Here's my proposal: let's forget exchange rates. Let's not confuse them with inflation[0]. That's a red herring. Exchange rates are important for BTC's legal users now because there's not (yet) production in BitCoin's economy. Apart from drugs[1], BTC is pure store of value, and it should be analyzed as such.
This is important for this discussion, because exchange rates ultimately won't matter that much. By "ultimately", I mean that phase of development when (if) BitCoin becomes a full currency, that is, when there's somebody, some corporation, operating and trading significantly in the currency. I won't lend the status of currency to any commodity which is not used this way.
And what's clear is that both BitCoin and gold are shit currencies. Even conceding the exchange rate could stabilize enough for a modern day Rockefeller[2] to pull it to a success, you still would have to contend with the deflation inherent in this "currency".
There's a reason why gold is traded in commodities markets -- and not as a currency. There's a reason why banks and states trade and store USD, instead of gold. You simply can't grow an economy like it's the 20th century with gold, or BitCoin. In fact, BitCoin is even more ruthless than gold. 19th century economies could at least pray for the discovery of a gold vein, to alleviate their deflationary comedowns. BitCoin denies even this possibility with the cold, germanic efficiency of a mathematical proof.
[0] The exchange rate we run against our future selves, if you will.
[1] Which doesn't count anyhow, since you would agree there's a risk markup on them for their illegal status, which makes dubious extrapolating any analysis from them.
[2] An improbably apt group of entrepreneurs, who even more improbably would decide to bet their future fortunes on a currency designed by computer geeks with a penchant for goldbuggering.
"You simply can't grow an economy like it's the 20th century with gold, or BitCoin"
Well, the past 4 years have proven you wrong.
Explain how the Bitcoin economy has been able to grow so much since 2009? Why is it that 10,000+ merchants decided to use Bitcoin through Bitpay alone? Why is it that Bitcoin gains more and more users every day?
The answer is that, even if deflation was a problem, which is itself debated [1], Bitcoin's advantages such as being censorship-resistant are unparalleled by any other currency, and that alone gives Bitcoin the ability to succeed where no other currency could.
But Bitcoin isn't a currency for vendors, that is how the problem was solved. It is an investment strategy for consumers and a transaction method for vendors, but not truly a currency.
He was talking about whether Bitcoin will ever become a currency not backed by USD (or whatever) and postulating why that will never be the case.
Bitcoin is currently surviving off its liquidity, not its value as a currency.
The fact that Bitcoin is deflationary is purely a product of the software/protocol. Given consensus to change it, one could make it inflationary easily. E.g. by having blocks always pay out 25 btc as a reward or even have successive blocks pay out increasing rewards.
It would still be inferior to modern fiat currency from a macro-economic perspective, because whatever your rule is going to be, it will not adapt to the development of the economy.
Think of it this way: The abundance of money should somehow correlate with the abundance of real resources. When this correlation breaks down, bad things happen to the economy.
In modern fiat currencies, the supply adapts automatically, without government intervention to the development of the economy, via the mechanism of bank loans. When a bank makes a loan, the money supply grows. When a loan is paid back, the money supply shrinks.
Bitcoin cannot work that way by design, which makes it a bad choice for a common-use currency - at least from the perspective of macro-economic behavior.
I hadn't thought of that before. So bitcoin is like gold in this regard, when gold was used as currency.
It occurred to me that bank notes today are the ancestors of a receipt that promised you a certain quantity of gold. Cash is just a promise - an abstraction from the underlying thing of value.
Whilst bitcoins are limited, you can create as many promises as you like - you just need an extra layer on top of bitcoin. Does this solve the loaning problem?
You would still have bitcoin as the base, like the gold standard but with none of the physical limitations of actual gold and with people still being able to easily transact in bitcoins.
I'm not sure whether having two things that you can pay with - bitcoin / promise of bitcoin - would be implementable. Would it require another crypto layer on top of bitcoin, with some parallel blockchain?
I think it's possible that introducing reserve banking on top of Bitcoin could solve the lending problem for a while, just like it solved the lending problem on top of gold - for a while.
In the end, though, the same problems would crop up again after a while: bank runs, the attempt to deal with bank runs via a central bank, the tendency for downward spirals in countries with a trade deficit, and so on. Eventually, countries would have the same incentives to get out of a "Bitcoin standard" as they had with the gold standard.
> Think of it this way: The abundance of money should somehow correlate with the abundance of real resources. When this correlation breaks down, bad things happen to the economy.
citation please. The abundance of real resources in the cpu, memory, and storage markets have been outgrowing the dollar supply for several decades (evidence by the steady drop in prices even with a much larger dollar + credit supply). Nothing bad has happened to those markets. The growth of real resources varies wildly from resource to resource. If your first statement was true, shouldn't we see see resources that are not correlated with the dollar supply have 'bad things happen'?
Also its almost impossible to measure 'abundance of real resources', so any fiat currency pegged to that metric will not be aligned.
