The Evolving Economics of Bitcoin, Gold and Fiat Currencies
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Finally someone acknowledges this reality. I've brought this up multiple times in Bitcoin discussions and never heard one good argument to backup the claims that Bitcoin can became a mainstream p2p fiat replacement for the masses all while having a 21 million coin limit.
Does anyone outside of the most zealous ideologues really believe this?
So, there really are 2,100,000,000,000,000 bitcoin units. When you purchase a single "bitcoin", you really are purchasing 100,000,000 "satoshis".
>but that completely misses the point of the article: that the money supply isn't large enough
It seems you misunderstood my point, which is that bitcoin is not "21 million coins". There really are many more units, with the option of increasing the divisibility past eight decimal places in the future.
You are still missing the point. It is not divisibility that makes bitcoin unsuitable as a spending currency, it is the fact that its price keeps rising. Imagine if you are presented with two coins one that historically inflates and another that deflates and are asked to spend one and hold the other. Which do you pick? An inflating coin will always replace a deflating one as a medium of exchange. This is called Gresham's law.
A coin with a fixed supply will never be suitable for daily transaction because the demand for currency isn't fixed (due to economic and population growth).
This isn't true though, the supply of the money has no relation to whether or not something becomes a store of value. The key attribute is that it's finite (deflationary).
However, I need to say that a finite currency isn't deflationary forever, it can only be deflationary until there is no more demand for the currency, which has to happen at some point, then the currency becomes stable and mature.
The money supply is important as well, bitcoin is infinitely divisible (easy network upgrades possibly required) so for all practical reasons money supply (liquidity) will never be a problem for bitcoin, but it has been a problem for every single currency which came before. Gold especially because it's expensive to deal with changing and re-issuing the money supply each time you want to add liquidity.
Today, it's much easier with digital banking but liquidity is still not 100% all the time so when liquidity needs to be added or removed, it's done in unnatural ways, which leads to instability in markets.
Granted, most currency's don't last all that long, but their are not enough accuracy to last say 20,000 years.
It is however highly unlikely that all 21 million bitcoins will end up in that drain.
Bitcoin can also be sent to an address of which there is no known private key. Future advances/exploits of Elliptic curve cryptography should make those coins recoverable.
In the end, users will probably not even know each other's public keys for everyday spending of bitcoin. They will only check the public keys for large purchases such as houses, cars, etc.
> Future advances/exploits of Elliptic curve cryptography should make those coins recoverable.
It's possible for that to be true without also completely destroying bitcoin. But, it's not particularly likely.
You also reduce risks by paying taxes in the same currency you conduct business in. So, while having large savings in deflationary currency is not a great idea, for the average person deflationary currency's are surprisingly appealing.
PS: Remember, many things like socks are valued in USD, but are not actually USD. Total USD supply is actually fairly low per person limiting average losses from inflation.
But all else isn't equal. Since the deflationary one induces people to horde, you might have sudden, extreme inflation if people panic sell.
Bitcoin and other crypto are only deflationary if their economies grow faster than the supply. But that isn't at all guaranteed.
A mortgage, a car payment, becomes more expensive over time since the deal was struck when prices were higher. A bitcoin can buy you a heck of a lot more now, but the mortgage you signed in 2014 was for 200 bitcoins. Uh oh...
Now, of course you can argue the necessity of credit until the cows come home. The bottom line is whatever credit is to you, deflation really throws a wrench in it.
Naively, other things the same, the best time to take out credit for something you need is now. Under a deflationary currency that time is never.
https://www.theonion.com/chipmunk-s-plan-for-future-better-c...
In anything technology related, this has already been true for a couple of decades now. I can buy a phone, TV, computer, tablet etc today, or I can wait a year and get much more for the same amount of money.
People still buy all of those things because, as others have posted, you reach a point where you just have to or want to upgrade because the alternative is you spend years on old technology endlessly waiting for "just the right time to buy".
