This document, like many others, could not find a home with the usual suspects.
Imagine that one dollar that you owned in February 2011, had six times the purchasing power by December, and over 12 times that purchasing power by December of 2012. Before the next year was out, that had grown to a thousand times, but had slipped back by next year end to eight hundred times.
By the end of 2014, your dollar was looking a bit seedy – not compared to 2011, but to the previous December: only three hundred times. Two years later, that thousand multiplier is within reach again. But two years!
At the end of 2017, you find that you dollar has 20,000 times the original purchasing power. Two years later, 7,000 times. What kind of crazy dollar is this? Another year, an additional 3,000 pushes the value to a factor of 10,000. Happy New Year, 2021! 30,000 times more. By March, 60,000 times more.
What would you buy with it? When would you buy? If the price has slumped, do you say, “Oh well,” and spend your dollar? Or do you wait in the expectation that it will buy more soon. When it zooms to some record level, do you spend it then? Or are you tempted to wait a little longer, because this dollar is magical?
This magic dollar is, of course, BitCoin (BTC, symbol ₿), initiated by the pseudonymous Satoshi Nakamoto in 2009. It is supposed to be a currency, and a deliberately deflationary currency. It’s certainly not inflationary. But you can hardly call it a currency, unless your idea of currency is the inverse of the Weimar Papiermark. How do you set up a parallel economy with a currency whose purchasing power is so wildly unpredictable?
How is the design of BTC deflationary, and does that design explain this level of deflation?
Folks like me (and, I presume, you) don’t buy whole BTC. If we do buy, it is a fraction. As things stand, a ₿ is divisible by up to 100,000,000. This tiny unit is known as a satoshi; ₿0.000 000 001. ₿ (hence satoshis) are only created by “mining” blocks for the BitCoin blockchain. “Mining” requires work – not with a dragline, but with a computer and, nowadays, very specialised processors. As the power of mining computers increases (or decreases) the amount of work required to mine a block is adjusted, to keep the time-to-mine to around 10 minutes. The difficulty of this work is measured by an index.
The first miner was Satoshi Nakamoto himself, and he laid down the future of BTC mining. The index of difficulty of the initial blocks was 1. The current index of difficulty is 23 trillion. Yes, you read that correctly.
Note that it is blockchain blocks that are mined, but the miner of each new block is rewarded with a specified amount of ₿. Every block initially mined earned ₿50. At each reward level, after 210,000 new blocks have been mined, the number of ₿ earned per block is halved. This is the only way ₿ are created. You can’t just print more, not even with a 3D printer. So the rate of increase of the supply of money (in the form of BTC) is gradually being choked down.
Halving takes place about every four years. The first occurred in 2012, thence 2016 and just last year. The value of a mined block fell to ₿25, then ₿12.5, and now ₿6.25. There is a story of Chinese mathematician who was asked by the emperor what reward he desired for services rendered. “I am a man of simple needs, O Luminance of Heaven. All I ask is that you place a single grain of rice on the first square of a chess board, then twice that number on the second, twice that number on the third, and so forth, until all sixty-four squares are covered.” His Luminance agreed, temporarily, and the mathematician came to a grisly end.
Like other aspects of the BitCoin story, the halving tells an inverse story. There are, however, only 32 squares on this board. In the year 2136, should BTC still be mined, the reward will halve to 1 satoshi, one one-hundred-millionth of a ₿, and in A.D.2140, it will go to zero. At that point, ₿20,999,949.97690000 in total will have been mined; just shy of ₿21million. The total amount so far mined is approaching ₿19million. Mining commenced in 2009. In less than 120 years, all things being equal, the last fraction of the last one will have been mined.
Currency speculation is not new. Some of us remember the day when the Aussie had a fixed exchange rate. Ask Mahathir Mohamad about exchange rates pegged to the US dollar. Most day-to-day purchases with a pegged currency under upward or downward pressure were unaffected. Those anticipating sales or purchases in foreign currency may have changed their plans, but for most payments and receipts in the larger economy it was business as usual.
The fluctuations in fiat currencies under stress are as nothing, though, compared to the volatility of BitCoin. If you are buying BTC at US$60,000 a pop, what are you going to do with them? Pay the mortgage? Renovate the house? Go all-in on the luxe (sic) beauty treatment that you were going to borrow $10,000 for? Why would you not just spend the money directly on those goods? The only reason for buying them is as a hedge against the collapse of the dollar (US or AU) or in hopes of a speculative fortune. What you won’t do is buy the groceries or pay the electricity bill.
However, BitCoin was envisaged as an alternative currency. It was to be a medium of exchange that escaped the manipulative grasp of fiat currencies and central banks. Its deflationary structure, its value increasing with increasing scarcity, would maintain the incentives to mine increasingly rare BTC, and when the production of new coins ceased, transaction fees denominated in satoshis, would be sufficient to maintain the mining of new unrewarded blocks of transactions. BitCoin was never envisaged as a store of value. That original rationale was swallowed whole by hyper-deflation.
Arguments about monetary and fiscal policy, or about the virtues and blights of this or that central bank decision, or about what the world’s or country’s real base money is, are beyond my tremulous grasp. But the opinions laid out above seem to me self-evident. I look forward to having my errors pointed out.