Bitcoin adoption

[badukJr]

I would like to quote this comment as it highlights my biggest concern about bitcoin.

Do you want to create a new online currency? Fine. However, keeping to yourself or distributing to the very early adopters the majority of the "wealth" is a certain way to kill it.
I'm saying this assuming good faith from the creators, even though I highly suspect that this was planed from the beginning as a "feature".

Not only that, but the identity of the creator is pretty much an unknown.
https://en.bitcoin.it/wiki/Satoshi_Nakamoto

[SpongeBob]

... and the usage (number of clients connected to the networt) is declining significantly, see the current chart.

[daniel_the_smith]

... and the usage (number of clients connected to the networt) is declining significantly, see the current chart.

It's unclear how meaningful those charts are. I start up my client only rarely. Trading doesn't require running a client.

I would like to hear what jts has to say about my comment earlier (what kind of automated rule would cause a small amount of inflation?)...

[jts]

... and the usage (number of clients connected to the networt) is declining significantly, see the current chart.

It's unclear how meaningful those charts are. I start up my client only rarely. Trading doesn't require running a client.

I would like to hear what jts has to say about my comment earlier (what kind of automated rule would cause a small amount of inflation?)...

It depends what you mean by "automated." Your earlier question takes as a premise "bitcoin clients can only effect supply, not demand", so I took that to be the context: something like "what automated rule could produce a small amount of inflation, despite only taking account supply, not demand?" And the answer is "none". After all, inflation is affected not only by the physical monetary base, but also by how fast people are spending/lending it as opposed to hoarding it.

On the other hand, bitcoin could have an automated rule like "if inflation isn't accelerating, produce bitcoin at a faster rate; if inflation is accelerating, produce bitcoin at a slower rate." But that would require you to build a model of inflation into the bitcoin protocol, if I understand correctly what sort of automated rule you're looking for, and that would be a little bit difficult. Not difficult by the standards of science fiction, but difficult for the here and now.

[Bill Spight]

... and the usage (number of clients connected to the networt) is declining significantly, see the current chart.

It's unclear how meaningful those charts are. I start up my client only rarely. Trading doesn't require running a client.

I would like to hear what jts has to say about my comment earlier (what kind of automated rule would cause a small amount of inflation?)...

From Wikipedia:

The network adjusts the difficulty every 2016 blocks based on the time taken to find the previous 2016 blocks such that one block is created roughly every 10 minutes. Thus the more computing power that is directed toward mining, the more computing power the network requires to complete a block confirmation and to receive the award. The network will also halve the award every 210,000 blocks, designed to occur about every four years.

Bitcoin blocks are created at a fairly steady rate. It is the halving of the award that makes the total number of bitcoins constant, and is severely deflationary. If you follow Milton Friedman's formula, you would increase the award by a certain percentage, such as 1/512 every 2016 blocks. That should be mildly inflationary, at a similar rate to most developed economies.

Edit: You are really "debasing" bitcoin by increasing the award, but debasement tends to have inflationary effects. Also, increasing the award rewards current miners instead of rewarding early miners, which is what halving the award does. That's what you want for a virtual gold standard.

Edit 2: I changed the increment to yield around a 5% per year increase in the award. About half that should accommodate economic growth, about half that should be inflationary.

[daniel_the_smith]

... If you follow Milton Friedman's formula, you would increase the award by a certain percentage, such as 1/512 every 2016 blocks. That should be mildly inflationary, at a similar rate to most developed economies.

Edit: You are really "debasing" bitcoin by increasing the award, but debasement tends to have inflationary effects. Also, increasing the award rewards current miners instead of rewarding early miners, which is what halving the award does. That's what you want for a virtual gold standard.

I guess my point was that a system like that will at times be extremely deflationary (I.e. if bitcoin caught on and 300 million people bought at the same time) and other times it would be overly inflationary.

I can think of another way, which is that the system automatically adds virtual interest to every account with every block (like multiply by 2097153/2097152 for each block, that should come out to a few percent per year). That might actually be fairer than the current method of increasing the money supply (it distributes new money evenly instead of to borrowers/governments).

The argument for rewarding early miners is of course that they are making a risky investment. Mining hardware is not free... It's unclear to me if this extra incentive was necessary to get things off the ground or not.

[Bill Spight]

... If you follow Milton Friedman's formula, you would increase the award by a certain percentage, such as 1/512 every 2016 blocks. That should be mildly inflationary, at a similar rate to most developed economies.

Edit: You are really "debasing" bitcoin by increasing the award, but debasement tends to have inflationary effects. Also, increasing the award rewards current miners instead of rewarding early miners, which is what halving the award does. That's what you want for a virtual gold standard.

I guess my point was that a system like that will at times be extremely deflationary (I.e. if bitcoin caught on and 300 million people bought at the same time) and other times it would be overly inflationary.

