That’s a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy. So it gives you the exactly average return on investment with zero volatility. So it seems like a near-perfect store of value and people will want to hold it rather than spend it. This decreases velocity which causes deflation and value that increases apparently even faster than the total global economy. This makes Bitcoin apparently an even better investment, until the volatility or expected volatility from the huge stores of unused Bitcoins outweighs its apparent returns on investment, and note that financial markets are apparently unusually bad at expecting future volatility to be greater than present volatility; people try to time bubbles instead. This is bad for Bitcoin because of the inevitable crash followed by hyperinflation. And it’s bad for the global economy because your currency is deflating and any given bank would rather hold Bitcoins, on average, than make loans; and then the inevitable crash is also bad. That’s a nutshell version of a longer story.
That’s a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy. So it gives you the exactly average return on investment with zero volatility. So it seems like a near-perfect store of value and people will want to hold it rather than spend it.
Assuming BTC gives exactly the average return on investment with zero volatility we shouldn’t expect all people to hold it rather than spend it. Neither an economy of actual humans nor an economy of ideal agents would act that way.
With respect to consumption: Use as a transactional currency for spending would track convenience factors. People buying stuff with one fungible asset is much the same as buying stuff with another asset then transferring between their two accounts. For spherical cow in a vacuum purposes we can ignore this. Investment spending is the issue here.
In the counterfactual BTC currency which perfectly tracks the global economy the incentive is for anyone who believes they know of any investment that they expect to have higher returns than the average of the global economy to spend their bitcoins and invest in that opportunity. Those who don’t believe they have any knowledge of anything that will produce better than average returns or who are risk averse will instead purchase bitcoins either directly or indirectly from those that do have that knowledge.
In that idealised scenario the BTC currency is essentially operating as a vehicle to efficiently transfer real-world capital to places those who people with value expect will provide better return in investment than the average growth of the economy. Note that I am emphatically not claiming that this is an ideal system, it would be bizarre if something so arbitrary happened to be optimal. Just that it doesn’t seem to quite have the degree of problem that is described. People would certainly want to spend it.
There are plausible reasons why predictable inflation of the above currency could be more desirable than precisely zero inflation. Let’s say Satoshi had arbitrarily decided that BTC mining should go on indefinitely, with the bitcoins produced per year exactly equalling 2% of the number of bitcoins already mined. Then the incentives to the the participants change slightly. Rather than people who expect an investment to grow at more than the average for the global economy to be the only ones to so invest, it is any (risk neutral) person who expects an investment to grow at not less than 98% of the rate of the global economy. That has (well known) advantages.
The unfortunate problem with the above monetary policy is that we just effectively dedicated 2% of the of the value stored in the bitcoin currency each year to the computation of irrelevant hashes (in addition to irrelevant computation that is proportional to transaction fees). This problem applies to any cryptocurrency based on cryptographic mining. There may not be a good solution to that problem that potentially prohibitive degree of waste that does not rely on something external to the cryptocurrency as basis. (And the latter is not necessarily a problem. The currency having value in itself isn’t the most potentially useful feature of bitcoin.)
Let me rephrase: The problem is that Bitcoins will have an advantage over the average productive investment, e.g. stocks (sort of), as a store of value, since Bitcoin has all their average expected growth with none of their added (local) volatility. This is what presents the starting problem in an economy that starts out with a steady velocity of Bitcoins, and then increased holding makes the velocity go down (and the value go up, and the bubble effect hit even harder). This is why we don’t get an equilibrium with steady Bitcoin velocities. Even if we did have that equilibrium, people would have a much greater incentive to just “invest” in Bitcoins instead of being forced to try to invest in something productive. You don’t want an economy to have a perfect non-inflating store of value which is intrinsically unproductive!
Let me rephrase: The problem is that Bitcoins will have an advantage over the average productive investment, e.g. stocks (sort of), as a store of value, since Bitcoin has all their average expected growth with none of their added volatility.
I like the rephrasing. To expand on what seems to be a generalisation of this problem: Any cryptocurrency sibling of bitcoin that relies on cryptographic mining as a basis will either have this problem or will result in (value of currency * inflation rate) additional resources wasted on computation each year.
I believe (tentatively) that the above is an unavoidable result of the cryptographic and micro-economic principles that such currencies rely on.
Note, I wrote this in reply to the original version of the grandparent, which is as quoted in the parent. This is confusing since it is a bug/feature of the lesswrong system that Eliezer’s edits to his own comments do not get marked with an asterisk like others.
I do not endorse the current version of the grandparent, in as much as it overstates the position and seems to verge on encouraging magical thinking about how a currency can extract value from a system.
