A few months ago Vijay Boyapati asked me to "steel-man" the bubble theory of money. The bubble theory of money, which can originally be found in a few old Moldbug posts, has been used by Vijay and others to explain the emergence of bitcoin and make predictions about its future.
So here is my attempt. I am using not only an article by Vijay as my source text, but also one by Koen Swinkels, a regular commenter on this blog. Both are interesting and smart posts, it's worth checking them out if you have the time.
Steel-manning the bubble theory of money and bitcoin
1. Unlike a stock or a bond, which is backed by productive assets, bitcoin cannot be valued using standard discounted cash flow analysis. And since it has no intrinsic uses, it can't be valued for its contribution to various manufacturing processes, nor for its consumption value. Rather, bitcoin is a bubble. Its price is driven by a speculative process whereby people buy bitcoins because they think that other people can be found who will pay an even higher price.
2. There is no reason why bitcoin must pop. At first, bitcoin will be bought by those on the fringe. As more people get in, the price of bitcoin will rise further. It will continue to be incredibly volatile along the way. But once bitcoin is widely held (and very valuable), the flow rate of incoming buyers will fall, and so will its volatility. At this point it has become a stable low-risk store of value. The eventual stabilization of bitcoin's price is a commonly held view among the bitcoin cognoscenti. For instance, bitcoin encyclopedia Andreas Antonopoulos has often said the same thing (i.e. "volatility really is an expression of size").
3. Once its price has stabilized, bitcoin can transition into being a widely used money, since people prefer stable money, not volatile money.
So having steel-manned the bubble theory of money as applied to bitcoin, where do I stand?
I agree with points 1 and 3. My beef is with the middle point.
Will a Keynesian beauty contest ever stabilize?
First off, let me point out that there are elements of the second argument that I agree with. Yes, bitcoin needn't pop, although my reasons for believing so are probably different from Koen and Vijay. In the past, I used to think that a popping of the bitcoin bubble was inevitable. After all, as a faithful Warren Buffett disciple, I believed that the price of any asset eventually returns to its fundamental value, and bitcoin's is 0.
But the eternal popularity of zero-sum financial games, or gambles, has disabused me of this view. People are lured by the promise of winning big and changing their lives without having to do any work. Heck, even though a Las Vegas slot machine will take on average 8 cents from every $1 wager, people still flock to insert $1 bills into slots. And so they will play bitcoin too, which like a slot machine is also a zero-sum game.
But I digress. The key point I want to push back on is Vijay and Koen's assumption that bitcoin volatility will inevitably decline as it gets more mature. I'm going to accuse them of making a logical leap here.
If bitcoin is fundamentally a bubble, or—as Vijay describes it—if bitcoin's price is determined game-theoretically, then why would its price dynamics change if more people are playing? Almost a century ago, John Maynard Keynes described this sort of game as a beauty contest. Presented with a row of faces, a competitor has to choose the prettiest face as estimated by all other participants in the contest:
"...each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."Whether 100 people are participating in Keynes's beauty contest, or 10,000, the nature of the game has not changed—it is still an nth degree mind-game with no single solution. Since the game's underlying nature remains constant as the number of participants grows, its pricing dynamics—in particular its volatility—should not be affected.
The stabilization of Amazon
We can think about this differently by using actual examples. I know of an asset that has become less volatile as it has gotten bigger: Amazon. See a chart below of its share price and volatility over time:
Why has Amazon stabilized, and will bitcoin do the same? When Amazon shares debuted back in 1997, earnings were non-existent. Jeff Bezos had little more than a hazy business plan. Since then the stock price has steadily moved higher while median volatility has declined. Amazon shareholders used to experience day-to-day price changes on the order of 2.5-4.5% in the early 2000s. By the early 2010s, this had fallen to 1-2% or so. Over the past several years, volatility has typically registered between 0.5-1%.
I'd argue that the stabilization of Amazon hasn't been driven by a larger market cap and/or growing trading volumes. Under the hood, something fundamental has changed. The company's business has matured and earnings have become much more stable and predictable. And so has its stock price, which is just a reflection of these fundamentals.
I've just told a reasonable story about why a particular asset has become less volatile over time. But it involves earnings and fundamentals, two things that bitcoin doesn't have. I'm not aware why a Keynesian beauty contest, which lacks these features, necessarily gets less volatile as more people join the guessing game.
