@1: A trade alone does not help BTC stabilise. We ARE seeing an increase in BTC trade, but all of this is pegged to local currency, and usually traded out for that immediately. As it is held for a very short period, there is no real effect on price, and is essentially the same as cashing out.[1] What might help BTC stabilise would be if there were a true, significant BTC economy, that is, items priced in BTC, rather than pegged to local currency. When I wake up tomorrow I can reasonably expect my loaf of bread is going to cost the same as it did when I went to bed. But that can't happen (yet) with BTC, because pegging goods to BTC carries far too much risk due to the volatility. Frankly, I can't see an attractive way to get to a situation where there is a substantial, viable BTC-first economy-- displacing local currencies as the first-choice isn't going to be easy. The only thing affecting the price of BTC is people buying and continuing to hold BTC (ie, in the absence of a real BTC economy-- speculators).
Further, I’m sure you can paint BTC stability as improving/worsening based simply on altering the time frame involved. The fact is the volatility is way too high (for consistent pricing), and we certainly don't have enough evidence to predict the future. You might have thought it was stabilising in October of last year before all hell broke loose.
@2: Not really a coherent argument there. An upward price trend (existing for whatever reason) encourages hoarding, which reduces liquidity. This creates a feedback loop, resulting in bubbles and crashes. Deflationary + speculation inherently leads to this, and we've seen it over and over already with BTC. Again, there is a chicken/egg problem because only speculators are interested in it, making it volatile, making it no good for non-speculators, which keeps it volatile! I think the best we could hope for is a little worse than gold (as it continues to be mined), which AFAIK still carries a significant amount of instability.
All this is not to say that bitcoin can't, or won't, be a long term success. It may well be; it has first-mover advantage, there is significant vested interest in it succeeding from those who have bought in, and it has a vast computing army. But it could be displaced. Or marginalised by an unlimited number of clones.
1. Ironically it is in a way simply passing half the transaction cost onto the customer.
Actually, the best we could hope for has much, much higher volatility than gold: there are vast reserves of gold available and the oceans contain about 9 pounds of gold for each person on earth, 100x the total amount of gold mined throughout human history. There are many old mines that could be reopened in a few months or years if the price would justify it.
On the demand side, there are technical uses of gold, medical and jewelry. So we clearly have demand and supply curves that are pretty flat and a price driven by fundamentals, yet we see significant volatility, especially related to gold's speculative and monetary use.
On the other hand, Bitcoin is a digital asset designed purely for speculative and monetary use. It has NO fundamental demand and an almost vertical supply curve. There's no way to price a Bitcoin on it's fundamentals, the only driving factor is "what other people think". As a future PhD in economics, let me tell you that is not conducive to stabilization, quite the opposite, it's prone to violent and self-sustaining boom and boost cycles.
If it continues to become more useful as a payment network, the value will grow and the volatility will go down.
2: "encouraging hoarding": no, this is not what was observed in practice with Bitcoin. I can't remember if it was Bitpay or Coinbase, but they have explained in a blog post seeing the exact opposite effect: during a Bitcoin bubble, people tend to spend or sell more bitcoins (to cash in on their newfound fortunes).
While run-away inflation and run-away deflation are both awful, an economy which slowly inflates is better than one that slowly deflates.
http://www.nytimes.com/2010/10/17/world/asia/17japan.html?pa...
http://www.businessweek.com/magazine/content/11_06/b42140145...
http://www.bis.org/publ/bppdf/bispap70c.pdf
http://www.kyotobank.co.jp/houjin/report/pdf/201305_02_e.pdf
- Japan's GDP grew by 12% between 1990 and 2010, from 430 to 482 billion Yen (the NYT author incorrectly assimilates it to "an economy remaining the same size"?!)
- GDP per capita is 16% higher in Japan in 2010 than it was in 1990 [1]
- The NYT article gives absolutely zero other economic numbers, no objective evidence, nothing (it merely gives annecdotal evidence as in "so and so lost their house")
Why is this NYT article so bad and vague, when economic indicators I quoted above ARE actually (slightly) improving? I am not the only one to criticize it, see this response by the Center for Economic and Policy Research: http://www.cepr.net/index.php/blogs/beat-the-press/deflating...
[1] http://www.imf.org/external/pubs/ft/weo/2010/01/weodata/weor...
A downward price trend encourages splurging, which provides excessive liquidity. This creates a feedback loop, resulting in Zimbabwe. Bitcoin opponents have a vested interest; the desire to attack something you missed out on due to your own lack of foresight is a known psychological effect. I don't necessarily believe all of the above, but it's a pretty symmetric mirror image of the opposite argument. You could go up a notch and make the case that inflation is worse because at least an upward bubble has to end eventually whereas a downward crash can keep going down forever until the currency is replaced. I'm known for my stance that finite supply cryptocurrency is probably more deflationary than optimal (though my concerns are more about wealth concentration and the potential for use of seignorage revenue for secondary purposes rather than some idea that spending is good), but there are good reasons why one might think otherwise.
