Do High Transaction Fees Give More Meaningful Transactions?

The block size debate is reaching a new higher level, we may never get over it. With the slow propagation of segregated witness and the heavy transaction load on the bitcoin network seen in the last months as the price retests $1200USD. The once simple debate, it has now become philosophical and expansive. It can be polarising, we now have bitcoin Unlimited being proposed rather than just 2mb blocks, but broad concepts need to be taken into account. It calls for a fresh morning mind I had. I had felt a little hazy on the subject until this morning. I think the debate is a challenge worth detailed discussion.

The heart of the debate is what you believe is the main purpose of the bitcoin blockchain. To me after allowing for transaction to occur in a decentralised way, providing transparent transaction information is its main purpose. This I think is an antidote to the problems of the 2008 financial crisis.

Transparency and publicly useful information sets bitcoin apart from the more anonymous altcoins (like Dash or Monero, some people would gladly drop public information for privacy). The bitcoin blockchain allows the public to track and analyse the flow of value in the world in real time in a way that was impossible in the past.

The problem now is that if someone wants to buy ice cream from the store and have the transaction be on the blockshain in ten minutes then they would need to pay a fee equivalent to 50c. Not really practical and not good for adoption, especially in the poorest countries that need bitcoin the most.

Segregated Witness, a technical bitcoin upgrade, is set to help with this by more than doubling the capacity of the bitcoin network and therefore reducing the amount competition in the elective fee market. But as "SegWit" comes in it also allows for sidechains and the lightning network. this is no small change, they effectively allow for infinite transactions. Though the block size easily becomes the focus, It is actually the auxiliary applications that are most significant and that may come at a higher cost. there are risks here to decentralisation, transparency and quality of information.

Sidechains can be centralised (owned by a company) which is very un bitcoin like. Though they might be seen as a poor substitute they do offer a good medium ground for people transitioning from banks. They are likely to have a real time record of transactions that is easily compatible with current block chain analysis software. Corporate governance lays a veil in front of transparency and allow government involvement. Side chains are also not required to publish their transactions. This means information on some ice cream transactions can be lost. Sidechains mirror the altcoin function and in my opinion erodes bitcoins point of difference.

The lightning network is in a way similar to sidechains in that it makes transactions off chain near unlimited, but it is different because it is not centralised. It does however potentially impact on transparency by adding a layer of complexity to the information that can be extracted from the blockchain. This is because transactions use smart contracts secured by the blockchain and are not accounted for in the standard transaction format. Lightning network, i think on the whole is a better system, as far as sticking to the original principles of bitcoin as digital cash, but it could compromise bitcoins point of difference as a transparent record as compared with more private crypto currencies.

Does bitcoin need all of its transactions to show up on the block chain? Many would argue that this currently doesn't happen anyway. Do we need a permanent publicly traceable record of transactions less than $5 in value? I argue that we can split transactions into multiple types  and get better information, better privacy and better transparency all at once.

Already user are able to divide and manipulate transactions into larger and smaller parts on the blockchain. They may want to do this to hide the true purpose of the transaction ie: illegal stuff. At the moment this is expensive. These transactions will move to specific sidechains and networks because of the costs and this somewhat false coin mixing data will no longer muddle blockchain data. Transaction requiring low levels of trust will also move off of the blockchain, for example when people need to move funds from one personal wallet to another. the cup of coffee purchases will also begin to make more sense on the blockchain because they can all just be aggregated when merchants sell bitcoin. At present it is possible that merchant payments show up twice on the blockchain, as the item is purchased and again as the coins are sold. The better data differentiation and aggregation within bitcoin may actually give us a clearer view of what is going on in the bitcoin economy.

Big data is a complex issue. It may be that the NSA's "collect it all and get no distortion" philosophy is not ideal when looking specifically at financial data. A compromise may be needed to preserve decentralisation, transparency and maintain useful information on the blockchain. In a world where bitcoins transactions are ever increasing and altcoins are fast on its tail, something needs to be done. Bitcoin will become more complex but I think analytical systems will be able to handle it.

   

Bitcoin Inflation Convergence

A few months ago bitcoins "inflation" rate was effectively halved from 8% to 4%. This happens through a process called the halving, where the supply of new bitcoins is reduced every 210,000 blocks (or approximately every four years). We have seen demand for the currency growing faster than this creation rate which theoretically leads to bitcoins price increase. Since the last halving we have seen the price of bitcoin go up around 80% to date.

National price inflation rates, the ones people used to talk about in the 80's and 90's are rising reported at around 2% in the USA. What happens when bitcoins reducing inflation rate and increasing headline inflation rates converge? Could there be a relationship between interest rates, national inflation and bitcoins increasing value. Could this changing environment put cash "behind the curve" in a whole new way?