Vijay and Koen draw an analogy between gold and bitcoin. Their claim is that if gold once transitioned from being a volatile collectible into a low-risk store of value, then so can bitcoin. But we really don't have a good dataset for the price of the yellow metal, so we really have no idea how its volatility changed over time. Going back to 1969—admittedly far too short a time-frame—gold has certainly increased in size (i.e. the total market value of above-ground gold has increased), but unlike Amazon there is no evidence of a general decline in price volatility:
I'd argue that in gold's case a lack of a correlation between size and volatility makes sense. A large portion of gold's daily price changes can be explained by speculators engaging in a Keynesian beauty contest, not changes in industrial demand or earnings (unlike Amazon shares, gold doesn't generate income). There's no good reason to expect that the volatility generated by gold speculators' beliefs should level off as participation in the "gold game" grows. Any game in which speculators base their bets on what they expect tomorrow's speculator to do, who in turn are guessing about potential bets made by next week's speculators, who in turn form expectations about the choices made by next month's players, is unlikely to converge to a stable answer for very long.
Will Proof of Weak Hands 3D tokens ever become money?
As a third example, let's take Proof of Weak Hands 3D (PoWH3D), an Ethereum dapp that I've blogged about a few times. PoWH3D is a self-proclaimed ponzi game. Basically, a player purchases game tokens, or P3D tokens, with ether. Each player's ether contribution goes into the pot, or the PoWH3D smart contract, less a 10% entrance fee which is distributed pro-rata to all existing P3D token holders. When a player wants to exit the game, their tokens are sold for an appropriate amount of ether held in the pot, less another 10% that is distributed to all remaining players.
So if a new player spends one ether (ETH) on some P3D tokens only to sell those tokens an instant later, they'll end up with just 0.81 ETH, the first 0.1 ETH having been paid to everyone else upon the new player's entrance, the other 0.09 being deducted upon their exit. Why would a new player take such a bad bet? Only if they believe that a sufficient number of latecomers will join the game such that they'll get enough entrance and exit income to compensate them for the 0.19 ETH they have already given up.
PoWH3D is a pure Keynesian beauty contest. A new entrant's expectations are a function of whether they believe latecomers will join, but latecomers' expectations are in turn a function of whether they believe yet another wave of even greater fools will pile in, etc, etc.
Applying Koen and Vijay's assumption that volatility decreases with adoption, then the return on P3D tokens should become less volatile as more people join. It might even transition into a stable investment, say like a blue chip utility stock. Who knows, it could even become a medium of exchange to rival the dollar. But surely Koen and Vijay don't want to walk out on a limb and argue that a pure ponzi game like PoWH3D will ever stabilize. Or that it might become a form of money. I think the most reasonable thing we can say about PoWH3D is that once a ponzi game, always a ponzi game. The volatility of its returns will not decline as the game grows, and that's because the game's fundamentals, its ponzi nature, doesn't vary with size. (If you are interested in PoWH3D, here are some great charts and stats).
At this point, it may be useful to map out a chart of bitcoin's 200-day median volatility. As in the case of Amazon and gold, I use the median rather than the average to screen for outliers:
new Bitcoin volatility chart from @jp_koning— Tim Swanson (@ofnumbers) August 20, 2018
based on the 200-day rolling median daily price change: pic.twitter.com/U3zfHPQsVd
I haven't updated the chart for two months, but volatility has declined since then. Vijay and Koen will probably say that as of October 2018 bitcoin is less volatile than it was in 2011. That's certainly true. But eyeballing the chart, we certainly don't get the same clean relationship between size and volatility as we do with the Amazon chart.
Here's the biggest oddity. By December 2017 bitcoin had reached a market cap of $300 billion, its highest value to date. If Vijay and Koen are right, peak size should have corresponded with trough volatility. But this wasn't the case. In late 2017, bitcoin volatility was actually quite high. In fact, it exceeded levels set in late 2013, back when bitcoin was still a tiny $3 billion pup! The lesson here is that with bitcoin, bigger is just as likely to correspond with more volatility as it is with less volatility. More broadly, when it comes to Keynesian beauty contests there seems to be no fixed relationship between volatility and size. It's chaos all the way down.
This leads into Koen and Vijay's final point, that once bitcoin's price has stabilized, it can transition into a widely used money. I agree with the underlying premise that only stable instruments will become accepted by the public as media of exchange. But since I don't see any reason for bitcoin to stabilize, I don't see how it will make the leap from a speculative instrument to a popular means of paying people.
Bitcoin isn't on the verge of going mainstream. It's already there.
