Deflationary structure does not provide incitation for use of money

Developers Misc Dev Talk
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Hey all,

Cardano is a great project, certainly one of the most advanced technically. However, the economics seem to contradict the will to use it as a mean of payment and a tool for smart contracts.

To put it very simply, the price of the token is linked to the scale of its use (aka demand), the velocity of the transactions and the total number of tokens available on the market (aka supply).

The canonical equation is PY = MV where :
P : Price of a unit of money
Y : Volume of goods exchanged in the economy
PY : monetary GDP
M : Total coins available
V : Speed of circulation of money in the economy

Your aim, if I’m not wrong, is to create a coin used for transaction, such as a fiat money enhanced with a ledger and smart contracts. If your money gains enough traction, you will necessary encounter an increase of use to exchange goods, leading to an increase of Y.

SInce supply of money is follows a concave curve ending at 45G Ada[1], at one point M will stop to follow the growth of Y and thus P will need to increase to provide liquidity to the market. In layman’s terms, that means that the value of coins will increase, in a deflationary fashion. That’s what is happening with bitcoin at the moment. That’s what happened with gold or silver before.

What are the incitations of the stakeholder in such system? You may have many people willing to sell good in exchange of your coin, since they expect the price of your coin to increase in the future (million dollar pizza effect). However, no one will want to buy stuff using it when they can use inflationary cash ($). The best response is thus to keep it (HODL effect). This leads to the well known effect of a deflationary spiral[2]

Since no buyer is willing to use the coin as a mean of exchange, the coin may as well be worthless. The only source of valuation on the market are the speculators that want to enter the market, resting on the irrationnal(?) belief that the coin will get traction and get used as a mean of exchange for goods (and not only classic fiat money). That’s again what we are seeing for bitcoin.

The classic role of a central bank is to keep the monetary creation is check with the GDP, ensuring a price stability and discouraging speculation in favor of investment and hard work.

My questions to the devs :

  • Why don’t you adress this very well-known problem in the docs?
  • How do you propose to avoid this effect?
  • Why should I start contracting in your currency if I know I’ll earn more money holding my coins and cashing in later?

[1] https://cardanodocs.com/cardano/monetary-policy/
[2] https://www.investopedia.com/terms/d/deflationary-spiral.asp

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I have said in the forum that I would like this issue debated. So I am glad to see someone making the case. However, it is a long term issue. Once minting starts it will be at full minting rate, so the issue can be put off a bit. Via the governance system everyone can decide if it is better to have capped, constant inflation or variable inflation.

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Deflation provides an incentive to save, but at the same time as long as the rate is fairly consistent and transaction costs are low it shouldn’t be a impediment to spending in general. Problem with Bitcoin is if you spend 1 btc today at $12,000 it could be worth $17,000 tomorrow. No one is going to want to use it as a currency when it varies that much, and no one is going to want to price their goods in that system.

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spend 1 btc today at $12,000 it could be worth $17,000 tomorrow

It is valid for every cryptocurrency to different degrees, isn’t it?

To stay within the Bitcoin analogy, what if a side & paired currency was released, which value is stable and ideal to spend through the blockchain, while the existing one becomes the currency that oil the system, a sort of “share”? Currencies would function as pairs, one that is forever stable and used to be spent, and the other more as a “share” (ADA).
I don’t know I’m just throwing ideas around to solve the volatility problem. I’m not sure I am clear.

On second thoughts, it seems like a bad idea lol

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I believe you answered your own question as have the devs:

Devs (my take): Cardano is built for the future - millions and billions, not at all like the limited role playing out in cryptos now.

The more use Cardano delivers on the more stable its relative value will become.

We are in the Wild West phase at the moment, limited adoption, so speculation is to be expected. But once Cardano starts to make erodes into markets, especially those that lack true price discovery, well that will be something to witness.

We are after all talking about real versus nominal value. Today we have no true price discovery, everything is skewed in favor of x or y outcome.

So I’m changing your title, adding in mass adoption:
“Deflationary structure does not provide incitation for use of money, yet”

BTW
I agree with what you are getting at, I just don’t have any metrics that I would take action on.
GDP - compile it from Cardano - then I would know what GDP really is.
Unemployment - compile it from Cardano - then I would know what unemployment really is.

Do you see what I’m getting at?
We need real truthful data to make appropriate decisions, anything less and we are at best flying blind, worst already dying.

You cannot revive a living thing only something dead and dying.

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If you had $12k USD fiat today, instead of spending it, you could buy BTC/EUR/XAU/AMZN/X that could be worth $17k USD tomorrow. In other words, any economy where its participants can speculate and invest have the property of being implicitly deflationary. Is there anything wrong with this reasoning?

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This doesn’t make for a good liquid currency though. The reason people use dollars in everyday purchases is because a dollar today is pretty close to what a dollar tomorrow will be worth. If you knew that the $20 dollars in your pocket was going to be worth $100 tomorrow you wouldn’t spend it, but if you thought that the $20 dollars in your pocket might be worth $20.02 tomorrow you might go ahead and spend on stuff you need and save more.

US dollars used to be deflationary as well, as we’ve turned to inflation policies and low interest rates people are enticed to spend, and now everyone is in major debt.

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I believe it could easily be solved with two coins, ADA and ADA-CASH. ADA floats freely and is used for savings (store of value) while ADA-CASH is pegged to the US dollar and used for daily transactions. Daedalus should be able to easily store both and change from one to another with ease, perhaps with a built in exchange? ADA is fixed in supply while ADA-CASH can grow on demand by adding one zero to all wallets at once so there won’t be first receivers who have an advantage over the rest (FED/GOVT).

I hope somebody tries to implement this solution soon and I would like to be part of it.

