Topic: Economics of inflating side-chains (Read 1106 times)
No.
I posted in the Technical sub-forum about an idea I was thinking about where a side-chain of Bitcoin could be made to inflate, at say 2% per year, in order to add security to the network and lower transaction costs on the side-chain. Full details at https://bitcointalksearch.org/topic/can-side-chains-be-used-to-achieve-optimal-network-security-transaction-fees-799465.
TLDR for the main idea: If you move X coins from Bitcoin to the side-chain, then move them back one year later, you can only unfreeze 0.95*X bitcoins, because the side-chain's coins are inflating at 5% per year. You can move coins back without waiting a year, of course, and they'll only have lost a proportional fraction of that 5%.
This thread is for anyone interested in discussing whether people would have real incentives to use such a side-chain, and the economic implications of that solution.
gmaxwell and andytoshi raised these issues:
(1) If you move coins to a side-chain to avoid paying transaction fees, but this side-chain is inflating, then won't any money you save on transaction fees just be eaten away by inflation anyway? Does the net effect perfectly cancel out?
(2) Just a general skepticism about any compelling reason why a Bitcoin user would move coins to an inflating side-chain.
Let's assume that the rules of the side-chain result in in taking one week to move coins from the side-chain back to the Bitcoin chain (for security reasons). What can we say about the price of side-chain coins?
The side-chain price won't be higher than the Bitcoin price, because you can always move X bitcoins into the side chain, turning them immediately into X side-chain-coins (call them sidecoins).
How much lower will the sidecoin price be than the bitcoin price? Since it takes a week to move coins from the side chain to the main chain, and inflation is 5% per year, then if you move coins from Bitcoin to the sidechain back to Bitcoin as fast as possible, they'll have lost 5/52 percent of their value, or roughly 0.1% of their value. So if you start out with $1000 worth of bitcoins and move them back and forth, you'll have about $999 worth of Bitcoin in a week (assuming the USD/BTC rate stays the same).
This means that the price of a sidecoin will be at least 99.9% the price of a bitcoin, because if it were lower then someone could buy up all the sidecoins, immediately convert them back to bitcoins, and sell them as bitcoins.
So even at a 5% inflation rate, the actual movement of coins from Bitcoin to the sidechain doesn't result in much immediate loss of value. What if transactions in Bitcoin were $1 each and transactions on the side-chain were 0.01 cent each? Then if you knew you were going to spend $100 worth of bitcoins next week, it'd definitely be worth converting even if you only spent it on 1 transaction. The more transactions you'd do in that week, the more it'd be worth it.
USD inflates at about 2% per year, and people still keep cash in their checking account / wallet, because for small amounts of cash, the effect of inflation is very small.
Someone might claim that the situation I describe is impossible ($1 Bitcoin fees, $0.0001 sidechain fees) because of some inherent relationships that must hold between the transaction fees, based on the inflation rate, etc. I didn't show that that isn't the case, but I don't see a good reason to believe that such a relationship exists.
Anyone have thoughts on this?
TLDR for the main idea: If you move X coins from Bitcoin to the side-chain, then move them back one year later, you can only unfreeze 0.95*X bitcoins, because the side-chain's coins are inflating at 5% per year. You can move coins back without waiting a year, of course, and they'll only have lost a proportional fraction of that 5%.
This thread is for anyone interested in discussing whether people would have real incentives to use such a side-chain, and the economic implications of that solution.
gmaxwell and andytoshi raised these issues:
(1) If you move coins to a side-chain to avoid paying transaction fees, but this side-chain is inflating, then won't any money you save on transaction fees just be eaten away by inflation anyway? Does the net effect perfectly cancel out?
(2) Just a general skepticism about any compelling reason why a Bitcoin user would move coins to an inflating side-chain.
Let's assume that the rules of the side-chain result in in taking one week to move coins from the side-chain back to the Bitcoin chain (for security reasons). What can we say about the price of side-chain coins?
The side-chain price won't be higher than the Bitcoin price, because you can always move X bitcoins into the side chain, turning them immediately into X side-chain-coins (call them sidecoins).
How much lower will the sidecoin price be than the bitcoin price? Since it takes a week to move coins from the side chain to the main chain, and inflation is 5% per year, then if you move coins from Bitcoin to the sidechain back to Bitcoin as fast as possible, they'll have lost 5/52 percent of their value, or roughly 0.1% of their value. So if you start out with $1000 worth of bitcoins and move them back and forth, you'll have about $999 worth of Bitcoin in a week (assuming the USD/BTC rate stays the same).
This means that the price of a sidecoin will be at least 99.9% the price of a bitcoin, because if it were lower then someone could buy up all the sidecoins, immediately convert them back to bitcoins, and sell them as bitcoins.
So even at a 5% inflation rate, the actual movement of coins from Bitcoin to the sidechain doesn't result in much immediate loss of value. What if transactions in Bitcoin were $1 each and transactions on the side-chain were 0.01 cent each? Then if you knew you were going to spend $100 worth of bitcoins next week, it'd definitely be worth converting even if you only spent it on 1 transaction. The more transactions you'd do in that week, the more it'd be worth it.
USD inflates at about 2% per year, and people still keep cash in their checking account / wallet, because for small amounts of cash, the effect of inflation is very small.
Someone might claim that the situation I describe is impossible ($1 Bitcoin fees, $0.0001 sidechain fees) because of some inherent relationships that must hold between the transaction fees, based on the inflation rate, etc. I didn't show that that isn't the case, but I don't see a good reason to believe that such a relationship exists.
Anyone have thoughts on this?
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