Vijay's message (Koen's not so much) can be taken as investment advice. Because if he is right, and bitcoin has yet to progress to a popular store of value and finally a medium of exchange, then we are still in the first innings of bitcoin's development. Vijay points to what he thinks are the features that will make bitcoin win out against other popular stable assets, including portability, verifiability, and divisibility. Given that only the “early majority” has adopted bitcoin (the late majority and laggards still being far behind), Vijay thinks it would be reasonable for the price of bitcoin to hit $20,000 to $50,000 on its next cycle, and hints at an eventual price of $380,000, the same market value of all gold ever mined. So buying bitcoin now at $6,000 could provide incredible returns.
I have different views. Whereas Vijay thinks bitcoin has yet to go mainstream, I think that bitcoin went mainstream a long time ago, probably by late 2013. Bitcoin is often portrayed (wrongly) as a payments system-in-the-waiting, and thus gets unfairly compared to Visa and other successful payments systems. Given this setup, cryptocurrencies seems to be perpetually on the cusp of breaking out as a mainstream payments option. But bitcoin's true role has already emerged. Bitcoin is a successful decentralized gambling machine, an incredibly fun censorship-resistant Keynesian beauty contest.
Viewed this way, bitcoin's main competitors were never the credit card networks, Citigroup, Western Union, or Federal Reserve banknotes, but online gambling sites like Poker Stars, sports betting venues like Betfair, bricks & mortar casinos in Vegas, and lotteries like Powerball. By late 2013, bitcoin was at least as popular as some of the most popular casino games, say baccarat or roulette. It had hit the big leagues.
Whereas Vijay hints at a much higher price, where do I see the price of bitcoin going? I haven't a clue. But if I had to give some advice to readers, I suppose it would be this. Like poker or slots, remember that bitcoin is a zero-sum financial game (For more, see my Breaker article here). You wouldn't bet a large part of your wealth in a slot machine, would you? You probably shouldn't bet too much with bitcoin either. Vijay could be right about bitcoin hitting $380,000. It could hit $3.80 too. But if it does go to the moon, it will do so for the same reason that a slot machine pays off big.
It's worth keeping in mind that when it comes to gambling, the house always wins. Searching around for the lowest gambling fees probably makes sense. As I said earlier, Las Vegas slots will extract as much as 8 cents per dollar. Lotteries are even worse.
In bitcoin's case, the "house" is made up of the collection of miners that maintain the bitcoin system. All bitcoin owners must collectively pay these miners 12.5 bitcoins every 10 minutes to keep things up and running. So if you hold one bitcoin and its market value is $6000, you will be paying around 62 cents per day in fees, or $230 per year. That works out to a yearly management expense ratio of 3.8%. Beware, this number doesn't include the commissions that the exchanges charge you for buying and selling.
So before you start gambling, consider first whether the benefits of decentralization are worth 3.8% per year. If not, find a centralized gambling alternative. If the costs of decentralization are worth it, then buy some bitcoin, and good luck! But play responsibly, please.
The PoWH3D doesn't seem like a good analogy as one is spending ETH with the hopes of acquiring more ETH. With Bitcoin, one is exchanging X (USD) for BTC. This seems to be an important distinction but I'll leave up to others to explain if my intuition is correct.ReplyDelete
Also, I think the volatility analysis would be more complete with a longer time series going back to the earliest trading data. I'd guess that over time interbubble Bitcoin price volatility has decreased. Again my intuition tells me that we should strip out the half dozen or so manic bubble phases to get a better idea of baseline volatility.
Thank you for the post,
My mistake with respect to the volatility time frame. I see that it does in fact go back to 2011.Delete
"...to get a better idea of baseline volatility."Delete
That's why I used median instead of average. It ignores really big 1-day change, the idea being to provide a more general sense of what sort of volatility bitcoin holders experience on a day-to-day basis.
"This seems to be an important distinction but I'll leave up to others to explain if my intuition is correct."
Sorry, not really following your intuition.
The PoW3HD Ponzi game that you describe is fundamentally different than the BItcoin market. Specifically, in your Ponzi people are not buying anything. There is no exchange of good A for good B. There is simply the hope that one will receive more ETH than one put in with the PoW3HD tokens simply representing a claim on future ETH. The information from this market is meaningless signaling the obvious fact that people value more ETH than less ETH. This is pure gambling and I'd never expect the volatility to decline.Delete
The Bitcoin market is different in that people are exchanging unlike goods based of how they value them. There is novel information being conveyed to other market participants which signals people's preferences. When the price of BTC goes up it implies that people value BTC more than fiat and when it goes down vice versa. As more people come to the realization that Bitcoin serves their needs better than fiat more fiat will be converted into Bitcoin. I'd expect volatility to decrease over time in this scenario.
