Topic: Proposal from a macroeconomist for an optimal crypto-currency (Read 4296 times)

When I am putting or accepting an order with 3 quantities: B, r_r and r_b, another order with 0.5B, 2r_r and 2r_b is almost same to me. The only difference is the latter has a leverage of 2 times.

Then the seller (no matter how risk averse) will wish to participate in the swap/repo at least if R_b>=1+r_b and r_r>=R_r-1

I LOVE how you portray this as a positive thing when it's really the start of where all the fraud began.

I LOVE how you portray this as a positive thing when it's really the start of where all the fraud began.

Bitcoin has many similarities to gold. But societies have persistently chosen to use fiat currencies over gold.

Regarding the modified proposal, I believe it is not a repo deal any more, it's more like a fx swap deal. As a result, Rr is not real repo rate of repocoin, but a function of the rates of both coins. If so, how could we apply these numbers to adjust repocoin's PoS interests rates?

Dear all,

I'm an academic macroeconomist (with a doctorate, university post etc. for what it's worth). As such, BitCoin and the various other crypto-currencies hold a great deal of interest for me. However, there's something I'd like to discuss with the community, possibly with the ultimate goal of collaborating on a new crypto-currency.

While I have very few doubts that a crypto-currency will come to dominate in the long run, I am somewhat sceptical that it will be any of the current crop, despite Bitcoin's substantial first mover advantage.

Given the constant proliferation of alternate crypto-currencies, it seems likely that in the long-run there will be a range of crypto-currencies all of which use an algorithm without obvious flaws, but which differ in the degree of inflation/deflation and/or price volatility they generate. In such a circumstance, which currency would people pick? Well, the answer to this depends on what the main costs of inflation/deflation are for them.

In standard macro-models today, there are two main costs. Firstly, people face costs due to the necessity of holding cash. If you have to hold cash to make purchases, and that cash is subject to inflation, then the contents of your wallet are constantly losing value -- you are effectively paying a tax to the people creating ("mining") new currency. Secondly, people face costs due to constantly adjusting prices and/or contract terms. For buyers, these costs include search costs, information costs, etc. etc. (If a loaf of bread always costs $1.00 in your normal supermarket, then when you see a loaf of bread on sale for $0.90, you know it's a good deal. If the cost of that loaf of bread is wildly fluctuating in your normal supermarket, then you face a much harder job assessing whether another store's price is a good deal or not.) For sellers, these costs include the cost of going round and physically changing prices in a store, and again various information costs.

Depending on which of these two sets of costs dominate, the exact optimal policy prescription varies, but never by so much. If the former cost dominates, then nominal interest rates should be set to 0 (so steady-state deflation is equal to the real interest rate), meaning there is no opportunity cost of holding cash rather than having your money in a bank. (This is the "Friedman-rule", not to be confused with the "Friedman K% rule", which is not optimal in any standard model.) If the latter cost dominates, then inflation rates should be set to 0.

Directly targeting an inflation rate of 0 to fix the second cost would be very hard with a crypto-currency. Yes, the supply could be controlled to ensure a constant exchange rate to some (basket of) currency(ies), but this would mean putting your trust in the maintenance of the value of the crypto-currency back with national central banks, rather defeating the purpose of using such a crypto-currency in the first place. Even monitoring the relevant inflation rate for a crypto-currency would be difficult, because at present much of their use (if I understand correctly) is in the purchasing of goods where one or both parties don't want it made public that the transaction took place (e.g. because the good is illegal), making it very hard to build a price index.

What about the first cost? Well, first note that with any electronic currency there's no need to set the nominal interest rate to 0 in order to remove the opportunity cost of holding cash. Instead, one can directly pay interest on the currency. With a crypto-currency, this can be done via Peercoin style "proof-of-stake" payments, where the payment rate is tied to the observed risk free nominal interest rate on the crypto-currency (appropriately smoothed). To get this risk free nominal interest rate, the creator of the crypto-currency would create a (ideally, decentralised) platform for the exchange of repurchase agreements denominated in the new currency, using "old" currencies as collateral (though in the long-run, other assets could come to fulfil this role). Although using repurchase agreements rather than unsecured loans removes much of the risk, it may still be desirable to construct a simple reputation system, so that the repo rate for high reputation parties is truly a risk-free rate.