That said
>It will probably need to have constant money supply growth and preferably money supply growth that matches economic needs and not some algorithm’s hard, mathematical constraint
Why not have a "hard math" algorithm which looks at the trade volume in the blocks and adjusts accordingly.
[update: I see this argument is raised over and over in other parts of this discussion, I didn't add much]
Wether it's a savings account, a 401k or a revolutionary business idea everything is better for society than your mattress. And people won't invest in anything today when they can invest more tomorrow, but then they'll wait until after tomorrow, or the day after that, or not at all because they reached that time when they eventually have to spend (which would mean they're broke, which is bad).
Inflation is a hidden tax that impacts the poor and middle classes the most. Worse, wealthy people have the means to escape inflation. Today the worlds weathiest simply buy land and property. Is that the sort of “investment” you’re cheering for as a positive result of inflation?
And it's good that you brought up land and property because that's exactly what I don't want people to invest in (unless they actually want to use it for production, like renting it out to people or companies) but housing is something a lot of people do invest in for retirement, especially in my country. I would much rather people invested it in their 401k, a mutual fund, their business idea, bonds or whatever would enable production. Inflation is a tax on people who have money in their mattresses, if you invest money rather than save it you will beat inflation over your life. That's what I want people to be incentivized to do, not to pile them up or freeze them in status symbols like homes.
And inflation can actually help the poor, it makes it much easier for them to pay off their debts as the principal decreases in value. It's the main reason poor farmers fought for bimetalism in Gilded Age America because rich bankers were making a killing on low inflation.
If other people build something or sell something they increase the supply of stuff which makes the prices drop if the currency stays the same. In other words, they're less incentivized to build or sell something (since selling and building has costs) than just keeping the money themselves in their mattress if the amount of currency is fixed.
A healthy economy requires money to flow through it at a healthy, manageable rate.
To put it short: that people won't have jobs.
Why doesn't it lead to a decrease? Well, as soon as the economic output decreases (but the money supply didn't change!), then each dollar is worth less, so the incentive (to not spend because it will be worth more tomorrow) disappears, so the spending starts back up...
https://en.wikipedia.org/wiki/Nominal_rigidity
Some things (like labor) simply do not react well to a decrease in price. And if your money supply isn't increasing, those will see some years of price increases and others of price decreases.
I am not convinced it is a good reason for inflation. It is the reason for inflation. It does exist. It does cause a lot of problems (as in bankrupting even rich countries) when inflation is gone.
Yet I do think it is self inflicted in that a society can organize in a way that where it doesn't exist. I also have no idea it this way would be better or worse than our current ways.
There is a misconception that governments only 'print money' and push it out, creating inflation. But this isn't true. Governments also take money out of circulation to prevent the economy from overheating.
If the economy-wide goal[0] is increasing wealth[1], then why are increasing prices better than flat or decreasing prices[2]?
[0] There is general consensus that stable economic growth is our macroeconomic goal, generally defined as increasing output per person, or GDP. [1] Generally in economics this is taken to mean real purchasing power. [2] An increasing money supply is a side effect of the real goal of central banks: small amounts of inflation. If a population were shrinking, or if output was contracting, it might well mean that the money supply could remain flat or decrease and there might still be inflation. But as the population grows, the money supply must increase not just to keep prices flat but to encourage slight inflation.
Keynes writes brilliantly on this topic in "Essays on Persuasion," and many of the points are addressed here in the comments. But it can generally be distilled into three main points:
A low level of inflation 1) compels business activity because businesspeople can sell things at a higher price than they paid for all of the inputs; 2) compels consumer spending because today is the most valuable your cash will ever be; and 3) compels lending because there is a cost to simply doing nothing with cash.
Without those incentives, there would be a severe pull-back in lending, spending, and business and job creation, which are the same deflationary forces fought in the 2008 financial crash.
If not, you won't spend your money on any of those things, and if you don't spend your money on it, the demand goes down and less of the stuff is produced. The reason you won't spend your money today is because you'll get more tomorrow, so why not buy it tomorrow? And why spend your money tomorrow when you'll get more stuff the day after tomorrow?
