Thursday, December 18, 2014

Bitcoin: up to noise, the eternal downward trend is very likely

On November 28th, 2013, I wrote a blog post about the Bitcoin with some explanation what the money supply of the Bitcoins is and how the value may evolve. I said many things about the substance that I still believe to be true but I also included a prophesy – which was also included in the title – that the Bitcoin bubble would probably await some new peaks before it bursts.

With the hindsight, I tend to think that my prophesy was completely wrong. I am not a good prophet – because there are probably no good prophets allowed by the laws of physics. November 2013 when I wrote the blog post was actually the month when the price of the Bitcoin peaked. On November 17th, 2013, the price surpassed $1,200 at MtGox but it was before I wrote the blog post where I already talked about the "current price near $1,000", so you couldn't earn any more money by the extra investments.

Since that time, the bitcoin-to-dollar ratio dropped from those $1,000 or $1,200 to $307 today, by a factor more than three. It's easy to see that the drop of the Bitcoin surpassed the drop of the Russian rouble and the Ukrainian hryvnia (they're similar, after the recovery of the rouble yesterday).

Bitcoin was already voted the worst investment of 2014. So I hope that no TRF reader interpreted my 2013 blog post as invitation to make any substantial investments into the Bitcoin.

The 70% drop in a year is bound to undermine the confidence of many people that they may use the Bitcoin for savings and investments. It may easily happen in 2015 or the following years, too. The potential for a spectacular growth has shrunk and you just don't want an investment that is likely to drop by 70% in a year.

The Bitcoin fans don't seem to care about the value of one Bitcoin and its dynamics at all.

They seem to be focused on some technicalities of the payments – the anonymity and decentralization of the "log" that remembers all the transfers. You know, from a theoretical viewpoint, I think that the solution to the mathematical problem how to guarantee the "decentralized record" of the payments etc. is a cute piece of mathematics.

However, I don't think that this theoretical cuteness translates to any practical virtues. I don't really want a currency or a payment system to be completely decentralized, independent from a "state". If someone robs me in some way, I want to have a place to complain, to fix something that are obvious errors or frauds even though a human judge is needed to see it. I don't want the anonymity to be absolute because in serious enough circumstances, it's simply right to find out who made a certain transaction.

Equally importantly, as I have already suggested, the proponents ignore all the economic complaints. They say that the price of one Bitcoin – and the stability of the price of products if expressed in Bitcoins – is irrelevant. But that's just silly. If the Bitcoin or anything else were supposed to serve as a currency, as the name indicates, the prices of products bought for that currency should be stabilized or determined "from the first principles". They should not rely on the price in a conventional currency that is converted to the constantly changing price in the Bitcoins.

If the dollar price is still used to calculate the Bitcoin price, then the Bitcoin is just a payment system to pay dollar-denominated prices, and I think that an inconvenient one. You first need to convert your cash from the conventional currency to the Bitcoin to buy something – which is a lot of hassle – and then use the Bitcoin to pay. Or you accept Bitcoins and you must immediately convert them back to a conventional currency because you don't know what will happen with the value of those Bitcoins.

Some mechanisms of the price stability (or predictable inflation rate) in a given currency are absolutely necessary. Central banks target the inflation rate, either because of official or semiofficial rules or due to some tradition and expectations. The U.S. dollar is such an important reserve currency partly because the total amount of savings in the world that are stored in them is large. This "large mass" gives the dollar a "large inertia" which is a reason to expect that the average prices of "other things" won't change dramatically.

Like the gold fanatics, the Bitcoin enthusiasts like to talk about the solid, not evaporating nature of these alternative currencies and the gold or Bitcoin savings. You can't create these commodities or crypto-currencies out of thin air! You can't but it's irrelevant. It doesn't mean that the real value of your savings won't plummet. The real value of the gold savings dropped by 35% since the 2011 peak, and the real value of the Bitcoin savings dropped by 70% in a year. It's primarily the exchange rate that matters and you simply can't overlook the rate – and the things that drive it – because it's the key issue.