Though these are not calculated in quite the same way for bitcoin, at its next halving it's inflation rate (1.73%) will match the 2% target or ceiling that many countries now use. At this point, we could assume that the bitcoin price should be theoretically stable against the dollar if all other factors stayed the same and volatility is put aside. This halving is due to happen in 2020 with another in 2024 and again until eventually, the rate becomes zero. At this point, we could expect the bitcoin price go up, all things equal again, by the same rate as the national inflation of that year. If countries hold a 2% inflation rate this means the older bitcoin gets the more upward pressure there is on its price and the more attractive it is a store of value as compared with cash. In other words, bitcoin users automatically earn interest on all their bitcoin accounts.

You can see in this situation why more and more people would prefer to be involved in the bitcoin economy and want to move all their finances into this space. The math that once had the effect on average of slightly dampening bitcoins price growth will start to provide an increasing boost. There comes a point where if you are a large investor and have cash you will want to move it all over to bitcoin. Further to this, the curve can become moon like when it gets to a point where it will be worthwhile for a company, able to take out a fiat loan at a low rate, to hold bitcoin with that money rather than pay down debt. Because you can deduct the inflation rate from the interest and then add the expected gains from holding the asset,

It all does sound extremely bullish but there are a few details to be aware of. The premise relies on bitcoin holding together, proving itself as a hard currency, not being replaced and most probably also sorting out transaction volume. Also comparing the money supply side calculations of inflation used for bitcoin with the purchasing power calculations like "core PCE" of fiat currencies like the USD is not an exact match. Bitcoin price can move up and down a lot where the supply is constant. Conversely, fiat values are relatively consistent even when the supply (money printing) is increased a lot. Though this may balance out in the longer term for fiat, there is a level of control here. The PCE number does not show the whole picture in fiat and this is not yet available in bitcoin. We need a new measure for bitcoins inflation and deflation and value growth something to match the current PCE and CPI numbers.

A key to the situation is the level of integration in the economy and digitisation. Where the cost of goods in bitcoin can be updated in real time, the cost of goods in your store with stickers on them are not changed as easily. The inflation convergence concept is strengthened when bitcoin prices for goods become more sticky. Without this bitcoin doesn't counter inflation as directly. online goods purchased with bitcoin simply have prices to mirror those of goods in fiat on a day to day basis. The fiat inflation is masked in the volatility of the bitcoin price. Often high bitcoin prices lead to higher levels of bitcoin spending and stores often sell their bitcoin straight away leading the bitcoin price to fall. Many of the technical advantages of the international cryptocurrency are lost. If bitcoin is not economically integrated price movement simply interpreted as "a bubble" and that inhibits real uptake and removes any sticky prices altogether.

Everything of course is comparative.  In Venezuela, for example, quoting a bitcoin price is better than using your own currency, where in the USA digitally converting to USD prices is favoured. The inflation rate is also much higher there, so run away inflation could be a major to bitcoin utility and price increase. Which comes first is hard to tell. With bitcoins current adoption level, new tools could be developed to measure bitcoin inflation in the same way countries do. This would help. With fiat inflation increasing some people may start wanting to use bitcoin as a checking account and not just as savings. It is a slow process in different pockets of the world but it is proving to be sustained. It could be exponential.  

Mathematically bitcoin is transitioning into deflationary bitcoin environment, and that means the value of bitcoin should continue to go up should it prove to be a truly hard currency. The only way for Janet Yellen to get behind the bitcoin curve is to put interest rates up fast and try to induce some fiat deflation... And that I think is unlikely. 

The Follow Follow Arbitrage Positive Bias

Recently in the bitcoin market a switch has occurred. The PBoC have suspended bitcoin withdrawals from Chinese bitcoin exchanges and the Chinese bitcoin markets, normally leading the way, have dropped and become timid. Now instead of the European western market following the Chinese markets, it is the other way around, the USD exchange rates are leading the market. There are some psychological factors at play. I call these the follow trade and the follow follow trade.

The follow trade effect happens when traders see the more volatile market as an indicator of what's likely to happen in their home market. They buy their home market in the assumption that the price of a bitcoin should be similar across the world. The follow follow trade is where this confirmation of a trend started at home in now in both markets leads to more buying in the original market.

Rates in different countries also tend to be drawn together in the longer term by a process called arbitrage. This is where people can sell bitcoins on one exchange with a high price, do a swift transfer to an exchange in a country with cheaper bitcoins. Alternatively traders can buy bitcoins on a cheap exchange send them via the bitcoin network to an exchange with a high rate and sell them there. These two alternate processes can be repeated until the market prices come together. the Chinese and US markets have been around $50 or 5% for the last month so you could have done this cycle six or seven times over. The profit is limited only by the speed and cost of a SWIFT transaction, about three to five days.

