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Here's an email I sent someone yesterday about it:

    I am very intrigued by Bitcoin.  It has all the signs.
    Paradigm shift, hackers love it, yet it's derided as
    a toy.  Just like microcomputers.

Personally I deride it because solves the wrong problem. I just don't see how it can be an efficient long term medium of exchange with the built in deflation. As far as I see it, the hype around bitcoin is built around the broken idea that the main purpose of money is as a store of value. But it is not - the main purposes are to act as medium of exchanges and as the unit of account.

I'm a lot more intrigued by Ripple I feel they try to solve the correct problem, though there are some issues left. The most glaring one being that it lacks a unit of account of it's own but instead pickyback on a different unit of account. It is also a harder to explain, especially to people that believe in hard money since it is basicly a stripped down fiat system.

What we need is a currency that automatically implements NGDP level targeting a la Scott Sumner, and does so even as it's adopted in a more widespread fashion. Right now Bitcoin is a beautifully elegant transaction settlement mechanism married to a horrible, horrible crackpot goldbug theory of how money works as a store of value.

You cannot make loans denominated in Bitcoin (because the price is going up too fast to ever be paid back, and if it ever stops going up, people will be dumping it too fast for an interest rate) so there's no basic demand for the currency at a given price level (to pay back loans). People who want to use the beautiful transaction-settlement mechanism do not have any motive to thereby hold coins, and that means everyone holding the coins is doing so in an expectation that somebody else will buy them at a higher price. Bitcoin is pure instability, pure feedback (in either direction) of the velocity of money into the inverse price of money. I wish I had time to write an article about what an awful, terrible, no good, very bad idea it would be to try running a planet on Bitcoin.

If anyone does have a good idea how to implement NGDP level targeting in an e-currency, please say so or write me at yudkowsky at gmail. In fact, just write me if you can figure out how to measure NGDP in an e-currency in a way that can't be hacked and can distinguish more widespread adoption from increasing RGDP.

RGDP is such a subjective term that it's going to be impossible to design a decentralized currency that targets it. Maybe there's a more objective highly-correlate proxy that would work.

Then there's the problem that bitcoin is an international currency and GDP is a measure of national economies. As far as I know, Sumner does not have a theory for optimal monetary policy for a currency shared by a coalition of nations (i.e. the EU). The management of the Euro roughly stabilizes NGDP in Germany, but not in Italy and Spain which is the source of the current crisis in Europe.

On the other hand, an old-fashioned monetarist coin (constant rate of increase - "Friedman Coin") would be easy to implement and a lot better than a fixed supply coin. I'll leave others to figure out the "Sumner Coin".

You're not trying to detect RGDP. You're trying to detect NGDP, but in a way that isn't fooled by more widespread adoption of the currency.

Who gets the extra Friedman coins? Also if you don't have a central bank stabilizing the supply of money via interest rates in response to velocity changes things can go to crap very quickly a la the Great Depression.

>"You're trying to detect NGDP"

The problem with NGDP is the D. As far as I know, there is nobody (including Sumner) that believes the total nominal transaction volume of an arbitrary subgroup of international users should grow at some low constant rate over time.

Remember that MV = PY, Money Supply times Velocity equals Price Level times Real GDP. PY is nominal GDP, Y is real GDP. AFAIK, Sumner's followers argue that M should grow so that PY grows at some constant rate. V is assumed to be endogenous.

Now think of two countries with similar sized economies that share a currency. Imagine country 1 had Y growth of 3% and country 2 had Y growth of -1%. How should M change? As far as I know, this is virgin territory. Also, country 1 and 2 are basically Germany and Greece.

NGDP is easy to calculate for the users of bitcoin as every transaction is encoded in the blockchain. Of course, you are right that there is a difficulty because of a rapid unstable increase in V due to adoption, the NGDP of the Coin economy is measuring the economic activity of its users + some amount of canibalization of the legacy dollar economy. If you are looking for the "right" answer, I think it will elude you. But I have a "good enough" proposal for a Sumner Coin - start with the BTC reward scheme, and after PY stabilizes (i.e. changes less than 10% per month), use that as the base for PY and then set block rewards to grow PY by a constant amount. V is public so it is easy to calculate the appropriate M.

The Friedman coin is much simpler, since you are pegging M to a growth rate and not PY. Of course, the miners get the extra coins.

Both models decrease first mover advantage and relieve the need for transaction fees for stability of long-term mining. And for both models I would recommend an initial deflationary period to sweeten the pot for early adopters.

You're comparing the Bitcoin monetary policy to what you think will be the ideal automatic monetary policy.

But it's more interesting how the Bitcoin monetary policy compares to the current real-world human-controlled monetary policies of government money - which in the cases of most countries is definitely pure instability and filled with error.

The Bitcoin monetary policy doesn't have to be perfect to be an improvement, because the status quo is very imperfect.

> You cannot make loans denominated in Bitcoin

I'll give you 1 BTC on April 1st, 2013. You can repay me 1.5 BTC on April 1st, 2014, adjusted for deflation or inflation according to mtgoxUSD × CPI, as the case may be.

Problem solved. I give you spending power today, you give me more spending power later on, and we conduct the transaction in Bitcoins.

In the future, we will have our choice of price indexes that are denominated in Bitcoins directly.

I refuse. I think Bitcoins might appreciate more than that, and I don't want to take on the risk.

