and employees.

But to be a legitimate, full fledged currency it will need to both be a
reliable store of value (low volatility) and be useful for producers (minimal
depreciation). It has neither right now, and I personally don't see a path
from the present state to that ideal equilibrium.

------
n00b101
> it will cost you 1 BTC to produce, market, and sell a single widget, and
> that it is only worth your effort if you can sell each widget for 2 BTC, a
> handsome 100% margin.

That's a 50% profit margin, not 100%.

profit margin = 1 - cost/revenue = 1 - 1/2 = 0.5

------
stevedekorte
the deflation argument:

1) if value of A increases relative to B, people with A that want B will wait
to trade for B

Make A money and B some good and you have the deflationary spiral argument.
But notice that the structure of the argument is unchanged if we make B a good
and A money. The sellers and buyers are symmetric - when you buy a good with
money, you are selling the money _for_ the good. If the deflationary spiral is
correct, it is correct both ways, and if it is correct both ways, it isn't
correct at all. Any temporary asymmetry in price movements run into time
preference barriers that return it to a relative equilibrium.

~~~
dllthomas
If people are waiting to trade A, then there will be a shortage of A, which
means (in a marketplace) that people trying to trade B for A will need to
trade more B. The pressures are not symmetric just because the action is when
we restrict our viewpoint to two participants.

------
badinker
Deflation, where your money actually goes up in value, real bad. Ok got it.
[http://tinypic.com/r/2d102dj/5](http://tinypic.com/r/2d102dj/5)

~~~
atmosx
Real bad for a currency (if you are the FED), very good for an asset :-)

------
knowitall
I think the "deflation can't work" people are making the same mistake as the
"interest can't work because one penny will eventually be worth as much as the
weight of the earth in gold" crowd ("Joseph's Pfenning"). They interpolate
incorrectly.

In the case of interest, some borrowers go bankrupt (which is fine, because
the world needs risk taking). In the case of deflation, presumably at some
point people will want to buy things. They can not hold on spending forever
because they might starve.

In any case it seems obvious that the price of one Bitcoin can not go to
infinity, because there is nothing of value "infinity" on earth. From that it
follows that the deflationary dread scenario has to come to an end at some
point, just like Joseph's penny can not accumulate interest long enough to be
worth the earth in gold because all his lenders will go bankrupt before that.