Five days is a long time in the digital currency world where a lot can happen quickly. It quickly becomes apparent that the arbitrage trade works best in one direction. Arbitrage is best when transferring bitcoins to the highest exchange and selling there. Bitcoin transfers can happen internationally within 10 minutes and cost much less that other transfer methods. Arbitrage opportunities pop up the whilst the overall price can be moving up or down and they are seen more commonly during volatility. The swift side of the arbitrage trade is ok, useable when the bitcoin market is going down or flat, but not good when it is rising. The time delay gives a risk of the arbitrage disappearing whilst the money is stuck in SWIFT limbo land and the arbitrage trader also misses out on the overall up movement of the market.

The only way to sustain the bitcoin transfer side of the arbitrage trade without a swift transfer is to keep on buying on the exchange with the cheap rates. This exchange would likely need to be in your home country otherwise it would take a long time for your money to get there. It is a lot easier to find a good arbitrage trade if you have a lot of fiat funds on the exchanges in different countries ready to buy bitcoin with.

Therefore in order to take advantage of arbitrage more and more fiat capital is required to be available to the market and this creates a positive bias. The more volatility the more arbitrage the more capital available, the more the price stabilises. After the arbitrage is gone the traders have little choice but to invest more fiat to stay in the game. This increase in capital eventually increases the price.

In China when bitcoins can't be withdrawn because of the government suspension, this only serves to exaggerate this effect. They can't dampen the USD market with BTC transfers and profit from the arbitrage. They will not want to actually withdraw fiat as this could be used to buy cheap bitcoins. To much FOMO in an upward trending market. When your market is the lowest the capital simply builds up and flows in. the USD value is not dampened by as much arbitrage and the Chinese become captivated by the follow trade. The USD market is charged by the follow follow trade. As long as the USD rate is above the Chinese rate it is a moon sand wedge. 

No SEC, No Corporate Takover

Today the SEC in the USA declined to make an exception to an obscure rule for the Winklevoss twins bitcoin ETF application. It got declined. the bitcoin market, which in a sense had hoped for its acceptance, has taken a hit. Down to $975 at one point but now rising at over $1100 USD. There are at least two other ETF applications in play in the USA at the moment, but this one, in particular, has grabbed a sensitive reaction. Some would say bitcoins fabled volatility is back.

The ETF concept has a strange relationship with bitcoin. It is debatable wether the ETF actually makes investing in bitcoin more accessible to the general public.For young people comfortable with computers it is easier to buy the real thing than the ETF. So in a way listing on the New York stock exchange with ETF has been out-moded by bitcoins new international trading ecosystem. It does however make the investment more accessible to established investors who don't want to change the way they do things. Ironically the same establishment that got bailed out in 2009 and for the failing of which bitcoin is the intended cure.

In integrating with old money using the old financial establishment's tools there is a moral hazard for bitcoin. As the currency is in its infancy there is a risk that it could be overwhelmed by new larger financial stakeholder. At this point, the initial vision of the cryptocurrency may be distorted. We are seeing lots of volatility induced by government and large corporate organisations, evident in the release today. Do we actually want more of this?

A large popular ETF will add a new mysterious metric to the bitcoin structure and things like the blockchain debate. I'm not sure I like the SEC conferences being involved in our future. Where we now can talk freely about the pros and cons of on and off chain transactions, Bitcoin core and Bitcoin Unlimted, settling the score in the in the public forums of the internet. Backed up by the real-time node and hash rate statistics it's like a new hyper-democracy. We can see already that with the ETF comes closed door meetings, announcements by insiders and section b part 11 exert 6, paperwork burial.

Where we now come to the bitcoin prices in a fairly decentralised way, ETF's will likely lead to larger the stakes with more influence. This is more important when forking the code on the card. The corporate agenda and profit maximisation will edge its way into consideration. For example, if a bitcoin ETF holds a quarter of the total market cap of bitcoin ($5 billion worth) then bitcoin forks in two, say bitcoin and bitcoin unlimited, it will double its money. It will then also have the power to cash out of one side if it chooses at a time to its advantage in order to crash the price of that fork and gain an advantage over competing ETFs. This profitable scheme leads to fork pumping and dumping on a major scale due to the inherent vulnerability of new bitcoin forks.

Though ETF funds can't directly effect miners or node counts they do increase the centralisation of price discovery between forks. This could prevent a hard fork from ever being effective or ensure only forks that benefit the ETF find traction. This allows old smoke screen corporate politics into bitcoins publically programmed political structure.

Money talks, at least it used to. The bitcoin price would rise but it's still not clear if a corporate takeover is a good thing. I prefer echo chambers of the blogosphere and the Git hub hive mind. 