And if most people aren't spending their money, you don't get any money either, because you only get money by someone else wanting what you produce (or wanting what your investment produces). Then you'll spend even less of your money, because now that you're strapped for cash, you really need to wait until the prices drop to maximize your purchase power.
It's the main reason we have near zero interest rates across the West years after 2008; that crisis was deep and we need to drive up inflation to kick start the economy for real and make the growth more equal.
Doesn't it rely on the premise that "we" (as a society) are deciding what currency all of us will use? I think what you're saying is totally true, but as a single rational person, I'd rather store my savings in something that is not (by design) decreasing in value.
People could always theoretically do this with gold, but it's not quite the same since gold has its own risks (like it being lost or stolen), ongoing costs (to protect it), and is trickier to trade.
Bitcoin is still in its early phases and another cryptocurrency may surpass it at some point, but if we don't already, it's likely people will have increasingly easy access to currency that is algorithmically constrained (like Bitcoin). Won't people rationally flock to such currencies, and if that's the case, won't it be difficult to encourage spending / investment using a minorly inflationary currency?
That's why you don't want to store your wealth in "cash" for investing, you most likely want to lend capital to new ventures that needs it.
I could invest with a deflationary currency. I might not have 100% of it invested at every moment. When I do, the company could hold onto that for a while until they're able to make use of it. It benefits both of us (individually) for that money to not be decreasing in value, even if it works against us (as a society) in that we have decreased incentive to spend.
The key question is that if normal rational people would choose a deflationary currency if given a choice, and that choice is becoming more and more realistic, at what point does the current strategy of "assume everyone uses the nation's main currency and do what's best for the whole economy" not work any more?
When the government stops using it as the basis for taxation, damages in civil cases irrespective of the specific nature of the assets at issue, and criminal fines.
Because as long as those (especially the first two) are true, essentially everyone will use the natiobal currency substantially, both directly and indirectly, regardless of what other assets and currencies they use, and normal monetary policy measures will affect the broader economy in the normal manner unless the auxiliary currencies are actively managed to counteract national monetary policy.
I guess to me it doesn't seem fundamentally impossible that those things could be based in a national / fiat currency that is not the same currency a large number (or even majority) of people use.
That's immaterial, in the same way that you can sell non-currency assets to get dollars to pay federal taxes is.
As long as the taxes are denominated and collected exclusively in dollars (and as long as that's the norm for civil damages, as well), the supply of dollars will affect the economy in the usual way, whether or not for most transactions people directly use things that are not US dollars.
That's one of the reasons currency decreases in value, it's a deliberate effort to get people to use just about anything else as a store of value.
> Won't people rationally flock to such currencies
Supply constraints combined with utility to drive demand (whether a supply constrained “currency” has the latter is another question) makes for a good store of value—investment—but that's orthogonal to utility as a currency.
That argument has been levelled and Bitcoin, and I personally agree with it. It explains the adoption boom up to this point, and off the back of it it's possible to fairly confidently predict a bust when returns fail to materialize. Right now returns are based on adoption coupled with increasingly constrained supply.
In theory, when bitcoin reaches a saturation point of adoption, the value of bitcoin won't increase anymore (it can't if there is no more demand). At this stage deflation would technically have stopped and the currency is matured.
This should lead to a much more stable economy than we have now, where people aren't encouraged through the use of cheap credit to make emotional purchases for things they don't need, sure the economy might not "grow" at the same rate but the growth would be a more precise representation of what people truly needed (instead of just being a big party). Maybe people would even lead more stable responsible lives.
Right, we'll die of starvation because our money will be worth more in the future. Instead of paying rent we'll all sleep in cardboard boxes. Then the economy will grind to a halt and global warming will cease to be a threat. Thus resulting in the onset of another ice age. The reason you don't want another ice age is, it'll destabilize the snow-shoe equities market. It's all pretty self-explanatory. (This is how I imagine your typical economist reasons).
