The Post Where I Fix Bitcoin

bitcoinIt’s no secret that I think Bitcoin has issues that limit its viability as a currency. However, criticism is easy, finding solutions is hard. So I want to take a shot at solving some of the issues that I think will prevent Bitcoin from gaining mainstream adoption.

In actuality, I don’t intend to “fix” Bitcoin per se because I’m not particularly sure this solution can be implemented. However, I definitely think that, in an ideal scenario, it could make Bitcoin or another virtual currency far simpler to use and more attractive to adopt.

When evaluating Bitcoin, I’ve had a tendency to think in terms of units instead of fractions. Why? Because it’s much simpler. A single whole unit is a pretty easy concept to grasp. Indeed, adding two whole units together is pretty much where everyone starts in mathematics:

1 + 1 = 2

One of Bitcoin’s major flaws is that it moves away from this simple premise and introduces fractional units into basic accounting. Our current money system also has fractional units but they only go two places to the right of the decimal point. Fractional units for accounting in Bitcoin can go infinitely more places to the right. So I think it’s imperative that Bitcoiners get back to the concept of whole units. For the rest of this post, the following concept will be very important:

1 unit

Rather than drag this out, I’m going to keep it simple and just introduce my concept for simplifying Bitcoin. Here it is:

1 unit of Bitcoin = 10 units of the most highly valued fiat currency with which Bitcoin is exchanged

My concept is a hard cap on the value of every unit of Bitcoin. The way this would work is that, starting from the top most unit of Bitcoin, a bitcoin, each unit of Bitcoin can have a maximum value of 10 units of the most highly valued currency of the time or other baseline correlated currency. Using the US dollar as an example, it would look like this:

1 BTC = $10 MAX

What this means is that every bitcoin can only have a maximum exchange value of $10 USD. Now what happens when the exchange rate exceeds $10? Then Bitcoin drops down to the next fractional unit, expanding its potential unit base by 90%. It would look like this:

(1 BTC = $10 USD) = (1(.1) BTC)

1(.1) BTC = $10 USD MAX

In the above statement, Bitcoin’s potential unit base has been expanded by 90%. The “(.1)” of the statement is what I will refer to as the “fractional rate.” This number lets you know how much one unit of Bitcoin is worth relative to the full money supply. The best thing about the fractional rate is that it is completely unnecessary for persons or businesses to track, they only need to concern themselves with units. What happens when these new fractional units reach the $10 USD exchange rate?:

(1(.1) BTC = $10 USD) = (1(.01) BTC)

When those fractional units reach a $10 exchange rate then:

(1(.01) BTC = $10 USD) = (1(.001) BTC)

When those fractional units reach a $10 exchange rate then:

(1(.001) BTC = $10 USD) = (1(.0001) BTC)

… and so on.

The elegance of this solution is that the fractional rate can be tracked in software while people and businesses need only concern themselves with units. For the purpose of familiarity, Bitcoin unit prices could be set out to two decimal places just like it is done with US dollars or any number of decimal places with which a nation or culture is familiar.

This solution also combats two serious issues with Bitcoin today: hoarding and disproportionate control of money supply.

As I pointed out in “Bitcoin and Divisibility,” high demand on a fixed currency lowers the average amount of purchasing power each person holds. Early adopters who have purchased large amounts of Bitcoin benefit disproportionately as higher exchange rates and limited supply constrain the amount available for each subsequent holder. This concept largely mitigates the negatives of mass holding of Bitcoin as the number of available units increases by 90% every time any one unit of Bitcoin exchanges for 10 units of a correlated fiat currency. Not only does this allow proper expansion and contraction of Bitcoin unit supply (the process can simply go in reverse in times of low money demand) but the process, in theory, should not have an actual inflationary effect because the new units are potential units rather than actual; the units don’t count against the money supply until they are actually purchased. In this fashion, the supply of Bitcoin is always in sync with demand.

The most important aspect of this strategy is that it prevents anyone from controlling a disproportionate amount of Bitcoin because they are always measured in units and not ratios. For instance, if someone bought 100,000 units of Bitcoin at the fractional rate of .01 and the rate moves to .001, the biggest loss s/he could take is roughly $10 per unit (using the US dollars example); this applies regardless of how many times Bitcoin moves to the next fraction and only if the holder converts them back into fiat currency. This is an excellent loss limiter.