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This is a very complex topic and I don’t think any of us have enough background in macroeconomics to discuss this properly (does anybody here have a Ph.D. in Economics?). In any case, I’m not convinced by OP’s argument nor I understands yours: first of all, we should separate the current speculative pricing of cryptocurrencies as these are not defined by them but by the market; the extreme volatility of Bitcoin is not related to the cost of mining (which is attached to the current difficulty, reward, electricity cost, hardware development, weather, etc.). I see the deflationary property defined by the controlled supply algorithm similar to how we can keep our fiat savings in a normal savings bank account. I know that I could buy US bonds today and have more fiat tomorrow, but if I want a new laptop today I will buy it today… it’s not like I am buying a laptop today because USD is inflationary (since the inflation rate is only significative in long periods of time). The only time when this pressure of buying things ASAP happens is when you have hyperinflation.

My hypothesis basically is that while the rate of inflation or deflation is lower than the growth rate of a stock market or a real estate market, people will not take decisions based on some inflationary/deflationary properties of their default currency.

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Absolutely @Ikarus , that was exactly my thought in a previous post above

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We don’t need any economic background to identify the pain points we face as daily users of commerce instruments and cryptocurrencies which are the first step in recognizing the need for solutions.

The most important social pain points are:

  • Volatility (Merchants won’t be changing prices on every crypto tick)
  • Fractionality (Consumers won’t buy a loaf of bread for 0.00634512 ADAs)
  • Convertibility (Consumers and merchants are resistant to make conversions from fiat to crypto)

The most important usability pain points are:

  • Instant confirmation (Some cryptos excel at this)
  • Vanity numbers (Sending money to 1-800-MYSHOP instead of 1a53380170f384699a45f09ed952edbed)
  • Simplified wallet (Easy conversion from fiat to crypto)

The most important technical improvements:

  • Scalable to millions of transactions per second (World commerce)
  • Minerless (Energy conciousness)
  • Low transaction fees (Pennies not dollars)

See, we should understand these pain points as users not as developers so the solutions come from ergonomics first and not from technology first, technology should facilitate the solution not impose it regardless of ergonomics or there will be high resistance in the adoption.

And that’s why a pegged crypto is the first step in that direction but nobody wants to face reality that everybody wants to get rich quick so currencies without profit are not even considered, and that sentiment comes from investors and programmers alike, while merchants and consumers (the real users) are ignored. And that’s why after a thousand cryptos nobody has cracked that nut yet, they’re all looking in the wrong direction. And that’s why the proposed solution implies the use of both a floating and a pegged currency, easily interchangeable, with a simple and powerful wallet every mere mortal can use and not just savvy geeks.

I firmly believe that’s the direction we should take in the crytpocurrency world whether it is Cardano or any other team. Cardano will provide the tools, we should provide the solutions.

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I agree 100%, you formulated my thoughts much better than me. ADA, like all cryptos, is designed for speculation (so far) on getting rich quick, while ADA-Cash would be the true solution for merchants and users, because its price would be stable.

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We don’t need a PhD in economics to discuss this topic. Inflation/Deflation on the US dollar is not strong enough to impact your spending decision on buying a laptop, this was exactly my point. You need the currency to be stable enough so that people can transact in it with the knowledge that the rate isn’t going to fluctuate wildly over the next day. Speculation is driving much of the volatility right now, and you are right that it isn’t tied to mining. In the end deflation still promotes saving, while inflation promotes spending. US dollars are inflationary, but only since the 1970s.

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I am sorry I didn’t understand that that was your point. I don’t think there is anything a decentralized cryptocurrency can do to avoid the volatility caused by the speculation of the market. This is why: Let us suppose we develop an inflationary altcoin, this could be accomplished in several ways (e.g. constant difficulty). What happens if the market suddenly have a lot of interest in this altcoin and start buying as much as they can? the supply will reduce and the price will increase, because even that in the long term more tokens will be minted, in the short term supply will be scarce, so whoever needs to use this altcoint will have to pay market price. What if we could just control the supply? how we could do that? for instance, we could let the network decide the reward based on the demand, but then the problem is how to quantify this demand. And then there is also the problem that some part of the network will probably have more interest in creating artificial scarcity than controlling the volatility.

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That’s the whole point of brainstorming, instead of saying no upfront.

Welcome to the discussion, we need more heads proposing solutions not more mouths saying it can’t be done.

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Continuing with the proposals, it’s a good idea to do some research on what has been done up to now and how they performed in the market, what were their good and bad points and why their failure.

I remember time ago there was a coin controlled by stakers that minted on demand and bought on supply to keep it pegged to the dollar, unfortunately don’t remember its name/symbol. Also right now we have USDT Tether which besides being in the eye of the storm it has accomplished that goal to perfection.

What else?

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But, we could get some phd macro economics to join the debate… i mean, Cardano foundation is a group of phd and engineers wich makes every step they make a little more strong.

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Accomplished what goal exactly? Tether is 100% centralized, and people using USDT have to trust in iFinex Inc.

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A crypto pegged 1:1 to the USD?

That’s the point. ADA-CASH would be semi-centralized (some replicator supernodes come to mind) and Cardano would be the gatekeeper (coordinator). Remember we are trying to introduce a non-volatile coin pegged to the USD to handle million of transactions in world commerce and need to propose different approaches. Cardano will keep ADA as store of value and Daedalus will easily handle both accounts.

Keep your savings in ADA and your daily expenses in ADA-CASH.

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First of all I am so happy to see this kind of questions. It shows the maturity of the people here. Keep it up!

Now on topic: This is a very good question. First we should ask ourselfs what gives the dollar, eu etc. its value? Why is Eu right now more valuble than dollar? When this question is answered, maybe we can apply the same model into cryptocurrencies?

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