Bitcoin is an idea developed by Satoshi Nakamoto for an independent, fully de-centralized P2P currency. Technical details of how it is generated are described in a White Paper titled Bitcoin: A Peer-to-Peer Electronic Cash System
http://blog.p2pfoundation.net/bitcoin-p2p-cryptocurrency-now-in-public-beta/2010/06/16/
I have argued (elsewhere) that bitcoin is a deflationary currency. As the user base increases, and the difficulty to generate bitcoins is also increasing, relative scarcity will make each single coin more and more valuable.
This may be a good thing for the early adopters, who are sitting on bitcoins and have not spent them. It isn’t good for the stability of a monetary system however, as there is a constant pressure for price changes, in this case it is a pressure for prices to increase. In other words, prices for things, as expressed in bitcoin, will automatically keep increasing.
This is however not the only point in bitcoin’s disfavor. According to a recent article on the trustcurrency blog, bitcoin is
a rube-goldberg machine for buying electricity
quote: In the end, BitCoins create a perverse incentive to consume energy to “create money.” Here is why.
http://trustcurrency.blogspot.com/2011/03/bitcoin-rube-goldberg-machine-for.html
quote:How much energy does it require to mine the average BitCoin? — With my “older computer,” the hash rate averages around 2000 khps on a microprocessor going full-bore consuming about 65W. The current difficulty shows that a new BitCoin can be mined by a computer at this speed on average every 113 days. So, 113 days × 24 hours = 2712 hours. 2712 hours × 65W = 176280 Wh or 176.28 KWh. The average cost of a KWh in the United States is 10.45 cents. So we’re looking at spending $18.42 to create 50 BTC (at the moment). So the electrical cost is about $0.36/BTC.
Not really the greatest incentive to save electricity in times of a possible future energy shortage…
Another argument against bitcoin is of course the absence of any mechanism to adjust to fluctuations in the level of demand. It is quite clearly made by theundergroundeconomist…
After being openly critic about Bitcoin mostly for reasons well explained by this article, I’ve also reached the understanding that is very hard to achieve a system where issuing authority is decentralized like Bitcoin without relying on electricity, which is primarily required to run such advanced algorithms that let decentralization happen in the first place.
Surely there is place for some more invention there and in my experience Bitcoin developers have shown an open mind in discussing it.
We are having a workshop and discussion in Amsterdam next 4th April at 15:00 in http://nimk.nl about all this, see also http://pixxxel.net
The relative scarcity question is an interesting one. My understanding, based on a rather in-depth discussion of Bitcoin on the Security Now podcast a few weeks ago, is that the cap on the number of Bitcoins at 21 million is an attempt to introduce a predictable rate of inflation into the system, and that the scarcity problem could be resolved by the fact that the system will not limit transactions to integer increments of Bitcoins.
“Now, the problem would be, of course, if we absolutely cap the total number of coinage at 21 million, and there comes a much greater demand for this, the tendency is to want more. Well, the solution is that you’re not forced to trade in integer amounts of bitcoins. That is, the UI right now gives you two decimal digits of coinage. So you’re able to create, for example, you could exchange 0.01 of a bitcoin, but the technology supports eight decimal digits, although right now we’re only using two.”
http://www.grc.com/sn/sn-287.htm
That would seem to address the problem of early adopters hoarding Bitcoins, at least to some extent. But I gather from what you’re saying that this won’t entirely solve the problem. Is there something Bitcoin could have done (or could do) to achieve the stability you’re talking about?
You’ve got it backwards. Based on your first two paragraphs, prices for things, as expressed in bitcoin, will automatically keep *decreasing* (as the user base increases).
The same was true for USD, prior to the creation of the Fed, as can be seen here:
http://users.silenceisdefeat.net/~chris/blog/images/USACPI1800.png
In a free market, prices naturally fall over time due to increased efficiency.
> According to a recent article on the trustcurrency blog, bitcoin
This “rube goldberg” article keeps getting dredged up, because of a good title, I suppose.
The daily energy consumption of the entire bitcoin distributed computing network today is currently less than the output from a diesel train engine running for two hours.