So of course that a fiat currency may be more reliable than these "unproducible" alternative currencies like gold or the Bitcoin and the year 2014 was another example of that.

But there's a related, equally important point. Even if the gold savings or the Bitcoin savings were guaranteed not to lose their value, it wouldn't be a virtue for their being a currency. The reason is that if something is guaranteed to gain value – because an increasing number of increasingly wealthy people in the world need to use the fixed amount of gold or the Bitcoins – they just won't get rid of these remarkable investment tools. Whoever has these hypothetical precious, guaranteed-to-grow commodities and numbers on the hard disk, will keep them "forever". It's better to keep them than to own houses, cars, and so on. The payments done in Bitcoins will be limited to the minimum for this reason and even the people who own the Bitcoins will try to find something else to use for the payments, something that is not this miraculous.

This problem may be described in a simpler way. The gold and Bitcoin fanatics seem to care about the savers – but they don't care about the borrowers. But in a healthy economy, savers are partly lenders and lenders and borrowers are equally important, two parts of an important transaction. So everything that is good for the savers would be bad for the borrowers. The optimum situation for the system is not the situation that maximizes the virtues for the savers, or one that maximizes the advantages for the borrowers. It is some balance between the two. And at least some aspects of the balance – the long-term real interest rates – are unavoidably dictated by the free markets, regardless of the currency system.

If I return to the paragraph before the previous one, one should realize that the very derivation what would happen if there were this "miraculous guaranteed to grow investment tool" has one extra implication: such an investment tool obviously cannot exist. If something is really guaranteed to grow forever (and, let's assume, at a higher rate than what you could get anywhere else as long as it is safe enough for you), you don't ever want to get rid of it. But if you know that it will never be used to bring you some great products, services, or luxury, then its actual price for you (and even your descendants – we assume that the investment will keep on being miraculous in the future) is zero.

So the whole calculation assuming that the value of the Bitcoin or the gold would safely grow has to be wrong or inconsistent. As I already said, it's of course wrong because it completely ignores the actual mechanisms that decide about the price of gold or the price of one Bitcoin: the supply and demand. In the hypothetical situation where the gold or the Bitcoin is so marvelous for the savers, the supply drops to zero (no one wants to lose his miraculous Bitcoins or gold) which actually means that the price of the gold or the Bitcoin is incalculable, like the 0/0 indeterminate form.

This intedeterminate form may be zero or one or 307 or infinity and they're very different results. But these big differences are irrelevant, too, because there are no exchanges occurring that would use this miraculously growing currency.

In the real world, no investment tool can ever achieve this "absolute" status. Everything has a finite price and the price is dictated by the supply and demand. The more lively the trading involving the object is, the more accurately its price may be expressed from the market transactions. Everything is equal.

From some purely material viewpoint, the intrinsic price of the gold, the Bitcoin, or the U.S. dollar banknotes is zero. In all cases. Unlike the Russian caviar, those things can't be eaten and they can't be directly used for almost any other practical things, either. Almost all of their high price in the real world is indirect. They have a big value because they're viewed as currencies, to one extent or another, and this adds some (huge) "premium" to their value.

In the case of the pictures of Benjamin Franklin, the "premium" is most spectacular, in absolute terms. The pictures would cost much less than $1 if there were not this whole culture saying that "you can get almost everything for these pictures". But because the whole world has been preprogrammed to assign some value to the banknotes, everyone takes this value for granted. The value has a huge inertia because the supply and demand can't "radically change". The Federal Reserve almost certainly won't be pouring quadrillion dollars from the helicopters without doing anything that actually compensates almost all of these maneuvers – it is extremely unlikely because it's also illegal – and the rest of the world believes that such a high value of their wealth and obligation is denominated in the U.S. dollars that this world can't really "conspire" to do something that would suddenly change the value of the dollar dramatically – or, equivalently, that would immediately change the value of everything expressed in the dollars.

Just exaggerate a little bit. Imagine that 99% of the people's wealth is in the U.S. dollars and there are N dollars in the world. In that case, one U.S. dollar can be pretty much defined as 1/N of the mankind's wealth. And the mankind's wealth is naturally an almost stable unit of wealth (even if the mankind gets richer or poorer, comparing yourself with "everyone else combined" is just a natural way to quantify how rich you are), and that's why the same thing holds for the U.S. dollar.

