Bitcoin and Blockchain Technology: Hayek Money

Bitcoin and Blockchain Technology The Cryptocurrency Frontier in Commodity Monetary Standard

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Table of Contents

1. Bitcoin, Money, and Gold

2. Hayek Money

3. Dual Asset Ledger & Reserve Asset Bank

Ferdinando Ametrano 2017 2/55

Understanding Lags Well Behind the Hype

Understanding of the technology however lags well behind the hype, amongst practitioners, policy makers and industry commentators alike. ‘Blockchain’ technology seems to promise major change for capital markets and other financial services – some say it may ultimately prove to be as important an innovation as the internet itself – but few can say exactly how or why.

Michael Mainelli, Alistair Milne (2016)

The Impact and Potential of Blockchain on the Securities Transaction Lifecycle http://ssrn.com/abstract=2777404


http://ssrn.com/abstract=2777404

Why Bitcoin Is Hard to Understand

At the crossroads of:

1. Cryptography

2. Distributed systems (networking and data transmission)

3. Game theory

4. Economic and monetary theory

Mainly not a technology,

a cultural paradigm shift instead


• Decentralized digital currency • Not backed by any government or organization • Instantaneous peer-to-peer transactions • No need for trusted third party • Cryptographic security • Synergic economic incentives • Efficient low-cost banking for everybody everywhere

https://bitcoin.org/en/faq http://www.coindesk.com/information/


https://bitcoin.org/en/faq

http://www.coindesk.com/information/

The Information Economy

• Data is transferred with zero marginal cost

• Why pay a fee to move bytes representing wealth?

• Why only 9-5, Monday-Friday, two days settlement?

• Who (and when) will gift humanity with a global instantaneous free p2p payment network?

BANK


Bitcoin

• Decentralized: no central authority, no intermediaries

• Permissionless: no regulator

• Censorship resistant: no frozen funds

• Open-access: no discrimination, no amount limits, 24/7, 365 days

• Free: negligible transaction costs

• Borderless: no geographic limits

• Transnational: no specific jurisdiction applies

• Secure: non falsifiable, non repudiable transactions

• Resilient: nothing has been able to stop it or break it


A Bitcoin Transaction https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3

About $83M transacted with $0.04 fee


https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3

BTC/USD Exchange Rate http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25

• BTC Market Cap: about $50B (USD M0 1959-2017 average has been $680B)


http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25

http://www.tradingeconomics.com/united-states/money-supply-m0

Double Spending Problem

• To securely transfer value using digital means has been possible for decades

• In digital cash schemes, a single digital token, being just a file that can be duplicated, can be spent twice

• A centralized trusted party has always been required to prevent double spending


Mining

• All bitcoin network nodes validate and propagate transactions

• Transactions are cleared in blocks, thus a blockchain: the nodes providing computational power for clearing are called miners

• Miners compete to validate a new block of transactions: the winner providing proof-of-work is rewarded with the issue of new bitcoins in a special coinbase transaction included in the block

• Miners solve the double spending problem: – conflicting transactions spending the same coins would invalidate the block

– an invalid block would be rejected from the network

– the bitcoin reward would be removed from transaction history

– miner would have wasted his work Ferdinando Ametrano 2017 11/55

Distributed Consensus

• How do miners reach consensus on the transaction history?

• Consensus in an asynchronous network with faulty (or malicious) nodes is proved to be impossible

• A problem known as Byzantine General Problem


Nakamoto Consensus

• Nakamoto achieves Practical Byzantine Fault Tolerant consensus using (game theory) economic incentive for the mining nodes to be honest. Bitcoin – solves double spending without a central trusted party

– can resist attacks of malicious agents, as long as they do not control network majority

• Miners are compensated for their proof-of-work using seigniorage revenues, i.e. with issuance of new bitcoins

• Seigniorage revenues subsidize the network, making transaction almost free


Network Costs Covered By Seigniorage Revenues • 144 blocks per day, 365 days per year

• 12.5 BTC per block, $6,000 per BTC Currently about $4 billions per year (as of November 2017)


Virtuous Cycle

Hashing Power

Bitcoin Security

Bitcoin Price

Mining Reward


Validation Process: Block Generation

The proof-of-work difficulty is adapted to the overall available computing power to ensure an average of one block every ten minutes


Bitcoin Monetary Rule

• 2009: 50BTC per block, every 10 minutes

–halving every 4Y

• This is the only way new bitcoins are released

• It is called mining because of its similarity with the progressive scarcity of gold extraction

• Supply free of discretionary intervention


Bitcoin Inelastic Supply: Deterministic Decreasing Rate

chart

2029: 96.88% of

all BTC issued

2141: last satoshi

(0.00000001 BTC)

will be issued


What after 2141?

