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The Bitcoin Printing Press Problem

September 7, 2011

Bitcoin has been promoted as stable digital currency, and in fact it’s 100% transparent. The opensource nature of bitcoins as well as the technology behind it has a strong allure with several groups. The libertarians love it due to the fact that it’s money supply is well documented and not controlled by a core group of people or individuals. The technology savvy group loves it due to the innovative way it distributes though a peer to peer system. Others like it due to the nature of how bitcoins are decentralized.

Some history surrounding the bitcoin system:

The bitcoin system was initially designed by an individual (or group) that goes by the name of Satoshi Nakamoto (most likely the name is an alias). The self published whitepaper was published in 2009. In mid 2010 the currency was actively traded for pennies for each bitcoin. However in 2011 after some articles surrounding it in mainstream media it skyrocketed to 35 dollars a bitcoin. Showing an appreciation of 10′s of thousands of percentage points.

Then the bottom fell out in July after a series of high profile hacks, high profile thefts and a questionable PR individual that has a legacy of fraud. It was amazing that the currency still traded in the 10 dollar per bitcoin range.

Now bitcoins are trading in the mid 6 dollars per coin range. Still an impressive jump from the pennies it traded from last year, and the year before it didn’t exist.

It proves that it has staying power due to the distributed nature of them. It also proves without a doubt that the currency can survive huge amounts of problems, especially at it’s sub 900 day old age.

However it’s fault may not lie with the hacks, scandals and theft, it’s fault may lie with the initial design by Satoshi Nakamoto. It’s strongest strength may turn out to be strongest weakness as well.

Currently the bitcoin system awards 50 coins every 10 minutes to whoever solves a block. It’s typically called mining. The miner then when he receives his award he also generally passes along any transactions which include fees to him.

This means that the typical “reward” is 50 coins plus 2 or 3 additional as transaction fees (if it was a a decent transaction loaded block).

This extremely innovative way to continue transactions allowed for individuals to have timely transactions. It will continue to reward 50 coins every 10 minutes. However the amount is halved every 4 years.

The coin value of a block is 50 BTC for each of the first 210,000 blocks, 25 BTC for the next 210,000 blocks, then 12.5 BTC, 6.25 BTC and so on. In other words it continues to half in reward all the way until the year 2140. Then the total number of coins in circulation will remain static at 20,999,999.9769 BTC.

The problem is when Satoshi Nakamoto designed the bitcoin system in 2009 he didn’t allow for a mechanism to decrease or increase the creation rate. It’s not the total of 21 million bitcoins that are the problem, it’s how fast they are released that is.

The algorithm as designed expects demand to decrease in 1/2 strength amounts every 4 years over the next 129 years.

The problem is that since there is no way to adjust the reward ratio, the coins fall in value dramatically if demand doesn’t meet that high growth rate. Flexcoin, the bitcoin bank released a study showing exactly how much money needs to enter into the bitcoin community in terms of growth every month. It’s a staggering $1.5 million dollars at current growth rates just to maintain the $6 dollar per bitcoin price, because $1.5 million dollars (at current prices) worth of bitcoins are created every month. It’s a grand total of 216,000 new bitcoins printed per month.

216,000 multiplied by the spot price of each bitcoin printed every 4 weeks and you start to appreciate the magnitude of it’s inflation rate.

Now this number drops in 2013 to half that figure, that means in 2013 it will need only $750,000 entering the system (again assuming 6 dollars per bitcoin, which most likely will change dramatically from this point).

A central bank when faced with a huge inflation rate like what bitcoins are experiencing would virtually halt printing of coins until demand caught up. However since bitcoins lack that aspect it’s going to be a downhill road in the per bitcoin price until 2013 unless demand increases dramatically (possible, but unlikely). Then the banker would most likely allow for it to increase based on demand back to it’s natural level.

However since we’re at the mercy of a algorithm penned in 2009, we have to wait until 2013 when the algorithm automatically will attempt to stabilize the price by reducing by half the amount of bitcoins printed. It’s an endless swing cycle until the year 2140 (abit a reduction in swings as each instance is half as much as the one prior).

Perhaps the best way to phrase this is simple. If bitcoins can survive with an above 3 dollars per bitcoin price until 2013, it’s most likely going to be with us forever.

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Written by TheFounder · Filed Under Advertising Agency News 


Comments

  • http://twitter.com/stevenwagner stevenwagner

    Why is $1.5 million dollars a month so staggering to you? Thats only $18 million a year. There are plenty startup companies out there who are able to get $100 million a year in funding from a single investment firm, and bitcoin has a much larger audience.
    Also, you can change your figure and guesstimate that 50% of miners are speculating and holding their coins because they have already paid off their hardware costs and have cheap/free energy. So that cuts the need down to only $9 million in new funds a year.

    For some people, its quite easy to drop a mil into a project they like. Just look at politics.

  • Anonymous

    I am not disagreeing… it’s just unlikely it will reach that point in anything looking like a short order. As much as we like bitcoin, it’s path is most likely going the linux route. Where it’s a slow uphill battle over the course of 20 years… but one day someone picks up his android phone, searches on Google and realizes where that came from.

    Of course someone could come up with a killer idea and make that happen quicker… or someone in Washington could come up the opposite idea and send it underground. Or someone in Wall Street could start investing in them in large numbers sending the price skyrocketing.

    The issue is honestly we don’t know what will happen. It could be a mixture of all of them.. Someone makes a client that is so easy to use that everyone can use it, Wall Street Traders get excited about it and start investing, the price skyrockets and because of that Washington get’s involved…

    Interesting times

  • http://twitter.com/stevenwagner stevenwagner

    Miners are barely able to make a profit as it is, so its not like they have tons of coins they need to dump on the market to rake in their rewards. They are lucky at this point if they are able to get a few coins with how heavy the competition is, so I think most miners are going to be holding their coins and planning for the bright future.

    The price of bitcoins is determined not by the amount of new coins generated, but by supply and demand. It doesnt matter is 7200 coins are generated if none of them get sold. At the same time, someone who bought coins a year ago could decide to drop 10,000 coins on the market. Its simply a matter of supply and demand. Just because someone has coins doesnt mean they are going to sell them.

    What is going to determine the market is PR! New businesses being launched…the state of the economy. If bitcoins are perceived as becoming more valuable, people will pay more for them and sellers will be less likely to let them go at a lower price.

  • Anonymous

    “The price of bitcoins is determined not by the amount of new coins generated, The price of bitcoins is determined not by the amount of new coins generated, but by supply and demand.”

    Steven, what you wrote is a contradiction… the NEW COINS PRINTED ARE THE SUPPLY and boy is that supply growing MUCH faster than demand.

  • http://twitter.com/stevenwagner stevenwagner

    Supply is the amount of coins for sale, not the number of coins existing. But I agree that more coins entering the market will mean more for sale. At the current rate of coin creation we have 2.8% inflation per month. Can demand for bitcoin demand grow by 2.8% per month to keep up with this? I think so. Probably a lot more coins are being sold then are being mined, and that the price is going down because of early investors cashing out. Probably just fear more then anything else. Keep the btc being redistributed!