I thought the true utility of bitcoin was as a money-laundering device -- a way to make payments for things that are illegal, or to get money out of countries with capital controls. Aren't those true sources of utility?ReplyDelete
Love the Moldbug reference btw.
Sure, a few people are using it for the reasons you mention.Delete
But I'm pretty sure that the great majority of people who hold bitcoin are engaging in gambling.
Hmm ... how do we find this out? Perhaps they are gambling on the fact that the utility of Bitcoin will increase in the future ... in which case they are gambling in the same way an investor in Wayfair is gambling that eventually profit margins will finally cross 0%? I don't know ... just asking. How do we know how many billions have been shifted around Asia and Africa via bitcoin? Maybe billions and billions. Especially now that money laundering laws are so much more stringent.Delete
Great piece, a few comments:ReplyDelete
1.The users of bitcoin does not pay 12.5 BTC per block. The BTC protocol does. Those are newly minted BTC. The fees are maybe 0.2 BTC per block, and as such, your calculation is faulty.
When all BTC are mined the fees will be in that size, but that is not in the immediate foreseeable future, maybe 30-40 yrs from now.
2.The rise in mining cost + halving of block rewards should also be considered when talking about future prices. We are currently at mining cost.
Thanks, glad you liked it.Delete
"The users of bitcoin does not pay 12.5 BTC per block. The BTC protocol does. Those are newly minted BTC."
I was hoping someone would comment on that.
Let me push back. The moment that 12.5 newly-minted BTC hit the market, the supply of bitcoin increases and the price gets pushed down. The amount by which the price falls hurts all existing bitcoin holders. This wedge represents the totality of resources that have been transferred from each bitcoin user to the miner who found the block.
I'd argue that the same effect would be created if, instead of 12.5 newly-minted bitcoins being created and rewarded to the miner, the miner was rewarded with 12.5 existing bitcoins. The protocol might do this by automatically transferring a pro-rata amount from each existing address to the winning miner.
So that's why I don't think its wrong to say that existing users pay 12.5 BTC per block.
If existing bitcoins (rather than new bitcoins) were rewarded to the winning miner, each address holder would experience first-hand the fees involved in holding bitcoin, since their address would be directly debited. But since the reward mechanism uses new bitcoins rather than a direct debit, no one actually experiences the cost of holding bitcoin. Rather, price falls by a little bit. It's a stealth fee.
Does that make sense?
It's exactly the same as inflation beeing a hidden tax.
I like your article because it brings sobering points. However you don't discuss how the actual utility of Bitcoin (crossborder, permissionless, auditable, etc.) which is likely to entertain demand on the long run.
Beauty contest: the identity of the winner stays indeterminate, but price volatility goes down as number of participants goes up. If an average of N people play, the std. deviation of the number of players is IIRC as sqrt(N), thus std.dev/mean (which is what we are interested in) is 1/sqrt(N). In simple terms: if you draw 10 balls from a sack with 50/50% reds and blues, you draw 10 reds and no blues 0.1% of the time. On the other hand, if you draw 100 balls, you end up with all reds 0.0000000000000000000000000001% of the time. What's the chance the gold market will see a buyers' strike and crash?ReplyDelete
"A large portion of gold's daily price changes can be explained by speculators engaging in a Keynesian beauty contest"
Um, not really. Gold has won the contest centuries ago.
The "contest" is about establishing common knowledge; this is most obvious in the case that knowledge is mistaken. To go back to the original setting: suppose for the argument's sake, that "everybody knows" that blondes are hot, but all the men judging the contest are actually attracted to redheads. All of them will bet on blondes, and blondes will win---but if you asked for their preferences privately and averaged those together, redheads would have won.
To argue against myself a bit, iterating a beauty contest doesn't necessarily lower the volatility just because more bettors play. If in round T the contestant loses some votes, the price dip becomes part of the common knowledge and "is she really going to become/stay a winner?" means that in round T+1, a further loss of votes is probable. In the drawing-balls-from-a-sack analogy, the draws are not independent of each other, because the result of each draw alters the composition of the balls in the sack *towards* its color.