If this is all one did, the interest rate and the inflation rate could be unstable. However, with a crypto-currency one has a second instrument, namely the release of new coins via the "proof-of-work" mechanism. With this one could ensure that the nominal interest rate remained at least (say) 4%, which is approximately the long run real interest rate, meaning that prices would be roughly stable (thus minimising the second cost), and is high enough that any problems stemming from the zero lower bound on nominal interest rates are avoided. In the unlikely scenario in which interest rates actually exceeded 4%, then Peercoin style transaction costs could be applied, though this is to be avoided if at all possible since transaction costs reduce allocative efficiency, having a big welfare cost (and meaning consumers won't be persuaded to use your currency).

Happy to discuss this further if anyone's interested. And if anyone's seriously interested in creating this crypto-currency and wants help, PM me. Another possibility would be open development which seems the best way of avoiding the stink of scammery...

Best regards,

ZeroNominal

A point that puzzles me is how are the miners, following the implied instructions recorded in the blockchain, to manipulate the bitcoins?

Parts of the protocol seem to have the miners sending bitcoins somewhere, or holding bitcoins somewhere, but since the blockchain is the only data upon which to decide which bitcoins to send to where, how are the private keys controlling the bitcoins that are to be moved etc stored?

For example when someone uses bitcoins as collateral and gets a loan, where is the private key of the address used to hold the collateral (those bitcoins) stored?

And the last point is, what benefit does the community at large derive from this activity that makes it reasonable for them to freely choose to act as guarantors?  Why would they not prefer  another cryptocurrency that exposes them to no guarantor risk?

BTW, I am delighted to have someone who actually knows something about financial markets here, and I sincerely want to understand how that knowledge can be used to improve the state of the art in cryptocurrency.   I appreciate your work and knowledge, and sincerely thank you.

I don't intend my responses to be belligerent or argumentative, but instead keep asking questions because much still isn't clear to me.  I don't understand for example the motivations of people who would choose to use an over-collateralized market in debt instruments over the option of using the collateral itself.

Modify 3 as follows, changes in red. These changes also ensure that the interest rates are 100% risk free, with the risk now being spread equally over all of the users of the currency, not just those participating in bond markets. I have an idea for further simplifying things by combining 3 and 4, but I'm not sure I have the will power to spend further time arguing here...

Perhaps I was a bit hasty in my discussion of Freicoin previously. If you could get an interest rate of -1% to 1% then without demurrage that would be an unambiguous improvement, since it represents a lessening of the inflation tax on holding money. However, doing it via demurrage is just replacing the inflation tax on holding money with an explicit demurrage tax. The fact it's explicit makes it marginally preferable, but the economic distortion is still there. People have to hold money to perform transactions, but they're penalised in doing so by the presence of inflation/demurrage.

I'll see if this can be remedied.

Okay, what I'm reading into this is that in order to borrow 15 coins (sell 15 repocoins worth of bitcoin with an offer to buy the same amount of bitcoin back for ~15.005 repocoins the following day) the borrower must "lock" collateral worth a bit more than 15 repocoins for the duration of the time he's borrowing. 

If this collateral is repocoins, then obviously his borrowing makes no sense because repocoins are fungible.  whatever purpose he has for the repocoins he intended to borrow would be just as well served by the repocoins he's locking up for the duration.  Therefore I conclude that the collateral here must be in some other asset.  But if the collateral is in Bitcoins, then he's locking up the same amount of Bitcoins that he's loaning out, so wouldn't he be charging additional interest because this is tying up twice as much of his assets as are actually appearing on the market?

Why wouldn't I default every time it's in my favor?