For instance, a side effect is that only high productive investments will be made. That leads to high return on investment. Which leads to higher profitability. (Look up ROIC if you want a quick overview of the effect - it’s very well documented).
What’s this leads to is a society which has a highly improving productivity, and therefore a highly improving quality of life.
I’m not sure why some economists leave this effect out. It’s a very significant effect, and leads to a different set of outcomes when you include it in a model.
Side note - using ROIC is a great filter for ranking companies to invest in. Over the longer term, companies with higher ROIC tend to significantly beat their competitors.
If you're willing to ask the question and listen to the answer then you're not in the set of idiots.
I'll go for the short answer rather than the wall-of-text exhaustive answer. Deflationary currency leads to stagnation. People buy less because holding money under the mattress is incentivized. Its nearly impossible to run a business in an economy where people only buy essentials and never loan money out as startup capital.
Look at the history of economic panics in the US back when the gold standard was a thing.
I'm into bitcoin for reasons other than the 21 million limit.
The Great Depression was exacerbated and prolonged by us being on the gold standard and thus not being able to use monetary stimulus. Also with a gold standard, there's a limit to how much fiscal stimulus a government can conduct as well because every dollar has to be convertible to gold.
Essentially, fixed money supply = less control. On the surface this might seem like a good thing, and if money is in the hands of a corrupt oligarchy I'd prefer the fixed money supply. But most people don't realize that only 3% of the money supply is printed by the government (the rest is created by private banks), and economic bubbles/crashes and inflation/deflation aren't restricted to fiat currencies.
do you have a source for this claim?
[1] http://www.bankofengland.co.uk/publications/Documents/quarte...
Hence, why low amount of inflation is considered a good thing, and sometimes used to measure the health of our economy.
This comes from a quantity theory of money -- MV = PQ, where M is the total amount of money in circulation, V is the velocity of money (or the amount of times it exchanges hand in a given year), and PQ is equal to GDP [1].
To understand this belief, we should consider 3 scenarios: deflation, low inflation, and high inflation.
In a deflationary economy, where 1 dollar today is worth more than 1 dollar tomorrow, people are incentivized to save. What follows is a decrease in M and or V, which has a detrimental multiplier effect on PQ. Under these circumstances, owning a business would be very hard as interest rates would be incredibly high.
Let's consider the opposite event -- high inflation. In a highly-inflation economy, where 1 dollar today is worth less than 1 dollar tomorrow, people would be incentivized to spend. This may initially sound like a good idea, with M and V increasing, and interest rates extremely low; but in a global economy, greater foreign demand for goods would drive up local prices, resulting in people unable to buy the goods and services they want. There's that other thing where wages are sticky, or not as reflexive to economic changes as prices are.
The happy medium is a low-inflation economy, where people are incentivized to spend and banks willing to loan, and saving money a low-risk activity.
[1] https://en.wikipedia.org/wiki/Equation_of_exchange#Quantity_...
The first year, you buy the machine, put it to good use, and sell more of your stuff for an additional gross profit of 200K - a GREAT return for a 1M machine. After paying 100K interest to your friend, you're left with a good 100K in pre-tax profit, which isn't bad at all!
The second year, DeflationaryDollars deflated by 10%. You're lucky, because all your employees gladly accepted a 10% salary cut, you slashed your prices by 10%, and you still make 180K in gross profits from your machine. But you still need to give your friend 100K, so your pre-tax profit is only 80K.
Third year, another 10% deflation. Gross profits are 162K, you're left with 62K after paying interests.
Fourth year: gross 145.8K, 45K after interests.
...
Eighth year: gross 95.6K, but you need to pay 100K in interests. You better have saved your profits from the previous years, and not paid any taxes on them, otherwise you're already in trouble.
...
Tenth year: gross 77.5K, and you need to give 1.1M to your friend. But the total gross profit you made before taxes was 1.3M, so, even with a very low tax rate, you're broke, because your machine is worth nothing by now. Next time, instead of investing to expand your business in a deflationary environment, you should think better and just spend as little as possible, save and hoard your DeflationaryDollars under your mattress, like most other people are doing.