• We are all dead ;-)

• Gradually switch over to a fee-based system: as block space is limited, market is already requiring a growing satoshi/byte fee to be included into a block

• Switch to a different paradigm? We have about 120 years to come up with a solution


What Makes Bitcoin Special?

• Digital and scriptural: it only exists as validated transaction • Asset, not liability • Bearer instrument • It can be transferred but not duplicated

(i.e. it can be spent, but not double-spent) • Scarce in digital realm, as nothing else before • Mimicking gold monetary policy • More a crypto-commodity then a cryptocurrency

Bitcoin is digital gold this is the brilliant groundbreaking achievement by Satoshi Nakamoto


Trade Economy From Gold Standard to Fiat Money

• Gold: the commodity money standard – scarce

– pleasant color, i.e. resistant to corrosion and oxidation

– high malleability

– relative easiness of its purity assessment

• Gold purity certification

• Representative money

• Fractional receipt money

• Fiat money and legal tender


Money As A Social Relation Instrument

1. Human beings are born into a gift economy

2. Enlarged relationship circle requires exchange economy

3. Barter economy: coincidence of wants

4. Trade economy: money as medium of exchange

5. Global information economy: supranational digital money


Friedrich August von Hayek Denationalisation of Money

• history of coinage is an almost uninterrupted story of debasements; history is largely a history of inflation engineered by governments for their gain

• why government monopoly of the provision of money is regarded as indispensable? It deprived public of the opportunity to discover and use a better reliable money

Blessed will be the day when it will no longer be from the benevolence of the government that we expect good money but from the regard of the

banks for their own interest

A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204

Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs, http://www.mises.org/books/denationalisation.pdf


https://mises.org/daily/3204

http://www.mises.org/books/denationalisation.pdf

Permissionless Innovation Fast and Effective

• No centralized security mechanism, no barrier to enter, no editorial control

– Email has not been designed by a consortium of postal agencies

– Internet has not been developed by a consortium of telcos

• Will a decentralized transactional economy be shaped by a consortium of banks?


Explain Money to an Alien

fiat money

• No intrinsic value (legal tender, social contract)

• Currency based on paper/ink security

• Discretionary governance

• Wicksellian interest-rate approach

bitcoin

• No intrinsic value (digital gold)

• Currency based on math/cryptographic security

• Algorithmic governance

• Deterministic supply


Bitcoin as (Digital) Gold in the History of (Crypto)Money

gold • Its adoption was not centrally

planned

• For centuries it has been the most successful form of money

• It has bootstrapped all monetary systems we know of

• It has been surpassed by other kind of money without becoming obsolete

bitcoin • Its adoption has not been centrally

planned

• It is the most successful form of cryptocurrency

• It will bootstrap new monetary systems

• It might be surpassed by more advanced type of cryptocurrencies without becoming obsolete


Table of Contents


2. Hayek Money



Unit of Account: Money as Numeraire

• Money is the unit of account against which the value of every other good is measured

• The price system measures the value of goods relative to the value of money

Good money should provide stable prices to best perform its role as unit of account


Money Comparison Medium of Exchange Store of Constant Value Unit of Account

Live cattle

Diamonds

Gold

Fiat coins and notes

Bitcoin

• swappable • fungible • portable • divisible • recognizable • resistant to

counterfeiting

• reliably saved, stored, and retrieved

• retain usefulness over time

• Maintain its storage properties

• non-perishable or with low preservation cost

• relative worth unit of measure

• stable value for stable price comparison

• supply must be controlled in some way


The Holy Grail of Stable Prices

• Gold standard, bimetallism, symmetallism

• Fixed value of bullion (Aneurin Williams 1892)

• Compensated dollar (1911-20 Irving Fisher)

• Commodity Reserve Currency (1932 J. Goudriaan, 1937-44 B. Graham, 1942 F. Graham, 1951 M. Friedman)

• ANCAP basket (1982 Robert Hall)

• Futures contracts (1984 Miles, 1989-95 Sumner)

• Quasi-futures contract (1994 Kevin Dowd)

• Price index option (2000 Kevin Dowd)


Bitcoin is Digital Gold Not a Good Unit of Account

• no salaries, no mortgages, no stable purchasing power

• successful at getting rid of a centralized monetary authority, it has given up the flexibility of an elastic supply of money


