Essay:On the Bitcoin

The following is later going to be a collection of rants and ideas I have about the bitcoin, and economics in general.

Deflation and Interest
Subject: Bitcoin Date: December 3, 2011

The following is my first rant on Bitcoin Forums. It's about some of the problems inherent in the system. Others probably thought of these same principles before, but I thought all these independently. As I'm a newbie, this is also in the newbie section on their forums. For your viewing and commenting in the talk section, here it is.

ESSAY START

I've looked at the system of the bitcoin, and from what I know, there seems to be a few problems which revolve around the fact that only 21 million bitcoins can possibly exist at a time. Let's look at each of the problems. We'll begin with a background where the economy is growing. Everything is fine, until the bitcoin mines run dry: all 21 million bitcoins have been harvested. In order to adjust to the growing economy, an individual bitcoin becomes more valuable (deflation). During a period of deflation, money becomes more valuable even when it is unused. People realize this: why should they risk loss in investment when their money will gain value risk-free by letting it sit? As such, people stop investing and let their money sit untouched. Companies are no longer able to take out loans. Companies wither and die, people lose jobs. New companies cannot start as they cannot get their initial loan money. Due to the lack of production, the bitcoin shrinks sharply. The people who just kept their money away suffer, too, as the bitcoin is no longer backed by an economy. Bitcoins suddenly lose value and face hyperinflation. Now we're back we've a shattered economy, the bitcoin's a 21st-century German Mark after WW1 (i.e., worth practically nothing), and literally everybody involved has suffered. How is this supposed to be avoided?

In some ways, the bitcoin reminds me of the gold standard, the bitcoins simply being virtual gold with literally no value except as money. Gold, although not exactly world's most useful substance, has practical use for its electrical conductivity, malleability, and its resistance to corrosion. Here's one way the bitcoin reminds me of gold.

The bitcoin, like gold, is a limited resource. There is only so much gold in the earth to dig up, and the bitcoin has been set up so that a finite number of them (21,000,000) can exist. Gold was often hoarded, taking it out of use. I fear bitcoins could also be hoarded. Since there are only so many bitcoins out there, each bitcoin hoarded is one less which can contribute to the economy. The hoarders will grab every bitcoin they can reach. In order to counteract the hoarding, individual bitcoins become more valuable, just like any scarce resource. This too leads to the same problems above (bitcoins gain value without contributing anything useful, causing economic depression and hyperinflation), only quicker and without the period of growth I've mentioned in the background above. Point is, hoarded money is taken out of use, and leads to deflation.

Also, even without central banks, there is still a major problem with banking in the bitcoin system. Alice begins systematically lending out bitcoins with interest. As such, she gains more money. Although this money is being invested and doesn't face the same problems as the hoarders face, there is a problem if the money supply is not infinite. Alice's share of the money supply increases, until she eventually gains all of it. It's impossible to pay principal and interest from a total money supply which only contains the principal. Even though the money isn't being created as debt, it doesn't matter. Alice ends up with all the money, and once all the foreclosures and such are filed, she ends up with all the real stuff, too. Even if Alice could just create new bitcoins into existence for all the money she loans out, she doesn't create the interest. No matter how the money is created, systematically charging interest means Alice soon gets everything. Good for Alice, not so good for everyone else. Alice needn't be a single person: Alice is actually the sum of all the lenders in the bitcoin system, but the result's just the same as if it were all one person. If lending with interest is forbidden, then why would Alice even go into banking? She would do better off just holding onto her money and letting it sit, leading to the deflation problems above.

Then there is conversion. Between other currencies, that is. How is it determined how much a bitcoin is worth in dollars, pounds, euros, pesos, yens, rubles, shekels, or whatever currency you use? An easy pseudo-investment technique could be to buy bitcoins with an ordinary currency (call them monies), let it sit and let deflation do its work, then convert all your bitcoins back into monies for a huge profit. Bitcoins converted out of the bitcoin system means less bitcoins available in the bitcoin economy and more monies available in the other economy without anything at all behind them. Are ordinary currencies converted to bitcoins producing new bitcoins which didn't previously exist, or do the converters pay from their pockets? Why would the converter want to remain in business if they lose more in bitcoins than they gain in ordinary money as a commission? What becomes of the original bills or coins? Are they taken out of circulation or what? Once all 21 million bitcoins have been mined, it becomes equivalent to any other currency with the exception of being tethered to a non-existent object, which I call "somniaurum" (loosely "dream gold" in Latin). As such, it would be subject to rampant deflation as mentioned above, something which other currencies would be immune from due to being tethered to the strength of the economy rather than literally a no-thing. Not even a vacuum, not even space. No-thing. Nothing but a thought. A currency based on nothing but a thought is stupid and childish. Even most fiat and debt currencies out there today have value in the sense of real-world objects and the economy. The bitcoin is strange, and not in a good way. Could somebody please address all these problems?

ESSAY END