On a planet with a growing economy and a growing population, Bitcoins will always be appreciating faster than material investments can grow. If you can plant 100 seeds to get back 103 seeds (3% material interest) and also the planetary population is growing at 2%, that's 5% interest on Bitcoins. Except then people try to hold more Bitcoins since they grow faster than seeds, which makes Bitcoins appreciate even faster... but even before taking that into account, you still wouldn't be able to grow enough seeds fast enough to pay back a loan in BTC, if the planetary economy used Bitcoin.

The deflationary process makes things much worse; the more people try to hold Bitcoins, the fewer circulate and the lower the velocity, increasing the apparent price of Bitcoins. This process continues until instability in the price of Bitcoins as people occasionally dump their hoards is so great that Bitcoins stop appreciating. Then fewer people want to hold Bitcoins and they dump their Bitcoins and the velocity goes up and the price goes down and the bubble pops.

(The reason this doesn't happen with existing central bank currencies is that central banks regulate interest rates to stabilize the supply of money and hence its price in response to velocity changes, or at least they're supposed to. The reason this doesn't happen with equities is that they have an intrinsic rate of return due to dividends or stock buybacks; real estate has intrinsic rent; bonds have returns denominated in stabilized money.)

So like I said, Bitcoin is a horrible crackpot theory of money as a store of value, married to a beautiful transaction settlement mechanism.

Why do you refuse? Here, I'll lower my rate to 1.05x. If CPI remains stable and mtgoxUSD goes up by 1.06x between now and next year then you'll owe me less BTC than what I gave you. If mtgoxUSD goes down then you'll owe me more than 1.05 BTC but it'll be that much easier for you to buy them.

I am happy to offer you the loan, because Bitcoin prices are volatile and there is no guarantee if I keep my Bitcoin in storage that it will still be worth much one year from now. There have been many crashes. But if you agree to repay me an amount equivalent to 1.05x my current spending power then I know whatever you pay me I'll be in a better position than I am today in terms of my ability to pay my rent.

Such a loan offers me a drastically different risk profile than holding Bitcoins. If BTC were as guaranteed to increase as you say then they would cost more.

Oh, sorry, I didn't understand your original proposal.

This is a loan denominated in dollars, it's just being transaction-settled via Bitcoin. The medium of account is dollars and the medium of exchange is Bitcoin. This is pretty much exactly the original point I was talking about. :)

Well, it's not really denominated in dollars, it's denominated in the CPI. You could also have a Bitcoin Price Index that tracked how much spending power Bitcoins had and denominate your loan in that.

I sincerely doubt this will happen, but lets run with the scenario. In a totally deflationary world, more people try to hold bitcoins, I agree. The complementary effect is that the value of real goods, land and labour is reducing.

People earn to consume. The bitcoin rich, if they apply the Kelly criterion to their own portfolios, will diversify into whatever assets will provide them a regular real dividend. That is, farms yielding grain, orchard yielding fruit, NG wells yielding NG, wind farms yielding electricity. They will not be buying any investment for the purpose of money, but for the purpose of CONSUMPTION.

There lies the negative feedback that will stabilize any new currency as it conquers the world.

The way I would see a hypothetical solution work is to target price stability directly through some kind of supply/demand mechanism - that is, add a way to create currency units at a few percent above some target rate and a way to destroy them at a few percent below it. Somehow integrating computer power rental into the network is as close as I can think of, although that does give you a very high inflation rate of Moore's law. Another possibility might be velocity - look at the average age of unspent outputs (or, better yet, something like the sum of the inverse of the age over all coins, so lost coins automatically approach value zero) and add more currency units if it looks like things are going too slowly, but you would have to think long and hard to ensure that that's not gamable. It's an interesting unsolved problem, I admit.

Yeah they definitely need to stabilize its value somehow.

I'm actually not totally sure if NGDP-LT is optimal in a free-banking scenario though. But certainly some sort of value stabilization is.

> because the price is going up too fast to ever be paid back, and if it ever stops going up, people will be dumping it too fast for an interest rate

Is it implausible that these two forces would reach a relatively stable equilibrium, like stocks?

I think it is implausible.

What ultimately sets the price of stocks (and prevents undue speculation) is the profit earned by a company.

This mechanism doesn't exist in currencies, where the value comes only from what people think it's worth.

Can you make loans denominated in gold? I think you can. The volatility of bitcoin will settle down eventually. It's essentially the 19th century international gold standard for the 21st century.

> Can you make loans denominated in gold? I think you can.

Nobody does. Now why is that?

Friedman understood perfectly well that failure to increase the money supply in response to decreasing velocity was responsible for the Great Depression. He's sort of famous for that part, if I understand economic history correctly, it's why Bernanke apologized to Friedman's memory on behalf of the Fed. It seems odd to call them 'Friedman coins' when they depreciate automatically, but don't adjust to velocity and especially to changes in fractional reserve lending.

>Nobody does. Now why is that?

Probably executive order 6102 in 1933. By the time the government allowed private ownership of monetary gold again, it had fallen out of use as currency.

The world is a lot bigger than the scope of executive orders.

There's nothing stopping you from devising a coin with a different mining schedule. I'm working on two proposals right now, one with constant growth over time and one with a slightly increasing growth. Both of them have an initial deflationary period to encourage adoption. Working title is "Friedman Coin".