To be clear, I don't think bitcoin that good a currency either. I wanted to point out that the deflationary aspect is an arbitrary (and I think stupid) restriction.
You are right, modern fiat currencies can adapt and that is the main thing bitcoin lacks. My understanding was that happened mainly as a result of central banks who can adjust all kinds of parameters. This is antithetical to Bitcoin's entire design principles, let alone the underlying technology (which could me modified to accept some parameters modifications from a board of governors).
Normal banks can't do that. To the extent that they do cause things to happen, can't they do that with Bitcoins. I.e. issue loans and collect payments with them.
But you're only looking at bitcoins as a replacement for fiat. What if it worked in conjunction alongside the dollar. You can have both. Just like gold is not used as currency but alongside printed money.
I think that's quite a plausible future for Bitcoin, though I find it hard to give an estimate of likelihood and of the relative relevance that Bitcoin will have.
The next-most plausible (though I think much less likely) future is that the hype will die down, there will be widespread disappointment, and it will turn into a kind of ghost town.
One big problem of Bitcoin is that in terms of efficiency, pretty much any centralized service can beat the shit out of it. If you think of Bitcoin as a ledger, and then look at the amount of resources spent on maintaining that ledger, and compare it to the amount of resources required to run a simple centralized ledger... well, Bitcoin loses big time.
This means that whenever Bitcoin comes close to having a large mindshare for everyday internet transaction, there is a serious window of opportunity for non-Bitcoin startups to take its place.
The only market where this logic doesn't apply is the Silkroad-type market and the stuff that caters to gold-bug/libertarian ideologists.
I agree with you that Bitcoin is an expensive ledger to maintain. That said, it's nonsense to say that low transaction costs (that's what efficiency means to the end user) is the sole factor for anyone besides Silkroad users and ideologists.
People pay a lot for security, and the problem with centralized systems is that they grant the organization running them both the means and incentives all the rents it can get away with, not only directly with added fees, but by using abusive tactics to pass the costs of fraud onto the user (see PayPal's infamous freezing policy) and by skimping security as much as it can.
Of course, you can reduce the likelihood of such events by adding external auditing, insurance, regulation, etc, but all of that adds friction which will inevitability result in increased transaction costs (TANSTAAFL).
If risk was irrelevant, nobody would invest in treasury bonds.
On a related note: It boggles my mind when people bring up Bitcoin as a way of doing distributed work, it is nearly the exact opposite of how you would want to do distributed work, increasing the duplicated workload tremendously.
I'm probably missing something, but why can't Bitcoin work that way? Say I deposit 10 BTC in Coinbase, which records that as a liability in their books, and then they lend out 8 BTC to someone else. Isn't that the definition of fractional reserve banking?
Fractional reserve banking effectively creates more money. Assume you have to keep 20% available, you can lend out 80% of your deposits. You lend that out, but your depositors still have access to "spend" their money, so you've increased the money supply by 80%. Now suppose the borrowors repeat this process at a second bank, and that bank loans out 80% of their deposit, we now have 164% extra money in the system, all available for spending.
If you try the same with BTC, it's not possible. You give me 10BTC to hold, I loan out 8 BTC, you can't spend from your 10 anymore (well, 8 of it). The total currency in the system is unchanged, just who can use it has changed.
You lend that out, but your depositors still have access to "spend" their money
They have access to their money because the bank keeps a reserve that is enough for covering regular activity, but if the depositors as a whole tried to withdraw more than that, the bank can't simply invent USD with which to pay its depositors. That's why banks default when there's a run.
And of course, Bitcoin banks could also keep a reserve of BTC, so I really don't see why you can't have fractional reserve banking with Bitcoin.
Only partial for that reason. If everyone demanded all their money, yes, it would break the bank. But if 30% of the money were requested, and only 20% were held in reserve, the bank can still act as if it has the money. There's no similar mechanism for bitcoins.
Sure, but that doesn't mean that new money can't be created with a Bitcoin-based fractional reserve banking system, it just means they wouldn't have a central bank acting as a lender of last resort - though they could still get loans from other banks.
I guess my point is, under the system present in the US and (to my understanding) many or most other countries, you have more dollars floating around than there actually are, a fair chunk is technically non-existent, but still used in transactions.
With bitcoin, unless you're using bitcoin as the backing for another system, you don't have excess floating about. If there are 100BTC in the world, the system doesn't allow the ledger for all bitcoin addresses to sum up to anything over 100BTC. This breaks, for better or worse, the lending model that fractional reserve banking depends on. Now, if BTC is treated like a commodity and is the backing of some other currency (like gold used to be), then that other currency could be used in an economic system that uses fractional reserve banking.
But my point is that the system doesn't have to support it, you can have "technically non-existent" Bitcoins like you have technically non-existent dollars. The bank can just tell you in your balance that you have Ƀ30 without actually having them according to the ledger.
