Topic: Will deflation be the fatal weakness of bitcoin? - page 2. (Read 10625 times)

That is a terrible example: Your whole premise means that anyone doing business needs to KNOW THE FUTURE. You assume it will be 5% per year... with the volatility of bitcoin can be upwards of 50% or more.

How can you possibly set realistic profit margins when value can swing in such huge unpredictable fashions?

I just don't see how fractional reserve banking will ever be a major force wrt Bitcoin. FRB only operates to expand the money supply when I.O.U.'s begin to be treated as the equivalent of money. Why would we expect this to happen with Bitcoin? The I.O.U.'s wouldn't provide an advantage over actual BTC that would compensate for the risk of default. In contrast, people began using the first bank notes (I.O.U.'s from the gold-smith) way back when because they were easier to transact with than physical gold. And there's no system of implicit and explicit governmental guarantees that would back up the issuers of Bitcoin I.O.U.'s. Some have speculated that Mt. Gox could be operating in FRB mode. And I understand that some people pay each other by simply transferring from one Gox account to another, but most people, most of the time are going to want real money to settle payments (i.e., "Blockchain or it doesn't count").

What is the ratio of most nations physical currency to their total money supply? What is a typical fractional reserve requirement? Could anyone estimate the total money supply of Bitcoins in a fractional reserve system similar to modern fractional reserve systems? I'm not sure where to begin...

For the time being it is. Anyone doing fractional reserve banking *now* without the *intention* to default is plain stupid.

In a mature Bitcoin economy, the situation may change and the "real" Bitcoin (the ones in the blockchain) may take the position of gold in gold backed currency.

At some point, the Bitcoin window may be closed like Nixon closed the gold window and we call a currency "Bitcoin" that has nothing to do with the stuff we use now - we go full circle

Even with fiat money the amount of currency (paper bills) is a small fraction of the total money in circulation. Most dollars are in checking accounts and exist only as a promise by banks to redeem in dollars on demand. This represents the financial market's response to "demand for money" by the market.

I know a lot of you don't like fractional reserve banking, but Bitcoin is not immune to this. If the world decides it wants to hold Bitcoins in large numbers then financial institutions will invent ways to create instruments that satisfy that need. We will see Bitcoin "checking accounts" backed by nothing more than a promise and that will be fine for the vast bulk of people and companies. This is because of all the conveniences and security (audits - rollbacks - etc.) built into the financial system today. Truly, a large company would prefer to deal with Chase checking accounts than fiddle with secret keys and such. So would my grandmother.

People would only bother with real Bitcoins in situations similar to when you need cash today. A drug deal or a trip to the bazaar in a town in Africa, and so on. Most of the time people would be fine leaving their coins at the bank and using a debit card to pay for coffee.

So the real Bitcoin economy can be MUCH larger than the Bitcoin base and it is meaningless to take 21M bitcoins and divide by the population of the earth when having these discussions.

I agree with this. However, it will only happen after Bitcoin can be bought and sold quickly and Bitcoin markets can support the volume.

Based on my research, people choose what to use as money based on transaction costs, not on its macroeconomic properties. Even one of the more famous "fighters against deflation", Paul Krugman, wrote two papers arguing that in international trade, the choice of currency is determined by transaction costs. In his models, he uses liquidity to account for all transaction costs. With Bitcoin, there is however, a technological advantage influencing the transaction costs that I don't see likely to be beaten by the encumbent system.

So, even if those that worry about deflation are entirely correct, the consequence would be depressions and crises, not a loss of market share for Bitcoin. But economists other than Austrians tend to assume that the choice of currency within a state is a given. They entirely miss the broader issues.

While price is unstable, Bitcoin will be used as an intermediary currency, quickly bought and sold to purchase goods or services whose price is stable in another currency.  While Bitcoin deflation is rapid, it's other use will be as a value store. An rapidly inflating coin would be either unused or highly circulated. A quasi-stable, slowly deflating coin seems to me to be the steady-state for Bitcoin in the long term, should it survive.

