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I'd like to put the a question to the community regarding the inherent stability/instability of Bitcoin. I hope it's not off-topic since it's more a economics-type question. So, here's the scenario in question that I think might lead to an instability:

Scenario:

As we know Bitcoin mining is a race, whoever finds a new block first publishes that block and, if there is a fork, hopes that consensus is reached in favour of his block. The costliness of this race is the key feature of the game-theoretic aspect that makes Bitcoin safe. Now suppose that

  1. mining capacity is concentrated in the hands of a few big miners and
  2. using debt they invest heavily in order to add capacity faster
  3. and they eventually generate Bitcoin faster than the market demands.

If supply vastly outstrips demand the buying power of Bitcoin should fall considerably. If the miners' investment is based on debt the depreciation is violent enough the 'supply side' will see several, if not all of the miners go bust. Then Bitcoin will appreciate, and the cycle will repeat.

This type of cycle is typical for the commodity markets, e.g. gold and oil. So here's the

Question: Is Bitcoin susceptible to the same instability?

The assumptions are not too outlandish and the overall logic is sound, I think. We do see a concentration of mining power. The growth of global mining capacity is not so obvious, but there are reports of a "mining capacity glut". Whether the big miners have a sound balance sheet is not known, as far as I can tell. But it's plausible that they borrow money to expand. So, potentially, all the ingredients are there to make Bitcoin intrinsically just as volatile as gold, silver, oil, etc.

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  1. and they eventually generate Bitcoin faster than the market demands.

This assumption doesn't apply, unfortunately. The production rate of Bitcoin is self-regulating and does not correspond to the overall mining capacity. This is due to the difficulty resets that happen every 2016 blocks which adapt the production to the network's mining capacity.

So, when miners compete, they do so for a roughly fixed amount of new bitcoins. When one miner grows their hashrate faster than their competitors, they may get to produce a larger share of the total, but they will not be able to significantly increase the overall production.

  • Good point. So the difficulty resets achieve a constant rate of production on average. Also the number of bitcoins per block falls exponentially. But if I rephrase the statement and say "the market demands less new bitcoin than is produced" then the whole logic still holds - although it now requires a more complicated argument: Nominally less and less bitcoin is produced by construction but in real terms, e.g. measured as buying power, the real value of bitcoin could completely disconnect from the nominal. And the economics is driven by the real value of bitcoin. – mcmayer Apr 22 '16 at 13:25
  • @mcmayer: I'd be happy to take another run at it, if you want to edit your initial question, or create another. It does remind me of Will Bitcoin suffer from a mining Tragedy of the Commons when mining fees drop to zero? now, though. – Murch Apr 22 '16 at 13:34

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