Where is the InterestRate in a Cryptocurrency system ?

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Avatar for HasibulAzam
3 years ago

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.

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Avatar for HasibulAzam
3 years ago

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