This solves the problem of decreasing mining incentives and the possibility of a too-big windfall for early adopters. It's not unrealistic that Satoshi could own 2% or 3% of all the money that will ever be made. That's a problem.

> It's not unrealistic that Satoshi could own 2% or 3% of all the money that will ever be made. That's a problem.

Not really. It might offend someone's sense of fairness, but it hardly has an impact on whether the currency will achieve adoption.

It's really only behavior on the margin that matters.

"I'm working on two proposals right now, one with constant growth over time and one with a slightly increasing growth."

Such a coin has been created. Freicoin is a bitcoin-variant that devalues at a constant rate. It hasn't caught on, probably because people prefer currency that doesn't lose its value.

"It's not unrealistic that Satoshi could own 2% or 3% of all the money that will ever be made. That's a problem."

He owns 2-3% of all the money at one point in time. He can only spend that money once. Money circulates, and can only give value to its user when they circulate it.

Given a given unit of money will circulate indefinitely, the relative economic power of a holder of a particular percentage of the money supply at a particular point of time will decrease over time as a percentage of total economic power exercised throughout the currency's existence.

You should really look into the history of altcoins because I'm positive one with a constant mining release schedule has been done. One issue with some of them has been premining but if it wasn't premined and was reasonably well-known at launch it probably stands as a good test of whether something like it will ever work. Funnily enough the altcoin that has done the best has changed very few parameters.

You are correct, the HYPE around Bitcoin is built around a broken idea, but Bitcoin is built around a good idea. Indeed, the main purpose of Bitcoin is in fact to be a medium of exchange and as a unit of account. Bitcoin will be highly profitable for those who treat it as a store of value, until the market gets saturated, but the fact that they treat it as a store of value and hype it up will only expedite the market saturation process.

When that happens, then Bitcoin will maintain a steady price and it will serve its purpose as an efficient medium of exchange on the Internet without the need of a central authority. Until, of course, something better comes and replaces it.

Deflation is easily negated by the natural rate of inflation, which will always occur simply because of supply/demand economics. Natural inflation is actually healthy for the economy. Artificial inflation forces people, businesses and governments to depend on lending a lot more than on the money they earned. Note that lending will still continue with natural inflation, but the interest rates won't have to be kept artificially low (like they are now).

Re: "Built-in deflation"

This being the theory that "no one is going to spend Bitcoin if it keeps increasing in value, since they will sit on it instead, for the future gains. Therefore the currency is deflationary."

Amazing how this rationalization, given to slaves to justify their slavery, ends up being touted by the slaves themselves.

Technically the same is true of the U.S. dollar: If you put your dollar in a savings account, instead of spending it, you will earn interest. Therefore you will have more money in the future, from the interest earned, if you don't spend that dollar now. Therefore the dollar is also "deflationary."

That's not correct with regards to the dollar. It's inflationary because the purchasing power of those dollars in the bank decreases more rapidly than you accrue interest on them.

The current US inflation rate is around 2%, so unless you're making more than 2% interest on your money every year, your purchasing power is going down. For point of reference, yield on a 1yr treasury bill is around 0.14%.

Bitcoin is deflationary because, once the coin limit is hit, the number of available coins will decrease over time simply due to coins being lost. As the currency contracts, the purchasing power of a coin goes up over time.

In a world where BTC had an inflation rate of -2%, 1 BTC now would buy what 0.98BTC will buy in a year. Any investments you make now need to yield in excess of 2% per annum for you to be better off. In an inflationary world, an investment only needs to beat the T-Bill rate for you to gain (or least be less worse off), which allows for less risky investments.

A gradual rate of deflation didn't stop world markets when they used an international gold standard.

Very few people forgo buying something they need because they could get 2% one year later if they hold on to the currency.

I think deflation IS economically inefficient, but the negative effect of slight deflation has been exaggerated in the popular economic literature.

For a peer-to-peer currency network, a fixed money supply could even be beneficial by creating an incentive for bitcoin holders to invest in the technology.

Bitcoin is working, has created the most powerful distributed supercomputer in the world, and is processing an increasing number of instant global transactions every month.

It works in practice, as a medium of exchange, and that is a better argument for it working as a currency than theories about how deflation affects economies.

The problem is that the time period of the world that had a gold standard had several instances where the world markets did stop. Both the Great Depression and the Long Depression happened in the period in question, and that that is more depression than either before or after the gold standard.

The Great Depression was not during the international gold standard period. By the time it rolled around, central banks controlled the money supply of every advanced economy, and in the midst of the Depression, the U.S. government further left gold-redeemable currency by enacting Executive Order 6102, which ordered all private citizens to turn in their gold, criminalized private gold possession, and made dollars irredeemable in gold.

But let's grant that the Great Depression, along with the Long Depression, was during the gold standard's reign. That's two serious economic contractions interspersing mostly long periods of expansion. Compared to the last several decades, which has been marked by several 'lost decades' for the Middle Class, the gold standard era doesn't look bad.

Bitcoin doesn't have built-in deflation; it has built-in hardness: a(n eventual) strictly fixed supply. Deflation comes from currency concentration; inflation comes from currency dilution. Bitcoin has neither.

Any thoughts on the currency vs hoarding issue?