Compare that to the cost of mining $5 million worth of any other commodity used as investment and you might find Bitcoin to be among the more eco friendly options.
“good thing for the early adopters” = pyramid scheme
Deflation would cause prices to decrease, not increase.
Interesting article. The thing is… deflation actually makes prices for things (when expressed in bitcoins) to go down, not up: it is simply a reflection that people value bitcoins.
Like gold, the value of bitcoins comes mostly from the fact that they are scarce (there is a limited amount of gold in our planet which is equivalent to the upper limit on the total number of minted bitcoins). This, together with the fact that the Bitcoin P2P network dynamically controls bitcoin generation difficulty, diminishes the possibility of uncontrolled inflation.
I have covered a bit the differences between Bitcoin and other traditional payment methods/fiat currencies in a blog post, but the essential is that despite bitcoins’ intrinsic value, what is important is that it is already being recognized and accepted as a useful method of performing payments online (especially micropayments).
Commenting on your final statement, if that estimate is still correct, you can make lots of money with bitcoins, it seems (as you can nowadays sell bitcoins for about 0.9 USD each). The fact that you have to spend electricity shouldn’t be so odd, after all, everything that’s scarce (think ‘oil’ or ‘gold’) requires lots of manpower and resources (including energy) to be obtained (that’s the reason those things are valuable: people are willing to spend time and money on getting them).
Finally, if deflation does occur like you predict, it will only be good for everyone holding on to their bitcoins. In fact, lots of people in the Bitcoin community are counting on that, I think 😉
If the value of a bitcoin increases, then “prices for things as expressed in bitcoin” would keep DECREASING!
I can’t believe people write about bitcoin without basic understanding of economics.
@Julian – I think what he was trying to say was that the “real” price of something that is expressed in “nominal” bitcoins would increase (unless the price is adjusted downward on a regular basis). The example I gave recently is, imagine you are a kid working at McDonalds and you get a salary of 10 BC/hr when 1BC = 80 US cents. Six months later, you’re still getting 10 BC/hr but now 1BC = $1.60. If we assume the value of the dollar has not changed, then your salary has doubled, so the real price of your labor has increased and McDonalds probably can’t afford to pay it anymore. But people are used to thinking of money’s value as more-or-less constant (that’s kinda the point of money) and resist their wages going down. In fact, people complain if their wages stop going up. Thus, inflation is useful – it allows everyone to get a raise every year without destroying the employers.
@Clinton Weir: You got a point. Bitcoin shouldn’t be relied on right now for things which require it to have a relatively stable value: since it’s still in its infancy, it is prone to display some value oscillations due to low transaction volume and the uncertainty associated to its “true value”. I still believe that Bitcoins have an intrinsic value and they are most certainly going to deflate in the short to medium-term (which means I’m more than happy to keep part of my property as bitcoins). On the other hand, I agree: I wouldn’t want to have my wage in bitcoins (and neither would my employer); not until it gains some stability.
I just came across an article by “theundergroundeconomist” (added at the end of the article), who explains the deflation/inflation issue perhaps more clearly than I was able to. Here is the link again.
http://undergroundeconomist.com/post/1528511369
@Richard – no, increasing the divisibility of bitcoin is not going to solve the problem. It merely shows that deflation is a design feature of the currency that is considered acceptable by its creators.
Yes, in my view there is something bitcoin could have done or could still do to achieve reasonable stability. Here is my idea for it:
Instead of a fixed target of bitcoin creation of 21 million bitcoins, make that a moving target.
Include, somewhere in the algorithm of bitcoin creation, the capability of sensing a parameter that indicates bitcoin usage. Somehow the volume of use of bitcoin should be linked into the system to guide changes in the target number of bitcoin creation. I would suggest that the number of active users who have adopted bitcoin be linked in some way, or the number of computers actively computing blocks.
The idea is to make bitcoin not simply work towards a fixed number of coins, but towards a number that can change and that indicates in some way how much demand there is for the coins. One could even link a bitcoin exchange rate with something considered stable, and adjust the target figure to keep that exchange rate in a reasonable state of stability.
It’s not going to be perfect, but better than just working towards a fixed target number of bitcoins.