As for gold, an important point is that gold's volatility is quite recent. Before 1971, and especially before 1913, it was actually quite stable:
http://www.zerohedge.com/news/charting-price-gold-all-way-ba...
Yes, that's a 6x margin that maintained itself over six centuries. The 18th century fall and the 16th century fall can likely be attributed to the sudden introduction of new supply in North America; that's an uncertainty that cryptocurrencies do not have. I don't know why gold was stable before but is not now; perhaps it's the fact that a fixed-supply commodity is stable if used as a currency but not stable if used as a form of black-swan insurance. The former use case might have more constant demand, or price stickiness might play a role.
I'm honestly not sure what will happen. Maybe cryptocurrencies will die, maybe BTC will die but others succeed, maybe BTC will become gold 2.0 and other currencies will take on other roles (if this happens, environmentalists at least would be quite happy given gold miners' current track record), or maybe something else entirely. I do agree one-world-currency domination is exceedingly unlikely though.
Bitcoin's volatility is a direct result of this feature.
>Bitcoin is an experiment that will perhaps disprove it.
The hilarious thing is that the experiment already proved it.
You want a cryptocurrency that isn't absurdly volatile? Make it steadily inflationary, not steadily deflationary.
There are cryptocurrencies that do this, PeerCoin and Dogecoin for example, and they don't seem to work out, maybe because there is a lack of incentive to be an early investor if your investment steadily loses value.
There is no significant barrier to entry for creating a cryptocurrency that represents your economic ideals, so far however, only Bitcoin seems to have the right mix of incentives.
Besides, the characteristics of a "good coin" depend entirely on who you are and what your goals are. Some people want to gamble and get rich, others are looking for a reliable store of value, others are looking to transact. The ideal coin will have different properties for each of these people, but no coin will be able to satisfy all three groups completely. They all need one another and they all have competing goals.
Particularly the deflation argument does not predict that Bitcoin will fail, it states that if Bitcoin replaces traditional currency, the economy will fail. If you choose to believe it however, it's an argument to hoard Bitcoin from a rational economic perspective.
People looking to criticize Bitcoin should rather focus on the centralized mining problem.
They seem to have been the "next big" currency for market cap after BTC and LTC for the last 9 months, which would point in the direction of, at least, inflationary nature not being such a big deal.
Bitcoin isn't inherently deflationary. It isn't even a fixed supply, it will grow for the foreseeable future. For short periods of time it was deflationary as people speculated that it was actually worth a lot more, but that seems to have stopped.
An inflating currency would never catch on. It's a hot potato situation of "I don't actually want to own it because it's decreasing in value. If I do have some, I want to dump it on the next sucker as fast as possible to minimize my losses."
While the supply will keep growing for quite a while, eventually it will stop growing. And lost coins will ensure that the supply keeps dropping beyond that point. Bitcoin can only avoid being deflationary in the long run if demands drops faster than supply.
> An inflating currency would never catch on.
Like US dollars? Or Euro?
Both of which are not just used where they are legal tender, but are also widely used for international trade, by choice.
> It's a hot potato situation of "I don't actually want to own it because it's decreasing in value. If I do have some, I want to dump it on the next sucker as fast as possible to minimize my losses."
This is an issue if the inflation is rapid. If the inflation is slow and steady, it's a benefit: It means the value of currency that is inactive - because someone put cash in their mattress for example - steadily diminishes, which gives you a reason to ensure your currency holdings are put to use, whether by spending them, investing them, or lending them to someone who will invest them (e.g. in the form of bank deposits). It helps stimulate economic activity.
As long as the rate of inflation is low enough, people are relatively insulated from the negative effects - you won't really notice price changes from day to day or month to month much -, and the yearly inflation can be accommodated when your salary is adjusted.
That's a very long time in the future. Some coins may be lost, but not enough to have a significant force on the price.
> An inflating currency would never catch on.
>Like US dollars? Or Euro?
US dollars were backed by gold. I'm not sure about Euros but I believe they were probably initially backed in an established currency.
>This is an issue if the inflation is rapid. If the inflation is slow and steady, it's a benefit: It means the value of currency that is inactive - because someone put cash in their mattress for example - steadily diminishes, which gives you a reason to ensure your currency holdings are put to use, whether by spending them, investing them, or lending them to someone who will invest them (e.g. in the form of bank deposits). It helps stimulate economic activity.