Bitcoin is Back at Price Levels Rarely Seen

Bitcoin is back at price levels only seen at the top of the 2013 Bitcoin peak. The ceiling is broken and a floor is being installed. its been explosive, but this time it feels like its holding steady.

 $1000USD bitcoins are in the house.

Bitcoin is Putting in a Wall of Buys at $1000

Someone has put a bid in for 1777 bitcoins! at $1000 USD. The price still holds after 24 hours.

https://www.bitfinex.com/stats
http://bitcoin-analytics.com/

Bitcoin Proliferation is Good for Chinese Macro

The Bloomburg propaganda machine has been working overtime lately. They promote articles claiming that China is pulling the market down. The language is clear when they publish articles with plunge, crash, and free fall, despite the fact that bitcoin has been steadily rising over the last year and remains near all-time highs. They Promote fud so frequently that it is having a diminishing effect that people are charting.

It doesn't take long to see why they are untrustworthy, they have major support from organisations whom have a vested interest against Bitcoin, but let's also take a step back and look at the macro reasons. Why is it many American media outlets keep talking down bitcoin and why the Chinese aren't as threatened by bitcoin as one might think.

The Chinese are the major source or bitcoin repression according to American media. however China have been consistently trading bitcoin at higher prices than elsewhere in the world for at least the last two years. The capital flight drum gets beat here as a reason.  Lets talk about the chinese macro economic environment.As you know are an exporting economy.They do a lot of their business with international transactions. These are often made in dollars, are slow and costly. They also have more people than any other country, you can see why they don't want to use someone else's a dollar. you can also see why a world currency would able to be transferred easily across borders for trade appeal to them.

In the past China has taken advantage of a weak currency which has given it a competitive advantage on its exports. this has helped build up their economy quickly. Now they are going to float their currency. This is in part because the IMF and WTO wanted them to do this to become part of the world currency call the SDR. (yes those are the world bankers acronyms, equivalent to advance crypto jargon, IMHO they are worse) China need to prove a stable currency for the IMF so they have held their currency level with a basket of currencies for many years. They have done this successfully but it just so happens that the USD has been going up out of line with their main trading partners and other countries in the SDR. Despite what many people think the Yuan is not in "free fall".

China have the largest foreign exchange reserves of any country. They own more USD than anyone else and more of other countries money as well. This is generally made up of government bonds built up over the last twenty years of trade surpluses and currency devaluation. So now that they want a stable currency, they can use this reserve to do it. Selling off foreign currencies for Yuan when they get to high against the Yuan or when the yuan needs support. China is holding a lot of USD, more than any other foreign currency so they made money out of the USD gain. They can also potentially influence a drop in the dollar. Scary I know, but 3 trillion in reserves, makes a pretty significant impact on a $15T a year FX market.

So what is the threat of bitcoin to China. It is such a small thing at the moment with around $15billion total market cap. What could be the potential risks of a prolific bitcoin to the governments agenda there?

The Chinese government already struggles to control its financial system. They try to impose strict rules on reporting and deposit rates, have recently removed dozens of corrupt officials and yet they still have real estate bubbles and stock market crashes. With the traditional system central administration is actually quite difficult. I would suggest that blockchain like technologies might actually provide a solution for central planners as the allow more transparency of transactions and better potential oversight. Bitcoin is not excluded from this.

Bitcoin is also practicle for exporting. It is not linked to any nation, making it neutral and great for bi-lateral agreements. China being first to adopt it would give it an advantage over its competitors and provide a moral high ground. The many emerging countries which China is actively trading with as part of its strategy can easily get on board. Countries with unstable politics, often with anti-American factions, will have no issue, and countries with no infrastructure but people with smart phones can leapfrog to the latest methods.

Further, with all of its foreign funds, the Chinese could gain a lot of control over bitcoin. With the potential of no longer needing their foreign funds to stabilise the Yuan. 1. they could make bitcoin stable 2. the could make the USD less stable. 3. they could push up the bitcoin price in foreign currencies without anyone really knowing,

All of this type of thing requires a market capitalisation in bitcoin, and transaction volumes, many factors higher than we currently have , but given this is sorted, it is al quite logical. Infact what happens in a financial crisis where the USD starts to drop before the Chinese have got their money out? The USD could restrict capital flight in some ways and in that case they may be left with no other method to repatriate their funds.
 
The speculation is fun, and I don't see a reason why the government of China would want to go down a path of repressing the bitcoin technology. I think the anti-communist libertarian idea of bitcoin is not the full picture. Bitcoin and certainly blockchain like technologies are more suited to communist type thinking than the current financial system. Chinese people are very quick to integrate new technologies into thier lives and I think we should give them some respect.