Bitcoin deflation

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Today, right this minute, we have a massive natural experiment in deflation going on. The demand for Bitcoin (BTC) is far outstripping any increase in supply. If this were a national currency, the central bankers would have been institutionalized for their nervous breakdowns quite some time ago. It would be front page news every day and panic would rule the airwaves.

None of this is happening with Bitcoin. BTC insiders, movers and shakers seem pleased with the increase in value for their currency and the worry is the appreciation of the currency will go away, not that it will continue. Bitcoin pessimists like Paul Krugman, not surprisingly, believe that deflation will lead to transaction collapse and hoarding. Reality, so far, disagrees with them.

I think that the problem is that nobody among the pessimists understands what BTC is for. It’s never going to be the legally mandated monopoly currency in any significant economic zone. The ethic of the BTC community works against that. This means that BTC is not competing against the US dollar, the euro, or even the renminbi.

What bitcoin does very well is create a space for moving currency without the ability for it to be stopped. That challenges national currencies in crisis that want to impose currency controls to stop money leaving their borders. You can’t stop BTC transactions without draconian controls on communications.

As a practical matter, you can’t stop a coin key from crossing borders. It also creates an incredibly small unit of currency. The smallest unit in the BTC world is the satoshi, or 0.00000001BTC. Is there any currency in the world that equals one satoshi? Until bitcoin reaches the point where its smallest transactions (looking at ads and other microtransactions) can no longer be done with single satoshis, BTC will not suffer transaction reduction to to value increase.

Current pricing would seem to imply something of a damper on BTC transaction flow when BTC rises above $100,000 USD per coin. In other words, the cheapest, cheapskate ads are offering a hundred satoshis for a second of your attention in a world where 1BTC is approximately 1,000USD. We have a long way to go before those transactions cease to be denominated in BTC. And even then, there will be prestige associated with working in BTC which will keep interest in the currency relatively high and larger transactions flowing around the $100k level. Any reduction will bring back a number of the bottom feeders from other currencies.

There are several wannabe BTC competitors waiting in the wings for the day that people want to conduct microtransactions smaller than 1 satoshi. They have established exchanges with national currencies and with BTC itself. when BTC grows in value sufficiently to give up the low end of its microtransaction market, the marketers will move on to alternatives until one of them gains enough advantage to be the next BTC.

Ultimately, BTC is about mad money for a lot of people. As an experiment, I’ve mined BTC overnight and done micro-tasks using the thing in my spare time. Since April of this year, without any impact on my productivity, I’ve gotten the price of a fairly nice night out with my wife in BTC right now. It’s a piece, but only a piece, of an emerging 21st century wallet which diversifies currency use and manages transactions both online and offline. That wallet probably won’t fully emerge for a decade at the very least and more likely will take two to really standardize but it will be the death of the ability of national currencies to live on their past reputations. People will gain the ability to react to currency foolishness much more quickly. BTC will be an important part of that technology suite.

cross posted: Flit-TM

9 thoughts on “Bitcoin deflation”

  1. Governments jealous of their national currency’s monopoly will be able to suppress bitcoin in the same manner as they do child pornography.

    Anyone with a residue of bitcoin on their computer will be arrested. Even those without bitcoin can be charged as planting such evidence will be easy to do, should the authorities find it convenient.

    I’m also skeptical of hiding ownership or transactions from agencies like NSA.

    But best of luck to bitcoin!

  2. If I am not mistaken bitcoins first appeared with what has been called the deep web – an entire world where illegal transactions (heavy drugs), communications among terrorists etc, occur. And it is secret because – if I understand the mechanics correctly going from a PC to the web site involves being bounced off multiple servers around the world – each server decrypting a “layer of the onion” as it works its way to the destination.

  3. Whitehall – It’s obvious that governments will have the technical ability to suppress bitcoin, much like the US has the technical ability to turn any country into a radioactive lake of glass. What’s missing in your analysis is how you get from jealous government wanting to do it to making it national policy to do it. There are powerful forces arrayed against this plan of action, not last of which the hard limit of 21M BTC built into the system.

    Bill Brandt – Where BTC came from is something of a mystery. Satoshi Nakamoto is currently whereabouts unknown and the identity may be a collective one. Nobody cares, much like most people don’t care that all their $20s are laced with cocaine traces. It hinders the acceptability of the USD exactly… not at all. The deep web has lots of disreputable people in it but is about due for gentrification. I am quite looking forward to it.

  4. I can certainly see, as one example, Venezuela suppressing bitcoin, at least for the average citizen.

    Argentina won’t be far behind.

  5. There’s an upper bound on the total BTC that will ever be in circulation — 21 million, I believe. And although they are much harder to mine than they used to be, rising prices have given birth to a dedicated hardware market. That hardware means there’s still something of a golden age of BTC discovery/mining in the near future — even if prices drop by a factor of 10 or more.

    One example: At current prices, some of the new, dedicated mining hardware due out in January will allow anyone, for the price of a crappy used car, to mine about $13k worth of BTC per month at current prices. And if BTC drops down to $100 per coin? It’s still profitable — just with a longer earn-out on the hardware.

    Will your garden-variety computer geek drop $5k on computing hardware just to mine BTC? Nope. But with ROI like he current rise delivers, dropping $500k on 100 units and selling the BTC as soon as they’re mined is a perfectly reasonable flip play.

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