Bitcoin’s Deflationary Weirdness

By Dan Kervick

I appeared today on The Attitude,  broadcast by WNHN 94.7 in Concord, New Hampshire, to talk with host Arnie Arnesen about the Bitcoin phenomenon.  The podcast of the second hour of the show can be accessed at the link below.  My appearance occurs right at the beginning of the hour:

The Attitude – Bitcoin

The purpose of our brief discussion was just to provide some general background information for Arnie’s listeners about Bitcoin, including what bitcoins are and why anyone would buy them or accept them in exchange for goods and services.   We touched on several topics related to the Bitcoin phenomenon, but there is one very peculiar and puzzling feature of Bitcoin that we didn’t get to discuss and that seems especially important to me:  the Bitcoin system has what appears to be a built-in deflationary architecture.

When the Federal Reserve System was created, it was charged with providing the US with an “elastic currency”.  That means that the quantity of Fed-issued dollars in circulation is supposed to vary in response to the changing dynamics and needs of the real economy.   The Fed is expected to monitor economic activity, and conduct a monetary policy that provides us with a stable but flexible medium of exchange.

Bitcoin, by contrast, is much more rigidly designed so that new bitcoins are introduced into the system at a mathematically predictable rate that is almost completely independent of any economic activity for which bitcoins might be used.   New bitcoin production is supposed to take place at an exponentially decreasing rate so that production decreases by about 50% every four years.  As a result, the number of bitcoins in existence will effectively flatten out at 21 million in about 2040 – if anybody is still using the Bitcoin system by then.  But long before 2040 the rate of bitcoin growth will slow very dramatically.

The Bitcoin system therefore possesses a hard-coded and extremely rigid monetary policy determined by the software itself, software which lives on the computers of everyone who is participating in that system.  Now, you could say this means Bitcoin’s monetary policy is decentralized.   That’s certainly how Bitcoin enthusiasts tend to describe it.   But another way of looking at it is that it is that Bitcoin’s monetary policy is highly centralized in the persons of the people who wrote the Bitcoin code, and who established a weirdly inflexible Bitcoin monetary policy regime in advance – determined for all time.

Now what does this mean for the future value of Bitcoin as a medium of exchange?  That all depends on whether the Bitcoin economy – the universe of producers of goods and services who accept bitcoins in payment – continues to grow, or instead settles into a small and unchanging niche economy for a limited number of enthusiasts.   But suppose as a thought experiment that the Bitcoin economy continues to grow, and that the volume of goods bought and sold with bitcoins continues to increase, as the rate of bitcoin creation first slows and then flattens.  Then one of two extremes might occur: either (i) prices in bitcoins remain stable as the rate of bitcoin transactions increase, or (ii) the rate of transactions stays roughly the same, but bitcoin prices fall as the finite quantity of bitcoins is spread over more and more transactions.  Since the pace of transactions depends on real-world constraints on production and consumption, the effect that is likely to be the dominant one is that prices will fall.  In other words, there will be a deflationary spiral in the Bitcoin economy.  This makes Bitcoin a poor long-term candidate for a stable, alternative medium of exchange.

Deflation might appear to be an attractive thing at first look.   Wouldn’t it be nice for our money to appreciate in value as the prices for goods and services continually fall?   But economists associate deflation with two negative phenomena:  First, if prices are falling then the incentive to hoard the currency increases, since anybody who possesses that currency is seeing its value increase each day.  Thus, the currency itself becomes an appreciating investment vehicle for its owner, so long as it isn’t spent.  Hoarding by an individual agent is no big deal, but it is clearly bad news for the economy when hoarding is widespread, since if people stop buying things, then producers stop producing things and stop paying workers to produce things.  That’s one reason why downturns are often associated with deflation, and growth is usually associated with modest inflation.

The other problem with deflation is that contracts and debts are usually fixed in nominal terms, and so deflation makes debt more onerous.  Imagine an office worker, Sal, with a $50,000 annual salary and a $200,000 debt, such as a mortgage debt.  Now suppose there is a general deflation, and both consumer prices and wages drop 20% over some period of time.  Sal’s wages fall to $40,000.  Sal’s ability to buy groceries is unaffected since grocery prices have also fallen by 20%, but the $200,000 debt is now worth five times Sal’s annual salary rather than four times the salary, and has become much more burdensome.   If the deflation continues, Sal will be wiped out.   But before that happens, Sal’s creditor makes out handsomely as the real value of Sal’s monthly payments increases.

Bitcoins are infinitely divisible, so while there is an ultimate cap on the quantity of bitcoins, there is no lower limit on Bitcoin denominations: there is no Bitcoin “penny” that can’t be subdivided further.  So Bitcoin’s designers seem to have built these deflationary prospects into the system as a feature, not a bug.   And here we must look at another curious feature of the Bitcoin system, the feature its developers decided to call “mining”.   As we have noted, Bitcoin has a built-in mechanism for adding new bitcoins to the system at a decreasing geometric rate.  But note that new bitcoins are not simply sprinkled evenly among all bitcoin users when they are added to the system.  They are awarded to “miners” – in practice, people who have substantial computing power and computing speed at their disposal – in exchange for those miners using some of their computer power to win online races to authenticate new blocks of bitcoin transactions.

So you can see why you would very much like to be a miner in a thriving Bitcoin economy and why early adopters of Bitcoin are so fanatical about keeping the system going.  Those who manage to accumulate bitcoins in the earlier stages when the pace of bitcoin creation is high, could profit handsomely when the deflationary phase kicks in.  These miners would, if the world-conquering dreams of the Bitcoiners ever came to pass, be something like the descendants of medieval vassals who acquired some poor land from their lords in an early era when there was still much land to be claimed and settled, and who then became fabulously wealthy over time by hanging onto their holdings as the finite stock of land was all brought into private owner ship and production while the population continued to increase.

So it looks to me like the developers of Bitcoin were thinking like this:  “Mining system + deflationary architecture = we’re rich!!!”

However, none of these get-rich dreams are likely to materialize.  Since the system’s architecture is set in the unchanging software, and we are looking at only a few years rather than several centuries as the time frame for the rapid exponential decrease in new bitcoin additions, sophisticated investors can all see the pre-determined and rapidly approaching deflationary future of Bitcoin, and will price that into their decisions now.   Their incentive is to buy in the immediate term, accumulate some bitcoins, watch closely as they appreciate, and then dump them on suckers at the first sign of the broad market realization of the inevitability of the deflationary stage.  There might be a few volatile swings before the final collapse hits for good, but eventually the speculative demand for bitcoin will evaporate, there will be a massive selloff, the deflation will reverse into a brief hyperinflationary spasm … and then pfffft.