People do save money by putting in the bank. If bitcoin got large enough there would likely be bitcoin banks. There is also nothing preventing people from doing this with other resources. E.g. rich people buying oil rights or something to store their wealth in, just like they hypothetically would with deflating cash. Spending money also isn't inherently good for the economy. See the broken window fallacy. Prices are flexible. If someone takes money out of the economy, prices will just go down by that much to make up for it. Reverse with spending.
>As long as the rate of inflation is low enough, people are relatively insulated from the negative effects - you won't really notice price changes from day to day or month to month much -, and the yearly inflation can be accommodated when your salary is adjusted.
Wages are generally the last price to change in response to inflation. Wages are the least liquid market. (Artificial) inflation hurts the general population to benefit whatever group receives the printed money first, before prices rise.
People do indeed have a tendency to do exactly that. Take gold hoarders, for instance.
>An inflating currency would never catch on. It's a hot potato situation of "I don't actually want to own it because it's decreasing in value. If I do have some, I want to dump it on the next sucker as fast as possible to minimize my losses."
The point of the inflation would be to offset the natural hoarding instinct with an incentive to actually spend it.
If inflation goes TOO high, you will, of course, end up with everybody trying to dump the currency off on to everybody else.
There is a sweet spot in the middle, however.
http://en.wikipedia.org/wiki/Friedman%27s_k-percent_rule
Most mainstream economists agree with a steady expansion of the money supply (which does not necessarily lead to inflation unless the monetary supply grows faster than demand).
Cryptocoins are an interesting example of rule-based monetary policy, I hope economists will learn a lot from them.
Moneys based upon industrial processes, most notably mining of metals and coin minting, would then naturally increase the money supply at about the right rate, assuming improvements in the relevant disciplines occurred at about the same rate as everything else.
Obviously, Moore's Law pushes certain specific disciplines a lot faster than the rest of the economy. Computing hardware tech advances about 40% every year, over the last 50 years. Kryder's Law and Butters's Law, for hard disks and network bandwidth, goes even faster. Those, in turn, make automation and computerization of other industries cheaper, and they continue to improve in productivity.
When the increase in money supply is tied to increases in productivity, naturally, the people providing the innovations and advances reap the benefits by getting the new money first.
This does not imply that the controller of a fiat currency should set a target inflation rate. That new money is going to the wrong people. It goes to the bankers who happen to be robbing the economy at exactly the same rate that inventors and innovators are adding to it. They are now treading water to stay right where they were before, and everyone else loses ground.
If you have no mechanism to ensure that the growth in the money supply goes directly to the people growing the economy, you are better off establishing a completely fixed money supply. That allows innovators to gain as they should, but with steadily falling prices rather than stable prices. That complicates the business math somewhat, but if everyone just assumes the same 2.5% annual growth in the economy over the same fixed money supply, it isn't that hard to work out.
If people can use Quickbooks to run their business, they can handle a fixed-quantity money supply. What no one likes is a steadily inflating money supply where only the people running like mad on the treadmill can stay in the same place, while fat cats in motorized carts throw pennies at them.
Bitcoin has a bit of a compromise, in that the people reaping the inflation windfall are the ones covering the actual operating costs of the system. But it is unfortunately not tied to the value of goods and services in the Bitcoin economy. Fixing the money supply increase in advance requires that you predict how quickly suppliers and consumers will adopt the medium of exchange. I think the guesser guessed wrong. But even so, the proof of concept is pretty darned good, for the first iteration. The only real danger is that it is good enough that people will never migrate to anything better.
I also hope that Bitcoin is a proof of concept for a better system :) .
Thanks for the lengthy post. It's worth the read.
So then why aren't all rich people hoarding gold and destroying the economy? The argument can be generalized into "any resource deflating is bad", there is nothing special about currency. It would at most be one more resource which is deflating.
That sounds like a great currency. Not a great asset, or investment, but a great currency, one that is useful as a medium of exchange, not something people can just sit on and expect to get rich from.
1. As the use of Bitcoin increases over time, as the exchange markets become bigger and deeper, as economic activity is surpassing speculative activity, etc, the effect of speculation are becoming smaller and smaller. There is evidence that this happening right now: graphs showing the volatility level of Bitcoin (at a coarse level: 6 months) is decreasing... I can't find a link at this moment unfortunately.
2. Although deflation is, as of today, "generally" believed to be detrimental, it is disputed. For example the very famous 1939 paper "A Program for Monetary Reform" argues (amongst many things) that deflation is healthy and normal[1]. One thing is certain: our understanding of financial systems is imperfect, and just because more economists think, today, that deflation is generally negative, does not mean it is true. Bitcoin is an experiment that will perhaps disprove it.
[1] "Some authorities regard prices falling, to some extent at least, with technological improvements, as a proper result of a successful monetary policy" http://en.wikipedia.org/wiki/A_Program_for_Monetary_Reform