Great article that re-started my thinking. Some initial thoughts:ReplyDelete
I guess my key point is not that bitcoin will become sufficiently less volatile as more people enter the market that it can come to be used as a medium of exchange. Instead it is that the bitcoin valuation function is the same as the gold valuation function: They're both bubbles. And since gold is obviously a huge success bitcoin could be too.
You point out that we have way too little information about historical gold prices to know that it followed a similar 'becomes less volatile as the market grows' trajectory as you write Vijay and I predict for bitcoin. And that the little price information we do have does not show a reduction in volatility, and that there are good reasons to think there is not much of a correlation between size and volatility in the case of gold.
But that's all fine! I can accept all that.
My point is: Gold has succeeded. Despite it being a volatile bubble.
And Bitcoin could too.
The obvious response to this concession is: If bitcoin's price remains a volatile bubble it will not become a successful medium of exchange. A medium of exchange requires price stability.
And I think that's right. But I don't see it as a problem.
I used to be wedded to the idea of bitcoin succeeding as a medium of exchange. Very early on I think I thought that bitcoin would succeed as a store of value because it would succeed as a medium of exchange. Soon I realized it had to succeed as a store of value first for it to succeed as a medium of exchange, but that the key to bitcoin's success would lie in its use as a medium of exchange.
I let go off that belief a while ago: I now think bitcoin could succeed as a pure store of value, and that it does not need to succeed as a medium of exchange for that. I now regard bitcoin more as a more (the most) idealized, extreme version of gold. Bitcoin is a store of value first, and need not be more than that.
And that is the core of what I regard as the bubble theory of money: It explains the store of value function, not the medium of exchange function.
People have always looked for ways to store value, value that is in excess of that provided by consumption & production use functions.
Traditional solutions are found in the form of gold, collectibles, original works of art etc.
Though some of the value of these may be explained by reference to value in consumption (eg aesthetic experience of looking at art) or production use (eg gold in industry), by far the largest part of their value is bubble value: And bubble value is created and determined solely through a decentralized game-theoretic consensus process wherein everybody values something at price X because they think other people will value it at price >X in the future.
In the case of gold, works of art and other collectibles a wide array of social, cultural, institutional etc practices develop in which these valuation processes are embedded, eg art history, museums, wearing jewelry, explanations/rationalizations why expensive wines taste better etc.
Bitcoin idealizes away from these matters. In the case of bitcoin there is only the valuation process itself.
Lastly, you point out the costs of the bitcoin game: The price users pay to miners in the form of inflation.Delete
But here too the analogy with gold may be useful: Gold users pay gold miners. The gold game is less than zero sum.
Yet the gold game is obviously a big fat success. And the bitcoin game could be too. Because it works in the same way.
There are obviously many factors that could cause bitcoin to crash and burn in the future, or make it so that it remains a relatively small phenomenon. But I don't think it is its nature as a bubble --even a volatile bubble-- that would so doom it. The case of gold shows this. Although it is possible that bitcoin is too pure, too detached from the kinds of social, cultural etc practices in which other stores of value such as gold, fine wine and original works of art are embedded, for people to 'buy' it.
"I guess my key point is not that bitcoin will become sufficiently less volatile as more people enter the market that it can come to be used as a medium of exchange."Delete
I should note that this realization may in part be the *result* thinking provoked by JP's article, so I am not saying he was arguing against a position I did not hold.
Hi Koen, it sounds like after many years of debating our positions are much closer.Delete
I do wonder about your point about art and collectibles. Take coins as an example. This summer I wrote about Nicholas Veeder's Republic of Eutopia coin. Given what I know about the coin, I think it would be really neat to own one. First I need to calculate how much of my income will go to food, transportation, lodging, vacation, school, etc. With the remainder, I figure I can afford $20 a year to own the coin, which means I'd buy it now for $400.
Well I'm out of luck, it recently sold for $5,400.
$5,400 certainly doesn't reflect my own appraisal of how much "consumption value" the Republic of Eutopia coin provides. So it must be a bubble, right? Not necessarily. The $5,400 price could be a reflection of the consumption preferences of someone equally informed as me, but far richer. A coin-collecting CEO with a big salary will have much more disposable income left over after deducting expenses, and can thus direct more purchasing power to buy curiosities like Veeder's Eutopia coin. Prices in high-end markets like art and coins may seem to be disconnected from fundamentals, but only because they are connected to the fundamentals of people who are far richer than most of us.
I suppose buyers who only want to speculate could push the coin's price up. But at some point our rich CEO will sell the Veeder coin. It exceeds his notion of fundamental value, and buying cheaper coins with the proceeds provides him with a bigger consumptive punch. And this should somewhat dampen the influence of speculators.