The dramatic change of "all prices in dollars" won't occur simply because these prices – and various promised salaries, pensions, obligations, debt etc. – have fixed numerical values written in the U.S. dollars and those things are the cause of the inertia and stability of the U.S. dollar. Price stickers in the supermarkets may be rewritten and countries with inflating currencies have to do it much more often. But even in the modern world, even this "trivial" operation is nontrivial and the existing stickers in the shops are actually a significant portion of the reason why the value of the conventional currencies is largely fixed.

However, contracts, treaties, commitments, and bonds play an even larger role for this inertia. People and companies realize (sometimes long-term) construction projects for a pre-agreed number of dollars (or another conventional currency), the governments promise to pay a certain amount of dollars (or other currencies) as pensions and other things, and all these (medium-term and long-term) treaties help to define the actual value of the currency for the following years. They more or less guarantee that the value of the U.S. dollar (relatively to some inclusive and objective enough basket of things you may buy) won't change by a factor of 3 in 3 years.

Many things may change but some people are still promised to be getting $1 million for something in 2017. While you may say that you don't know what one U.S. dollar will mean in 2017, you may know that $1 million is the same thing that a hockey player will be getting somewhere, and it's not bad. You also know that it's equal to N' times the average pension somewhere, or the debt that someone will have to repay to someone else, and so on. Those are the things that allow you to plan in the U.S. dollars – the U.S. dollars are a good unit of wealth even for the future planning. And that's essential.

Similar considerations must be applied to other currencies but also to gold and the Bitcoin. Their "direct" and "intrinsic" value is near zero, as I explained. But their actual value depends on the "currency premium" – how big a portion of the savings has been converted to this form. If someone could guarantee that all the people in the world will agree to convert all of their cash savings to gold and the world will use it, then indeed, it's clear that during the process, the price of the gold would have to increase by a factor of 100 or 1,000 and by the assumptions, gold would be able to back all of the global savings and the world economy again. The price would be $1 million per ounce, or something like that, and it would be very unpractical to use it.

But of course that in the real world, no one will convince the people to be getting this ever smaller amount of gold for their dollar savings. The people who already had gold before this operation would be in a huge advantage. They would be made 100 or 1,000 richer than those who bought the gold at the insanely elevated price. And everyone, at least everyone who was already buying at the insanely high price, will agree it's unfair. They just won't agree that they should switch to the "new currency". Why should they be doing it? It is clearly against their interests. It is a plot of the old owners of gold to get richer. It would make the new buyers of gold relatively poorer – by orders of magnitude – if they are compared with the chosen ones who had lots of this "new currency" before it became the new currency.

So this "switching to a new currency" accompanied by a drastic increase of the premium associated with a currency just won't happen in the real world, at least not in any short enough time scale. Everyone would know that someone (the early adopters) would benefit and others would lose. If you realistically want to switch to a new currency, it is actually absolutely critical that the number of the "new coins N" is variable and it is being adjusted so that the rate (analogous to a temperature or a chemical potential in thermodynamics) is kept more or less fixed during the switching process – the exact opposite of what the "currencies celebrated because they can't be produced out of thin air" promise. It is very important for a new currency that should replace the existing ones to be produced out of thin air so that the rate, and not the number of the "new coins", is fixed! The gold and Bitcoin fanatics are celebrating a lethal economic flaw of a would-be currency as a virtue.

The very same ideas apply to the Bitcoin or anything else. The number of the Bitcoins is guaranteed to be below 21 million – the maximum reached around the year 2140, by the Holy Scriptures of the Bitcoin. The deviation from this "ultimate upper bound" is decreasing exponentially with time so we're almost there, anyway – the number of the Bitcoins is about 13 million now and is growing rather slowly.