70 Responses to Bitcoin’s Deflationary Weirdness

  1. Thank you Dan for this essay on bitcoins, which are an alternative electronic money system produced by computer entrepreneurs. The appeal to people who wish to use them for business transactions, is that there is no sales tax applicable and there is no paper trail within the existing banking system, or banking charges that are associated with using credit and debit cards, which can be up to 3% of the value of the transaction. For larger transactions, which normally have wire transfer fees of say $100 per transaction, are not applicable.

    The fact that bitcoins should increase in value over time is also a feature which can be alluring, since most other currencies depreciate in purchasing power over time due to inflation of the currency as more money has to be created as debt to pay the interest on debt based currencies. In this way they obviate the need to keep seeking investments, such as bonds, commodities and the stock market in order to make a return on accumulated money to offset the effects of constant inflation. Hedge funds generally make large profits by ladling and teeming their assets from one asset category to another in line with price trends. Financial manipulation now extracts around 20% from the real economy essentially by doing nothing socially useful.

    One might comment “Who wants a currency produced electronically by the private sector, which can be manipulated at will?” Well, thats exactly what we have now with the federal reserve system. The private banks are allowed to create money as debt with computer keystrokes.

  2. Thanks for pointing out the infinitely divisible aspect. Was just thinking about that w.r.t. “obviating the need for the double coincidence of wants”. Without units to provide transactional exactitude, one is left with this feature of possibly owning whole number + large-number-of-deimal-places amounts of bitcoin.

  3. wandering mind

    What I would like to see is MMT’ers such as Mr. Kervick imagine a decentralized monetary system which adheres to principals which he finds important, rather than point out the flaws of the bitcoin system. Yes, it has flaws built into it as features, not bugs. However, the idea of a decentralized monetary system which responds to the needs of an economy in a decentralied fashion should appeal to anyone who is distrubed by the capture of the current monetary system by plutocrats. That is a feature of the capitalist system, not a bug.

    Another point worth mentioning is that while the algorithm which controls the volume of bitcoins is fixed, there is no reason that a second, third or fourth set of similar coins cannot be brought into being through a second, third or fourth algorithm. There is already a second algorithm similar to bitcions called “Litecoins,” so why could there not be further iterations?

    I would like to know if Mr. Kervik thinks that a decentralized currency which adheres to the fundamental insights of MMT would be something he would welcome.

    • MMT primarily describes contemporary monetary systems, which are state-run. In itself it neither prescribes or proscribes that system, although it describes the things that can be done within it. So the following is only my own opinion. I am not attracted to decentralization in the area of money and do not believe a decentralized sytem will serve our needs better than a centralized one.

      Before Social Security, we had a thoroughly decentralized retirement system. There were all kinds of pension plans and savings plans and charity plans. But they didn’t meet the needs of the people as well as Social Security has. Social security, in my view, should be strengthened and given a larger role in our retirement system. In that case at least, decentralization seems the opposite of the way to go.

      We now have a very decentralized health care system. There are uncountable numbers of private health insurance plans and health care delivery systems. As a result we have the costliest health care in the world, and a few lucky health care entrepreneurs, CEOs and prima donna specialists make unconscionable fortunes off of the miseries of the sick and dying. I think we would all do better with a single national health insurance program that can control prices, regulate the industry and deliver better value at lower cost, with less exploitative profiteering.

      Finance is inherently fraught with the risk of instability, illiquidity, risk, fraud and failure. Free market finance, left to its own laissez faire devices, leads ineluctably to waste, speculation, bubbles and ponzi activity. In the neoliberal era the thrust has been toward deregulation and decentralization, and financial collapse was the result. So, I have no reason at all to think a decentralized monetary system is even remotely the right approach. Some might think there is something romantic about the idea of the unregulated, entrepreneurial “free banker”. But the small entrepreneurial money-man of today is the plutocratic financial overlord of tomorrow. Between now and then, they will blow up bubbles and sow instability.

      What we need in 2013 is engaged, empowered democratic government taking control of our future and wresting it from the control of poorly regulated corporations, hucksters, fast-buck operators, flim-flammers and avaricious free agents. We need more government, not less. People need to organize themselves to take democratic control of national governing institutions, and then use that power to remake society and topple the plutocracy.

      The plutocracy is a creature of the private sector. It is the result of plain old capitalism doing its plain old capitalist thing. Plutocracy is what you get if you give license to the libertarian prescription for society. It is not the result of a government plot; it is not the result of a cabal. Plutocracy is the mighty oak that grows naturally from little libertarian acorns. Bitcoiners and the like think that they are purer somehow, and won’t just recreate the Enrons, the Goldman Sachses, the Lehmans. But they are no different, because their underlying psychological impulse is the same. It is a radically individualistic urge for personal freedom and personal profit, not a democratic urge for social justice, the rule of law and shared responsibilities.

      • wandering mind

        I see that you agree that plutocrats are able to exert undue influence over supposedly democratic institutions because that is what capitalism does. You also seem to be accepting of the idea that we are limited to fighting for a better deal for the average citizen within that system.

        At what point do you think we are beyond the point of no return? In other words at what point would you come to think that government has been too compromised to be reformed within the capitalist framework?

        • Despite the erosion, the United States still has a number of vibrant democratic institutions. We have thousands of democratically elected town governments; and each of our states has a democratically elected legislature. The smaller the polity, the more opportunity there is for democratic wishes and values. The Assembly in my state, for example, has 450 members! It’s full of ordinary folks.

          I see the crypto-currency movement as the ultimate manifestation of capitalism. It embraces the idea that the currency system should not be a public utility run by government, but should lie in the hands of private entrepreneurs. It’s based on a far right libertarian ethos of radical privatization.

          • wandering mind

            In the first response above Mr. Kervick states:

            When I asked at what point he would lose faith in those national governing institutions, he does not answer, but turns to small government as the answer:

            I am surprised how little energy Mr. Kervick seems to devote to how we capture the national institutions of power which are the source of the national health care, social security and other important systems he mentions, not to mention the monetary system which he contrasts with bitcoin.