Quick background for those unfamiliar with the issue - Bitcoin was built to be a currency, to be used to trade for goods and services. However, a significant portion of BTC is being hoarded and not traded, thus leading some (like Nobel Prize laureate Paul Krugman) to argue that it's not a currency at all, and any value is purely speculative. For the record, I don't agree with Krugman's argument.

I also wonder what percentage of the "hoarded currency" is actually currency that has been destroyed and if it will have any long term consequences. For example, in the early days of Bitcoin I mined a few blocks with an old laptop. The computer eventually died without any backup of my wallet thereby destroying the those Bitcoins. There doesn't appear to be anyway for anyone to know whether I am simply hoarding those Bitcoins to dump on the market at a later date or if they have been permanently removed from the money supply.

I'm in the same boat. I played around with BitCoin in the early days and never really cared for the coins I earned. I wiped the machine I used and only recently realized they were gone forever. Apparently I just flushed a few hundred bucks, meh.

> There doesn't appear to be anyway for anyone to know whether I am simply hoarding those Bitcoins to dump on the market at a later date or if they have been permanently removed from the money supply.

Yeah, this is the big problem with the papers or blog posts pointing out how many coins are not moving around and then insinuating that Bitcoin is a scam or that it will soon be destroyed as an old miner dumps a few hundred thousand coins: for most of them, the parsimonious explanation for them not moving is simply that they've been lost. But there's no way to prove this! Did Satoshi wipe his hard drive when he moved on to other 'projects'? We have no way of knowing.

(There apparently are ways to verifiably destroy bitcoins - send them to impossible addresses or something like that - but I haven't heard that anyone has bothered doing that and this wouldn't apply to people losing coins accidentally or apathetically.)

If a few blocks is 3 or 4, you might want to keep that HD around. Could be worth sending it to a professional data recovery firm and having the platters removed etc.

Blockchain.info has this chart that tracks the number of bitcoins traded on known exchanges vs the number of bitcoins exchanged in all other transactions.

This chart gives a somewhat measure of if the hoarding has gone up or not. It gives us a good idea about bitcoin speculation.


The lower the number on this chart, the less the speculation. Recently, the number has almost always been under 20. This number was at 225 during the July 2011 bitcoin bubble.

(More explanation about this chart: http://codinginmysleep.com/measuring-bitcoin-speculation/)

So while we would think that more people would be hoarding bitcoins, the data shows thats not necessarily true.

Combining this chart with the number of bitcoin transactions per day chart gives us a good indication that the price is increasing because more people are hearing about bitcoins and using it. (Number of transactions per day have gone up from 6,000 a year ago to 70,000 today.)

I personally think economists don't have that good models on deflatory currencies. Since pretty much all currencies are designed to be inflationary, it's easy to fall into the trap of thinking only inflation can make currencies work. The best thing is to wait and see the empirical data.

My bet is that some people will hoarde money, but it doesn't really matter. There will always be people who will use bitcoins for real economic activity, and 'speculators' will keep the value inline with other currencies. Prices will be adjusted for deflation just like they're adjusted for inflation.

Saying that the rational action is to hoarde the money until it rises in value is like saying that the rational action when buying computers is to wait an infinite amount of time, since you're always going to get a better computer by waiting 6 months.

Some early adopters would be filthy rich. Not so different from other filthy rich people. Hoarding would be more profitable than investing. Would everyone stop investing, would the currency just keep on deflating? Forever?

When a really rich person doesn't have to do anything at all to keep getting richer, what will he do? If he hoards until he dies, how will that affect the economy?

I too want to see empirical data on this.

If he hoards until he dies, his currency is effectively worhless. If he tries to spend it all at once, hyperinflation.

Money is not a store of value. It is currency, for current exchange.

Someone should call the banks and warn them their depositors' accounts are worthless then.

I think the argument is a sufficiently deflationary currency creates an investor's dream: once you get enough of it, you can spend just what you need and what you have left gains value just sitting there. You don't have to work anymore or invest in anything besides the currency itself. If that becomes the most profitable investment strategy, it's in each individual's best interest to hoard money, but if enough people do that the economy collapses.

If one person "cheats" the system by hoarding money and gets to spend less and less of it every day because it's actively gaining value, that person gets something out of the deflation. If everyone tries it, the system's in deep trouble.

That seems to be the argument, anyway.

What would actually happen? I don't know… I'm a programmer, not an economist.

As far as I can tell that should be what happens. I'm a programmer and I have friends who are economists.

My thoughts are that we need a new crypto currency without the deflationary flaw of bitcoin. The rate of new coins mined should increase as time goes on in a controlled fashion.

A crypto currency with managed inflation wouldn't make early adopters as wealthy, but it would be a better medium of exchange.

I don't know that you can call deflation an inherent flaw. In most econometric schools of thought, the debate between deflation and inflation boils down to expectations, making predictability more important than either tendency. IE Actors knowing what to expect from the money supply, eliminates some of the uncertainty that drives volatility. Predictability gives actors the opportunity to properly hedge protecting against the negatives normally attributed to both inflationary and deflationary currencies.

With central banks, it just became accepted that when dealing with unpredictable economies, the tendency to inflate was less dangerous than the tendency to deflate and thus why most banks will err on that side when making policy decisions. There are some great historical examples where banks organized mass deflation (I can't find one right now, but the one in my mind involved the entire country dropping zeroes from the end of their notes) and by making the change predictable, they were able to avoid many of the harmful effects.