Because of this more or less fixed number of the Bitcoins, the price of one Bitcoin would have to grow by more than 4 orders of magnitude for the Bitcoin to match the part of the world economy denominated in the U.S. dollars. So if the whole world were supposed to switch from the U.S. dollars to the Bitcoins, it would mean that the people will be converting their savings etc. from the conventional currencies to the Bitcoins at an increasing price – because the "currency premium" of the Bitcoin would strengthen along with its currency status.

But it's very clear that you can't get too far. At some point, people who are still mostly in the conventional currencies (all of the people) start to ask whether they may survive or keep their wealth or anything if they convert everything (or too much) into the Bitcoin. The old dollars still work – to "ban them" immediately is impossible (at least without a huge crash) – so aren't they better than the new Bitcoins, the people would ask? Because by that moment, it's totally clear to everyone that almost all the Bitcoin price is the "currency premium", they will inevitably start to ask whether this "currency premium" is sustainable.

And it's only sustainable if the Bitcoin is actually able to work as a functional currency, similar to the U.S. dollar. The mythical "final state" world where the U.S. dollars are completely replaced by the Bitcoins is theoretically conceivable. The stability of the Bitcoins would be determined by the same "stickers" and "numbers written on bonds and pension laws and other treaties with compensations" as those I described in the case of the U.S. dollar. There is no difference.

But the problem is that we can't get to that point. To get to the middle of the road, the Bitcoin would have to become a "pretty good usable currency" in the middle of the process so that it can go further. But it won't become a pretty good currency because no significant loans and long-term commitments will be denominated in the Bitcoins. To borrow X Bitcoins for a year or two is a very risky thing because the price of one Bitcoin may grow 10 times and you will have to pay 900% interest rates. You may make a profit if the Bitcoin goes down, too. But it's the other way around for the lender. You may lose almost everything if the price of one Bitcoin goes down while you can make a big profit if the price goes up.

It's a big lottery for both sides of the Bitcoin loan. And it's a speculation which side is more likely to benefit etc. because you don't know for sure whether the Bitcoin has already peaked. But in the absence of any numerically fixed contracts, price stickers, and even in the absence of any other mechanism that would stabilize the price of the Bitcoin, the price will simply never be stabilized. So the Bitcoin can never really get a "really big currency premium" that would make the total value of all Bitcoins comparable to the value of the U.S. dollars (or at least Czech crowns) in circulation. It cannot simply because it is not really a currency.

And because we know it will never happen, it's a waste of time, and that's why we may conclude that the very high price of the otherwise worthless Bitcoin is just due to its "temporary mirage currency status" that can't last because the road towards the real currency status is mathematically impossible – and the Bitcoin is therefore a bubble that is guaranteed to burst or fade away. And I feel that the year 2014 is already making this "sketch of the future" rather obvious.

If you want to introduce a new currency that is supposed to become the new one in a whole nation or be comparable in influence to a national currency, you simply have to guarantee some mechanisms that stabilize the value of this new currency relatively to the old one(s) or relatively to something else. In the case of new national currencies – or newly reformed national currencies – the policymakers often choose to peg their currency to another one, or a basket of other currencies, sometimes strictly, sometimes within some bands, and so on. Obviously, their ability to control the number of new coins and banknotes in circulation is essential for their control over the exchange rate.

(I am writing these things about pegging as a guy who has "lived" through the process of making the Czechoslovak crown convertible after the Velvet Revolution. Big changes like that may potentially cause havoc and Czechoslovakia avoided it in the safest and most conservative way, and we didn't really allow any inflation of the type known in Poland or Hungary or elsewhere. Pegging to a basket of currency has been used for years.)

When you achieve this stabilization, at least approximately, it becomes irrelevant whether you own the old currency that the new one was pegged to, or the new one. People are not afraid to borrow in the new currency which is why contracts, treaties, and price stickers denominated in the new currencies start to spread, and those are the reasons why the value of the new currency may be stabilized. But with no inflation targeting or pegging of the new currency to anything stable, its price is guaranteed to oscillate unpredictably (perhaps by those 70% a year that we saw in the Bitcoin's story of 2014) which prevents the adoption of this currency by anyone who actually needs to quantitatively plan the future.


