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Since the Mt.GOX problem occurred (such an expression is rather accurate than “the bitcoins problem”, I think), virtual currency has been focused suddenly.
However, it seems that most public opinions have not yet pointed out the following issues, so I’m going to write as the memorandum.
< Contradiction between Diminishing of Currency and Network Externality >
As I had mentioned on Facebook since the affair happened (2/26、2/27、3/2、3/3、3/5-1、3/5-2、3/9、3/11), we have to understand that it’s not the issue about the bitcoins itself but about secondary business including exchange markets.
Nevertheless, there are some factors that induce the matter in the system of the bitcoins (but it’s not about all of the crypto currency).
Of course, that’s not about its algorithm such as prevention of double-spend or counterfeit. As described below, it is recognized as “a practical solution to the Byzantine Generals Problem (It’s a technical term in computer science.)” by some experts.
Alternatively, it’s not due to “lack of currency backing” by a certain authorities, although something like that has been pointed more generally. Various authors have pointed out possibility and utility of a P2P value exchange medium, which is including micro payment due to the dramatic reduction of capital movement costs, or freedom from control by public authority. Generally speaking, it can be summarized “To decentralized cooperation from centralized governance” of the economic system.
Moreover, this point can be said it’s “an attractive idea” for almost economists who are relying on market mechanism, especially its efficiency of resource allocation and its democratic nature.
However, there is a certain limit even if the bitcoins. The reason why secondary business such as derivatives or exchanges markets has rised so much is increase of speculative demand to the bitcoins, although they were just the maniac and pure value exchange media initially.
Then, the cause of such an alteration is contradiction between diminishing volume of newly issued coins and the network externality of credit money.
< Is its Antithesis Just “Public Stance”? >
Credit money is relying on a kind of self circular reasoning. Its worth can be maintained by the simple fact that everyone think it has “value”. Such its nature tends to accompany something like so-called network externalities . As a result of that, demand for it is likely to swell exponentially. On the other hand, a newly issued amount of bitcoins is set to be decreased, so coins gained by mining per once will become to halve in 4 years according to extension of the block chain which is accumulated transaction data.
Therefore, diminishing an issuance amount contradicts the exponential increase in demand. If matching against both of them, demand for coin will become more and more greater than its supply in the course of time, so such expectation will amplify various movements caused by speculative intention.
As a result of that, the nature as “a pure P2P value exchange medium” which its inventor would have intended cannot help faded. If the purpose of the bitcoins is reform of governance of economic society through a currency system, it is desirable that such speculative movements are repressed as much as possible.
In spite of that, why was sequential diminishing of an issuance amount embedded? According to the Satoshi Nakamoto’s paper, that seemed to be due to “Freedom from Inflation”.
It was published at the later of 2008, the world economy faced the days leading to the collapse of Lehman Brothers through the sub -prime loan problem at that time. (I posted such an entry on this blog.) Considerable degree of monetary easing was not only “solution”, but also “cause” of the series of the financial crisis. (I also posted such an entry about quantitative easing competition at that time.) The paper seemed to include something like irony to such social condition.
However, that seems to be something like “a public stance”, I think. True aim of sequential diminishing of an amount of issuance bitcoins would be a mover advantage to the maintenance collaborators of the block chain?
< “Stumbling Due to Its Success” Caused by “Mover Advantage” >
Authenticity of a transaction history of the bitcoins is collateralized by sharing and approval by participants in the P2P network. It’s like that everyone has the same “Bitcoins Account Book” of whole of the world.
Yet, it’s also a fact that electronic information is easy to copy or tamper. Of course, it is possible to prevent tampering with an encryption technology, but double -spend by copying cannot be overlooked, so it’s a crucial issue for something like currency. Moreover, this point is a matter about rather framework and mechanism than technology.
The bitcoins program is solving this point by “majority vote among participants” with Proof of Work using a hash function.
In detail, work to register new transaction records to “the world bitcoins account book” (it’s to add the block summarizing the transaction data of 100 to about 1,000 new at the end of the block chain) is called “mining”, and “miners” can get newly-issued coins as a reward along with fees imposed on transactions.
In order to register new transactions, they have to solve a huge amount of calculation problem. The problem is to look for a certain key value (It’s called “nonce”). The value is connected with a hash value obtained from a block of transaction history, and if throwing it into hash function, its answer must become less than a certain value. Number of upper digits which have to become “0” decides difficulty, so it is automatically adjusted intervals of issuance of new coins to become about 10 minutes in 2 weeks average.
To solve the problem, because of the one-way nature of hash function, there is no way except trying brute force of all values in rotation. It is said that an amount of computation required for such brute force is so enormous that it’s virtually impossible for a part of miners to register false contents for stealing march on the majority of miners. Even if having a computer resource which can do it, such a miner will be able to get reward with fair mining work more than an unfair registration.
It adopts something like democratic thought while also taking a measure as incentives for mobilizing even malicious third parties to work for maintenance of the system. Such a method is evaluated as innovative and practical solution to the “Byzantine Generals Problem” by some experts.