After you run the software to generate the coins, you can sell them to other people and tell them the coins are rare. Maybe you can leave a few coins to be generated by other people too, that way they you can let them feel like they're part of it.
Why does that matter? Well, let's say you own money on your house. And let's say that each of those dollars is worth more money, year after year, for a thirty year mortgage. That's going to become a problem, a big enough problem to crush you.
So tl;dr static money supply directly leads to the economy grinding to a halt.
Because it will be gamed.
Indeed. https://blog.ethereum.org/2014/11/11/search-stable-cryptocur...
Having a hard math algorithm would be either too rigid or technological for our government.
There is probably a monetarist argument that looking at trade volume alone cannot understand the nuances and needs of an economy; mind that trade volume would be one of the more easily-accessible data. And that centralized banking is needed to aggregate that information, analyze it, and then relay that to government to decide what to do.
But what you're talking about has already been implemented in Bitcoin Cash during their emergency difficulty adjustment.
There are many reasons Bitcoin will not be the currency for daily transactions. Some of them are even technical. But, that is ok because it will be used as a store of value filling a need similar to gold. So I guess I'm agreeing with you. But it's taking people awhile to come to understand this subtle difference.
Many users are already using mBTC as a base unit (0.001BTC) as it's much easier to transact with at a human level. 1mBTC currently is ~ $6.50. The current smallest unit (1 Satoshi) is worth 0.0001USD, plenty of room for further unit division. It's been confirmed on a technical level that moving that division deeper is possible, but unnecessary in the short term.
What might surprise you is that there are a lot of people who think that planned inflation is a way for governments to rob people who are prudent with their personal finance (and save up money)
If we are 10 people who each have 100 dollars, we have a money supply of 1.000, evenly distributed. If I'm the national bank and I print another 1.000, the money supply has doubled, while the value of the total money supply has remained constant. Only now, instead of holding on to 10% of the total supply, I now own 55%!
So as long as somebody have control of the money supply, it is not a free financial market. Limiting the money supply, either through the scarcity of gold, or cryptography of bitcoin ensures that the market will distribute money, and not the printers.
But a much better estimation might arise from looking at global consumer demand for Digital Payments. By the year 2020 its conceivable that we are at 1T digital transactions. At an average value of $10 each, we are again speaking of roughly the size of the total market for Gold.
The million dollar question is: What percentage of all digital transactions globally will be made in BTC?
Approaching the problem from the FinServ lens, rather than FinTech, can radically alter your view ;)
What do you mean?
If there were $1T of Bitcoin transactions each year and the coins were held for 1 year in between, then yes, the total value of all circulating Bitcoin need to be $1T. If the coins are held on average for a week, you only need $20B worth of circulating Bitcoin.
When you leave out that last number, you implicitly assume whatever interval you're talking about is the transaction duration, which is usually a bad assumption.
If the general consensus is that Bitcoin's value will continue to appreciate, it makes more sense for one to hoard it rather than to use it as digital currency.
This is promote an upcoming product.
Their user acquisition cost must be $1k+ because barely a day passes that I don't see them somewhere - and it's a pretty broad base they deliver to since I use multiple profiles / incognito windows
Yet another 'money is a commodity' view that just doesn't fit reality.
Money is a representation of credit. That's actually what we use it for.
https://medium.com/modern-money-matters/crypto-shilling-8799...
Ergo, bitcoin is like gold. Hence, should be valued as gold.
Gold is a weirdly sticky anachronism of a wealth store that never made any sense in the first place.
Thus making tokens out them meant said tokens would last generations, and withstand the rigors of international transport.
As best i recall, gold and silver were rarely popular for domestic trade. There more common materials were used. They were instead used for international trade.
In the end people have come to confuse the token, a way to do trade accounting without an accountant always present, with the metal it was made of.