  1. Marcel van VelzenDec 18, 2014, 11:03:00 AM

    Lubos, did you know that a Czech company has made a wonderful bitcoin hardware wallet (external to your computer) called the Trezor. I own one and it is great. It is invulnerable to viruses and uses hierarchal deterministic address generation. The next important thing to keep your bitcoins even safer is to combine this with multisignature wallets, where one transaction is signed by the wallet and the other by the Trezor. You should be proud of your fellow countrymen.

  2. I am proud of them. (Trezor is a safebox, if the word isn't understood internationally.) But the last moment when I was thinking about putting any money to the Bitcoin was about 6 months ago.

  3. Off-topic:

    Dr. Motl,

    Any comments on the David Spergel item in "Nature's 10 people who mattered this year"?:

  4. Dear Rathnakumar, first of all, I think that this whole collection is tendentious and politically correct and I won't endorse it as any meritocratic pick of anything.

    Putting Spergel for his skepticism above the BICEP2 folks themselves is absolutely preposterous even if BICEP2 turns out to be due to the dust.

  5. Marcel van VelzenDec 18, 2014, 11:21:00 AM

    "My pride about the Czech makers of the antivirus software or PC games is probably stronger." Hahaha, I love this answer :-)

    "To lose the Trezor means to lose all the money, doesn't it?" No. All
    you need to do is to insert the 12/24 word seed in a new Trezor or HD-wallet
    and you're fine again.

  6. It can be used by someone who knows the pin, can't it? He just sends all the money from it outside and the Trezor is emptied, or do I misunderstand?

    If that happens, the owner's legal abilities to recover a penny are zero, aren't there?

  7. Let's also add that the sharp increase in Bitcoin price coincided with its popularity in China, while its drop came after PBOC (I think) prohibited Bitcoin transactions and Alibaba stopped accepting them on their site. Russia also prohibits Bitcoin I hear. It is pretty hard to get demand and supply going when something is prohibited and only illegal/(semi)legal avenues remain.

  8. Marcel van VelzenDec 18, 2014, 11:51:00 AM

    If someone knows the pin AND owns your Trezor, yes, in that case you
    loose all your coins. The way you insert your pin on the computer to
    approve a Trezor transaction is very smart. The Trezor display shows the
    numbers 0 to 9 in random order each time and you then click on the
    computer display your numbers where they appeared (unknown to a mouse
    logger) on the Trezor screen.

    In general you are right: with bitcoins you're on your own. That is why
    bitcoin is called anti-fragile, people (and the community) learn quickly
    from their mistakes because there is no one to bail you out and the
    system gets stronger each time, unless, of course, something will kill it
    or it is economically a failure altogether as you are suggesting.

  9. Marcel van VelzenDec 18, 2014, 12:06:00 PM

    Bitcoin is not prohibited in China. Banks were no longer allowed to
    transfer money directly to a bitcoin exchange (so they have to use an
    intermediary which indeed sucks) but the exchanges are nevertheless
    still allowed to transfer money directly to a bank.

  10. Well, Tony, it's discouraging for the "kosher" people if the Bitcoin is (semi)illegal, and that reduces the chances it may go mainstream. But the electronic currencies have always been great for organized crime because the people behind money transfers are masked, and that's true for the Bitcoin, too.

    Whether the Bitcoin *should* be legal, and how, is a difficult matter. Obviously, if someone uses it as currencies, the corresponding profits should be traced for tax purposes. A question is when and how the profit should be calculated. It may be caculated immediately, and converted to the normal currency in some way, or the profit may be obtained at the moment when someone sells the Bitcoins - as if they were stocks, regardless of what the Bitcoins did in between.

    But if there is a high probability that the Bitcoin is used for tax evasion in any way, obviously that the loophole should be fixed.

  11. Dear Marcel, you may think that if you say that people "will learn from their mistakes", the problem of the arrangement is fixed.

    But it's not fixed. What is a "mistake" depends on the rules of the game outside. If there will be any realistic chance that a virus that reads some secret codes needed to transfer all the wealth (in Bitcoins) is included in a Word file, people will have to stop opening Word files. They will have to become completely "paranoic" because this paranoia will really become "rational".