To expand on what seems to be a generalisation of this problem: Any cryptocurrency sibling of bitcoin that relies on cryptographic mining as a basis will either have this problem or will result in (value of currency * inflation rate) additional resources wasted on computation each year.
I believe (tentatively) that the above is an unavoidable result of the cryptographic and micro-economic principles that such currencies rely on.
This is not limited to cryptocurrencies, e.g., gold-based currencies cause people to “waste resources” mining.
This is not limited to cryptocurrencies, e.g., gold-based currencies cause people to “waste resources” mining.
Yes, the ‘mining’ metaphor was well chosen.
In terms of that gold analogy, what we are talking about in the context would be if gold spontaneously generated itself in proportion to the amount of existing gold and automatically buried itself at whatever depth makes it barely worthwhile to dig up. That waste is the unavoidable cost of making bitcoin-style cryptocurrency have ongoing inflation.
Okay, I think I understand the argument that Bitcoin will likely be permanently volatile, because growth at exactly the rate of the global economy is not a stable equilibrium for the reasons you describe (esp. ‘people like to time bubbles’).
Thinking about this a bit more though, it seems like the same argument would apply to any asset we might otherwise expect to grow in sync with global wealth. In particular, the apparently-perfect-store-of-wealth-attracting-investment-and-appearing-to-be-an-even-better-store-of-wealth phenomenon seems like a straightforward explanation of what’s been happening with the price of gold in the last decade.
But also, it seems like this argument could even apply to the stock market as a whole—would we expect a global ETF (like Vanguard’s VT) to grow at the rate of the world economy? Is that stable?
So I’m curious, do you agree that the no-stable-equilibrium argument applies to the price of these other assets as well, and if so, does the existence of Bitcoin still seem like it would be a problem for the global economy?
It partially explains the price of gold, yes. Gold’s situation isn’t really the same for three reasons: First, gold can be mined if the price goes too high, and higher prices would imply larger amounts of recoverable gold. Second, a lot of the gold on the market is paper gold, theoretical gold that two parties are trading rather than sending large gold bars around, which also adds to the supply. But most of all, unlike the supposed use-case of Bitcoin, gold is not being used as a medium of account or medium of exchange any more, just one store of value among many, so its real competition is not paper gold or mined gold but other stores of value such as platinum, silver, real estate, and many other things being added to the competition for ‘stores of value’ as the economy grows. If the same fraction of the population tried to store the same fraction of their net assets in gold today as in the 1600s then the price of gold would be vastly higher—or so I would think, I haven’t run the numbers. But this in turn means that the share of the economy represented by gold can easily drop further, making it less than a perfect store of value etcetera, although gold has still tended to be a better store of value than fiat currency.
Of course fiat currency is really supposed to be a medium of exchange and account, not a long-term store of value, though dumb people like me tend to use it as a store of value too because it’s convenient and we haven’t gotten around to setting up anything different and we don’t have that much value to store. And then using your medium of exchange and account as a store of value causes recessions and depressions due to the paradox of thrift; when people want to consume in the future instead of the present they try to hold paper money instead of demanding equity in projects with long-term payoffs. On the plus side, central banks can, in principle, easily rectify some part of this problem by printing more money to meet demand for currency when fear rises, and thus make up for velocity slowdowns, keeping NGDP on a level growth path. On the minus side, central banks are stuck in 30-year-old economic thinking and don’t keep NGDP on a level growth path. Bitcoin has the potential to make things much, much worse though.
New stocks on the other hand are constantly being created as the economy grows—no particular stock, or set of stocks starting at a fixed time, are guaranteed to grow at the same rate as the global economy.
To paraphrase, you’re pointing out that stocks and precious metals come with built-in demand shock absorbers, whereas Bitcoin has none. I’m not totally sure that I accept this point, because I could see alternative cryptocurrencies playing the role of marginal new stocks or newly mined gold. However, even if Bitcoin were unique in having no demand shock absorbers, I’m not sure this matters, because it seems empirically to be the case that these shock absorbers are not always up to the task, and that both stocks and precious metals do experience a great deal of price volatility, even over the medium to long term.
In other words, even if Bitcoin is especially sensitive to changes in demand, it is neither novel nor unique in being susceptible to bubbles.
This would seem to me to imply that Bitcoin’s existence and use as a store of value is no threat to the economy. (And its use as medium of exchange seems harmless as well.)
It would seem that problems would only arise for those who try to use Bitcoin as a unit of account. This is in line with Wei’s comment where he suggests that with a currency in fixed supply, fluctuating velocity of money implies that either prices or GDP must be unstable.
So my conclusion is that using Bitcoin as a medium of exchange or store of value is not detrimental to the economy, but one should continue to price goods or services in some other fiat, ideally NGDP-targeted, currency. Does that sound about right?
