Bitcoin Deflation and Economic Activity
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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?
Deflation at the rate of 100% over two weeks on the other hand (ie: BTC's current rate of change), is absolutely and utterly ridiculous.
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.
In comparison, the volatility of BTC is approximately 6000% / year.
The magnitude of volatility is straight up ridiculous. The behavior of BTC is more like a penny-stock than any commodity on the market
Are gold and silver not less volatile than government-issued currencies, the long-term value of which has traditionally ended at $0?
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.
> More importantly, though, volatility isn't even related to ending value
Yeah, come heat death of the universe, ending value of all currencies will look pretty similar.
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.
> 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%.)
In a bitcoin success scenario, this will change once bitcoin is no longer the sole domain of currency speculators, but starts seeing actual commerce. Some places where this could start:
1) International remittance. Wire transfers are slow and expensive. Bitcoin could make moving money internationall much easier. See, for example, YC-backed "Buttercoin": http://techcrunch.com/2013/08/20/buttercoin/
2) Merchant adoption. Credit card fees for online commerce are in the 2-3% + $.35 range. Bitpay currently offers 0% fees, instead charging a flat $30/month: https://bitpay.com/pricing
3) Micropayments: The "+ $.35" part of credit card fees precludes micropayments. Bitcoin could be used for things like pay-per-minute streaming.
Once these types of things start adding volume and depth to the exchanges, it will be harder to move the market, and that will add stability. Obviously, this will take a few years.
That would keep one measure of money supply stable. It wouldn't keep the value of the dollar stable, though.
...fluctuate wildly for the foreseeable future like the
value of gold has done and is doing.
Edit: If you think that USD has a fixed value, you are mistaken. You may use it as your reference point, but that just makes you blind to the fact that the perceived values of all currencies and assets are fluctuating all the time. There are some which are more closely tied together, and some which are less.
[edit] I have not done the analysis, but would wager that gold measured against a basket of goods or currencies is more volatile than USD similarly measured.
In 2013, we produce 21 million apples, so we could say that each bitcoin is worth 1 apple. In 2014, we produce 42 million apples, which is 100% annual GDP growth. Each bitcoin is worth 2 apples, which is a 100% appreciation in the value of the currency, aka. deflation.
Grow the (effective) money supply with lending and deposit accounts, and apples / dollar falls. When things are growing, people know there is money to be made, and so expect they are more likely to be paid back, and so lend more freely.
Inflation in other currencies has a moderate, and mostly beneficial, cost. It encourages people to invest their money instead of just saving it, which leads to enhanced economic activity. Deflation in bitcoin only has value to the people "saving" their bitcoins, which sets up perverse incentives in regards to use of the currency as a medium of exchange.
Using a lower number, like 5%, would have been more reasonable, IMO.
It is a completely reasonable number because it actually happened, and I point all of this out in the blog post.
It is easy to argue that it would be the rate of movement and not the direction that causes problems in transactions.
Because you have no choice. Currencies are imposed by a ruling power (in our case the government) by force. When you choose your currency is usually in form of asset. But you can not pay your taxes in gold. Consequently you can not live in the USA without USD and in Europe without EUR.
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%
That’s speculation, might be correct. No one knows.
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.
As that’s exactly how it should be. Currencies are inflationary to induce consumer spending more today.
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?
Did they ever do that? Bitcoin enthusiasts never used bitcoin for buying services. BTC buys you anonymity where is required that’s a revolutionary quality for a currency to have. But other than that, bitcoin has nothing to offer compared to fiat currency for daily transactions. Changing money from BTC to USD (and vice-versa) is not enough straight forward, as of today, to allow the majority of the population to use it. If I give you 10 BTC today, you need days to turn them to USD, while if I give you EUR, you needs hours probably maybe minutes.
The 33 countries of Europe that are not in the euro zone would beg to differ.
http://en.wikipedia.org/wiki/Currencies_of_the_European_Unio... http://en.wikipedia.org/wiki/List_of_sovereign_states_and_de...
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...
I'm just talking about the general idea of inflation.
I'm not arguing the merits of Bitcoin.
Are they right and both deflation and inflation can supply economic growth? If so, does that mean another factor is the main proponent for growth?
My opinion is that inflation does not drive economic growth.
> Are they right and both deflation and inflation can supply economic growth?
Neither one supplies economic growth.
> does that mean another factor is the main proponent for growth?
Increased productive capacity is the source of economic growth. Not the supply of currency.
Take a simple example.
Three people live on an island after a plane crash.
They fish, build huts, make tools. To facilitate exchange, they use paper money from the game Monopoly happened to survive among the wreckage.
One day a new box of Monopoly washes ashore, including a fresh supply of Monopoly money.
Their money supply has doubled.
Will they experience any economic growth? Clearly not.
The next day a power saw and generator wash ashore. They have new tools and increased productive capacity.
Will they experience any economic growth? Clearly they will.
Furthering your point on neither deflation nor inflation driving economic growth but rather productivity increases, does that mean what the FED is doing through monetary policy zero sum?