    Such fear would significantly cripple the economic (and other) activity. It must surely be considered when someone tries to decide whether the Bitcoins are better than the existing currencies. I think that the inability of the humans to fix such errors - and crimes - is a big drawback, not a virtue, of the Bitcoin.

  12. I still like the idea of cryptocurrency in the following sense.

    In the US it is rare nowadays that you walk into the restaurant and they tell you: sorry, we take only MasterCard, no AMEX. Still it happens, especially when you are dealing with small merchants. It is just too expensive for them. The owner of my neighborhood bar still hates the cost of having an ATM machine. On top of it, it charges $3 for every withdrawal.

    Lots of plastics gets spent and lots of leeches live on providing this service which is really pure convenience. It must be possible to do better in this age.

    OTOH, consider countries like Russia, China or India. Do they need to wait until Visa (or similar national service) comes to every village shop? It will probably never happen because the payments are too small for big profits to be had.
    But some sort of cryptocurrency may be the right answer.

  13. Marcel van VelzenDec 18, 2014, 1:38:00 PM

    It's both a drawback and a virtue but I agree it's more a drawback than a
    virtue. It's a drawback for the one that loses money but it's a virtue
    for the one that doesn't lose money. Let me clarify that with an
    example: If you get scammed with your credit card, the CC company will
    reimburse you your money but who is paying the CC company? The careful
    people are paying the not so careful people. This is called derisking
    but derisking also has its virtues and drawbacks.

  14. I am pretty sure that all these everyday-life technical issues with payments would be (far) more expensive with the Bitcoin which would de facto require every shop etc. to maintain a computer expert.

  15. Right, your formulation is more accurate. It's only a drawback for the honest people - but the advantage is that it is an equally great virtue for the thieves! ;-)

  16. Right. Bitcoin as it stands is definitely not an answer for the masses and whoever thinks that is delusional.

  17. I am complaining about the technology. I would like to be able to walk in anywhere and buy anything from my phone. Plus I think/hope that technology can make transaction charges much lower (i.e. I don't need postal service these days for what I can do via email)

  18. So would I even though I find contact-free payment card or cash just OK in most cases. I am sure it is a matter of a short time. Some year or two of battles between various NFC proposed solutions etc. before one choice gets mainstream and spreads everywhere.

    But you don't need the complicated cryptographic things and mining and variable rate of a new currency for these technical achievements, do you?

  19. No, I have always considered mining and Bitcoin as an experiment, a kind of game.

    Investment-wise, some penny stocks are no too far from it.

    Maybe somebody figures out how to use the Bitcoin network and provide some service on top of it that would attract enough users. Maybe it maintains or increases in value, but maybe it will simply fade and become a collectors item, sold on EBay.

  20. I spent some time looking into the mechanics of Bitcoin and while the whole proof of work thing is quite nice, I thought that the fact that the number of bitcoins approaches around 20m asymptotically seemed to make it a highly inflationary currency and therefore not one that people will want to use to trade but one which people would use to hoard. If it had been designed by an economist then it would have been allowed to have some growth, perhaps linked to some global index of GDPs i.e. an index large enough to be globally acceptable and also to be hard to manipulate. This flaw in Bitcoin means that it is hard to adopt and hence the low liquidity leads to high volatility.

  21. Inflationary? Didn't you mean deflationary?

  22. Yes I was a bit sloppy. I meant inflationary in the sense that as bit coins are used more and more their dollar price will increase. But yes I agree that a holder of bitcoins will be in a deflationary world where goods will fall in price and so hoarding will occur.

  23. Marcel van VelzenDec 18, 2014, 5:12:00 PM

    "The crypto-payments don't *allow* any insurance of the sort, and that's the problem" It can be done even better with bitcoin:

  24. Subsidies for Caribbean rum are a good thing, most Caribbean rum is fantastic and well made, and is having hard time to compete against the cheap flavored vodka style concoctions. Preserving quality and tradition against the thick-headed, stupid beast of the free market is always a honorable and good endeavor. Czech tuzemak is a vile liquor, a mixture of cheap industrial alcohol with artificial aroma, caramel color and sugar. It's very similar to Czech "absinth" which is good only for toilet cleaning.