Yep. If pretty much everyone (say, more than 3 Billion ppl) is using Bitcoin, then there is less than 7 milliBitcoin for everyone. Thus BTC 100 will be a fantastic amount of money.

The decrease of prices (the term "Deflation" is IMHO not adequate) is caused by the growth of the Bitcoin economy (ignoring speculative bubbles) - either new users entering the Bitcoin economy or old users increasing their use of Bitcoin. Assuming a 10% decrease in prices therefore assumes a 10% real growth. Assuming that most people are already in Bitcoin, this will have to be mainly increases in efficiency. Which doesn't seem right.

I'm assuming you mean me? Which numbers do I have wrong?

Your main idea is obviously right, but please fix your numbers.

I think these examples I used in the "Deflation and Bitcoin, the last word on this forum" thread were pretty useful:

Imagine that it's Jan. 1, 2020, and you're an investor in an economy where the currency is deflating 10% a year.  You're considering making an investment in a programmable widget-maker.  The widget-maker costs 100 BTC (naturally everyone uses Bitcoins in 2020).  To simplify things, assume that the widget maker is disposable and can only be used once, after which it has zero value.  Also assume that all you have to do to use the widget maker is to input two choices, e.g. color and shape, and then wait exactly one year.  Let's say that you know that you can make a green circle widget that will be worth 105 BTC in present 2020 BTC.  So it sounds like a smart (and wealth-creating) investment, right? Except there's a problem. You also know that when you can actually sell the widget on Jan. 1, 2021, it will only sell for 94.5 BTC as a result of deflation. So you're better off just sitting on your 100 BTC, and you certainly won't borrow money to make the investment.  Is that a bad result for society? I don't think so.  First, it should be noted that if the widget maker were only capable of making green circle widgets, it wouldn't sell for 100 BTC because no one would pay that much (everyone else would make the same calculation you did). In that case, the price would be adjusted downwards until it made economic sense.  But if it DOES sell for 100 BTC, what does that tell us? It tells us that there's someone else (who's presumably also aware of deflation) who knows that they can make, e.g., a yellow square widget worth at least 111.11 BTC in 2020 BTC (meaning it will sell for at least 100 BTC in 2021).  So there's no problem.  The asset goes to its most productive user and doesn't just sit on a shelf.

More generally, what does a 10% deflation rate tell us assuming a constant money supply?  I'm perhaps oversimplifying, but basically it tells us that the economy is growing at around 11.11% a year (with 10% deflation, the purchasing power of every BTC increases 11.11% each year).  So you now have the same amount of money chasing more goods.  If the economy is growing that rapidly, that tells you that there must be lots of investment opportunities with a return of at least 11.11%.  Basically, that's the number to beat.  If you're looking at an investment opportunity with a measly 5% return, deflation is telling you not to waste your time because there are higher and better uses of that capital. 

Krugman makes it sound like it's a bad thing that "just sitting on cash becomes an investment with a positive real yield." But I don't think that it is. And again, the only reason that sitting on cash can produce a positive real yield for some people is that many other people AREN'T just sitting on their cash.  There MUST be even higher-return investments occurring.  And it seems to me that "just sitting on cash" SHOULD return a positive real yield.  Deferring consumption is not something people typically like to do.  And people who do make that sacrifice ARE providing something of value to society by doing so.  By sitting on their cash, that cash is temporarily not competing with other cash for goods and services, thus keeping prices low for everyone else, including investors.

Now let's look at an inflation scenario.  Assume that it's Jan. 1, 2000 and the inflation rate is 10% (you're stuck using inflationary U.S. fiat because Bitcoin hasn't been invented). You're looking at a widget maker that costs 100 USD, but this widget maker is not programmable.  It only makes orange triangle widgets and once again, it takes a year to do so.  But these orange triangle widgets can only be sold for 95 bucks (in 2000 dollars).  But that means that on Jan. 1, 2001, when you can actually sell the widget, you'll be able to get $104.50 for it.  So buying the widget maker with your 100 bucks makes more sense than just sitting on the cash despite the fact that it's a wealth-destroying investment.  That seems bad.  Basically, it seems like inflation causes people to treat cash like a hot potato which will sometimes lead to economically-wasteful transactions.