            So, my question now is which is it? Do we go big (i.e. for control over national government) or do we go small? I am confused, not least because the last time I checked local and state governments are prohibited from issuing their own currency. (apologies if I screwed up my HTML tags.)

            • I think we need to go big. That means people need to get very active, very organized, very assertive and very political. The idea of escaping from it all into alternative communities is not feasible. Indulging libertarian escape fantasies will not stop the plutocratic leviathan from seizing control of the world’s food supplies, water supplies and industrial capacity. They are out to buy you and buy me, and they will buy Bitcoin as well if it turns out to be something useful. It’s either organize and fight for democratic control of our world, or accept serfdom.

      • “Plutocracy is the mighty oak that grows naturally from little libertarian acorns.”

        That’s a good one there, Dan. Can I steal it? Here’s what I don’t get about libertarians. If the government is bought and controlled by private interests, how would getting rid of the government do any good? The private interests would just buy and control the world without even the semblance of democracy and oversight that we have now.

        Say you have a town and the Sheriff is on the take of the local crime boss. Do you do away with the Sheriff’s Department altogether? At least now, the Sheriff has to occasionally take a few criminals to jail, even if he lets the biggest, baddest one slide. If you have no Sheriff, then all criminals can do whatever they want whenever they want. One could make the (better) argument that instead we should replace the Sheriff with one not on the take.

        Similar to the Sheriff problem, what we need is to get better people in charge of the government we have now, and not to do away with it entirely. I find it odd that those who most treat the Constitution like a religious text, have so little faith in the institution that it creates. The problem is not the institution, its the people running the show.

        • I agree, but the libertarians always seem to assume that concentrated power all comes from “the state”, and capitalism would be swell if it weren’t for “crony capitalism” powered by the state.

      • Damn, that comment should have been an article all on its own.. keep ’em coming Dan! 🙂

        • totally agree. the comment board proves as interesting as the article

        • No Excuse For Ignorance

          Actually they are not infinitely divisible. One satoshi is one hundred millionth of a bitcoin. So no it can’t suffer infinite deflation. Also, if the whole world went to bitcoin for all currency, do you not think people would invent new ways of doing things? Your whole point revolves around Sal making less for services and the store charging less for groceries, but you conveniently leave out that the loan he has would be also tied in to that same system? Therefore all loans would be made to be tied to the cost as well and it would fall in the same way.

          Now I hope this was just a simple oversight on your part and you aren’t just trying to write some more well written propaganda to destroy bitcoin, but if you are impartial I suggest you think a little more and try to be innovative before you post things with such simple explanations. I will say this though, yes the early investors are going to be much wealthier than the late adopters, but better them than the current financial tyrants that are destroying our entire planet for their personal gain. Especially since the early bitcoin adopters are doing something that will change the world for the better.

          Imagine a world where there are no lenders, no debt. Where everyday folk could band together through simple programs that would make mortgages public source as 0% interest and you would just contribute to it after you are done paying off your share for your beautiful home that you paid off in 10 years because you never paid a satoshi of interest. These are the types of things you need to start imagining. Not to mention that after about 20 years of this, before the final bitcoin has even been mined, everything would be so automated and everyone would be so debt free, doing hat they love and happy, that war would end. Crime would end. The end of suffering for all mankind, would end. Then one day we’ll realize that we don’t even need bitcoin or any currency at all because we’ve created a utopia and mankind will enter the most innovative and explosive evolution seen from our species. See innovative. If people could believe in the future rather than being cynical about everything the human race might just have a chance.

          • Therefore all loans would be made to be tied to the cost as well and it would fall in the same way.

            That’s not what typically happens in loan markets when unpredictable changes in the price level occur. Surges in inflation help debtors and hurt creditors. Surges in deflation help creditors and hurt debtors.

            How do you think financial tyrants get to be financial tyrants in the first place? They get rich, that’s all. You think that the early speculators in Bitcoin won’t be tyrants if they are orders of magnitude richer than everybody else? Why? Because they pure souls created Bitcoin?

            Bitcoin isn’t going to last, because most people in most countries are not going to stand by and allow a massive tax evasion, money-laundering and black marketing vehicle to thrive in their midst. Nor do people want a currency system that has no governing system and stabilization system

            Your concluding millennarian fantasies of a world without debt and heaven on earth seem sadly typical of many in the Bitcoin and anarcho-lib community. I’m not a cynical person. I think social progress is quite possible and much human potential remains to be realized. But to achieve this progress people need to stop thinking like babies.

            • No Excuse For Ignorance

              Not only is everything you said completely unfounded, but you were cynical the whole way through and then say you are not? If you would rather believe that evil will always prevail, keep it to yourself.

          • Therefore all loans would be made to be tied to the cost as well and it would fall in the same way.

            That’s not what typically happens in loan markets when unpredictable changes in the price level occur. Surges in inflation help debtors and hurt creditors. Surges in deflation help creditors and hurt debtors.

            How do you think financial tyrants get to be financial tyrants in the first place? They get rich, that’s all. You think that the early speculators in Bitcoin won’t be tyrants if they are orders of magnitude richer than everybody else? Why? Because they are pure souls created Bitcoin?

            Bitcoin isn’t going to last, because most people in most countries are not going to stand by and allow a massive tax evasion, money-laundering and black marketing vehicle to thrive in their midst. Nor do people want a currency system that has no governing system and now stabilization mechanisms.

            Your concluding millennarian fantasies of a world without debt and heaven on earth seem sadly typical of many in the Bitcoin and anarcho-lib community. I’m not a cynical person. I think social progress is quite possible and much human potential remains to be realized. But to achieve this progress people need to stop thinking like babies.

          • I really like the philosophy you lay out in the last paragraph above – “Imagine a world without debtors etc.” We have a good proposal from Dennis Kucinich before Congress as HR 2990 that proposes an end to fractional reserve banking and debt based money. Of course it will not even be voted upon for reasons we well understand. Head on frontal attacks like Kucinich’s will not succeed right now, since the banking industry is better armed with funding and propaganda.

            The bitcoin strategy is far more subtle, rather like a Che manoeuvre against the establishment and I wish you all the best with it. However, would it be better for the bitcoin to have a value, which rises slowly, rather than rapidly to deflect the criticism that it is purely speculative in nature ? If bitcoins are ever going to stand a chance of wresting debt based money creation away from vested banking interests, then it must gain wider acceptance, which means the supply of bitcoins should increase commensurate with the volume of trade being conducted with them.