Anyone bidding on a Bitcoin is not bidding on a productive project.
It seems that the same goes for gold, real estate, and so forth when they are used as a store of value. The difference is that unlike bitcoin, these things have other productive uses that they could be put to, less expensively, if they weren’t being used as a wealth-counting mechanism.
That’s a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy. So it gives you the exactly average return on investment with zero volatility. So it seems like a near-perfect store of value and people will want to hold it rather than spend it. This decreases velocity which causes deflation and value that increases apparently even faster than the total global economy. This makes Bitcoin apparently an even better investment, until the volatility or expected volatility from the huge stores of unused Bitcoins outweighs its apparent returns on investment, and note that financial markets are apparently unusually bad at expecting future volatility to be greater than present volatility; people try to time bubbles instead. This is bad for Bitcoin because of the inevitable crash followed by hyperinflation. And it’s bad for the global economy because your currency is deflating and any given bank would rather hold Bitcoins, on average, than make loans; and then the inevitable crash is also bad. That’s a nutshell version of a longer story.
“No one wants bitcoins anymore, they’re too valuable.”
Assuming BTC gives exactly the average return on investment with zero volatility we shouldn’t expect all people to hold it rather than spend it. Neither an economy of actual humans nor an economy of ideal agents would act that way.
With respect to consumption: Use as a transactional currency for spending would track convenience factors. People buying stuff with one fungible asset is much the same as buying stuff with another asset then transferring between their two accounts. For spherical cow in a vacuum purposes we can ignore this. Investment spending is the issue here.
In the counterfactual BTC currency which perfectly tracks the global economy the incentive is for anyone who believes they know of any investment that they expect to have higher returns than the average of the global economy to spend their bitcoins and invest in that opportunity. Those who don’t believe they have any knowledge of anything that will produce better than average returns or who are risk averse will instead purchase bitcoins either directly or indirectly from those that do have that knowledge.
In that idealised scenario the BTC currency is essentially operating as a vehicle to efficiently transfer real-world capital to places those who people with value expect will provide better return in investment than the average growth of the economy. Note that I am emphatically not claiming that this is an ideal system, it would be bizarre if something so arbitrary happened to be optimal. Just that it doesn’t seem to quite have the degree of problem that is described. People would certainly want to spend it.
There are plausible reasons why predictable inflation of the above currency could be more desirable than precisely zero inflation. Let’s say Satoshi had arbitrarily decided that BTC mining should go on indefinitely, with the bitcoins produced per year exactly equalling 2% of the number of bitcoins already mined. Then the incentives to the the participants change slightly. Rather than people who expect an investment to grow at more than the average for the global economy to be the only ones to so invest, it is any (risk neutral) person who expects an investment to grow at not less than 98% of the rate of the global economy. That has (well known) advantages.
The unfortunate problem with the above monetary policy is that we just effectively dedicated 2% of the of the value stored in the bitcoin currency each year to the computation of irrelevant hashes (in addition to irrelevant computation that is proportional to transaction fees). This problem applies to any cryptocurrency based on cryptographic mining. There may not be a good solution to that problem that potentially prohibitive degree of waste that does not rely on something external to the cryptocurrency as basis. (And the latter is not necessarily a problem. The currency having value in itself isn’t the most potentially useful feature of bitcoin.)
Let me rephrase: The problem is that Bitcoins will have an advantage over the average productive investment, e.g. stocks (sort of), as a store of value, since Bitcoin has all their average expected growth with none of their added (local) volatility. This is what presents the starting problem in an economy that starts out with a steady velocity of Bitcoins, and then increased holding makes the velocity go down (and the value go up, and the bubble effect hit even harder). This is why we don’t get an equilibrium with steady Bitcoin velocities. Even if we did have that equilibrium, people would have a much greater incentive to just “invest” in Bitcoins instead of being forced to try to invest in something productive. You don’t want an economy to have a perfect non-inflating store of value which is intrinsically unproductive!
I like the rephrasing. To expand on what seems to be a generalisation of this problem: Any cryptocurrency sibling of bitcoin that relies on cryptographic mining as a basis will either have this problem or will result in (value of currency * inflation rate) additional resources wasted on computation each year.
I believe (tentatively) that the above is an unavoidable result of the cryptographic and micro-economic principles that such currencies rely on.
Note, I wrote this in reply to the original version of the grandparent, which is as quoted in the parent. This is confusing since it is a bug/feature of the lesswrong system that Eliezer’s edits to his own comments do not get marked with an asterisk like others.
I do not endorse the current version of the grandparent, in as much as it overstates the position and seems to verge on encouraging magical thinking about how a currency can extract value from a system.
Reclarified?
This is not limited to cryptocurrencies, e.g., gold-based currencies cause people to “waste resources” mining.