Are you sure there are examples of actual successful deflations, where debts, payments, wages, etc denominated in the form of money deflating increased in value? I know of successful cases central banks have brought inflation under control or one currency was replaced with another that was much more valuable. But human nominal loss aversion[1] usually causes big problems during deflation in any modern economy. Maybe you could have pulled it off back in the day when 90% of the population were independent agents in the market, but not today where 90% are employees of firms with contractual wages.


I don't see how a currency like BTC would deflate, ever, besides runs on the market. At least if BTC became a real market force. Right now, almost all BTC transactions are between currencies like USD, so it is functioning more like stock than real money.

If it were legitimately used in widespread transactions, the currencies market wouldn't impact the valuation as much, and without that turbulance, since BTC's can't "disappear" under your couch, and you have a mathematically fixed growth rate up through 2140, the currency shouldn't deflate. Just as a frequently cited example, the US had a crisis in the 70's not because pegging the dollar to gold was bad, but because the real gold reserves were covering vastly less of the actual dollars in the market drastically due to money printing.

BTC doesn't have those issues - they are fixed in circulation, have a predictable rate of disbursement that will slow to nothing in 2140, and at that point the exchange rates for goods with BTC would only fluctuate its fixed value against other currencies or against goods scarcity. I wouldn't imagine, if it actually became a well grounded currency, significant swathes of the market making a run on it and depreciating its value as badly by that point. It lets you keep currency speculation, though, without the rampant inflationary effects of quantitative easing and money printing at whims.

There have been a few already made, check out the Alternative Cryptocurrencies forum on bitcointalk.

The problem with a coin like this is initial adoption (which is required to create the network effect that makes the coin useful). Why would anyone put serious money into a currency that is guaranteed to lose value forever through inflation and with no useful network?

The only reason inflation works for a currency like USD is because there are already billions of users locked in by the extremely large network effect, and similar inflation on any viable alternatives like the EUR.

Look at inflating currencies with smaller networks (south america) and how hard it is to keep people from getting rid of that money, usually it requires government (violent) intervention.

Because money is a medium of exchange, and has no inherent value. Hoarding cash is equivalent to destroying production-- by then time you try to spend it, there won't be anything left to buy. Inflation encourages people to be active in the system, exchanging to produce real value, not staring a the charts of growth of imaginary wealth that means only as much as a video game high score board.

That sounds awfully counter-intuitive. Before there'd be nothing left to buy, the prices of things to buy would go up (i.e. inflation), which would discourage further hoarding.

Hoarding cash does not destroy production, as the number of units of cash in circulation does not affect economic productivity.

Yes. Finally, someone levelheaded. Every bitcoin supporter I've ever spoken to has basically dismissed deflation as a non-issue. It is important, and if the bitcoin economy grows, the deflationary effects are only going to become more visible.

I have never met a single person who was able to convincingly raise at least a little bit of suspicion about deflation in me. Why is deflation bad? Because people stop spending? Can't you see how ludicrous this explanation is?

It's more because people stop investing

If the real rate return of investments over any period of time is on average less than simply hoarding the currency (an inevitable consequence of a permanently deflationary economy) your economy is screwed up.

Bitcoin and its users have no duty to any existing "economy", and certainly don't amount to one themselves. If one's holdings of bitcoin appreciate with respect to some other commodity, eventually the wealth effect will make investment and other spending in that second commodity attractive. No one is in any sense stuck in a "bitcoin economy".

If I'm misunderstanding, please clarify.

Your above points are correct; depreciation in general is a bad thing but for a "parallel currency" aiming for a particular niche like Bitcoin it's probably not an issue, especially because holding Bitcoins is definitely not without risk.

(In the unlikely event that Bitcoins ever became widely popular with speculators, then governments will tax or restrict domestic purchasers or exchanges for Bitcoins (they can't and won't be especially efficient at doing this; the US/EU don't need to be to severely damage the exchange value of a Bitcoin.).

Ok, let's say everybody in the world uses Bitcoin. Nobody invests. If that's the case, then the amount of goods and services in the economy remains constant, which means the price of Bitcoin doesn't rise. How do I make money then without investing and creating more value?

In that scenario, once you've adjusted for the risk associated with investment you'd give up all hope of "making money" - with no aggregate monetary growth(1) it would be like "investing" in a game of poker (sure, you might back the surprise winner but...). It's amazing how much less risk averse you are if you lose ~2% per annum from sitting on cash and you can make money from a slightly-worse-than-average investment portfolio (and there's a 2% return for an average investment)

Arcane hypothetical edge cases are unhelpful for exposition. It's easier to look at the conventional alternative: everybody in the world uses a means of payment which diminishes in value at a slow but stable rate. Now the average person that invests in production gains, and the average person holding cash is incentivised to convert that cash into something they want or funding the production of something others want. Isn't this better?

(1)strictly speaking we're better off looking at money as a flow, in which case the velocity of circulation comes into place, but a fixed money supply certainly wouldn't induce that to increase....

with no aggregate monetary growth it would be like "investing" in a game of poker.

This statement is wrong, because you measure profits in money rather than value. With bitcoin the amount of money in the economy stays the same, true. However the value of each unit grows as soon as you invest and produce something useful that people want. This means, you may receive back even less than you invested in absolute units of money, but more in value.