            • No Excuse For Ignorance

              Valid points Frank, Though I’d say the faster it rises, the more merchants will begin to accept it moving it every more rapidly from speculative security to a circulating currency. As for bitcoins supply increasing with volume of trade, there are only 21 million BTC that ever will be. With half the bitcoins in existence now that there ever will be, there is still an exponential gain to accomplish if they were to take over the market. The value of the bitcoins really dictates the supply since they are divisible, not created for newcomers. For instance all 10+ million bitcoins worth 160 USD each right now are worth 1.7 billion USD. That’s not nearly enough to have any sort of real economy, BUT when more people adopt it the supply is divided between the users and the demand goes up therefore increasing the price of a single bitcoin. If said bitcoin are worth 10,000 each then the global Bitcoin economy would be worth a hundred billion, which is more than enough for it to strike a major blow to the necessity of world banks making them very soon obsolete.

    • Paulo Garrido

      “What I would like to see is MMT’ers such as Mr. Kervick imagine a decentralized monetary system which adheres to principals which he finds important, rather than point out the flaws of the bitcoin system. […]

      I would like to know if Mr. Kervik thinks that a decentralized currency which adheres to the fundamental insights of MMT “.

      Problem with both the desire and the question is that a decentralized monetary system, a decentralized currency, in the strict sense, cannot exist under the fundamentals of MMT and other analysis.

      Of course quasi-monies or proto-monies as bitcoin and other named units of account can exist. That a named unit of account becomes a currency, and then money, depends on it being selected by a country as the unit of account in which all taxes of said state are denominated.

      This is so and so should be because money is a tool. A tool that can be used to get continuous coordination gains on the basis of being defined a public domain where it is required from all citizens to participate in the creation of the public, universal to all citizens, good.

      In a monetized economy this translates into producers being required to pay a tax and the tax being required by an entity able to enforce it in the universe of citizens. Conceptually, all taxes, for coordination purposes, can be bounded in one Social Tax. The ratio of the social tax paid to a producer income measures the percentage of his or her equivalent working time that he must allocate to production for public goods.

      A currency system cannot be decentralized, in the strict sense of no node recognizable as central, because the system must support as priority one the creation of public wealth, in the exact meaning of universal, or for all citizens, wealth. That is the mission of the Government and Central Bank: to establish the political macro-economic policies leading to realization of human rights, benchmark of civilizational advancement: security, full employment, universal access to health care, education, and social security.

      Now, rather than succumb to the idea of implementing extreme systems, completely decentralized or completely hierarchical, one can implement hybrid systems, centralized and decentralized.

      An hybrid system recognizes the inherent duality of concepts. There cannot exist private without public, decentralized without centralized, as it cannot exist day with night, light with dark, in without out. The fact of being polar opposites that can only get meaning one from another, makes no sense of the discussions about one is best or which should be greater, which should kill which, and other assorted inability to see things dually, to understand that a powerful private requires a powerful public, both have the most to gain from increased coordination and cooperation.

      To organize, distribute and increase the flow of money above the social tax there exists the public local and the private sector. In this large set of organizations public local or private banks replicate with constraints the power of the central bank to issue currency. This is a network that on the condition that the central node creates a favorable business climate can very much work in a distributed manner.

      One can argue that governments and central banks that behave along the criteria exposed above are few or none. I do not know exactly. But some of them (many?) are defending in fact the well-being of the citizenry in the public sense. One can even argue that the state is a barbaric relic headed to the submission, exploitation or even predation of populations. That was quite the case in the past and still plagues public organizations today. The state was born in pain and fire. Yet, quite usually in human history something that had a bad beginning turned to a better end.

      If we assess the data of evolution long term, clearly things are getting better. We are much near of understanding that state and public government are not the same thing. States had and have to exercise public government. Some did it well, most very badly. We can let go the word state and speak of public government and public organizations. The first is an objective need, the second are the means to meet it.

      On the other hand, the fact is: if a government was going for a shop of a digital unit of account software system fully adequate to the requirements of a fiat electronic currency, would most probably not find one.

      This requirements include, beyond the basic deposit and transactions maintenance at increasing levels of both, software to adjust government spending and government taxation, to defend exchange rate and international position, built upon a structural concept that shields production from non-productive financial activity.

  4. Bitcoin will most assuredly fail since deflation is built into the model. A constantly deflating “asset”(?) can never make a good currency. This is the same reason gold doesn’t make a good currency. (note that I look forward to seeing what happens with the gold as currency goings on in Arizona). If something you have is constantly increasing in value, the smart move is to hoard it and only spend it at the current value when absolutely necessary.

    Bitcoin (and gold) are nothing more than speculation vehicles. Their current owners realize the tremendous value they could capture (steal) by creating interest among the anti-government crowd. Indeed, the early creators and purchasers of Bitcoins (and gold) are making out like bandits now. I always wonder when seeing those buy gold commercials, why, if it is so valuable and will only increase in value, these people are trying to offload their gold on to me instead of hanging on to it. They are both blowing giant asset bubbles and bubbles only exist as long as you can get the next sucker to buy in to the Ponzi scheme. Gold is going to pop sooner or later. Bitcoin is going to go on a roller coaster ride until it spectacularly fizzles out.

    Another thing that you didn’t mention above about Bitcoin (I confess I haven’t listened to the audio yet) is that it is attempting to be a universal currency. If we all moved over to Bitcoins there would be no exchange rate flexibility between any locations on Earth. All that cheap stuff we currently buy from the rest of the world would suddenly become a lot more expensive.

  5. Bitcoin is not deflationary – it’s actually inflationary in the long term.
    Bitcoins are currently being released at 12.5% per year (that’s inflation of the money supply) – the price is going up becasue the user base is growing faster than this (creating price deflation).
    Once the user base stops growing, Bitcoin will be an inflationary currency until 2145. The inflation of the money supply halves every 4 years, so in 2016 it will become 6.25% until 2020.
    By 2016 the userbase should have stopped growing (as there are a limited number of people in the world), and from then on bitcoins inflation of the money supply will not be offset by an equal or greater growth in the user base, so it will be inflationary.