Well, if you want to fine tune things, then you probably need a monetary authority.

I can think of another way, which is that the system automatically adds virtual interest to every account with every block (like multiply by 2097153/2097152 for each block, that should come out to a few percent per year). That might actually be fairer than the current method of increasing the money supply (it distributes new money evenly instead of to borrowers/governments).

That should have no effect, except upon nominal prices, as long as bitcoin is indefinitely divisible. The problem comes with the diminishing effect of mining.

The argument for rewarding early miners is of course that they are making a risky investment. Mining hardware is not free... It's unclear to me if this extra incentive was necessary to get things off the ground or not.

Early miners automatically got a bonus, as the first bitcoins were relatively cheap to produce. The question is, what makes for a vibrant, ongoing enterprise? For that you need to reward current miners. In theory, keeping the block rewards constant (instead of halving them every four years) makes sense. However, experience over the past few centuries has shown that mild inflation is preferable. You are going to get swings, and deflation is not good. Even low inflation can produce stagnation. You also have the Gresham's Law problem that relatively low inflation leads people to save bitcoins instead of mining them. With no guarantee that anyone will accept bitcoins, that could be disastrous.

[daniel_the_smith]

I can think of another way, which is that the system automatically adds virtual interest to every account with every block (like multiply by 2097153/2097152 for each block, that should come out to a few percent per year). That might actually be fairer than the current method of increasing the money supply (it distributes new money evenly instead of to borrowers/governments).

That should have no effect, except upon nominal prices, as long as bitcoin is indefinitely divisible. The problem comes with the diminishing effect of mining.

Huh. So inflation won't "work" unless the money is distributed unevenly?

[Bill Spight]

I can think of another way, which is that the system automatically adds virtual interest to every account with every block (like multiply by 2097153/2097152 for each block, that should come out to a few percent per year). That might actually be fairer than the current method of increasing the money supply (it distributes new money evenly instead of to borrowers/governments).

That should have no effect, except upon nominal prices, as long as bitcoin is indefinitely divisible. The problem comes with the diminishing effect of mining.

Huh. So inflation won't "work" unless the money is distributed unevenly?

If all it does is change savings equally, it is neutral. Then inflation and deflation do not matter. A major point of mild inflation is to keep money circulating. One metaphor for money is blood. You want it to circulate. If you simply increase the amount of money that is doing nothing, what is the point?

[jts]

If all it does is change savings equally, it is neutral. Then inflation and deflation do not matter.

I'm not sure I follow this. What Daniel is proposing is to plop little bits of bitcoin in everyone's digital wallet, if I understand correctly. The reason we would not necessarily expect this to create inflation is that we would not necessarily expect it to cause the money supply to change - that is, while we're creating more pieces of the monetary base, we're also giving people a reason to keep money in their wallet rather than spending it or lending it. But if the extra bitcoin does not cause extra spending, there would be no reason for it to affect the price level.

(This is in fact the major flaw in monetary policy, i.e. printing money and using it to buy back government bonds. When economic conditions are dire enough, and prices are mildly deflationary, the underside of your mattress looks like a much better investment project than anything else. So no matter how much money the central bank prints, people just save it away, and since they aren't spending it deflation continues, and money under the mattresss to look like a good investment. --- The Bernanke Fed actually tried something similar to what Daniel describes: they started paying interest on the cash accounts which major banks hold with the Federal Reserve. Naturally, this led the banks to hold larger cash reserves with the Fed, which is exactly the reverse of what a central bank wants commercial banks to do during a recession.)

[Bill Spight]

If all it does is change savings equally, it is neutral. Then inflation and deflation do not matter.

I'm not sure I follow this. What Daniel is proposing is to plop little bits of bitcoin in everyone's digital wallet, if I understand correctly. The reason we would not necessarily expect this to create inflation is that we would not necessarily expect it to cause the money supply to change - that is, while we're creating more pieces of the monetary base, we're also giving people a reason to keep money in their wallet rather than spending it or lending it. But if the extra bitcoin does not cause extra spending, there would be no reason for it to affect the price level.

(This is in fact the major flaw in monetary policy, i.e. printing money and using it to buy back government bonds. When economic conditions are dire enough, and prices are mildly deflationary, the underside of your mattress looks like a much better investment project than anything else. So no matter how much money the central bank prints, people just save it away, and since they aren't spending it deflation continues, and money under the mattresss to look like a good investment. --- The Bernanke Fed actually tried something similar to what Daniel describes: they started paying interest on the cash accounts which major banks hold with the Federal Reserve. Naturally, this led the banks to hold larger cash reserves with the Fed, which is exactly the reverse of what a central bank wants commercial banks to do during a recession.)

MV = PQ.