"Gold users pay gold miners."
I suppose there's an analogy to be made there. But gold owners don't pay gold miners a fee to keep everything running. If anything they lose out thanks to the mining process--newly mined gold depresses the gold price, but unlike bitcoin owners gold owners get nothing in return for bearing this loss. Gold can continue to work fine if there are no gold miners. For bitcoin to function, it needs bitcoin miners.
re consumption, collectibles and riches: In the case of original works of art, special coins etc part of their price is definitely the result of the consumption value they have for users. And yes, rich users may be willing to spend a lot more for the consumption value of a collectible, and given the scarcity and non-reproducibility of these objects it is possible that at least in some cases a much larger percentage of the price of a collectible may be explainable by consumption value.Delete
(Although this is an inaccurate way of stating it: After all, maybe the buyer is only interested in the consumption value whereas the people he was bidding against were only interested in it for the investment value. So what should we say the percentage of the price is explainable by investment value and how much by consumption value? It seems one can only say this for individual users, not for the market price as such)
I guess a hypothetical way to test the relative importances of consumption and speculative value is to pass a law that says these kinds of collectibles can no longer be sold more than once from now on and see what this does to the price. This ban takes away the investment/speculative value.
Re gold mining: Sure, although I suppose one could say that the costs of mining new gold are the costs associated with using a naturally occuring metal as a store of value. After all, if this metal is so used it is inevitable that people will try to find more of it, which requires resources and the result of which dilutes the value of existing holdings. So the mining is not necessary to keep things running, it is just inevitable that it will occur.
"This ban takes away the investment/speculative value."Delete
Yes, I think that would do it.
"...After all, if this metal is so used it is inevitable that people will try to find more of it, which requires resources and the result of which dilutes the value of existing holdings. So the mining is not necessary to keep things running, it is just inevitable that it will occur."
Ok, but can't we that this same inevitability plagues bitcoin?
With gold, for instance, it isn't just new gold discoveries that "dilute" the value of each existing ounce, but also new discoveries of competing elements like silver, palladium, platinum, etc. The paper gold market also provides a huge amount of competing supply. Finally, the emergence of new speculative opportunities like cannabis stocks and cryptocurrencies draw speculators away from gold, as do financial games like poker.
Likewise with bitcoin, or any other asset/good in the world. The value of bitcoins is diluted as more casinos are built, or additional altcoins are created, or speculators migrate in the marijuana stock frenzy, or fractionally-reserved bitcoins are created.
But let's focus more on the idea of bitcoin holding fees. The direct cost of holding gold isn't the inevitable increase in gold supply (and the increase in the supplies of all close substitutes). It is the cost of securing insurance and vaulting the stuff. I think that generally comes out to around 0.5% a year for a retail customer. Likewise, the cost of holding a bitcoin includes insurance and vaulting (who knows what these rates come out to), and also a 3.8% decentralization fee. That seems like a fair comparison to me, no?
Sorry, not sure why I hadn't responded to this part earlier.Delete
"Ok, but can't we that this same inevitability plagues bitcoin?"
Yes, we can.
"With gold, for instance, it isn't just new gold discoveries that "dilute" the value of each existing ounce, but also new discoveries of competing elements like silver, palladium, platinum, etc."
Sure, but I think there is a limit to how much discoveries of competing elements could reduce the value of gold (and same for the analogous case of bitcoin), as one feature of bubble value is that there is a strong tendency for a small group of asset types to be valued very highly rather than more equal valuations of a multitude of assets. How this tendency works, what the nature of the mechanisms behind it are, is an interesting and possibly underexplored question.
"But let's focus more on the idea of bitcoin holding fees. The direct cost of holding gold isn't the inevitable increase in gold supply (and the increase in the supplies of all close substitutes). It is the cost of securing insurance and vaulting the stuff. I think that generally comes out to around 0.5% a year for a retail customer. Likewise, the cost of holding a bitcoin includes insurance and vaulting (who knows what these rates come out to), and also a 3.8% decentralization fee. That seems like a fair comparison to me, no?"
Sure, but with regard to the question whether bitcoin could succeed as a store of value I am not sure how important it is to make a distinction between these 3 different types of costs:
1. direct cost of holding gold (insurance & vaults) or bitcoin (insurance & vaults)
2. value decrease as a result of supply increase (suffered by existing holders)
3. costs of mining gold or bitcoin (paid by miners)
#2 is the price holders de facto pay to miners for #3.