    • Whether or not there is inflation or deflation with a currency is not a function of the size of the user base, but depends on the nature and quantity of goods and services being purchased with the currency. P = MV/Q

      • reve_etrange

        Don’t you think the nature and quantity of goods and services purchased with a currency depends on its user base?

        • Only loosely. Economies can and do continue to grow even if the population is relatively stagnant. And to have a stable currency, you would want the quantity of currency to grow along with the economy, as well as being able to adjust to sudden changes in the population’s behavior – such as changes in their desire to save the currency.

          But Bitcoin doesn’t even adjust endogenously to the size of the user base, since it is predetermined to hit a ceiling and stop, even if the user base continues to grow.

          The developers of Bitcoin seem to have put a lot of thought into the solution of certain technical problems with digital payment systems: like authentication and privacy. But they don’t seem to have thought much about monetary economics.

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  8. Bitcoin can only survive if it becomes a transactional ‘parallel’ currency (eg for cross border transactions); if people start hoarding it rather than using it for transactions it will become easy to attack (and hence fail) once mining slows down. As a parallel currency however it does not need to be deflationary once demand is settled at a decent level – but of course a lot of stars must align for this configuration to be stable

    http://www.oditorium.com/ou/2013/04/why-bitcoin-will-never-be-a-good-store-of-value/

    As an aside: bitcoin is not infinitely divisible- 100,000,000 Satoshi is one BTC; so approx 20m is maximal number of bitcoins outstanding, so maximal money supply is 20m x 1m x 100 Satoshi = 20tn x 100 Satoshi

    • Thanks for the clarification on the infinite divisibility. The transactional parallelism point has merit. I recently looked into the MPesa electronic currency being introduced in Sub-Saharan Africa by SafariCom. It’s being seen in some circles as a bonafide threat to state seigniorage. Again, though, BitCoin does not share a couple major (and IMHO necessayr) distinctions: an issuing body; and the absence of a fixed limit on issuable units.

  9. reve_etrange

    Bitcoin are not infinitely divisible. The smallest denomination is 10^-8 btc. Even assuming bitcoin retains value and the bitcoin economy continues to grow, bitcoin will one day be as useless for transactions as a Roman solidus in medieval Europe.

  10. As many described here, every currency have within it opposing forces of exchange value and value as store of value.
    Since deflationary/inflationary issues are remedied by float against existing currencies, BTC could never become self standing single currency. But such float tend to attract store of value speculators which destroys its value as a mean of exchange.
    BTC would be an excelent mean of exchange due to float with main currencies if you do not keep it as store of value over what is needed in imediete terms.
    That also counts for any fiat currency and hoarding it (holding it as a store of value) reduces its efficacy of mean of exchange.

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  12. I’m sorry but this “hyperdeflation” is just a fairy tale. But even if it was true, the mechanism explained by mainstream economists depends on the unit of account function. If Bitcoin ever gets to a stage when it works as a unit of account, it would most likely mean that all the fiat currencies have collapsed or are on a brink of collapse. If that happens, there wouldn’t be anything you can do to prevent it, and mainstream economists would be out of job, so their fairy tales won’t be in the media anymore.

    • I have no idea what you mean by the “unit of account function”.

      • Yep, it’s true. The hyperdeflation is a fairytale and actually never happened, even if some point at some pump-and-dump cases as being such. On the other hand, many times hyperinflation was the real destroyer of coins and economies. The deflation vs inflation debacle will exist for as long as a money based-economy will exist. But for those that worry believing that the world will run into problems when the mouse stops and the wheel slows down, I have news. Consuming just for sake of consuming and growing just for the fun of growing is a wrong thing to start with. So a little more caution and a donwshift not only of economy, but of our entire way of living, consuming and pillaging of this small planet’s resources is more than welcomed. Because, as they say, anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist…

  13. “First, if prices are falling then the incentive to hoard the currency increases, since anybody who possesses that currency is seeing its value increase each day. Thus, the currency itself becomes an appreciating investment vehicle for its owner, so long as it isn’t spent. Hoarding by an individual agent is no big deal, but it is clearly bad news for the economy when hoarding is widespread, since if people stop buying things, then producers stop producing things and stop paying workers to produce things.”

    You say “hoarding”, I say “saving”. Since when has accumulating savings been a bad thing? It’s certainly better to save than be in massive debt like we are today. I find this to be such an odd conclusion – society will never get to a point where we will stop buying things. We stop buying things because we have too much debt and can’t afford it.

    • It is not true that people stop buying only because they can’t afford things. If you want to buy a car, and you see the price of the car dropping day after day, you will hold onto your money until the price of the car hits bottom. If everybody in a society increases their saving in this way, then economy stagnates. Nobody is buying, and so people are laid off and production slows. Since sales are vanishing, those still in business attempt to boost sales by lowering prices yet further, which gives consumers further incentive to hold onto their money. This kind of deflationary spiral can be terrifying, and is associated with depressions.

    • Nancy

      Our current monetary system creates all money as interest bearing debt. It is more or less a zero sum game.
      No debts = no money.

      Therefore when one person saves, others must be in an equal amount of debt. For example, government deficits represent private sector savings. The solution to this dilemma is for governments to create debt free money.
      http://www.positivemoney.org/how-banks-create-money/

  14. No Excuse For Ignorance

    Oh, how could I forget to mention your complete blunder of the “unchanging software” comment. The BEST part about bitcoin is that fact that the software IS changeable. It’s open source, which means anyone can see and edit the code and people can pick up the edits if they choose. So if a game changing new code is written well guess what. It getts added by everyone in the community and becomes positive growth for bitcoin. That alone destroys any argument anyone has to say about bitcoin.

    For instance, when mining stops there will be a new development to allow the system to do it in a better way, through P2P when everyone uses it, that won’t be a problem. When AES256 encryption isn’t enough and computers are 10 million times faster, they can make it 1024AES or some other new kind of algorithm. There are already many proposals in the bitcoin community as to how to improve it, so anything negative that anyone has to say about bitcoin that is actually valid will be remedied. And at this point there isn’t a single valid negative response to bitcoin that I have seen. It’s all just people who are simply misinformed or trolling.

  15. No Excuse For Ignorance

    I don’t know how this originally got posted as a reply to a reply, so please delete the other one and I’ll repost this here:

    Actually they are not infinitely divisible. One satoshi is one hundred millionth of a bitcoin. So no it can’t suffer infinite deflation. Also, if the whole world went to bitcoin for all currency, do you not think people would invent new ways of doing things? Your whole point revolves around Sal making less for services and the store charging less for groceries, but you conveniently leave out that the loan he has would be also tied in to that same system? Therefore all loans would be made to be tied to the cost as well and it would fall in the same way.

