Legal tender and central bank notes and coins do not generate any
interest: zero interest rates. But if you deposit them in the banks or
other financial institutions, you usually earn interest income.
18 It should be noted there would not be a problem even if the price of Bitcoin
should fall sharply after the removal of bubble elements. Every participant should
understand all price movements are due to changes in market valuation. The
government and the central bank do not need to do anything because it is purely
private activity in the free market. If, on the other hand, the government and the
central bank start regulating the issuers of cryptocurrencies, they would create
responsibilities and accountabilities. That would, in turn, distort the pricing
mechanism. 9
Bitcoin and other cryptocurrencies, as a matter of principle19, refuse to
have any relationship with the banks and other financial
intermediaries20. Furthermore, as the price of the last Bitcoin is
indeterminate as we discussed before, the interest rate is also
indeterminate. It does not mean that we cannot calculate an implicit
interest rate for Bitcoin, but it means the value of an implicit interest
rate would be quite volatile and practically useless21.
However, in theory, any money and currency, including
cryptocurrencies, can earn interest income in exchange of lending or
deposit. In fact, McCandless and Wallace (1991) demonstrate that
(1) fiat money and other assets must offer the same rate of return as
private borrowing and lending do and (2) if there are two fiat monies,
in an equilibrium in which they both have value, they must each give
the same rate of return through arbitrage. As long as Bitcoin and its
followers are considered as money, it must yield the same rate of
return as those from the legal tenders such as Yen, U.S. Dollar, and
Euro22.
Sooner or later, someone will create a system or derivative to
generate the rate of return for lending cryptocurrencies to a third
party23.
19 The main innovation of this type of cryptocurrency is to introduce a
peer-to-peer electronic payment system. No third party involvement is the vital
issue.
20 Of course, there are Bitcoin and other cryptocurrency exchange service
platform such as Mt.Gox, BitPay, and WalletBit and assorted services and goods
are provided by many companies within the Bitcoin ecosysytem.
21 Šurda (2013) empirically calculates price volatility and velocity of circulation of
Bitcoin, probably for the first time. Both seem to be quite high compared with the
other legal tenders.
22 Here is an interesting research question. Since the interest rate differs
among countries, the same exchange rate between the two countries differs from
country to country. Bitcoin as a global currency may also face different rates of
return in different countries. Is there any mechanism to adjust the rate of return
for Bitcoin globally?
23 It is a very challenging issue to design a financial intermediary under a
peer-to-peer electronic payment system. The Bitcoin exchange service platform
would do it.
Why did Nakamoto (2008) set a limit of total Bitcoin issues?
Because he seemed to believe that a decreasing supply of money will
not lead to inflation24. A geometrical reduction of the money supply
rate does not necessarily create deflation25. But it will create a sharp
drop in the profitability of mining activity, even if we take into account
of technological growth based on the Moore’s Law. We think it is this
real factor that determines inflation and deflation in the Bitcoin
ecosystem.