Therefore, ensuring bookkeepers (miners) becomes a critical issue for developing and expanding the P2P network of bit coins. In spite of that, ironically, those who want to become miners are likely to waver in providing computer resources initially due to network externalities of credit currency. That’s why, it seems to provide “a mover advantage” to miners as compensation structure which can overcome such a contradiction.
Even if seeking for only the “freedom from inflation” as Nakamoto’s paper saying, all one have to do is adjusting monetary base (an amount of issued coins) in accordance with markets transactions, just like “the Taylor rules“. Each node in the P2P network is always sharing the account book, so it should not be so difficult to implement.
In short, it can be said that this time’s “stumbling” of bitcoins and its secondary business was caused by its own “success” to a certain degree.
In a view of its network externalities, it’s crucial point for developing and expanding to ensure participants more than a certain volume at a stage early as much as possible. The core participants are miners maintaining the block chain, so it becomes necessary to provide a mover advantage to them.
Such prospectus had succeeded to a certain degree, but because of its own success, nothing but just “electronic information” which had no currency backing of the authorities such as nations or central banks had become an existence encouraging speculative trading. As a result of that, its areas had expanded more and more without measures to evaluate and ensure technical adequacy and safety of secondary business including exchange markets, I guess.
< Bitcoins and Freigeld Thought >
By the way, if those who devised it intended “reform of the economic system” to decentralized cooperation from centralized control through value exchange means of P2P, his or her awareness of issues is common to complementary or alternative currency boom of several times in the past.
The former (movements to complementary or alternative currency, including regional currency) has been likely to intend to overcome financial capitalism with trust and credit based on “non-economic” factors such as community or society. Their awareness of issues is differentials of wealth or macroeconomic stagnation due to maldistribution and hoarding of money under economies predominated by legal tender. (I’ve wrote the past entries with common awareness such as 2010/7/2、2012/1/11、2012/1/29、2013/11/30)
On the other hand, the latter (virtual currency, including bit coins) also seems to share the same consciousness to authoritarian of legal tender or financial capitalism. This point may also be able to glimpse from that the Nakamoto’s paper is negative to “the mint based model”.
Nevertheless, they took a different approach from the past alternative currency movements. In drawing the prescription, they wouldn’t rely on non-economic factors such as social trust or credit, and they seemed to want to solve within just a framework of a currency system itself. They seem to suppose realistic presupposition that is “It’s not necessarily that the parties exchanging value have trust in each other”, and they also seem to make a strong commitment to the establishment of a medium to exchange economic value as an alternative medium of trust and credit that is the essence of currency.
However, there is also a point that the latter can learn from experience of the former.
There are several headwaters on regional currency or alternative currency, and one of them is freigeld of Silvio Gesell in the inter world war period. Under the idea which is something like “As same as all natural objects growing worse with the passage of time, money must also become aging”, he devised “demurrage currency”. In the bottom of his problem consciousness, there was a disparity of wealth and economic stagnation under legal tender which was in privileged position that did not deteriorate.
Then, in the 1930s, such his idea seemed to be tried in some parts of Germany and Austria. In addition, a part of regional currency such as Chiemgauer which I mentioned in the article of the three and a half years ago also seems to be affected.
In other words, maybe from the context of something like financial capitalism criticism, they seem to doubt that store of value function of money is attached too much importance. Therefore, they seem to intend to relatively increase value as an exchange medium by reducing value of stored currency.
If the remote cause of the “stumbling” of bit coins of this time is excess bias toward speculation caused by contradiction between network externalities and diminishing an amount of newly-issuance, the idea of “demurrage currency” is worthy of consideration. If gradually decreasing of nominal value is scheduled beforehand, aside its extent and ways, attractive as a speculative method should wane definitely.
Moreover, if being able to balance degree of depreciation and per unit mining remuneration (newly issued coins), it may be possible to suppress the excessive speculative trading while maintaining a “mover advantage” to miners. In addition, in its fine tuning, it would be able to take into account variation of market trading volume based on an idea like the Taylor rules.
Furthermore, many of “regional demurrage currency” ever put into practice has been so-called “stamp money” (which had to maintain the par value by buying periodically the coupons that stamp currency administrator issued). However, if it’s virtual currency like the bitcoins, it is possible to eliminate substantially such complexity for users, of course.
Self- circular reasoning of credit money has an aspect like a group illusion through a kind of “narrative”. One of the reason why bitcoins led to penetration and turmoil of only this is also that its scheme can be regarded as gold or the gold standard such as “mining” and “upper limit of issue”.
It’s a kind of so-called “gamification“, and ideas mentioned above from view of freigeld or regional currency may also be incorporated into such a story.
Meanwhile, in the community of virtual currency in the last few years, P2P value exchange technology started to be used toward smart contract which handles various and complex civil contracts, for example, colored coins, mastercoin, or ethereum. If they percolate to public, it’s not difficult to imagine that its impact will become huger than bit coins.
However, it will rely on whether they can spin an attractive yarn based on social psychology and economic reality, whatever its technology is splendid. Whether this “stumbling” will become the opportunity to gain such a lesson, I’m interested in its future, so going to pay enough attention to it.