I subscribe to a camp that believes that what the FED is doing through quantitative easing and zero percent interest rates, is actually harming the economy by sacrificing quality of life of persons without wealth (investments, property, assets) for gains for those that do (real estate bubble, stock market gains since 2008). Can this be true? Or am I looking at the situation too simplistically?
Regarding the topic at hand, do you believe that bitcoin's low cost of transmission and features such as escrow and consignment lend the commodity-currency true value (like gold's value being that you can wear it, use it for electrical equipment)? Or do you look at the protocol as having no intrinsic value (pure fiat)? -And do you think that that matters as a currency?
Many skeptics claim that a crypto currency backed by a mineral would be ideal, and that bitcoin's only value is in it's perceived worth. They also believe that this means it could be a big tulip party waiting to crash.
I'm not sure what to believe regarding bitcoin's future, as gold has had 4000+ years to earn it's place in the world. Thank you for your time.
It leads to malinvestment as you pointed out.
> Can this be true? Or am I looking at the situation too simplistically?
I agree. It's a wealth transfer.
> Or do you look at the protocol as having no intrinsic value (pure fiat)? And do you think that that matters as a currency?
I'm not a Bitcoin expert. Right now I see no value in it in the short term other than a speculative investment.
There is much political uncertainty surrounding it. It could go to zero in a day.
Like you say, gold has over 5000 years as a consistent store of value. Bitcoin is a few years old and wildly volatile.
Do I believe a crypto-currency with no real-world backing could thrive? Sure, someday.
Do I believe that crypto-currency will be Bitcoin? I have no clue.
I'm just referring to the idea of deflation in general and the fear mongering that happens around it.
I'm not talking about Bitcoin versus USD.
I'm just referring to the idea of deflation in general and the fear mongering that happens around it.
You'll have to do a little better to support your claim that deflation can result in economic growth. One data point from a rather unique point in history isn't enough.
Okay I will next time!
> You'll have to do a little better to support your claim that deflation can result in economic growth. One data point from a rather unique point in history isn't enough.
This isn't my claim.
My claim is that economic growth comes from increased productive capacity and not from manipulation of the money supply (neither inflationary nor deflationary).
See my simple economic example elsewhere in the thread.
Bitcoin is hardly viable as a unit of account at this point. It's a speculative investment at the moment.
No, it doesn't. It goes if people know that the future purchasing power of currency will increase, they will shift more investment to currency itself and invest less in things like real estate improvements, businesses, etc. -- and that investments in the latter have a multiplier effect and whereas money invested in the currency itself does not, such that, ceteris paribus, shifting to deflationary currency would reduce the overall level of economic activity.
It is not that people would direct defer economic activity, and even less that they would defer all such activity.
> We've seen periods of significant economic growth coupled with falling prices.
And we've seen periods of stunning economic collapse tied to deflation. But individual examples without considering other contributing factors and underlying processes and incentives aren't particularly useful.
The disagreement is whether or not artificially generating economic activity by inducing inflation is a good thing or a bad thing.
The Austrians think that the increased economic activity consists largely of malinvestments due to artificially cheap credit, which will cause a short-term boom, followed by a subsequent crash.
The Keynsian view is that you can ease out of the boom without a crash, and that the markets will take too long to equilibrate without such an artificial increase in monetary supply ("In the long term, we're all dead").
Underinvestment (Austrian): There is less investment due to risk being less preferable to steady savings. Example: I won't risk 1 million dollars today on a risky investment if my 1 million dollars next year will be worth more.
Overinvestment (Keynesian): These is over investment due to inflation outpacing savings. People are forced to invest in risky ventures, as at least there is a chance you can earn money as opposed to losing money over time. Example: I risk my 1 million dollars today on a risky (subjective, I'm referring to -10% to 10% gains) investment and if not, will definitely lose 5 percent of that money.
I'd love to hear your thoughts on the matter. Personally, I see strengths in both styles of economic policy, but believe that in our current economical climate, we are overinvesting and through central planning, mis-investing by stimulating the top echelon of investors who simply buy property (real estate asset prices go up), businesses (mergers & acquisitions), and commodities that hold their value. Look at the rise in value of fine art over the last 6 years. These to me, are signs of a bubble.
That is to say the wealthy will ensure that the central banks make policy decisions that benefit them at the expense of others.
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.
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!")
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.
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.
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≥
At least gold can be made into pretty jewelry and electronics.
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…
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?
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.
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.
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.
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.
What used to be a rounding-error that happened on every BTC transaction is now a $0.10 tax on every BTC transaction. If BTC continues to deflate, the transaction fees on BTC are going to become quite sizable.
The high level idea is to introduce market mechanics to bitcoin fees, with the expectation that competition will drive prices down.
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".
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).
"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".
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.
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?
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?
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?
So it all depends on the actual realistic rate of deflation if Bitcoin ever reaches widespread use.
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.
That's a 50% profit margin, not 100%.
profit margin = 1 - cost/revenue = 1 - 1/2 = 0.5
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.
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.