As I had replied to Eliezer, investing in a deflationary world will be tilted towards capital that yields a regular stream of real dividends: actual goods, not money. That is, there will be fewer corporations that will be expected to give money as a yield and more consumer cooperatives that will yield goods and services. Farms that yield food, NG well and that yields NG, a power plant and get a yield of electricity and so on.

Actually, it is only less for a sub-average investment. If you invest something with an above-average return, you'll be better off investing.

"Why is deflation bad?"

Deflation is bad because it makes loan repayment more difficult during both recessions and periods of growth. In the extreme, deflation will worsen recessions and hinder expansions of the economy.

Then we have to ask, bad for whom? For those who take loans certainly it's bad. For those who loan, it's great. Inflation creates a reverse situation. It is possible, I would imagine, to create contracts that adjust for the fluctuations in currency valuation, but it is unwise to blame deflation for all the bad luck of those who take loans. Deflation would only mean that people taking those loans would think really hard about the prospects of any future profit they are hoping to get from investing the loaned money. Which means we'll have a more, not less, stable economy.

Actually, deflation is bad for both lenders and borrowers, since it increases the likelihood of default. Let's put it this way: if you knew that it would be hard for me to repay a loan during an economic boom, and even harder during a recession, would you want to lend money to me? Deflation actively discourages lending, by creating an incentive to hold money.

It is easy to think that lending is a bad thing, but let's put it this way: it is because we are able to take out loans (of various kinds) to start businesses that non-wealthy non-aristocrats are able to participate in the market. Too much credit is a bad thing, but too little credit denies capital to anyone who is not already wealthy.

You have a point, however I would like to note that Bitcoin is not actually a deflationary currency as I explained in this comment: https://news.ycombinator.com/item?id=5403360

The bigger issue we should be focusing on is not deflation or inflation but rather who controls it. If it is controlled by one player (government) then it ultimately decides who benefits and who loses from it. It is a much more honest situation when market controls it. Once there are too many people taking loans and going bankrupt, then investors stop investing until a point is reached at which it is more profitable to invest than to hoard again.

In any case, the extent to which people are denied access to capital is almost exactly the same as the extent to which they benefit from hoarding.The distribution of capital changes, rewarding less opportunistic and more hardworking people during deflation. Ironically, it's exactly the opposite of what governments in almost any country tell people.

Finally, I would like to add that even though capital is important, it is not the only component responsible for creating value and wealth. Thus, economy would reward not only people capable of obtaining capital, but also those who have great ideas and skills to implement those ideas.

It is deflationary. I have 1€, I can buy one loaf of bread with it today. One year from now: Inflation - I can buy 0.5 loafs of bread. Deflation - I can buy 2 loafs of bread.

Have any loans ever been denominated in bitcoin? Given the disadvantages of a bitcoin loan, some of which you cite, when should we expect such to occur? Is there any reason to believe bitcoin could affect the supply or demand of loans denominated in other currencies?

I am not aware of any major Bitcoin lending, nor would I expect to see any major Bitcoin lending at any point. The reason is simple: Bitcoin is not a legal tender anywhere, nor does it enjoy any legal status as a currency anywhere. Courts deal in fiat currencies, and both lenders and borrowers need to deal with the court system in case of default; until courts start dealing in Bitcoin, issuing a Bitcoin loan will only add complication to such proceedings.

In my view, Bitcoin will ultimately be little more than another way to make electronic payments. Merchants will accept Bitcoin only to immediately trade the Bitcoin units for some fiat currency on a Bitcoin exchange. Bitcoin exchanges will basically be payment processors. This, of course, assumes that technical problems do not destabilize everyone's trust in Bitcoin as a secure payment system (and given that it fails to meet the formal definition of security used by cryptographers, I suspect that this is bound to happen).

All of this makes sense, which leads me to think that when you said "deflation is bad" above you meant it in a very general sense rather than as a criticism of bitcoin. After all if there will never be significant loans in bitcoin it can't very well be implicated in a breakdown of the lending system. Sorry for misunderstanding.

Yes. Ripple[1] has allowed for the use of bitcoins to denominate loan-like credit extended between people for quite some time[2]. You just have to be careful.

By the way I back my ripple credit entirely with bitcoin -- if you can make a payment go through the network to me, you are entitled to it.

[1] http://www.ripple.com

[2] http://ripplepay.com

It's too late for an "alternative" now. Regardless of your views on the impact of deflation in an overall society, a deflationary currency is always going to be a better store of value and a more attractive option for a consumer. The wheels are set in motion with Bitcoin whether we like it or not (personally I'm unconvinced that deflation causes as many problems as people claim, especially with infinite divisibility).

What happens when someone retires at the same time and tries to cash in their hoard of btc to buy stuff that no one is producing (since they also retired)? Liquidity shock. Years of deflation instantly give way to hyperinflation.

What are the deflationary effects? I am curious, I have heard this before, and I don't understand.

What are the effects you expect to see?

That's not easy to fix with more lucrative mining. Suppose your economy is growing at 3% real rate per annum. Now suppose that you try to have 3% more Bitcoins per annum, produced by mining. People will compete for these Bitcoins until the competition stops being profitable, i.e., until price exceeds profit. Then 3% of all your planetary resources are being burned on wasted computing power that competes to mine Bitcoins.

>wasted computing power

having a secure system with the properties of bitcoin is worth some amount of money compared to money wasted on frictional costs in the current financial system.