My hope in this scenario is that the built-in public nature of the Bitcoin blockchain will force banks to compete on reserve ratios and transparency.  In other words, as you're starting to see in the lender forum here, banks/lenders could make themselves more attractive by certifying certain addresses as theirs, so that customers could see how much Bitcoin reserve they actually held versus liabilities, in real time.  Customers could then choose to invest according to their risk tolerance: in a full reserve operation at zero interest rate, or a fractional reserve operation at a higher interest rate.  The main problem with FRB in our current system is the lack of disclosure to the customer, I bet not even 1 in 100 people actually understands that the bank is basically making bets with their money instead of holding it in storage.

Interesting point. The difference is, since BTC is already an electronic currency with no physical aspect (cash, metal, etc.) there would be little motivation to accept a placeholder credit for BTC instead of BTC itself.

Further, since it's impossible to create new BTC (other than mining) there would be now way to create new currency to bail out overextended banks.

It would be possible for the blockchain to eventually get so active (and large) that only banks and governments would have the resources to deal in actual BTC. In that case, banks could collude to overlend some new type of currency that is supposedly backed by BTC, but is secretly not backed at all.

Someone may have pointed this out already, but Bitcoin is not necessarily deflationary.  This is because it can be (and if it's successful, most likely will be) used as the base currency for a fractional-reserve banking system that continually issues "new money" (i.e., bank notes) denominated in Bitcoin, in amounts greater than the underlying BTC deposits held by the banks.  By this means, the effective money supply of BTC-denominated paper money can be inflated almost arbitrarily above the base amount of actual BTC.  This is the same as how the effective money supply of, say, U.S. dollars in bank accounts today is much larger than the actual amount of hard currency (US dollar-denominated coins and bills) in circulation.  Thus, Bitcoin is not inherently deflationary, but neither does it inherently solve the problem of today's debt-based currency that is prone to causing defaults, bank failures, etc. whenever the economy shrinks and the debts cannot all be paid back.  That can only be solved by outright banning fractional-reserve banking (whether based on dollars, gold, or BTC as the base reserve asset).  Arguably, such a ban should be instituted, since it is inherently a fraudulent practice for a bank to issue notes in excess of their physical deposits - no matter that bankers have been doing exactly this ever since the Renaissance, and this practice has been much of the basis for their whole business model.

This is true if you have hyperdeflation and your business's profit margin is 0%.
Lets take a scenario where annual deflation is 5% and you take 5% cut of each car sold. You have BTC100. First month you buy BTC100 car and sell a month later. Car costs now BTC99.5 due to the deflation. To take your cut you sell it for BTC104.5.
(BTC100- 5% / 12months)* 1.05 = BTC104.5
Pocket the BTC4.5 and buy another BTC100 car. Do that for 1 year and you end up with BTC154. If you count in the deflation you are now 58% richer.
If you didn't do anything then you are only 2% richer.

Gold and silver are legal tender in Utah.

Some people seem to have it backwards. Deflation is the intended solution to the debt problem of fiat money and the inflation tax. It's not the problem or a problem, nor is it simply a solution. It's the solution.

Bitcoin provides, eventually, the same level of value store that gold does and at the same time it's massively more convenient as a medium of exchange. Bitcoin I believe, could become a universal currency. The nonpolitical nature of it, the store of value capabilities and the convenience as a payment method, Bitcoin has it all.

All of this is of course dependent on Bitcoin being able to withstand the attack it will likely experience in a few years time. I'm personally not worried about it, even if Bitcoin fails new cryptocurrencies will arise and take its place.

Gold is not a currency anymore. Those who still believe it is should read http://en.wikipedia.org/wiki/Gold_standard.

Lol for you gold is worthless?

0/10 troll.