    Now I hope this was just a simple oversight on your part and you aren’t just trying to write some more well written propaganda to destroy bitcoin, but if you are impartial I suggest you think a little more and try to be innovative before you post things with such simple explanations. I will say this though, yes the early investors are going to be much wealthier than the late adopters, but better them than the current financial tyrants that are destroying our entire planet for their personal gain. Especially since the early bitcoin adopters are doing something that will change the world for the better.

    Imagine a world where there are no lenders, no debt. Where everyday folk could band together through simple programs that would make mortgages public source as 0% interest and you would just contribute to it after you are done paying off your share for your beautiful home that you paid off in 10 years because you never paid a satoshi of interest. These are the types of things you need to start imagining. Not to mention that after about 20 years of this, before the final bitcoin has even been mined, everything would be so automated and everyone would be so debt free, doing hat they love and happy, that war would end. Crime would end. The end of suffering for all mankind, would end. Then one day we’ll realize that we don’t even need bitcoin or any currency at all because we’ve created a utopia and mankind will enter the most innovative and explosive evolution seen from our species. See innovative. If people could believe in the future rather than being cynical about everything the human race might just have a chance.

  16. John Q. Public

    Though a little off topic I wonder how much bitcoin is being revalued by people like my “friend of a friend”. Though on a smaller scale, they are using BitCoin as a money laundering device and for illicit transactions online. Even dealing among themselves, because of the high utility to them, they are inflating dollar costs per BitCoin rapidly. As a currency for dubious activities it is definitely prefererred (at least among those my friend of a friend knows.)

    • No Excuse For Ignorance

      People who keep relating bitcoin to the illegal drug activity need to wake up and give it a rest. First of all, that’s not all it’s used for, you can buy anything, but most of all how is it any different than fiat world currency:
      -The illegal drug trade is the biggest industry in the world accoundting for half a TRILLION dollars annually.
      -Annual worldwide drug sales are greater than the GDP of 88% of countries on Earth.
      -An estimated 5% of adults took some form of illicit drug in 2010

      If anything bitcoin being an online currency that you can purchase illegal drugs with makes it MORE like normal currency than Credit cards and etrasnfers.

      • I think the question is why anyone would want bitcoins instead of dollars, given that there are far, far fewer sellers that will accept bitcoins than there are sellers that will accept dollars? Seems to me that the main reasons must be clandestine purchases, tax avoidance, etc.

        • No Excuse For Ignorance

          If you had read anything about bitcoin at all from the bitcoin community you simply would not even have posted that… not to mention guessing at it. That’s just ignorant. all you are doing by guessing is spreading more ignorance and disinformation. There are more sellers every day, new technology doesn’t spread through the world overnight.
          I will explain some main purposes:
          -To rip the money out of the hands of the financial tyranny plaguing our planet and put it in the hands of the people through open source technology.
          -It’s easier to use than anything(or will be once it’s adopted further)
          -To eliminate debt worldwide. Not just that created by private banks, but personal debt as private lending groups become community groups.
          -Safer, more secure, faster that cash and banking
          -Open source means that when the community decides there is an upgrade it simply happens
          -I could literally go on forever.

          • laughingAtYouInCamelCase

            -I could literally go on forever.

            Oh please do; your comments are ever so enlightening about the BitCon.

  17. Bitcoin is primarily a carrier for other currencies that provides secrecy for illicit/illegal/immoral/etc. transactions.

    If you have no use for the above you have no use for bitcoin.

    If you do need those types of services, here’s how you do it.

    You arrange with the seller of the ‘illicit thing’ you want to buy in secret to use bitcoin.

    You buy the coins you need and at the same time transfer them to him and he sells them, all at the same price you bought them at. No he has your payment, which can be in any currency, etc. and you have his stuff.

    The bitcoin price is only a numeraire. I doesn’t matter at all what it is. Neither of you have any exposure to fluctuating bitcoin prices.

    • Thanks Warren, that’s the impression I’ve been getting lately too. I think there are a certain number of people who had a sincere original intention for Bitcoin to evolve into an ordinary medium of exchange for ordinary, above-board transactions – i.e. restaurants, socks, etc. But it seems to me that the original goal has been swamped by the market that has emerged made of those who just use it to buy and sell other currencies – for the purposes you describe.

      Bitcoin in this case functions like cash, right? People use cash to hide their transactions too. Except you can carry out digital transactions with bitcoins much faster than with cash, so less exposure to volatility.

    • No Excuse For Ignorance

      This is ridiculously ignorant. Do research before you post instead of spouting off other peoples misinformation as your own. People who keep relating bitcoin to the illegal drug activity need to wake up and give it a rest. First of all, that’s not all it’s used for, you can buy anything, but most of all how is it any different than fiat world currency:
      -The illegal drug trade is the biggest industry in the world accounting for half a TRILLION dollars annually.
      -Annual worldwide drug sales are greater than the GDP of 88% of countries on Earth.
      -An estimated 5% of adults took some form of illicit drug in 2010

      If anything bitcoin being an online currency that you can purchase illegal drugs with makes it MORE like normal currency than Credit cards and etrasnfers.

      • You’re missing the point that bitcoins are not really a competing currency, but instead a vehicle for moving around dollars/euros.

        For example, here’s a quote from a torrent site:
        “We can only accept donations in bitcoins.
        We have been forced to do this because most payment providers will freeze any funds associated with adult content or torrenting. Suggested donation levels are listed in €’s as BC value is volatile day to day.”

        This is typical from what I’ve seen.

    • Neither of you have any exposure to fluctuating bitcoin prices. It takes time to complete transactions. So this is not physically possible. There’s always going to be somebody who runs the risk of being left holding the bag of depreciating bitcoins, if not the transactors, some broker. I guess you’re saying the risk is small enough that someone will be hit big, smaller than other impediments to near-instantaneous illicit transactions, one that bitcoiners will willingly run? But once the hits start coming and the value of bitcoins drops, what about when the amount of obtainable bitcoins aren’t enough to complete a transaction of the size desired? The limits (against thinking of and using it as a pure numeraire) might be tiny or distant, but they are there. Illicit transaction demand keeps the price of bitcoin up, but is it enough to always fight the fact that they really are an infinite-regress, pure trust, greater fool pseudocurrency? The house of cards only has to collapse once.