Setting fire to 3% of gross planetary product doesn't seem like it should be the best solution. Current financial wastage is more than this, sure, but who says that Bitcoin fixes all problems and they never come back?

It doesn't, but fortunately it only burns as much electricity as makes sense given the size of the bitcoin infrastructure which depends on how the market prices the bitcoin infrastructure. Bitcoin only needs to replace a small amount of inefficiency (in the grand scheme of the global financial market) to be worth it.

If you avoid drinking the kool-aid you don't regard bitcoin as a replacement for current methods of exchange. It only really serves one of the three functions of money very well.

The initial deflationary period is important for adoption. But in the long run, increasing scarcity of coin could jeopardize the health of the miners. Bitcoin has a transaction fee structure to handle this, but taxing transactions is hardly the way to get people to adopt your currency. Also, BTC and other fixed-supply coins suffer from early-adopter windfall effects. The early miners of bitcoin may own a significant fraction of the economy.

I'm devising a "Friedman Coin" or "Free Coin" to fix these issues. If you're interested, drop me a line.

I think there is a precedent here: deflation, which is the classical way of describing a currency whose spending power is increasing. I'm not well versed in the history of currencies, but that's one place I'd investigate to see how the "buy and hold" efforts will play out (the modern version of filling a mattress with money).

> Bitcoin was built to be a currency, to be used to trade for goods and services. However, a significant portion of BTC is being hoarded and not traded

This could easily be an instance of http://en.wikipedia.org/wiki/Gresham%27s_law in action, whereby BTC is considered "good money" by its holders and USD (etc.) considered "bad". i.e. When you take your sack of coins to the market, you spend the shaved and nicked coins first, reserving the finest coins for some more important transaction.

> thus leading some (like Nobel Prize laureate Paul Krugman) to argue that it's not a currency at all, and any value is purely speculative

This doesn't necessarily follow, if you understand Gresham's law. i.e. it's not a question of what is or isn't currency, but rather which form of currency is held more dear. This is, of course, a form of "speculation", in the broadest sense of the term.

Gresham law works only when the exchange between the good/bad money is fixed. Usually by a government/sovereign decree.

Otherwise quite the opposite is observed in real world. There's even a word for it. Dollarization.

Yes, I agree that the strict interpretation of Gresham's law is not exactly applicable here, since there is no enforced BTC-USD rate. But the broader sense can still inform, along the lines of Rolnick and Weber:

> They also focused mainly on the interaction between different metallic monies, comparing the relative "goodness" of silver to that of gold, which is not what Gresham was speaking of.

(from the wikipedia article)

People behave economically.

People take risks according to their preferences and perception of risks and chances. So, if they are willing to invest and hold bitcoins, they will be holding some amount which balances chances and risks accordings to their perception - this can be as little as 10 $ or tens of thousands of dollars.

Behaving rationally, they do not take efforts and go lengths to buy bitcoins, only to spend them for something they can buy otherwise more easily and with less hassle.

But, Bitcoins also have advantages in costs, speed, safety and privacy. For example, due to creditcard costs for backcharges etc., goods paid in bitcoins could be 5 % cheaper. Because margins in online trade are small and costs matter, this is a very significant advantage. Also, time matters.

Once these savings are larger than the cost and effort needed for refilling their bitcoin wallet, people will use them for sure.

"Bitcoins also have advantages in costs, speed, safety and privacy"

I think "cost" is the only place Bitcoin is actually a winner. Banks can clear transactions far more rapidly than Bitcoin will. Bitcoin does not meet the formal definition of security and there is a known polynomial time attack on Bitcoin (this is another way of saying "broken crypto"). Bitcoin has been repeatedly shown to not offer the anonymity or privacy that people think it offers.

I am a big fan of digital cash. The problem is that Bitcoin is not a secure digital cash system, and it should not be advertised as such.

Banks cannot clear transactions more rapidly than Bitcoin.

Waiting a few seconds and confirming that most nodes on the network have received the bitcoin transaction is safe enough for most transactions (those involving values less than $100) to be considered cleared.

Waiting 1 hour makes transactions with values in the tens of thousands of dollars safe to consider cleared.

These transactions can be done 24 hours a day, 7 days a week.

In contrast, bank transactions can only be cleared during bank operating hours. For international wire transfers, it's usually necessary to physically visit a bank branch too.

When the average wait time of waiting for banks to open and the time it takes to physically arrive at a bank teller's counter is added up, it's much longer than the maximum 1 hour one would wait for a very large bitcoin transaction to clear.

The actual transfer of funds sent in an international wire transfer usually takes several hours or days too, so it can be reversed without the cooperation of the receiving bank long after the funds have been credited to the receiving party's account, within that window of time.

The time it takes for a transfer of funds from the sending bank to the receiving bank to cleared is analogous to the one hour wait for six confirmations that one would wait for extremely large bitcoin transactions, so really, even under the worst conditions (when banks are open and the person is already physically at the bank branch and when six confirmations are needed for a very large bitcoin transaction), Bitcoin is much faster than traditional banking.

" Bitcoin does not meet the formal definition of security and there is a known polynomial time attack on Bitcoin"

When you discover a way to create a provably safe decentralized digital currency, please let us know. Bitcoin is the best that is possible given the features it has.

What attack are you referring to?

This attack:


The description dances around the issue, but what they are basically saying is this: the work needed to successfully attack Bitcoin is proportional to the total work done by all Bitcoin participants. That is an amount of work that is polynomial in the parameters of the system.

