Bitcoin’s Conundrum: Rewarding hoarders and punishing users

July 8, 2014

There are, theoretically, almost 13 million bitcoins in existence. Of this figure, I am going to assume that at least 2 million bitcoins have been lost. I believe this is a conservative figure, many more may be buried in long forgotten hard drives and Mt. Gox has accounted for a few, if Mark Karpeles is to believed. So that leaves us with 11 millions. Now, we don’t need all of those 11 millions to function successfully, as a matter of fact Bitcoin could function successfully as the World’s number one currency if we only had 1 Bitcoin. This would, of course, mean that that Bitcoin would be subdivided into tiny fractions that would account for all purchases and payments.  The lower the number of bitcoins in existence the greater the value of an individual Bitcoin; If there were more bitcoins, there would be a lower individual value on each one. Now, every day, the world destroys bitcoins; we lose keys and codes, the computer get’s lost, formatted or stolen, or we hit the wrong key and send a payment to a wrong address. So the amount of bitcoins is never what it should be. This leads us to Bitcoin’s Conundrum.

Bitcoin’s Conundrum

Imagine an island paradise with only one currency; coconuts. This particular island has no coconut trees and, therefore, the number of coconuts is capped. There are 100 coconuts. These coconuts are used extensively for every transaction, and each coconut will buy ten chickens, or twenty silver fish. If someone buries ten coconuts, and then dies, there will be only 90 coconuts in existence and since the island community cannot create more coconuts the price level must adjust. The value of each coconut must increase by 10%, and they can now buy more chickens and fish. The value of the total currency remains unchanged. This will be the case until the coconuts that were buried are brought back into circulation. Now this creates Bitcoin’s conundrum.

If there are 11 million bitcoins and owner’s choose to hoard their coins then the value of Bitcoin goes up. You look at your wallet in January and you have 100 bitcoins and the fiat worth is $50,000. You choose, like the majority, to hoard and next January you have 100 bitcoins and the value is $70, 000. If you cash out, and the majority of others don’t, you get the full 70K. But, for this to work, someone, somewhere, must be spending bitcoins. If everybody hoards we end up with a lot of complex encryption codes and no value. So Bitcoin’s conundrum is that the value is being maintained high by the practice of hoarding and hoarding is taking place only because of those users that make it possible by spending the currency.

Some will argue that Bitcoin’s conundrum is dependent upon the fact that all Bitcoin hoarders will not choose to cash out at the same time but this is the same logic that banks use. Your money is on deposit and they lend it out at a profit. If you go in for a withdrawal, they can meet your request for funds; if everyone goes in to withdraw funds then the bank has a run. People tend to follow patterns of behavior. But, assuming I have 100 bitcoins in my wallet today, the temptation is to hold them in expectation of an increase in value. Remember bad money pushes out good. Dollars and Euros will not go up by thirty, fifty, one hundred percent in the next year, Bitcoin just might.

This, of course, still leaves the question of how we reinstate the coins we have destroyed, but I will leave that sit for another day.

Featured image by Shutterstock.

PJ Delaney @P.J. Delaney@delboyir

Masters in Public Administration, Bachelors in Mgt., I live in Ireland, I have a bit of a background in Economics and lots of opinions on everything else.