The network effect should not be underestimated. The world is filled with examples of inferior systems that exist simply because they have more momentum than others. Investors demand a “store of value” investment vehicle. Up until now, gold has led that role. Now Bitcoin will take over. Not because it is the best, but because it is first to market and has enough momentum and utility to replace it.
Bitcoin and the like are entirely based on the idea that somebody else will want them as currency forever. Gold is based on somebody will want ti for either currency or jewelry forever. That gives gold a slight edge.
I don't know if it is significant, but it is a factor.
Oops, fork! Now there will be 42 million.
Another fork! Now the maximum is 63 million. There's no such thing as scarcity for a virtual currency.
Only if btc's total worth equates gold's. Which is a possibility, for better or for worse
According to an IEEE article[0], bitcoin's power usage is at around 1 Gigawatt. In 2012, Wikipedia[1] tells me that the global electricity usage was around 20,000 Terawatt hours, which makes an average power of around 2,000 Gigawatts. We can assume this has increased somewhat since then - the growth rates suggest annual consumption would be a few thousand Terawatt hours greater by now.
So the 2012 figures give us around 0.05% of electricity consumption being used by bitcoin. While this runs a little shy of your figure, and current values may be somewhat lower still, I'm really surprised at just how power intensive the whole endeavour is.
[0] https://spectrum.ieee.org/energy/policy/the-ridiculous-amoun...
[1] https://en.wikipedia.org/wiki/Electric_energy_consumption
If you had the balls to lever up your portfolio 3x you would have made a killing after the 2008 crash with just a few million in capital, and that's just by investing in the stock market.
There's no value "stored" in bitcoin that is missing anywhere else. It's all in your head.
If the hash rate drops to fast and you are the last miner left, you will have trouble finding a block and so you actually can't mine new blocks.
Of course, as the last miner in the world you won't have trouble conducting a hard fork the resets the difficulty.
Also the gold analogy is still flawed.
No it is not. Even if you are a single miner you won't be able to pass incorrect transactions, such as moving other people's money or create coins out of nowhere.
Bitcoin is amazing simply for showing us that monetary economists have no clothes. They’re astrologists that use math.
What they are saying is that it has exactly zero chances at becoming a serious rival to the US$ or other currencies as a medium of exchange.
And that prediction still seems pretty accurate, considering there's just about exactly almost no transactional volume happening in bitcoin. It's also now more expensive than credit card fees for anything <$100, and it takes much longer than PayPal or Apple Pay or cache. It's also not really anonymous, but of course everyone always knew that. It's so risky to store your private keys on anything with ethernet the real pros print them and put them in bank safes. It's about as decentralised and bottom-up democratic as you can be when you're basically living at the mercy of the Chinese government, which, by the way, has shown that autocratic governments can shut it down with less effort than it took Obama to kill a fly.
There is definitely a non zero percent chance of this happening. How much % chance is debatable, but it's certainly >0.
Economist here. That relationship is not clear. A currency skyrocketing in value induces suboptimal willingness to delay spending, yes, but one plummeting in value induces a similarly suboptimal willingness to spend too early.
Moreover, a depressed economy can cause deflation, rather than the reverse: Sluggish economic activity implies weak aggregate demand (people not buying a lot of stuff), which can lead prices to fall.
But as an average consumer and amateur investor (at best) I'm much more interested in using Bitcoin (and other digital currencies) as a medium of exchange rather than as a store of value. For short term transactions (ex: exchange fiat for bitcoin -> transfer bitcoin to recipient) digital currencies offer a very fast, secure, and simple method for transferring value across borders that would traditionally take much longer than a few ticks of the blockchain. And over that shorter term their value is relatively stable and suitable as a medium for such exchanges.
Additionally, when the dollar was fixed on the gold standard, employers needed to be upfront and honest with their employees. When they needed to cut wages, employees knew it was happening. Much of the labor movement and union formation happened because employers needed to be honest about what they were doing.
I've yet to hear a convincing argument that inflation is good for me.
Choose one.
If that happens, wouldn't demand for Bitcoin take a hit ?