Hayek Money

• The cryptocurrency monetary standard of elastic non-discretionary supply

• Price stability paradigm with respect to a given reference basket

• Concurrent cryptocurrencies will compete in monetary policy definition and reference basket choices


Fixed USD Exchange Rate

• USD/BTC: 15-Apr-11 1.0, 29-Mar-14 500.0

• x500 increase for BTC demand relative to USD

• 29-March-14: 12.5M bitcoins in circulation

• Inflate their number 500 times to 6250M

• On 29-Mar-14 it would have been equivalent

– to own BTC1 worth $500

–or (rebased) RBTC500 each worth $1


USD-Parity (Daily) Rebased Bitcoin • Adopting the USD Consumer Price Index

• 6% inflation in the period March 2011-2014


1.06

Avoid USD Monetary Policy: Brent-Wheat Commodity Price Index


Brent-Wheat Commodity Price Index Rebased Bitcoin


Brent-Wheat Commodity Price Index


Rebasing Bitcoin?

No, not really!

• Bitcoin has been used for the sake of discussion, basically to leverage its historic price time series

• Bitcoin is good as it is: more of a cryptocommodity than a cryptocurrency, bitcoin is digital gold


Hayek Money This First Simplistic Implementation

• Results: – Price stability

– Salaries, mortgages, forward payments are now possible

• Problems: – Number of coins in a wallet changes without direct in/out flows

– Purchasing power of a given wallet is not stable

– Coins still have speculative investment appeal and so enjoy limited transaction usage


Table of Contents


2. Hayek Money



Hayek Money Implemented as Dual Asset Ledger

Split transactional and speculative money demand with two non-fungible assets: • (stable) transactional coins • (unstable) speculative shares Blockchain technology tracks ownership and transactions for both: dual asset ledger


Reserve Asset Bank IPO

• Raise bitcoins as reserve asset in 𝑅𝑒𝑠𝐴𝑠𝑠 quantity Better to avoid non-crypto reserve assets: a custodian legal entity would

be required, re-introducing centralization

• Issue 𝐶 coins and 𝑆 shares

Monetary base is backed by 𝑅𝑒𝑠𝐴𝑠𝑠: 𝐶 ∙ 𝑃𝐶 + 𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠


Monetary Policy Target

Coin is pegged to a given reference basket for price parity:

𝑃𝐶 ≅ 1, allowing for a corridor, e.g. 0.95 < 𝑃𝐶 < 1.05

• Must be 𝐶 ≪ 𝑅𝑒𝑠𝐴𝑠𝑠 at IPO

• Hopefully 𝐶 < 𝑅𝑒𝑠𝐴𝑠𝑠 any time later on

The Reserve Asset Bank (even as Decentralized Autonomous Organization) enforces price boundaries by market operations using reserve assets


Monetary Phases

Expansionary monetary phases (when 𝑃𝐶 ↑ 1.05):

• new coins are minted by the Reserve Asset Bank and sold for 1.05 in exchange for bitcoin (increasing reserves)

Contractionary monetary phases (when 𝑃𝐶 ↓ 0.95):

• existing coins are bought at 0.95 (and destroyed) by the Reserve Asset Bank using bitcoin (until reserves are depleted)


Reserve Asset Bank: Stable Coins

• When 𝑃𝐶 ≅ 1, coins give up any speculative value

• Money velocity and transaction volume increase 𝑀𝑉 = 𝑃𝑇

M is the money supply (total amount of money in circulation;

V is the velocity of money for all transactions in a given time frame;

P is the price level;

T is the aggregate real value of transactions in a given time frame.

• Coins should not be inflated/deflated arbitrarily

• Transaction validation must be rewarded with the issuance of new shares, not coins


Reserve Asset Bank: Seigniorage Shares

Seigniorage: profit made by a currency issuer, especially the difference between the face value of coins and notes and their production costs

• Shares are never burned/destroyed

• Shareholders are in charge of reference basket maintenance

• The share price is free to float: shareholders absorb all monetary policy’s costs and benefits, shielding coin holders from volatility

• Share value = assets - liabilities 𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95


𝑃𝐶 ↓ 0.95: Losses for Shareholders

𝑆 ∙ 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95

• If 𝑃𝐶 ↓ 0.95 and 𝑅𝑒𝑠𝐴𝑠𝑠 < 𝐶 ∙ 0.95: coin is dead, Reserve Bank defaulted, 𝑃𝑆 = 0