      • No Excuse For Ignorance

        You have no exposure to either of us (I’m actually heavily invested) and your post is completely irrelevant to what we are talking about. I have already debunked half of your post in other replies, but as for the rest, people have already tried to crash the market with the propaganda mainstream media crap called “the bubble”

        It’s funny. When it started going up before the cyprus bank thing, the mainstream started saying that was the cause, and then it skyrocketed. I had been keeping daily tabs googleing by date and nobody had said anything about a bubble before at all. Then on April 8, every mainstream media site out there ran the same story saying how it was a bubble and it was going to burst. 48 hours later and exactly the time it takes for the big banks to get thousands of accounts verified and transfer money to the exchanges. Out of nowhere the price of bitcoin started falling dramatically as the algorithms started buying and selling their coins at increasingly low rates and they had already put the bubble mentality into peoples minds so a lot of people started panic selling except of course all the people who knew exactly what was going on. Then they ran stories saying how bad the burst was and that bitcoiners lost all their money and left it at that.
        -Here’s the kicker: at the very bottom of that “burst” bitcoin was still worth 50% more than it was only one week prior and has since tripled again. They failed miserably and all it did was make the people who believed in bitcoin buy more at a lower price. I have sent emails to all of the exchanges to suggest that they add a minimum selling point of 5% lower than the average the day before to prevent government bank algorithms from manipulating the market as they did and I sent those emails 2 days before this all happened. I didn’t even expect to be so right so fast, lol.

        Next time do your research before you go spouting off trolling people with a topic that they weren’t even discussing in the first place.

        • I hope you don’t lose a lot of money.

          • No Excuse For Ignorance

            When the MSM put out the bubble propaganda and then the banks flooded the system with new accounts and tried to crash it, my value went down a little, but them bounced back to 50% more than it was before they flooded the media with that bubble nonsense. The people who are using bitcoin because they believe in it will stay the same. everyone else who comes in for speculation and panic sells deserves to lose money. All the true bitcoiners haven’t lost a thing when these things happen. In order for bitcoin to fail, everyone would have to stop using it, but why would they?

            In my opinion there is no risk. Once people’ minds open, they aren’t going to just close again. This is the future. I recommend anyone who is unsure to just buy a single BTC worth less than a night on the town and sit on it. If it fails no big, but if it succeeds you’ll have enough to buy a house. Progress is like a train: you can get out of the way, you can get on or you can be crushed.

            • ^This is not an argument for a digital currency. This is an argument that Bitcoin is a great speculative investment. The very nature of a currency is that it gets spent to buy real goods and services, not hoarded for speculative gains. People are buying Bitcoins not because they want to use them to conduct trade (ignoring for now warren’s point about criminal activity), but because they think that they will increase in value. That is the driving force behind both the dotcom and housing bubbles. No real value is being creating. You are simply relying on the next dupe to purchase one to be willing to pay a higher price. The Ponzi speculation game will eventually run its course.

              If you want to speculate that there are idiots out there willing to pay more money than you for essentially nothing, that is your right to do so. I expect you are correct and you will definitely make money. It is true that plenty of people made money in the run-up to the dotcom and housing bubbles. The question is: when will we run out of idiots and who will be left holding the grenade when it blows up.

              • No Excuse For Ignorance

                Go troll elsewhere. The fact that you used “Ponzi” shows that you know nothing at all on this subject as the way bitcoin is set up, there is no possibility of a ponzi scheme.

                • Although I am happy to continue to approve your posts, telling another reader to “go troll elsewhere” makes it sound like you’ve forgotten what blog your on.

                  • No Excuse For Ignorance

                    I don’t know what blog I’m on and I’m not sure what you mean. I found this because every single day I read every new article I find on bitcoin. I’m positive there are less than 100 people in the world that know more about it than I do at this point. If by “what blog I’m on” you mean that this blog is intended for trolling then that makes sense as the post I responded to didn’t even read through and made repeat comments while ignoring previous answers to his nonsense, all the while calling people idiots. Or maybe you missed that and you actually mean that any bitcoin blog is going to be trolled and there isn’t much you can do about it. Well that is exactly why I am trying to spread the truth about bitcoin anywhere I can and thus is how I found this page where, for the most part people have actually been intelligently discussing it until this guy started calling people idiots. So I’m not sure what you want from me, but I’d rather not have to deal with trolls calling anyone an idiot. But hey, it’s your blog…

                • I used Ponzi here to refer to a scheme whereby the initial investors are paid returns only by the increased investment of subsequent investors. If you disagree that Bitcoin fits that profile, please feel free to elaborate. I haven’t seen you’re handle before, but I’ll assume that you are here to have an honest discussion with people you disagree with. I know I might be crossing the line calling people idiots and whatnot, but it’s Friday night so I don’t quite have the self-control I might normally have.

                  Warning: Snarky comment ahead.

                  Perhaps you should wonder back to mises.org where you will fit in better and leave the adults to their discussion.

                  • *your

                    damn apostrophes.

                  • No Excuse For Ignorance

                    And yet you allow more insults posted? ridiculous. Incidentally I don’t even know what miser.org is, nor do I care to rebuke your unfounded insults. Making up insults for people and putting them into categories they haven’t alluded to shows just how ignorant you are. It also shows me that you lack the information to maintain an honest discussion which you hypocritically cut towards others, and need to resort to insults to try to tank the conversation that you know nothing about. OR it may show that you think I deserve it somehow or that you are in a bad mood. Please just stop.

                    A ponzi scheme requires a central distribution getting other people to invest at increasingly diminishing levels of returns. With bitcoin the entire market gains value and that is inherently the opposite of a ponzi scheme. Everyone talking about investing in bitcoins are happy people who have invested and believe in it. It is open source so the source code has been reviewed by thousands of people to confirm that it’s awesome and nobody owns it. And there are no “returns”, it’s currency that eventually will be used to buy anything. It’s like trading US funds with the funds of a country that isn’t being devalued by central banks. ie: as the currency in your country is constantly devalued, bitcoin’s value will buy you more in your country. Only in this case the country is the world bank controlled Earth and bitcoin is just decentralized.