In other words, regarding units of Bitcoin, 1 always equals 1, the fractional rate is simply a measurement of Bitcoin’s current state of demand. For all intents and purposes, the price of Bitcoin can only fluctuate between 0 and 10 units of a correlated fiat currency so losses and gains are limited to this range. But, once again, this is only relevant when Bitcoin is exchanged for fiat currency; otherwise it always retains its absolute value in Bitcoin units.

By now you may be thinking “Couldn’t this screw miners?” Well, it kind of does… but it doesn’t have to. Simply multiplying the number of bitcoin mined by the number of times the unit supply has expanded and then multiplying that figure by the max exchange cap should create mining incentives similar to the current ones. The equation would be as follows:

(mined bitcoin * # of unit expansions) * 10 (max exchange cap)

For instance, if a miner creates 25 bitcoin and the fractional rate is .001, the number of unit expansions would be three (the easy way to determine this is simply to count the number of digits to the right of the decimal). With a max exchange cap of 10 exchanged currency units per 1 unit of Bitcoin (we’ll use $10 USD for the example), the equation would look like this:

(25 * 3) * $10 = $750

Using the current bitcoin reward of 25 units and its current exchange rate in USD ($314.62 aggregate as of this exact moment), we can compare compensation:

25 * $314.62 = $7865.50

(25 * ($314.62/10 = 31 shifts)) * $10 (max exchange rate) = $7750

[Note: the equation “$314.62/10” is the exchange rate divided by the max exchange cap. This estimates the fractional rate which would, in this example, be a decimal point followed by 30 zeros and a one or “.0000000000000000000000000000001.” This leaves a remainder of 4.62; using the fractional rate method, this would be the current exchange rate for a single unit of Bitcoin]

At double the current USD exchange rate:

25 * $629.24 = $15731

(25 * ($629.24/10 = 62 shifts)) * $10 (max exchange rate) = $15500

Using this method, there would be negligible difference in mining incentives.

To recap, my concept is setting a firm cap on each individual Bitcoin unit at 10 units of the most highly valued currency with which it is exchanged (or, at least, an agreed upon baseline currency). The number of times the cap was reached would be measured with what I refer to as the “fractional rate”; this rate would act solely as a measurement and point of reference regarding overall demand for Bitcoin. The advantages to this system are as follows:

  • Allows Bitcoin to be transacted mostly in whole units, simplifying accounting;
  • Allows more precise expansion or contraction of Bitcoin currency relative to demand;
  • Removes both inflationary and deflationary disadvantages of Bitcoin;
  • Sets absolute cap of losses to roughly 10x lowest possible investment (in whole units in related exchanged fiat currency; exchange rate range in fiat currency would be .01 to 9.99;
  • Sets an absolute profit/loss risk profile for potential investment;
  • Eliminates overall disadvantages of mass holding of Bitcoin while retaining an individual holder’s incentive for holding as an investment strategy. Holding, while no longer having the potential to be immensely profitable, becomes an excellent default strategy as loss of investment value is minimized;
  • Prevents disproportionate control of Bitcoin by early adopters/heavy accumulators, thereby eliminating the potential for structurally high inequality between early and late holders (in other words, minimal penalty for getting into Bitcoin late);
  • Mining incentives are mostly unchanged;
  • Most importantly, in my opinion, the value of Bitcoin tokens are always inexpensive enough to transfer or exchange. “Colored coins” and other programmable currency becomes far more practical.

As always, I acknowledge that this may not be the answer. But, if it is, then finding a way to apply it to Bitcoin should be the first order of business in my opinion. Using this concept, I think it is possible for Bitcoin to fulfill its potential as the currency for the Information Age. Though I doubt it will solve the inherent problems of Capitalism, I think it has the potential to make a positive difference overall.

Can it be applied to Bitcoin? I’m not sure. I leave that to the Bitcoin community to figure out. But, rather than a criticism, it’s an honest attempt at presenting a solution that could actually make a difference.

So here you go, Bitcoin community. My two cents. The ball’s in your court.

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5 thoughts on “The Post Where I Fix Bitcoin

  1. Pingback: The Currency Paradox | The Tone-Deafness of the Bitcoin Community

  2. Pingback: The Currency Paradox | Fixing Bitcoin Part II: Pricing with Bitcoin Units

  3. Pingback: The Gold (and Bitcoin) Fallacy | The Currency Paradox

  4. Pingback: Is Currency Devaluation the Cause of Deflation? | The Currency Paradox

  5. Pingback: Is Currency Devaluation Causing Deflation? | The Currency Paradox

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