Assuming that increasing everybody's bitcoin (M) proportionally does not affect the velocity of bitcoin (V), nor the production of real goods and services (Q), then prices denominated in bitcoins (P) will increase at the same proportion. Since everybody knows what is happening and when. All that we have done, in effect, is to change nominal values. The effects of inflation and deflation in the real world come about because not everything changes at the same time.

You and I are pretty much in agreement about Fed policy, but I don't want to get too far afield.

[jts]

Hmm, maybe we're wandering too far into the swampy subtleties of money. But there are two points I would make: first, accounting identities aren't causal laws. You shouldn't fall into the "doctrine of immaculate transfer" - that is, the idea that you can simply stipulate, hypothetically, the value of X-1 of X variables, and this stipulation will transfer something real from one part of the equation to the other. Second, the monetary base (bitcoin, in the techno-utopian's dreams) isn't the same as the money supply (M, the thing that keeps us out of a barter economy).

The standard picture of "pushing on a string" in a depression is that the central bank prints a lot of money, people hoard all of it without changing any of their economic behavior because they're freaked out by the poor economic climate, and as a result nothing happens in the real economy. I.e., M goes up, P and Q are the same. What happened to V then? Didn't V stay the same, too? No; V is just defined as PQ/M. MV=PQ is an identity. If we print lots of money and nothing happens in the economy, by definition V has fallen.

[Mike Novack]

The governemnts don't (usually) increase the "money supply" by printing more bills but the fact that you recognize that if people consider times very bad they will simply hide it under the matress is to the point (except it's not just "the people").

In an economy like ours the amount of "money" in circulation is not the amount of bills (physical money). Assuming the economy is running smoothly, the amount of money is determined by the percentage lenders must hold in reserve. For example, it the required (and/or effective) reserve percentage is 50% then the amount of money in circualtion would be twice the amount of physical money.

By lowering that percentage the government can increase the amount of "money" or by raising it decrease the amount of "money". Except the former might not work if the lenders (the banks) are disinclined to lend up to the limit they are allowed. The latter would always work.

Printing more is the last resort (lenders won't lend; people aren't depositing money for them to lend out, hiding it under the matress). Usually only results in runaway inflation because the economy was sick to begin with -- or the normal loosening would have worked.

[Bill Spight]

Hmm, maybe we're wandering too far into the swampy subtleties of money. But there are two points I would make: first, accounting identities aren't causal laws. You shouldn't fall into the "doctrine of immaculate transfer" - that is, the idea that you can simply stipulate, hypothetically, the value of X-1 of X variables, and this stipulation will transfer something real from one part of the equation to the other. Second, the monetary base (bitcoin, in the techno-utopian's dreams) isn't the same as the money supply (M, the thing that keeps us out of a barter economy).

The standard picture of "pushing on a string" in a depression is that the central bank prints a lot of money, people hoard all of it without changing any of their economic behavior because they're freaked out by the poor economic climate, and as a result nothing happens in the real economy. I.e., M goes up, P and Q are the same. What happened to V then? Didn't V stay the same, too? No; V is just defined as PQ/M. MV=PQ is an identity. If we print lots of money and nothing happens in the economy, by definition V has fallen.

Look. You are a merchant who accepts bitcoins and you know that, come Tuesday, everybody's bitcoin holdings will increase by 1%. You know this, perhaps, because you hold a few bitcoins yourself. In any event, it is your business to know it. Do you keep your prices in bitcoins the same, or do you raise them by 1%?

Also, the "doctrine of immaculate transfer" argument does not cut it with me. In a collision of billiard balls, both momentum (mv) and energy (mv^2) are conserved. (A conservation law is an identity.) Without going into details, typically the kinetic energy in the motion of the balls after the collision is less than before the collision. What happens to it? On earth typically most of it is dissipated in sound waves, which is why we hear the click of the balls. On the moon, with no atmosphere to carry sound waves, my guess is that the balls would heat up. Even on earth, when billiard balls were made of celluloid, sometimes they would explode.

Now, it is true that the conservation of energy identity does not tell us exactly what will happen with the extra energy. But what would you think of a physicist who claimed that it did not express a causal relationship?

[jts]

Printing more is the last resort (lenders won't lend; people aren't depositing money for them to lend out, hiding it under the matress).

Actually, it's the first resort. ("Monetary policy.") Generally the central bank, in the countries I'm familiar with at least, conducts "open market operations" in which they buy the debt of their own government. Now, they don't print the money and bring it in big duffel bags onto the trading floor, but whenever anyone wants to draw on the money they have "deposited" with the Federal Reserve, the Fed is ready to greet them with warm, crisp sheets of money.

The second resort, when the Fed keeps printing money and no one is spending or investing it, is to have the national government spend more. ("Fiscal policy." This also works as a good backup to monetary policy.) The last resort, when people are rolling back and forth mumbling to themselves about the apocalypse, is to use a blunt instrument like altering the regulatory structure of the banking industry in the middle of the crisis.