• If 𝑃𝐶 ↓ 0.95 and 𝑅𝑒𝑠𝐴𝑠𝑠 > 𝐶 ∙ 0.95: coin is dead, Reserve Bank has not defaulted, 𝑃𝑆 > 0 (no interest for stable coins, shares are the equivalent of bitcoins)


𝑃𝐶↑ 1.05: Profits for Shareholders

• fresh new coins are minted and sold in exchange for reserve assets pushing 𝑃𝐶 down to parity

• Reserve assets increase by 1.05

• Coin liabilities increase by 0.95

• Net effect: 𝑃𝑆 ↑


Leverage Bitcoin As Reserve Asset

• Bitcoin is the first and most successful instance of an intrinsically scarce digital asset: it’s digital gold

• When used as reserve asset, its qualities are magnified!

• Its limits are lessened. No more need to: – scale to huge (cash + bank accounts + credit cards) number of transactions

– support economically inefficient micropayments

– lower confirmation time

• The Reserve Bank IPO raises bitcoins, issues seigniorage shares and stable coins


The Ultimate Fate of Bitcoin: To Serve as a Reserve Currency

https://bitcointalk.org/index.php?topic=2500.msg34211#msg34211

Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer hired after Phil Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and received the first bitcoin transaction from bitcoin's creator Satoshi Nakamoto.




Transaction Validation Proof-of-Payment

• Instead of the hardware and electric power expenses of proof-of-work, bitcoins are irrevocably paid to the Reserve Asset Bank by validating nodes (proof-of-payment)

• Chances of being appointed for the next block generation are proportional to the overall submitted payments, i.e. to the accumulated proof-of-payment

• When a node is picked up for block generation its proof-of-payment resets to zero

• Even if a node is not picked up, its payments are never reimbursed


Transaction Validation Proof-of-Payment

• Block generation is rewarded with the issuance of a new share

• Since 𝑃𝑆 = 𝑅𝑒𝑠𝐴𝑠𝑠 − 𝐶 ∙ 0.95 𝑆 , that should be the price a rational agent is willing to commit as payment

• Share price estimation in bitcoin is obtained as by-product

• Existing shareholders are not really diluted: for the issuance of each new share, 𝑅𝑒𝑠𝐴𝑠𝑠 increases accordingly


Bibliography

• Ametrano F., Hayek Money: the Cryptocurrency Price Stability Solution, http://ssrn.com/abstract=2425270

• Morini M., Inv/Sav Wallets and the Role of Financial Intermediaries in a Digital Currency, http://ssrn.com/abstract=2458890

• Sams R., A Note on Cryptocurrency Stabilisation: Seigniorage Shares, https://github.com/rmsams/stablecoins/blob/master/00-main.pdf

• Buterin V., The Search for a Stable Cryptocurrency, https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/

• Ametrano F., Cryptocurrency Price Stability With Seigniorage Shares And Reserve Bank, http://ssrn.com/abstract=2508296




https://github.com/rmsams/stablecoins/blob/master/00-main.pdf



https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/






Bibliography

F. Ametrano, Bitcoin, Blockchain and Distributed Ledger Technology: Hype or Reality? (2017) https://goo.gl/Z9OeHt

Bitcoin and Blockchain Technology videos (ITA):

• Introduzione https://www.youtube.com/watch?v=Ef3d1N4Ogxw&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=1

• Hayek Money https://www.youtube.com/watch?v=Wu_7RVwoV84&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=2

• Distributed Ledger Technology https://www.youtube.com/watch?v=ByzoYHx7eTc&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=3


https://goo.gl/Z9OeHt

https://www.youtube.com/watch?v=Ef3d1N4Ogxw&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=1

https://www.youtube.com/watch?v=Wu_7RVwoV84&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=2

https://www.youtube.com/watch?v=ByzoYHx7eTc&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=3

Conclusions 1. Bitcoin solves the double spending problem relying on seigniorage

revenues 2. Bitcoin is a scarce digital asset, i.e. the digital equivalent of gold 3. Hayek Money is the price stability paradigm of elastic non-

discretionary money supply 4. Coin/share dual asset ledger can decouple transactional and

speculative money demand 5. Bitcoin can be used as reserve asset by a decentralized Reserve

Asset Bank (DAO) to stabilize the coin 6. Proof-of-Payment leverages bitcoin as off-chain resource to be

consumed in order to receive seigniorage revenues


Bitcoin and Blockchain Technology: Hayek Money

Economy & Finance