Yes, the ‘mining’ metaphor was well chosen.
In terms of that gold analogy, what we are talking about in the context would be if gold spontaneously generated itself in proportion to the amount of existing gold and automatically buried itself at whatever depth makes it barely worthwhile to dig up. That waste is the unavoidable cost of making bitcoin-style cryptocurrency have ongoing inflation.
Okay, I think I understand the argument that Bitcoin will likely be permanently volatile, because growth at exactly the rate of the global economy is not a stable equilibrium for the reasons you describe (esp. ‘people like to time bubbles’).
Thinking about this a bit more though, it seems like the same argument would apply to any asset we might otherwise expect to grow in sync with global wealth. In particular, the apparently-perfect-store-of-wealth-attracting-investment-and-appearing-to-be-an-even-better-store-of-wealth phenomenon seems like a straightforward explanation of what’s been happening with the price of gold in the last decade.
But also, it seems like this argument could even apply to the stock market as a whole—would we expect a global ETF (like Vanguard’s VT) to grow at the rate of the world economy? Is that stable?
So I’m curious, do you agree that the no-stable-equilibrium argument applies to the price of these other assets as well, and if so, does the existence of Bitcoin still seem like it would be a problem for the global economy?
It partially explains the price of gold, yes. Gold’s situation isn’t really the same for three reasons: First, gold can be mined if the price goes too high, and higher prices would imply larger amounts of recoverable gold. Second, a lot of the gold on the market is paper gold, theoretical gold that two parties are trading rather than sending large gold bars around, which also adds to the supply. But most of all, unlike the supposed use-case of Bitcoin, gold is not being used as a medium of account or medium of exchange any more, just one store of value among many, so its real competition is not paper gold or mined gold but other stores of value such as platinum, silver, real estate, and many other things being added to the competition for ‘stores of value’ as the economy grows. If the same fraction of the population tried to store the same fraction of their net assets in gold today as in the 1600s then the price of gold would be vastly higher—or so I would think, I haven’t run the numbers. But this in turn means that the share of the economy represented by gold can easily drop further, making it less than a perfect store of value etcetera, although gold has still tended to be a better store of value than fiat currency.
Of course fiat currency is really supposed to be a medium of exchange and account, not a long-term store of value, though dumb people like me tend to use it as a store of value too because it’s convenient and we haven’t gotten around to setting up anything different and we don’t have that much value to store. And then using your medium of exchange and account as a store of value causes recessions and depressions due to the paradox of thrift; when people want to consume in the future instead of the present they try to hold paper money instead of demanding equity in projects with long-term payoffs. On the plus side, central banks can, in principle, easily rectify some part of this problem by printing more money to meet demand for currency when fear rises, and thus make up for velocity slowdowns, keeping NGDP on a level growth path. On the minus side, central banks are stuck in 30-year-old economic thinking and don’t keep NGDP on a level growth path. Bitcoin has the potential to make things much, much worse though.
New stocks on the other hand are constantly being created as the economy grows—no particular stock, or set of stocks starting at a fixed time, are guaranteed to grow at the same rate as the global economy.
To paraphrase, you’re pointing out that stocks and precious metals come with built-in demand shock absorbers, whereas Bitcoin has none. I’m not totally sure that I accept this point, because I could see alternative cryptocurrencies playing the role of marginal new stocks or newly mined gold. However, even if Bitcoin were unique in having no demand shock absorbers, I’m not sure this matters, because it seems empirically to be the case that these shock absorbers are not always up to the task, and that both stocks and precious metals do experience a great deal of price volatility, even over the medium to long term.
In other words, even if Bitcoin is especially sensitive to changes in demand, it is neither novel nor unique in being susceptible to bubbles.
This would seem to me to imply that Bitcoin’s existence and use as a store of value is no threat to the economy. (And its use as medium of exchange seems harmless as well.)
It would seem that problems would only arise for those who try to use Bitcoin as a unit of account. This is in line with Wei’s comment where he suggests that with a currency in fixed supply, fluctuating velocity of money implies that either prices or GDP must be unstable.
So my conclusion is that using Bitcoin as a medium of exchange or store of value is not detrimental to the economy, but one should continue to price goods or services in some other fiat, ideally NGDP-targeted, currency. Does that sound about right?
Using it as a store of value is detrimental. Anyone bidding on a Bitcoin is not bidding on a productive project.
It seems that the same goes for gold, real estate, and so forth when they are used as a store of value. The difference is that unlike bitcoin, these things have other productive uses that they could be put to, less expensively, if they weren’t being used as a wealth-counting mechanism.
That seems to be saying that all of the BTC would always be able to buy exactly all of the things. I can’t imagine how that could be the case.