  25. I just have a few notes:
    1) The fact that the price of goods is primarily in one currency does not imply that other currencies are worthless. I mean there are shops in Czech republic that accepts both USD and EUR but prices are set in CZK and it is the price in the USD/EUR that fluctuates.
    Also there are local currencies specific to small markets, so bitcoin could become one (or it might not).
    2) Government involvement: governments could theoretically join the network and therefore influnce it.
    That means they could collect new coins and release it in the economy as they see fit and therefore regulate its value (but there is a natural bound on how much regulation is possible).
    3) Responsibility: Since bitcoin transactions take time to verify (10 minute cycle???) there could still be banks you could put your bitcoins in and which would be responsible for day-to-day transactions. Transferring outside of bank's account would have the same effect as taking the money from ATM.
    4) Deflation: This is a property of Bitcoin and it is possible to change it in priciple - you only need to change the amount of mined coins per block (to e.g. grow 1% p.a.).
    5) BTW: There are also various contracts that can be implemented within the protocol and this is something that could actually help the economy, because these days the only way to achieve the same effects is through a trusted 3rd party.

    P.S. I have no money in Bitcoins ;-)

  26. "all these (medium-term and long-term) treaties help to define the actual value of the currency for the following years."

    Long term contracts are made with reference to a currency *because* the currency is stable, they don't play any role in stabilizing it itself.

    By way of illustration: 100 year bonds used to be quite common in the US, and have recently made somewhat a of a comeback. But between 1954 and 1993, no US company issued any 100 year bonds (it was Disney's "Sleeping Beauty Bonds" which were finally issued in 1993, incidentally) Why was very long term corporate debt suddenly unattractive after 1954 and suddenly attractive again in 1993? A sort of cute answer would be that 1954 the Republicans lost control of the House of Representatives and didn't regain it until 1994. It's cute, but more likely the problem was that the status of the currency the debt was issue in was too uncertain on very long timescales for most of the 20th century. By 1993 there began to be greater confidence in the stability of the US dollar. By that time the disinflation begun in the 1980's had gone on long enough that people no longer feared a return of persistent high inflation as had occurred in the 1970's-and evidently the bond markets had seen the Great Inflation coming.

    Unfortunately, the promises of the government to manage the currency well are still sufficiently dubious to really make the value of the dollar in more than a few years very predictable. This is partly because the government is not bound by an explicit rule, but partly because even if it were, the government would have the authority to arbitrarily change that rule whenever it became inconvenient. These problems are unavoidable as long as government maintains it's statutory monopoly on the issuance of currency.

    On the other hand, the behavior of Free Banks issuing their own currencies, fractionally backed by whatever assets they see fit, would be dictated by market forces, and would hence be very reliable, subject to the penalties of bankruptcy for misbehavior or mismanagement.

  27. "If it had been designed by an economist then it would have been allowed to have some growth, perhaps linked to some global index of GDPs i.e. an index large enough to be globally acceptable and also to be hard to manipulate."

    This is roughly equivalent to George Selgin's BitDollar proposal:

    "But one could also design a “Bitdollar” protocol that, while resembling the actual Bitcoin protocol in being tamper-proof, allows, not merely for perpetual growth of the bitdollar base, but for growth that automatically responds to changes in, say, the volume of bitdollar payments. One could, in other words, have a “smart” yet tamper-proof base-money management algorithm — smart enough, for example, to automatically implement an NGDP rule, or something close to it. Such an automatic system, if only politicians would implement it, offers the best hope yet for monetary stability and, hence, for having a monetary arrangement that contributes to economic growth instead of hampering it."

    It's worth noting that this would best be accompanied by deregulation of banking, including restrictions against note issue.

  28. Dear Daniel,

    subsidies are always bad things because they distort the market prices which ultimately forces people to buy things that are more expensive or things they don't want too much, or forces others to pay something they wouldn't pay normally.