Even though it's deflationary, I don't see that as necessarily a problem since it is infinitely divisible, which fiat currency is not. It may just take time for people to start thinking in hundredths and thousandths instead of hundreds and thousands. If Bitcoin becomes less volatile in the future and deflates at a predictable rate, then I could see it being used more as currency.
Interesting to think of the reverse of "when I was a kid, a Snickers bar only cost 5 cents," e.g. "what I just paid for my new Macbook only bought me a pair of shoes ten years ago."
Deflation, meet downward rigidity of wages (and other prices).
Basically, the problem with deflation is that everybody who has only one (or very few) income stream, but at the same time many expenditure streams (especially fixed contract expenditure streams) is going to fight very hard against reduction in that income stream.
And empirical data suggests that that fight tends to be fairly successful, too. This is why deflation is poison for economic activity.
The empirical data is not about constantly increasing income. It's about a number of things, but the most striking is that in a deflationary environment, wage (and other price) changes have an abnormally large peak at a change of zero; this peak does not fit into any simple assumption about how price changes should be distributed (in particular, it is clearly not a normally distributed effect).
It's a lot easier to give someone a raise than to cut someone's salary, even after explaining them all about how 1 bitcoin is worth more now than when he or she started working for you.
I agree that the critical problem with Bitcoin is the inability to inflate at a controlled rate. It inevitably follows from the idea of having a decentralized currency - something has to control currency creation rates, and if you aren't going to trust an organization of people, then math is the only alternative, which is kinda both empowering and limiting. Because of that alone, if nothing else, I don't think we'll ever have a major economy in Bitcoin only.
That doesn't mean there's no use for it though. There may well be purposes and segments of the economy that find it very useful, and it may even be possible at some point for people in some niche markets/occupations to exist entirely in a Bitcoin economy. It'll just never be very big compared to any first-world national currency.
Exchange rates are important because they indicate a bigger design flaw than the fixed supply: there's no entity with the ability to prop up demand. By contrast, responsible governments with effective tax collecting powers can generally exert a large degree of control over the purchasing power of their currency. The dollar is backed by all taxable economic activity in the United States. Stocks, which often end up worthless after promising starts, are at least backed by assets that can generate future cashflows. Bitcoin is backed by faith.
Even if BTC is better to transact with in every conceivable way, businesses will still need hard currency to pay their taxes, which makes exchange rate and liquidity risk a very real concern if you're trading real assets for BTC.
> a bigger design flaw than the fixed supply: there's no entity with the ability to prop up demand.
That's a strange comment, considering that seems to have been one of the fundamental deliberate choices made in the design of the currency, and is one reason why a lot of Bitcoin enthusiasts are attracted to the currency.
I have yet to see a scholarly article showing that productivity caused deflation (currency held constant while increases in population or productivity cause prices to drop) has caused economic problems. There is much evidence of currency removal caused deflation (when a large amount of currency or credit is quickly removed from the system causing prices to drop) wreaking havoc on the economy.
I am interested if you have seen any documented evidence of the former?
Also, in the US under the gold standard (1776-1910), we saw history's greatest increase in individual wealth ever recorded (measured by per capita GDP). Yes it was more volatile than under a fiat currency, but it's hard to argue that a constant or slow growing currency dampens economic growth with that data point.
> There's a reason why banks and states trade and store USD, instead of gold.
Suppose you accumulate a lot of debt in a currency backed by gold. Further suppose that you control that currency, and have the power to change or remove the gold backing. It becomes very tempting to, say, issue some new currency with lower or zero gold backing to wipe out your debt.
Which isn't a currency backed by gold then, its a fiat currency. A gold backed currency can easily inflate if new gold mines are discovered - it just uselessly doesn't track with the production of things people need.
This is important for this discussion, because exchange rates ultimately won't matter that much. By "ultimately", I mean that phase of development when (if) BitCoin becomes a full currency, that is, when there's somebody, some corporation, operating and trading significantly in the currency. I won't lend the status of currency to any commodity which is not used this way.
And what's clear is that both BitCoin and gold are shit currencies. Even conceding the exchange rate could stabilize enough for a modern day Rockefeller[2] to pull it to a success, you still would have to contend with the deflation inherent in this "currency".
There's a reason why gold is traded in commodities markets -- and not as a currency. There's a reason why banks and states trade and store USD, instead of gold. You simply can't grow an economy like it's the 20th century with gold, or BitCoin. In fact, BitCoin is even more ruthless than gold. 19th century economies could at least pray for the discovery of a gold vein, to alleviate their deflationary comedowns. BitCoin denies even this possibility with the cold, germanic efficiency of a mathematical proof.
[0] The exchange rate we run against our future selves, if you will.
[1] Which doesn't count anyhow, since you would agree there's a risk markup on them for their illegal status, which makes dubious extrapolating any analysis from them.
[2] An improbably apt group of entrepreneurs, who even more improbably would decide to bet their future fortunes on a currency designed by computer geeks with a penchant for goldbuggering.