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The Currency Distribution Problem

The Currency Distribution Problem

Posted by Daniel Larimer on .
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The Currency Distribution Problem

Posted by Daniel Larimer on .

The distribution of currency is extremely controversial and ultimately a political issue. Whenever new currency is created it transfers value from the previous holders of the currency to someone new. A similar economic outcome could be achieved by a savings tax that reduces everyone’s balance and gives it to someone else. If markets were perfectly efficient then the purchasing power of someone’s account would be the same whether the inflationary approach or the tax and transfer approach is used.

When a currency is as universally accepted as the United States dollar people are left with little recourse except to complain while their purchasing power is slowly eroded. The ability to control where new money is directed gives the government and the central bank almost unlimited economic power. Even the most benevolent dictator backed by the most efficient bureaucracy would be unable to efficiently allocate even a small amount of inflation.

The problem of currency distribution also comes up when creating a new cryptocurrency. Bitcoin came up with the idea of using an objective measure of work, mining, as the basis for distributing its currency. The work performed added value to the Bitcoin network by making it costly to counterfeit the ledger. The problem with mining is the diminishing marginal utility each additional unit of work adds.

In light of newer, more efficient, algorithms for preventing counterfeit ledgers the question of how to distribute a new currency remains. All new distribution is ultimately inflation, so the question of how to distribute a cryptocurrency is ultimately the same as how to allocate inflation.

The Paradox of Scale

It seems intuitive that initially all currency must belong to its creator. The creator is faced with the challenge of distributing her currency in a manner that will give it the most value possible. If the creator retains ownership of all of the currency, then it will have no monetary value. This is where the creator faces a paradox where distributing more of her currency via inflation actually increases the purchasing power of her tokens. Satoshi used mining to distribute the inflation of his currency and as a result the Bitcoins he retained are worth hundreds of millions of dollars.

Bitcoin is advertized as a fixed supply currency even though new Bitcoins will continue to enter circulation for the rest of our lives. The economic impact of new mining rewards is identical to inflation or a tax and transfer. We can conclude from this that inflation is not an impediment toward a currency gaining value.

The real problem is how could a cryptocurrency like Bitcoin allocate over $1 million dollars per day in a manner that was widely perceived as fair and decentralized. At what point in time does inflation cease to have a positive effect on the valuation of a currency and start to have a negative impact?  Somewhere between the day a currency is created and the time it becomes the reserve currency of the world inflation changes from being a net-positive to being a net-negative.  Perhaps the problem isn’t the inflation itself, but how the decisions regarding its allocation are made that doesn’t scale.

BitShares

Systems like BitShares allow currency holders to vote on where to allocate new inflation. Many of these voters understand the negative impacts of inflation on a national currency, but fail to see the difference between inflating to grow vs inflation after maturity. These voters prefer to tax usage and then use a voting system to allocate the tax revenues. At scale, BitShares would end up with a committee of elected politicians voting on how to set the tax rates and a congress of voting proxies deciding how to allocate tax income.

Stellar

Stellar distributes 1% of its currency, lumen, via a direct voting method similar to “participatory budgeting”. Every account is able to select another account to receive new currency. Any accounts that have at least a minimum number of votes (0.05%) receive their pro-rata share of the new lumens. This system suffers from the prisoner’s dilemma where large stakeholders have more financial incentive to vote for themselves than for others while simultaneously limiting the number of people may qualify for rewards to less than 2000. On a national scale, this is like distributing money to only the congress, senate, president, federal judges and the Fortune 500.

Irrationality about Politics

People are irrational about politics. I define politics to be any discussion about how other people should behave. In this case, it includes discussions about how inflation should be allocated. Political irrationality is polarizing and causes people to divide into camps or tribes. Political division works against the goal of maximizing network effect and therefore the value of a currency.

The more people impacted by a political decision the more polarizing and irrational the debate becomes. A cryptocurrency that attempts to centralize the allocation of inflation will tear itself apart after it reaches a certain size. BitShares has users vote on which projects to fund. There mere act of giving the stakeholders the option to not fund anything is enough to make every project and its funding extremely political.  The typical voter employs rational ignorance regarding political issues because the cost of acquiring knowledge is greater than the benefit having that knowledge would bring them.

I can conclude from this that distribution of a currency and its inflation cannot be dependent upon any one party or even a relatively small group of elected individuals. Voters are unable to vote reasonably on issues for which they are rationally ignorant.  Currency distribution must be massively decentralized and distributed by people who are not ignorant about the causes they are funding. At the same time, distribution must be done in a way that discourages people from simply colluding to keep as much of the inflation for themselves as possible.

Until a solution is found, I encourage everyone who holds BitShares to consider whether we, collectively, are closer to Satoshi or the US Dollar in terms of the impact inflation will have on our currency. The political debates are already tearing the community apart. Each lost debate causes someone to leave which in turn usually creates more sell pressure on the price of BitShares than the inflation we were debating about.

Perhaps BitShares should decide once and for all whether it wants no inflation or maximum inflation (5 BTS/sec). Once the decision is made we can remove the inflation debate from the political discussion and move forward based upon this outcome. If a decision for maximum inflation is made then we can debate over what should be funded and who should get it. Either way the sell pressure from the inflation would be baked into the price and would no longer be relevant to the discussion.

Whether BitShares opts for no-inflation or maximum inflation I believe it will be better for its long term success to make a decision and stick with it.

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Welcome!

My name is Daniel Larimer and I am the founder of BitShares. My mission in life is to find free market solutions to secure life, liberty, and property for all.

The purpose of this blog is to help create a free society by encouraging people to join our community which is centered around Bitshares, a next generation fully decentralized crypto-currency exchange. I use Austrian Economics to engineer the economic incentives which make freedom and non-violence profitable.


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