    I like Caribbean rums - went to a tasting session with my bank - but the tuzemák (our domestic rum) is at least equally great, I like it, too, and the order-of-magnitude (sometimes) price difference is just ludicrous.

    On the other hand, I am not a fan of absinth - it's like some chemical in the hospital to me - but I have non-Czech friends who actually love it. However, I do like fernet and becherovka. And slivovice etc. People have different tastes.

    Your anti-market tirade shows that you have climbed from a cesspool but even if one accepted that such anti-market hysteria is compatible with someone's being a decent human being, and I do not accept it, it would still not be enough to justify your tirade against the domestic rum.

    By now, the domestic rum is actually almost as traditional as the Caribbean rum, and the relative difference in the length of the traditions will be getting ever smaller. ;-) I assure you that across Austria-Hungary, we've been producing the domestic rum since the 19th century. It doesn't match the whole history of rum but it does beat most of the well-known brands so if one treats domestic rum as a brand of rum, and one surely should, it's just one of the oldest brands of rum.


  29. Obviously going in the right direction - may still face some other challenges, however.

  30. Dear Karle,

    1) you're amusing. Most people in the world would think (perhaps not quite justifiably, but they would) that the euro and the dollar are more reliable than the Czech crown, and the Czech crown is deriving some of its stability from its being largely pegged to the euro.

    At any rate, the stability of the euro or dollar doesn't come from the existence of variable euro or dollar prices in Czech shops. It comes from the numerical constant prices (and numbers on bonds and contracts etc.) in the countries that use the euro and the dollar, right? ;-)

    The Bitcoin doesn't have such a country which is why it's intrinsically unstable and unusable.

    2) It doesn't matter whether you call some holders of the Bitcoin "the government". If the Bitcoin became important, and even if it doesn't, there are still some holders who effectively do what you are suggesting, and they "are" the government of the BItcoin economy.

    3) Sorry,I don't get it.

    4) Right, the economic/deflationary properties of the Bitcoin are separable from some of the cryptographic etc. ideas, so a new system that solves the economic issues more wisely may be devised.

    5) Contracts may be implemented but I am saying that people won't have the desire to do so.


  31. 1) Yes, the size of the economy gives the currency its value. Bitcoin exists for 5 years, widely known maybe for 2-3 years. I don't think that's enough time to draw any conclusions.

    My point is that as a paying customer I see relatively stable prices in one currency (the locally dominant one) and fluctuations in other currencies.
    Or are you 100% sure that you will be able to pay with USD everywhere in Czech republic?
    My guess is that in cities USD would be quite stable (and accepted), but I think you would discover that USD suddenly drops in value as you move to the countryside (simply because you have to drive to the nearest city to exchange it for the local currency).

    2) That was just point that today we have central banks with govenors who decide how much money to print and what interest rate is the right one.
    Equivalent in the bitcoin world would be large bitcoin mining operation run by the government.

    3) Bitcoin is slow compared to credit card transaction, bitcoin transfer (to be secure) is more similar to transfer between banks (when considering response time).
    Also there is no reason why banks could not take deposits and give loans.

    5) I don't know, but right now I don't see exact equivalents to some of the scenarios.

    Today when you make a large transaction (e.g. buying a house) you find a lawyer (trusted party), he opens an account for you, you transfer the funds, the other party fulfills some conditions defined in the contract and eventually the lawyer pays the money to the second person.
    But there is still a risk that the lawyer might steal the money.

    With Bitcoin-like currency you can actually eliminate that risk.

    I am not saying that this is for everyday usage, but it might be useful.

  32. Dear Karle, I don't think that you haven't read or understood this blog post.

    It is not a matter of time when the Bitcoin becomes usable as a currency. Its designed is flawed from economics viewpoint and it can never become a widespread currency - as opposed to unpredictable investment resembling a lottery - for those reasons.

  33. The property escrow where a lawyer acts as intermediary reminded me of Kurt Vonnegut. He explained that twoeople who don't trust each other engage a stranger who - whether or not justified - is entrusted to take a piece of the money to hand it from one to the other. I am unable to identify the book.

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