                    Now I hope that you will take this into consideration and do more research rather than post whatever unfounded retort first pops into your head. I assert that anyone who doesn’t believe in bitcoin simply hasn’t done enough research themselves and is just quoting whatever they hear on blogs, such as the consistent and completely incorrect “ponzi” or “bubble” comments. I’m simply giving you the tools to figure it out on your own and I hope you would rather take the time to figure it out this time rather than just cut me down because I have a different perspective.

                    I also hope the moderator will stop allowing you to post any more insults if that is the direction you are going to continue. I however understand that people can get riled up over things on message boards and assume the other person probably deserves it. I used to think like that too. But I am not a douche and I’m simply sharing information. PS: if you screw up your spelling again, don’t worry about it, as you can see I’m obviously not the type that’s going to resort to picking at your grammar to have a healthy discussion.

  18. when I was in Italy kids there told me they used bitcoin to buy electronics without paying vat.

    Just saying…

    • VAT is a regressive tax and needs to be abolished.

      If governments created their own money debt and interest free, then there would be no need for taxes of any sort, except to control inflation and redress inequality.

    • No Excuse For Ignorance

      Heh, nice one. Kids are always on the cutting edge. The stuff some of the freshmans are doing on their smart phones every year is really quite astounding.

  19. –the Bitcoin economy – the universe of producers of goods and services who accept bitcoins in payment – –

    Does the writer want to say that this Bitcoin will replace the dollar currency? Does this Bitcoin will have an independent existence?

    • I’m saying that there already is a bitcoin economy. There are people out there who will sell you stuff in exchange for bitcoins. The botcoiners promote dreams of the bitcoin economy expanding further over time so that bitcoin becomes a major currency – maybe even the major currency. But if that is their plan, then it is extremely odd that they didn’t build a mechanism into bitcoin that would allow the quantity of bitcoins in existence to expand indefinitely, in an organic way that responds to the growth of the bitcoin economy. The fact that they instead built in a pre-determined cap on the number of bitcoins indicates to me that they either don’t understand currency systems very well, or were trying to devise some kind of scam.

      • The deflation vs inflation debacle will exist for as long as a money based-economy will exist. But for those that worry believing that the world will run into problems when the mouse stops and the wheel slows down, I have news. Consuming just for sake of consuming and growing just for the fun of growing is a wrong thing to start with. So a little more caution and a donwshift not only of economy, but of our entire way of living, consuming and pillaging of this small planet’s resources is more than welcomed. Because, as they say, anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist… 🙂

  20. Pingback: Heisenderp | Rugged Egalitarianism

  21. Bitcoin is open-source code. Actually the inflation / deflation scheme can be changed in the code, and the new code can be distributed to the majority nodes by anyone whenever and however they please and if they have the mining power to boot that is what becomes of the currency. Just download the source code and make your own virtual currency for your university. Ask some of the students from your CS department to change the code as defined by Economics department and mine it in your campus and use it there in. See what people like inflationary or deflationary.
    Do you think the big venture capitalists who are investing millions into Bitcoin applications and mining computers are doing it for fun?

    Bitcoin can enable micropaymets without any or with very little overhead. People from all over the world can download just a single article, pr0n flick, or a single news article without ever divulging their credit card or bank details.

    Until now it was unheard of in the the whole computer engineering industry of crowd sourcing ASIC (chip) designs as done by some Chinese, Russian and American entrepreneurs (Bitfountain, BitSyncom, Bitfury, ButterflyLabs) etc for mining Bitcoins. This is huge and has been picked up by Dr. Taylor (UCSD).

    Before dissing something based on mental exercises it would be wise to experiment and do it and see 🙂

  22. I have looked upon the problems of the economy since many years and worked to find solutions. What we must abandon is the idea that owning money should give income. It is possible to create a system that doesn’t need to grow but still would be much better for almost all inhabitants of this planet, also including those not belonging to mankind. Here is my proposal:

    New Form of Taxation Solves Problems
    There is a technically simple way to solve the problem with increasing debt and unemployment. The solution is to implement a daily fee on ownership of money, but not on ownership of debts. Many will then be interested in lending their funds in order to avoid paying the tax, even if the interest rate is as low as 0%, or even negative. This would stabilize cost as interest on money causes inflation and does not slow down inflation as many economists still believe, as does most members of the boards of Central Banks.
    Such a fee is easily implement, both on currency and on money in accounts. The fee is never collected, it is noted only as the reduction of the sums in the accounts and the bills of various denominations have a table on them that show the value at different times. A bar code on the bill can be read and the reader program figures out the current value and transfers it automatically to the store cash register.
    The amount that is subtracted daily from the accounts and bills make the public sector able to pay out corresponding amounts in wages and for purchase of goods and services plus a basic income to all citizens of the country. No overseeing entity is needed to keep track of how much money anyone has, no administration for the collection of income tax, VAT or payroll tax. Black market jobs automatically become regular jobs. The basic income will be sufficient to live on. Education and child support, education loans, and most of the need for social and health program subsidies disappear. Hours of work can decrease. Less stress makes healthier people.
    The fee needed to be deducted daily is approximately 0.4%. Each citizen gets a personal account where a couple of years’ basic income can be kept without a fee being deducted from the account. Everyone, including businesses and tourists who exchange money, will get a fee free account.
    Speculations in real estate and resources are discontinued by letting the county or municipality compulsory acquisite them. Compensation for the owners will be deposited with a substantially lower fee, around 0.004% per day. The county then leases these properties. The price will be determined by public auction, and the terms of the contract depend on what is most reasonable based on the intended use of the land.
    Those who have bills or money on accounts will use those instead of waiting for the value of the accounts to diminish due to the fee. Those who want to make purchases will prefer to prepay and those who want to sell will often be willing to wait for payment until they themselves would want to buy something.
    The country that first implements such a taxation system will be very competitive. Administration is reduced, both for companies and for the public sector. Production and investments will be much cheaper as the interest rate is close to 0%. In the Swedish economy with its present taxation system, prices can be lowered by 40% without having to change the hourly wage.
    Per Almgren, MSc (Technical Physics)
    Silverringen 53
    SE-60369 Norrköping
    Sweden
    per[dot]almgren[at]soceng[dot]se

  23. As another poster noted… the resources of this planet are not infinite.
    Ever heard of peak oil? How about peak people? Deflation is in the cards. The meek shall inherit.