Bitcoin miners pay for electricity & hardware until their expected income in the form of newly mined bitcoins no longer exceeds those costs. And gold miners invest in materials until their expected income in the form of newly mined gold no longer exceeds those costs.
In both cases the newly mined gold or bitcoin makes the price of gold or bitcoin and hence the purchasing power of existing gold or bitcoin holders lower than it otherwise would have been.* True, the supply schedule of gold is less predictable than that of bitcoin, and at the moment bitcoin mining fees are comparatively larger than gold mining fees, but it is not obvious to me that this would mean that while gold was able to grow and succeed as a store of value, bitcoin won't be able to.
*I've wondered about an issue related to this, and saw that one of the people commenting on your post had too: If bitcoin's supply schedule is fixed and known then the current bitcoin price already "incorporates" this knowledge. Or less metaphorically put: The future increases in supply have already had a causal effect on the current price.Delete
- Suppose the bitcoin price at time t is $1000 and people know that at time t+1 a new bitcoin will be mined.
- Then at time t+1 the new bitcoin is mined.
- Why would the *actual* emergence of this new bitcoin at t+1 subsequently still affect bitcoin's price level? Hadn't the *expected* emergence at time t already done that?
You make an interesting analogy:
"I think about bitcoin rewards the same way as I think about stock and cash dividends paid by a listed company. A company announces on October 1 that a dividend (stock or cash) is to be paid to all people who own the stock on October 30. October 30 is known as the ex-dividend day. Anyone who owns the stock on October 31 won't get the dividend.
Even though the stock's "issuance schedule" is well known as early as October 1, the effect on the stock price doesn't occur till October 31. On that day, it will fall precisely by the amount of the dividend paid.
Why should I *not* think of bitcoin's 10-minute issuance in the same way? They are just stock or cash dividends, no?"
But where the analogy is flawed in my opinion is that there is no counterpart in the bitcoin example to the dividend payment in the stock example:
One miner who may or may not be a current bitcoin holder receiving a newly mined bitcoin is not the counterpart of all the stock holders receiving a dividend payment. It is not the bitcoins currently held by HODLers that produce that mining income. Moreover, unlike in the case of the newly mined bitcoin the dividend payment does not affect the stock's supply.
So the analogy breaks down, I think, and the question remains: Why would the *actual* emergence of this new bitcoin at t+1 subsequently still affect bitcoin's price level? Hadn't the *expected* emergence at time t already done that?
And if I am right that the *actual* emergence of a new bitcoin should not affect bitcoin's price, a problem emerges: Surely some kind of transfer of purchasing power takes place when a newly mined bitcoin come into existence, but apparently this cannot be the result of a change in the price level of bitcoin because that price does not change. So what the hell?Delete
Well, the thing is, at time t we know that at time t+1 a new bitcoin will be mined but we do not yet know who will be the person that mines it. Only the former type of knowledge concerns the supply and hence affects the price, the latter type of knowledge does not.
We could then say that at time t existing bitcoin HODLers have already "reserved" the purchasing power that will be "awarded" to a miner at time t+1 by having adjusted their current valuation of bitcoin. So at time t+1 no purchasing power is transferred. What happens instead is that tye miner "picks up" the previously "reserved" piece of purchasing power.
This would solve the paradox of on the one hand purchasing power apparently being transferred at time t+1 even though no change in the unit price (that would account for the transfer of purchasing power) takes place at time t+1.
It was very interesting to read your post. Even if I disagree with your conclusion, I think you raise some points worth thinking about and explaining:ReplyDelete
1. Bitcoin issuance is not paid by bitcoin holders. When they bought their coins, issuance schedule was well known, so block mining subsidy was discounted in the price they paid for their coins.
One could argue bitcoin issuance is not completely deterministic due to the delay of difficulty adjustments. But the effect of this elasticity in supply is fundamentally a reduction in price volatility, being nearly neutral in the long term.
You should also consider bitcoin distribution -unlike gold mining- is not totally worthless or inevitable for bitcoin holders, it helps to keep the blockchain expensive to mutate during bootstrapping, when fees revenue is not high and stable enough to secure it. If current holders consensus wouldn’t consider this valuable enough, they could change the emission rules to reduce or eliminate monetary inflation. It’s also a great way to do a widespread distribution or the monetary base, making holders’ coins more valuable, as most miners need to sell the coins they mine in secondary markets to pay for their mining operation expenses.