Seems odd to describe this as a polynomial-time attack, and I would argue incorrect to describe the result as "broken crypto", as this has little to do with the cryptographic components of Bitcoin, and is more a fundamental design limitation.

As a workaround, merchants will just demand more confirmations for higher-valued transactions, like waiting for a check to clear. Checks and physical cash also wouldn't meet your definition of formal security, but seem to work in practice.

"Seems odd to describe this as a polynomial-time attack"

Is there some part that does not run in polynomial time in the parameters of the system?

"I would argue incorrect to describe the result as "broken crypto", as this has little to do with the cryptographic components of Bitcoin, and is more a fundamental design limitation."

Cryptography is not limited to hash functions and digital signatures (the two primary cryptographic primitives used in Bitcoin). The "broken crypto" refers to the fact that Bitcoin fails to meet the security definition for digital cash, a type of cryptosystem. Moreover, Bitcoin is not secure as a multiparty computation protocol (also a kind of crypto) against malicious parties, as the attacker's work is polynomial in the system's parameters.

One should not make the mistake of trying to separate the security of cryptographic building blocks from the security of a system as a whole. My "pet" example of this fallacy is "robust" encryption. In a nutshell, an encryption system is "robust" if only the intended recipient can receive a valid message. Using PGP to sign and then encrypt a message is not robust, even though the signature system, hash functions, and ciphers in PGP are secure as signature systems, hash functions, and ciphers. The reason is pretty clear: if you send a signed+encrypted message to me, I can decrypt it, encrypt the signed message for someone else, and then send them a valid message.

For most PGP users, robustness is not an important security property; usually, the recipient's name or some other identifying detail will be clearly written in the message. On the other hand, for Bitcoin, the protection against double spending is absolutely necessary; a polynomial time double spending attack on Bitcoin is very bad.

"As a workaround, merchants will just demand more confirmations for higher-valued transactions"

Which only forces the attacker to make a polynomial increase in their work. An attacker only needs to do as much work as the sum of the work done by all other participants in the system to remove any workaround. Right now, that is well within the reach of governments, banks, and perhaps the larger criminal enterprises of this world.

"Checks and physical cash also wouldn't meet your definition of formal security, but seem to work in practice."

It would not be the first time someone has proposed that digital cash go beyond what is possible with physical cash (see Page 2, Property (e)):


To get the other side of the issue, you have to go back to the 1930s and read F.A Hayek's critique of "The Paradox of Savings" ( http://mises.org/daily/2804 ). Hayek, incidentally, was an advocate of competing currencies.

Bitcoin's got a few things right - open API, solid crypto. I can understand how you see these things within Bitcoin and view it as a paradigm shift. However, they're not competitive advantages: anyone can pick them up. If Bitcoin really takes off the old finance hands can tack these on and they'll have everything that made Bitcoin great plus their network effect.

n.b. I consider Bitcoin's decentralization to be flawed (it'll only decrease over time) and thus it doesn't count as a feature.

"Bitcoin's got a few things right...solid crypto"

Bitcoin does not have "solid crypto" -- it does not meet the formal definition of security, and there are known polynomial-time attacks on the system. The Chaum-style digital cash systems of the late 80s and early 90s were "solid crypto," in the sense that their security could be proved in mathematical arguments.

Please tell me what is the "formal definition of security".. Bitcoin is based on AES256 and a chain of hash-trees

Formal definitions of security depend on the security goals of the system. Bitcoin may utilize secure hash functions, secure signature systems, and secure ciphers -- but Bitcoin is not a hash function, a signature system, or a cipher. The security goals of Bitcoin are: (1) it should be hard to counterfeit the currency and (2) it should be hard to double-spend the currency. The meaning of the word "hard" is what matters here: formally, "hard" is captured by complexity theory, and means that no polynomial time algorithm exists for the problem e.g. for (1), there should be no polynomial time algorithm that can counterfeit the currency.

If you want an example of this approach to digital cash security (scroll down to the bottom of page 15 and see Definition 3):


I wonder whether it makes sense to define a weaker class of "economically secure" digital cash systems, where it is merely uneconomic to counterfeit and double-spend the currency.

Of course this means that such a digital cash system may be vulnerable to non-economically motivated attackers, and I suspect it is also a class that is harder to precisely define.

This is the argument for btc - even though you could try to fake the transaction chain, you are fighting a losing battle against the active market the second you try to generate one, and the longer chain always wins, and it only takes a bad transaction record to be parsed for your chain to be rejected. And controlling the transaction chain is everything in BTC. It relies on the coefficient of the polynomial of running the hashes to generate coins to add to the chain and the transactions taking place therein to get so large that it is infeasible to contribute the computational power necessary to catch up, and it would just be better to mine bitcoins with that computational power anyway.

Using the word "infeasible" like this is probably a bad idea, since in the crypto world it refers to problems that cannot be solved in polynomial time. Also, do not assume that controlling the transaction chain is "everything;" there may be some other part of the protocol that can be attacked, even if it is non-obvious.

"If Bitcoin really takes off the old finance hands can tack these on and they'll have everything that made Bitcoin great plus their network effect."

Why would they create a new network from scratch when one already exists?

Bitcoin is backed by privacy and the fear that banks are going to start "doing a cyprus" with your savings.

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