Supply elasticity image
2. Regarding volatility, I acknowledge the issuance of new coins in periods of low demand generates selling pressure and contributes to price volatility. But issuance decreases geometrically making this a temporary issue to fade away. In less than two years it’s share over total supply will be lower than in gold.
As a pure monetary asset, I believe bitcoin value is a function of its liquidity. So, the more liquid and expensive bitcoin gets, the more difficult for the price to jump with new money inflows.Volatility is the manifestation of value uncertainty, and this is greater after big moves. As bitcoin gets more stable in the long term, short term volatility will reduce as well.
Using just daily price change to compare volatility during bitcoin hyper-monetization (price growing exponentially) vs. other assets currently appreciating at a much slower pace is quite a partial view. Both historical volatility and daily price range values show that volatility is clearly decreasing in bitcoin.
Bitcoin volatility image
That's a lot of material. Maybe I'll try and unpack what I think is your most important statement first:
"Bitcoin issuance is not paid by bitcoin holders. When they bought their coins, issuance schedule was well known, so block mining subsidy was discounted in the price they paid for their coins."
That's an interesting way of thinking about it. I'm not sure I agree.
I think about bitcoin rewards the same way as I think about stock and cash dividends paid by a listed company. A company announces on October 1 that a dividend (stock or cash) is to be paid to all people who own the stock on October 30. October 30 is known as the ex-dividend day. Anyone who owns the stock on October 31 won't get the dividend.
Even though the stock's "issuance schedule" is well known as early as October 1, the effect on the stock price doesn't occur till October 31. On that day, it will fall precisely by the amount of the dividend paid.
Why should I *not* think of bitcoin's 10-minute issuance in the same way? They are just stock or cash dividends, no?
Bitcoin rewards are composed of two elements: subsidy and fees. Only the former affect holders.Delete
Bitcoin's monetary inflation is not like dividends. If we obviate tax implications, when a company pays a dividend its value is reduced by the exact amount of the dividend paid.
Bitcoin inflation can be better compared to security expenses of a company, payed with capital increases. When shareholders buy the stock, they must be aware of these expenses, which are priced in to the stock price.
Let's analyze what's the impact in price. If the security bought with the new capital is worth it's value for the company, these capital increases should be neutral for the stock price. Although usually, when a company raises new capital it's because it's expected to provide additional value to current shareholders.
If the security paid with the new capital wasn't worth its value, you would expect management to stop this practice to avoid dilution. In Bitcoin, if that was the case, holders would have forked the network to reduce or remove inflation.
The risk of this expenditure not being worth its cost (and the risk of forks) is mitigated in Bitcoin by reducing subsidy progressively and increasingly rely on fees.
- Bitcoin Price & Inflation-Free Implied Price chart: https://twitter.com/fnietom/status/1059415476709875712
I'd wondered about issues relating to the 'but future supply increases are already incorporated into the current price' point as well, and wrote about it here: https://jpkoning.blogspot.com/2018/10/bitcoin-and-bubble-theory-of-money.html?showComment=1545514764123#c3286283853617152437 (2 replies)Delete
3. I believe bitcoin hyper-monetization will complete and mcap will stabilize somewhere between gold mcap ($7.7T) and world stock of narrow money ($34.4T), when it gathers most of the world demand for a liquid and stable (not inflationary) monetary asset. It will then become the prevalent medium of account, fixing even further its purchasing power stability. You may think it’s a Keynesian beauty contest not converging to any value, but if you look at this chart, its hyper-monetization path seems quite stable and predictable:ReplyDelete
Bitcoin vs Gold image
4. Once bitcoin becomes the prevalent monetary asset, you need another asset to short it against. What would you buy, that doesn't get inflated soon after, in the environment of free interest rates it enables?
Ok, image links don't seem to work in the previous comments. Here you have them:ReplyDelete
- Supply elasticity image: https://twitter.com/fnietom/status/1055850502401990657
- Bitcoin volatility image: https://twitter.com/fnietom/status/1054014716169859072
- Bitcoin vs Gold image: https://twitter.com/fnietom/status/1057354295732039680
I disagree substantially that “has yet to progress to a popular store of value and finally a medium of exchange”.ReplyDelete
It´s other way around: first the sufficient adoption (or a prospective expectation of it) as a MoE (even if a niche), then comes at par the store of value quality.
Author of Portugueses books: "Bitcoin and Blockchain" and "Manifesto Anti-Keynes"